Swap Market project - BAHRIA UNIVERSITY ISLAMABAD...

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BAHRIA UNIVERSITY ISLAMABAD Derivative Investment Swap Markets Submitted to : Sir Saleem Altaf By : Asad Muzaffar 01-111072-050
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SWAP Market History: After the fall of the Bretton Woods System, the government of the Great Britain undertook various steps to prevent the downslide of the Pound and instituted new internal controls. One of the control measures was the creation of the Dollar premium market to discourage the direct foreign investment. However, this created opportunities for financial ingenuity by the British merchant bankers. To avoid Dollar premium, Parallel Loans were introduced. Here, the parties were required to exchange the principal on the value date. During the life of the contract, each party was to pay the interests on the currency it had received. The next crucial step was the introduction of the Back-to-back Loans, in which the loan was directly arranged between two parent companies in different countries and structured under one agreement. Parallel Loans were strictly designed to satisfy the letter of the law. That is why four entities ± the parent and the subsidiary in each of the two different countries ± had to be involved in structuring each loan. In Back-to-back loans, the intermediary level of the subsidiary was eliminated. Back-to-back loans tested the legal waters and did not face any problems. In Back-to-back Loans, only one documentation covered the transaction. These two instruments played an important role in paving the way for the emergence of the Swaps. Development of Swaps Market: The development of swaps market has been tremendous from its creation in the early 80’s to its leader position in the derivatives market, with over 60 trillion dollars notional value of transaction for the year 2001 out of a total of 180 trillion dollars market Although the first swap was a currency swap between the World Bank and IBM, the swap market has been mainly driven by the fixed for floating interest rate swaps market. Swaps are Over the Counter instruments involving the exchange of one stream of payment liabilities for another. The first swaps were motivated by the difficulty to exchange big sum of cash between two currencies. In the early 80’s, although the Bretton Woods agreements had already collapsed and
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there were no official foreign exchange controls (abolition in the US in 1973, and in 1979 for the UK), it was still expensive for a company to exchange funds between two currencies. In august 1981, IBM and the World Bank agreed to exchange the future liabilities associated with borrowings in the Swiss Franc and the US Dollar bond markets. This swap was to exploit the comparative advantage of the two counterparties. IBM enjoyed a very good reputation in Switzerland, perceived as one of the US best name. In contrast, the World Bank suffered from a bad image since it had used several times the Swiss market to finance risky third-world countries. Consequently, the World Bank would have to pay an extra 20 basis points compared to IBM. At the same time, the World Bank, with an AAA rating, was a well established credit name in
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Swap Market project - BAHRIA UNIVERSITY ISLAMABAD...

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