Occasionally it involves an exchange of one stream of floating rate interest

Occasionally it involves an exchange of one stream of

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Occasionally, it involves an exchange of one stream of floating rate interest payments for another. The principal features of an interest rate swap are : It effectively translates a floating rate borrowing into a fixed rate borrowing and vice versa. The net interest differential is paid or received, as the case may be. There is no exchange of principal repayment obligations. It is structured as a separate contract distinct from the underlying loan agreement. It is applicable to new as well as existing borrowings. It is treated as an off-the-balance sheet transaction.
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X Y Floating rate borrowing Fixed rate borrowing LIBOR + 0.25% 10.5% LIBOR + 0.25% 10.5% INTEREST RATE SWAPS
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CURRENCY SWAPS In a currency swap both the principal and interest in one currency are swapped for principal and interest in another currency. On maturity, the principal amounts are swapped back. Thus, a currency swap involves (i) an exchange of principal amounts today, (ii) an exchange of interest payments during the currency of the loans, and (iii) a re-exchange of principal amounts at the time of maturity. For example, if party A raises yens by issuing 5 percent yen bonds in the Japanese market and party B raises dollars by issuing 12 percent dollar bonds in the US market, a currency swap between them may be represented diagramatically as shown in Exhibit
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DEFAULT SWAP CREDIT DERIVATIVE TO PROTECT AGAINST DEFAULT RISK COMPANY P AGREES TO PAY A FIXED AMOUNT ANNUALLY TO COMPANY Q, AS LONG AS C, A DEBTOR OF COMPANY P DOES NOT DEFAULT. IN RETURN, COMPANY Q PROMISES TO COMPENSATE COMPANY P, SHOULD C DEFAULT.
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REASONS FOR SWAPS Spread compression Market segmentation Market saturation Difference in financial norms
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Spread Compression Fixed Floating A 9% LIBOR B 11% LIBOR + 0.5% A interested on Floating Rate B interested on Fixed Rate
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A B 9% Fixed Rate LIBOR + 0.5% 10.5% 10% LIBOR Spread Compression A: LIBOR + 9% -10% = LIBOR - 1% B: LIBOR + 0.5% + 10% - LIBOR = 10.5%
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