Week 9 Flashcards
What is a currency swap?
A formal agreement between two counterparties to exchange a series of different currency denominated payments for an agreed period of time, and at maturity the principal amounts in different currencies are exchanged at a pre arranged rate. This helps make their cash outflows denominated in the same currency as their revenue, reducing foreign exchange risk.
When is a matching strategy useful for subsidiaries? What does it involve?
A matching strategy is beneficial when subsidiaries are in countries with relatively low interest rates. The subsidiary will finance their operation with the currency they invoice their profucts. They will then use these cash inflows to cover their debt repayments, reducing any exposure to exchange rate movements. This means the inflow currency doesn’t have to be converted.
What is a parallel loan?
A parallel/back-to-back loan is an arrangement where two parties provide simultaneous loans, with an agreement to repay at some specified future date. They are used when an MNC cannot borrow a currency that matches its invoice currency, when there is a fear that foreign currency will depreciate substantially, or if forward and future contracts are not available.
For example, an Australian may have a subsidiary in China and vice versa. The parents then agree to borrow their currency for the other parent, and the subsidiary repays it with their inflows.
What is an interest rate swap?
A contractual agreement between two parties to exchange periodic payments related to fixed-for-floating, floating-for-fixed, floating-for-floating, or fixed-for-fixed interest rates.
Why might companies want to engage in an interest rate swap?
A company could have floating rate debt and expect the interest rates to go up so will want to exchange for a fixed rate. Or a MNC with a fixed rate debt may expect interest rates to go down so will want to exchange it for floating rate debt.
As long as the expected interest rate after the swap is less than our current it is a good idea to swap.
What is the difference between a broker and dealer/
A broker brings counterparties together for a fee. A dealer arranged the swap and guarantees the swap payment for each party, providing more security.
What is the quality spread differential in interest rate swaps? Why is it useful?
the fixed rate difference - the floating rate difference, it is useful because both companies can benefit by swapping as long as this is not 0.
How do we set up an interest rate swap using the quality spread differential?
Each company takes out the opposite loan to what they want. One company gets the loan swapped as is, the other is given the other company’s interest rate + a portion of the quality spread difference.
What are the limitations of interest rate swaps?
The time and resources required to find a suitable swap candidate and negotiate swap terms, there is also a risk that the swap counterpary may default on payments.
What is an accretion swap and amortising swap?
An accretion swap is an interest rate swap with the notional value increasing over time, an amortising swap has the notional value decreases over time.
What is a basis swap?
Exchange of two floating rate payments
What is a callable swap?
The fixed rate payer has the right to terminate the swap
What is a forward swap?
Agreement done today but swap payments begin at some point in the future.
What is a putable swap?
The floating rate payer has the right to terminate the swap,
What is a zero-coupon swap?
All fixed interest payments are postponed until maturity and are paid in one lump sum when the swap matures.
