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Lecture Financial institutions, instruments and markets (7e): Chapter 21 – Viney, Phillips

Chapter 21 - Interest rate swaps, currency swaps and credit default swaps. The objectives of this chapter are: Describe the nature of a swap and explain the structure and operation of vanilla and basis interest rate swaps, understand the importance of the interest rate swap market, examine the structure of a cross-currency swap and how they can be arranged, explain the rationale for the cross-currency swap markets,. | Chapter 21 Interest rate swaps, currency swaps and credit default swaps Websites: www.bis.org www.afma.com.au Learning objectives Describe the nature of a swap and explain the structure and operation of vanilla and basis interest rate swaps Understand the importance of the interest rate swap market Examine the structure of a cross-currency swap and how they can be arranged Explain the rationale for the cross-currency swap markets Introduce the concepts and parties to credit default swaps Consider the risks for an intermediary, or a counterparty, to a swap Chapter organisation 21.1 Interest rate swaps 21.2 Rationale for the existence of interest rate swaps 21.3 Currency swaps 21.4 Rationale for the existence of currency swaps 21.5 Credit default swaps 21.6 Credit and settlements risks associated with swaps 21.7 Summary 21.1 Interest rate swaps Notional value of swap market transactions in 2010 Australian market Interest rate swaps AUD 5 923 billion Currency swaps AUD 23 963 billion Credit derivatives AUD 247 billion International markets Interest rate swaps USD 347 508 billion Currency swaps USD 16 347 billion Credit default swaps USD 30 261 billion Note: the figures are not comparable. The Australian market figures are annual turnover while the international figures are notional value at a point in time. (cont.) 21.1 Interest rate swaps (cont.) Swaps may be used to hedge interest risk and exchange rate risk, and also enable investors and borrowers to obtain a lower cost of funds or a higher yield Organised between borrowing parties The two parties swap their interest payment obligations No transfer of the principal amount Both parties benefit from the swap (cont.) 21.1 Interest rate swaps (cont.) Example: Table 21.1 outlines the current cost of funds for two borrowers Firm A has a credit advantage in both markets (cont.) 21.1 Interest rate swaps (cont.) Strategy Firm A borrows in a fixed market, where it has comparative advantage (i.e. 12%) | Chapter 21 Interest rate swaps, currency swaps and credit default swaps Websites: www.bis.org www.afma.com.au Learning objectives Describe the nature of a swap and explain the structure and operation of vanilla and basis interest rate swaps Understand the importance of the interest rate swap market Examine the structure of a cross-currency swap and how they can be arranged Explain the rationale for the cross-currency swap markets Introduce the concepts and parties to credit default swaps Consider the risks for an intermediary, or a counterparty, to a swap Chapter organisation 21.1 Interest rate swaps 21.2 Rationale for the existence of interest rate swaps 21.3 Currency swaps 21.4 Rationale for the existence of currency swaps 21.5 Credit default swaps 21.6 Credit and settlements risks associated with swaps 21.7 Summary 21.1 Interest rate swaps Notional value of swap market transactions in 2010 Australian market Interest rate swaps AUD 5 923 billion Currency swaps AUD 23 963