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Multinational Financial Management Alan Shapiro 7 th Edition J.Wiley & Sons

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### Multinational Financial ManagementAlan Shapiro7th EditionJ.Wiley & Sons

### SWAPS AND INTEREST RATE DERIVATIVES

Power Points by

Joseph F. Greco, Ph.D.

California State University, Fullerton

CHAPTER 9

CHAPTER OVERVIEW

I. Interest Rate and Currency Swaps

II. Interest Rate Forwards and Futures

III. Structured Notes

I. INTEREST RATE AND CURRENCY SWAPS

I. INTEREST RATE AND CURRENCY SWAPS

A. INTEREST RATE SWAPS

1. Definition

an agreement between 2 parties to

exchange US$ interest payments

for a specific maturity on an agreed notional amount.

THE CLASSIC SWAP

a. Notional principal: a reference amount used only to calculate interest expense but never repaid.

b. Maturities: less than 1 to over 15 years

THE CLASSIC SWAP

2. Types

a. Coupon swap

b. Basis swap

3. LIBOR: the most important reference rate in a swap

4. Swap Usage:

to reduce risk potential and costs.

THE CURRENCY SWAP

B. Currency Swaps

1. Definition

two parties exchange foreign currency-

denominated debt at periodic intervals.

2. Purpose: similar to parallel loan

THE CURRENCY SWAP

3. Differences of a Currency Swap:

a. Currency swap is not a loan

b. No interest expense; no balance sheet entry

c. The right to offset any non- payment is more firmly established

THE CURRENCY SWAP

4. Similarities between Interest Rate and

Currency Swaps

a. Avoid exchange rate risk

b. Exchange rate is only a reference to

determine amounts exchanged

5. Economic Benefits of Swaps

when arbitrage prohibited, they provide

long-term financing.

II. INTEREST RATE FORWARDS AND FUTURES

Forward and futures contracts:

- three types used to manage interest rate risk

A. Forward forwards

B. Forward rate agreements

C. Eurodollar futures

INTEREST RATE FORWARDS AND FUTURES

Forward forwards

1. a contract that fixes an interest rate today on a future loan or deposit.

2. Contract conditions:

- specific interest rate

- principal amount of future loan

- start and ending dates of future

interest rate period

INTEREST RATE FORWARDS AND FUTURES

Forward rate agreements (FRAs)

1. cash-settled

2. over-the-counter forward contract 3. company fixes an interest rate

applied to a specified future interest period on a notional amount.

INTEREST RATE FORWARDS AND FUTURES

Eurodollar Futures

1. A cash-settled futures contract for

a 3-month eurodollar deposit

paying LIBOR

2. Contracts traded on:

a. Chicago Mercantile Exchange

b. London International Financial Futures Exchange

c. Singapore International Monetary Exchange

III. STRUCTURED NOTES

Interest-bearing securities whose interest payments are determined by reference to a formula set in advance and adjusted on specific reset dates.

STRUCTURED NOTES

Inverse Floaters

a floating-rate instrument whose interest rate moves inversely with market interest rates.

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