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

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

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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

Power Points by

Joseph F. Greco, Ph.D.

California State University, Fullerton

SWAPS AND INTEREST RATE DERIVATIVES

CHAPTER 9

I.Interest Rate and Currency Swaps

II.Interest Rate Forwards and Futures

III.Structured Notes

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.

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

b. Maturities: less than 1 to over 15 years

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.

B.Currency Swaps

1. Definition

two parties exchange foreign currency-

denominated debt at periodic intervals.

2. Purpose: similar to parallel loan

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

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.

Forward and futures contracts:

- three types used to manage interest rate risk

A.Forward forwards

B.Forward rate agreements

C.Eurodollar futures

Forward forwards

1.a contract that fixes an interest ratetoday 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

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.

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

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

Inverse Floaters

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