Foundations of Multinational Financial Management Alan Shapiro John Wiley & Sons Power Points by Joseph F. Greco, Ph.D.

California State University, Fullerton

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Special Financing and Interest Rate Risk Management Vehicles Chapter 13

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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.

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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

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THE CLASSIC SWAP 2. Types a. Coupon swap b. Basis swap 3.

Usage: to reduce risk potential and costs.

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THE CURRENCY SWAP B.

Currency Swaps 1. Definition two parties exchange foreign-currency denominated debt at periodic intervals.

2. Purpose: similar to parallel loan

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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 establish

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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.

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INTEREST RATE FORWARDS AND FUTURES I.

Forward and futures contracts: - three types used to manage interest rate risk A.

Forward forwards B.

C.

Forward rate agreements Eurodollar futures

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INTEREST RATE FORWARDS AND FUTURES A.

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

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INTEREST RATE FORWARDS AND FUTURES B.

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.

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INTEREST RATE FORWARDS AND FUTURES C.

Eurodollar Futures 1. a cash-settled futures contract for a.

a 3-month eurodollar deposit paying LIBOR 2. Contracts traded on: Chicago Mercantile Exchange b.

c.

London International Financial Futures Exchange Singapore International Monetary Exchange

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