interest

3. Currency Swap
 A currency swap is one in which one party
agrees to exchange payments based on one
currency with another party based on another
currency
 Party A borrows in one currency, e.g. INR,
and party B borrows in another currency, e.g.
USD: the loan is swapped so that party A
pays the interest in USD, and party B pays the
interest in INR
 In a currency swap, cash flows are exchanged
in two different currencies
 Notional principals are the same based on
current exchange rate, which are also
exchanged

4. Currency Risk in Currency Swap
 As periodic coupon and final exchange
of notional principal are in different
currencies, currency risk can arise
from this
 If a company has cash inflow in the
swap currency, the periodic payments
can be paid without converting local
currency—currency risk is thus
avoided
 If a company has no cash inflow in the
swap currency, currency risk exists

5. The Uses of a Currency Swap
1. To hedge currency risk; and
2. To reduce funding costs

6. Interest Rate Swap
 A fixed interest rate loan is exchanged for
a floating interest rate loan.
 Party A will borrow in the market at a fixed
rate; Party B will borrow in the market at a
floating rate; interest payments will be
swapped at every reset period of the
floating-rate loan.
 The rate at which party A will pay interest
to party B and vice versa are known as
swap rates, which are determined in the
market.
 Principal will not be exchanged, and
interest amount will be calculated on
notional principal.

7. Uses of the Interest Rate Swap
• Hedging interest rate
• Reduce funding costs
• Manage the duration gap by banks
• Speculating on interest rate
movements

8. Interest Rate Swaps: An Example
 A can borrow at either LIBOR + 70 points,
or at a fixed rate of 9%
 B can borrow at either LIBOR + 20 points,
or at a fixed rate of 8.2%
 Both can have a lower cost of funding if A
borrows at LIBOR + 70, and B borrows at
a fixed rate of 8.2%, and they swap
 Swap rates are fixed at 8.2%, and the
floating rate at LIBOR + 5
 Net cost for A will be 8.85% fixed, and for
B will be LIBOR + 5 points
 Both save an interest rate of 0.15%

9. Interest Rate Futures in India
 IRF will expand the scope of the financial
markets & exchange traded IRF are more
transparent in terms of price discovery
,margining ,risk management &
settlement.
 IRF will enable corporate to hedge
interest rate risk.
 Settlement date is the last day of the
month.
 In India Future Contract available 10-year
7% coupon (compounded semi-annually)
GOI bonds