SWAPS I

SWAPS?

Exchange of cash flows based on the U/L

The types of Swaps we will discuss are

 Interest Rate Swaps (IRS)

 Equity Swaps (EQS)
 FX SWAP and CCY Swap
 Credit Default Swap (CDS)

SWAPS – Is a Derivative contract where there is an exchange of cash flows between 2 parties based on
U/L such as IRS, EQS, CCY SWP, FI and CDS.

FX Swap

U/L – Currencies

Definition : is the combination of two FX trades with same TD but diff SD.

User for;

FX Swap is usually used for hedge against exchange-rate risk, speculate on currency moves.

CCY SWAP

U/L – Currencies

 3 stages of CCY SWAP

 Exchange of notionals.
 Exchange of interest on notionals
 Exchange notionals back.

Interest Rate Swap (IRS)

 U/L is interest rates.

 Definition: An interest rate swap occurs when two parties exchange future interest payments
(Cashflows) based on specified principle amount.
 Types of IR: Fixed IR and Floating IR
o Fixed IR : Where Int rate remains Fixed e.g. Fixed Deposit
o Floating IR : Where the Int rate would change depending on market condition
 Source to obtain Floating IR -
o LIBOR (London Interbank Offer rate), it was previously the benchmark rate used globally.
o It is the rate at which major banks lend money to each other.
 o It was based on five CCY’s including USD, GBP, EUR, CHF and JPY and for 7 different maturities
i.e. Overnight, 1 week, 1 month, 2 month, 3 month, 6 month, 12 month.
o It was introduced in UK as banks would borrow money from each other but each bank was
charging different Interest rate and they needed a benchmark reference rate which can be used
in the market to lend or borrow money.
o Hence this service was outsourced to Thompson Reuters who would go to 16 banks and get
their interest rate for overnight borrowing, then top 4 and bottom rates would be excluded and
remaining would be averaged to arrive at LIBOR rate. They would publish this rate every day at
about 10.00 GMT.
o This would help to know if a bank is charging lot higher rate compared to LIBOR rate.

Avg rate 7.0%

 Barclays – 5.00%
 BOA – 4.5%
 JPM – 6.0%
 DB 4.8%
 Nomura 10.0%
 BNP 8.0%
 SG 7.0%
 CITI 7.5%
 RBS 6.5%
 HSBC 7.8%
 MS 8.5%
 RBC 9.0%
 GS 8.9%
 UBS 12.0%
 CS 5.5%
 BOT 4.8%

o Some of the major banks were caught discussing and publishing same higher rate. They were
caught and fined by FCA (Financial Conduct Authority) and FED (Federal Reserve Bank).
o Hence it was decided to phase out LIBOR and replace with ARR (Alternate Reference rate).

CCY USD EUR GBP CHF JPY

ARR SOFR ESTR SONIA SARON TONA/TONAR
  Secured Euro Short Sterling Swiss Tokyo Overnight
Overnight Term Rate Overnight Index Average rate Avg rate
Funding Rate Average Overnight
SIX Swiss
Regulator Fed Res ECB BOE Exchange BOJ
Source Based on US Based on Based on o/n Based on Based on o/n
Repo o/n unsecured o/n Swiss Repo unsecured
 unsecured
fixed rate sterling
deposit over transactions
EUR 1 M over GBP 25M transactions

Let’s look at different types of SWAPS in attached.