Financing: fixed and variable rates. The role of swap contracts.

Presentation by:

19 Novembro 2013

Paulo Martins 65929 METI Antnio Junior 57699

Vilma Jordo 59056 MEIC

Antnio Alves 65872 MEIC

Swaps
Has Grown alot in the past 20 years Protection from financial risks

Balancing operational costs

Financing in moments of low market liquidity

Swap Dealer

Swap contracts arent made with well defined rules. There is always some entity in the midle called Swap Dealer.

Types of Swaps
Interest Rate Swaps

Currency Swaps
Comodity Swaps Credit Default Swaps

Equity Swaps

Interest Rate Swaps

In this kind of swap there is an exchange between fixed and variable interest rates. It implies a great risk and results in great losses for one of the parts.
One of the parts pays the difference between the fixed and the variable interest rate.

Interest Rate Swaps - Example

Two entities ( and ) need funding.

wishes to get financed with a variable interest rate.

wishes to get financed with a fixes interest rate.

Interest Rate Swaps - Example

Rates offered to company and
Fixed rates Company Company 6% 7% Variable rates Euribor 3 months + 1.25% Euribor 3 months + 1.50%

gets a loan of 10 m, at a fixed rate of 6%, for 10 years;

gets a loan of 10 m, at the variable rate Euribor 3 months + 1.5%, for 10 years.

Interest Rate Swaps - Example

1. will have a loan at a variable rate, as wished, with a rate of: Euribor 3months + (6%-5.25%) = Euribor 3month + 0.75% 2. will have a loan at a fixed rate, with a rate of: 5.25%+(Euribor 3months+1.5%)-Euribor 3 months = 6.75%

Interest Rate Swaps - Example

If had a loan at a variable rate, it would pay Euribor 3months + 1.25%, meaning a profit of 0.5%; If had a loan at a fixed rate, it would pay 7%, meaning a profit of 0.25%.
Taxa Valor Juro

Empresa Empresa

4.5% 5.25%

450 000 525 000

Currency Swaps

This kind of swap consists on the deal between two entities, in

the exchange for the obligations of a loan in one currency for

another loan obligations of equal net value in another currency.

Currency Swaps - Types

FX-Swaps

Back-to-back
Cross currency swaps

Currency Swaps - Example

1M 1.4M

Currency Swaps - Example

Commodity Swaps
The buyer and the seller both accept to exchange periodic payments, one with a fixed value and the other with a variable value, calculated over a predeterminated commodity amount

Commodity Swaps Advantages and Goals

Allow to establish a limit to the volatility of the commodity prices This way the raw material price stays immune to the market price flutuations

Commodity Swaps - Example

Credit Default Swaps

CDS Seller

CDS Buyer

Credit Default Swaps

Credit Default Swaps

-38.600 x 4

+49.200 +1,049.200 -1.000.000 x 3

42.900

CDS Seller

CDS Buyer

1.000.000 - Valor actual das obrigaes

Equity Swaps

In an equity swap, two parties agree to exchange a set of future cash flows periodically for a specified period of time.

Equity Swaps - Example

Notional Principal: $100 million Alpha Fund pays: Total returns on the S&P 500 Index Goldman Sachs pays: Fixed 6% Swap maturity: 3 years Payments to be made at the end of every six months, that is, 30th June and 31st December

Equity Swaps - Example

Lets see how the cash flows turn out in the first year. At the beginning, the S&P Total Return Index was at 2500 level, on 30th June it was 2600, and on 31st December it was at 2570. Alpha Pays Return on index = 2600/2500 = 4% 30th June = 100,000,000*0.04 = $4,000,000 Goldman Pays =100,000,000 * 182/365 * 6% =$2,991,780

31st December

Fixed payment =100,000,000 * 183/365 * 6% Return on index = 2570/2600 = - =$3,008,219 Floating payment 1.154% = 100,000,000*0.01154 = $1,154,000 Alpha pays nothing. Total payment = $3,008,219+$1,154,000 =$4,162,219

Thank You

Questions?