Professional Documents
Culture Documents
Swaps-TSM 2020
Swaps-TSM 2020
Swaps-TSM 2020
Dr. N Vijayakumar
Evolution of Swaps
• Swap as a financial instrument came into existence when
exchanges are controlling the movement of capital from one
country to another. This concept was originally conceived in
1970’s in UK which was named as ‘back -to- back loan or
parallel loan agreement’.
• Swaps overcame the operational difficulties faced in parallel
loans and developed into an instrument independent of the
underlying loan transaction.
• Parallel loan refers to an arrangement in which foreign
company borrows in its home country (where it has a relative
advantage in terms of interest cost) and given to the subsidiary
of a foreign company located in its country at a lower interest
rate than the subsidiary may have to pay in domestic market.
Swaps
• Swap is simply defined as an exchange of future
cash flows between two parties as agreed upon
in accordance to the terms of the contract.
• The dictionary meaning of the word swap is “to
give in exchange.” A Swap is an arrangement for
exchange of commitments between two parties,
without nullifying the primary external
obligations of these parties.
• Swap arrangements can be used to hedge
interest rate risk or to hedge currency risk.
Types of Financial Swaps
• Interest rate swaps
• Currency swaps
• Equity swaps
• Commodity swaps
Salient Features of swaps
• It is a contract between two parties (except triangular currency swap
which include three parties) whereby one party raises loan desired by
another party and exchange the interest.
• Principal amount of the loan remains notional and hence not exchanged
( except for currency swaps). Only interest payments are exchanged.
• The amount of loan required by both the parties and periodicity of
interest payments are identical.
• The amount of loan required by both the parties is in the same currency
unlike currency swap.
• The swap is generally structured for longer duration say for 5 to 10 years.
Facilitators of Swaps
• Swap deal is generally agreed upon over telephonic in OTC market.
• But, to avoid confusion, the swap agreements are arranged by the intermediary such
as financial institutions and banks.
• In India, RBI permitted scheduled Commercial banks and financial institutions to act as
facilitators.
• International Swap Dealers Association (ISDA) plays a vital role by framing the rules
regarding documentation with respect to identification of the parties, payments,
representations, agreements, default, termination, tax matters, jurisdiction etc.
A PAYS to bank at its Floating Rate (L PAYS to bank at its Fixed Rate
– 0.25)% (4.25)%
B RECEIVES from Counter Party A+ RECEIVES from strong Sequence C
strong share of gain L+2.05% + (4%)
0.125%
C PAYS Counter Party Strong's Fixed PAYS Strong's sequence B
rate (4%) (L+ 0.25% + 0.125%)