Dr Kishor Bhanushali www.ibmajor.wordpress.com Financial Swaps Dr Kishor Bhanushali www.ibmajor.wordpress.com

Introduction The term swap refers to exchange Financial swaps are tools used for asset liability management Risk management tool Interest rate swaps and currency swaps are financial swaps which facilitates exchange of assets and liabilities Financial swaps are asset liability management tool Swaps are not traded in organized exchange

Swaps Swaps are private agreement between two companies to exchange cash flow in the future according to a pre-arranged formula. Most common types of swaps: interest rate swaps and currency swaps Derivative instruments used for hedging the risk Interest rate swaps (coupon swaps) are used for hedging interest rate risk Currency swaps are used to hedging the exchange rate risk Cross currency interest rate swaps

Interest Rate Swaps Fixed interest rate loan exchanged for floating exchange rate loan and vice versa Fixed-to-floating interest rate swap also called “plain vanilla coupon swap” LIBOR : London Inter-Bank Offer Rate MIBOR : Mumbai Inter-Bank Offer Rate Swapping through financial intermediaries Motivation : (a) hedging (b) desire to reduce interest rate costs

Currency Swaps Used to transfer loan in one currency into loan in another currency Liability denoted in one currency and income stream denoted in another currency Foreign exchange risk Borrowing and payment in from abroad Exchanger of principle amount in one currency for the principal amount another currency between two parties at the beginning of the deal Interest payments in the two currency would be exchanged between the parties at periodical intervals during the tenure of loan Principle amount will be re-exchanged between two parties at the end of term Direct negotiation or intermediaries Used to reduce borrowing costs

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