Over the past decade, the interest rate swap market has been one of the fastest growing segments of the international financial market. In a short period of time, trading volumes in interest rate swaps have reached hundreds of trillions of dollars. According to the Bank for International Settlements, the total notional notional value of interest rate swaps as of early 2016 was $311.5 trillion. Interest rate swaps for this indicator rank first among all derivatives, representing more than 57% of the total notional notional amount of all OTC derivatives.

Interest rate swaps are mainly used by companies that want to convert their floating rate debt to fixed rate debt and vice versa.

In many ways, they are similar to futures contracts for short-term interest rates and are used similarly, often as an alternative to futures. Accordingly, at the simplest level, the essence of an interest rate swap is reduced to the exchange of fixed interest payments for floating interest payments, and vice versa. However, today the swap market offers more and more complex tools(Fig. 16.2).

Rice. 16.2.

According to the definition given in the Russian standard documentation for futures transactions in financial markets, adopted by Russian professional associations: the National Currency Association (NVA), the Association of Russian Banks (ARB) and the National Association of Stock Market Participants (NAUFOR), the simplest type of interest rate swaps are swaps without special conditions, or simple swaps(generic swap / plain vanilla swap). The parties making the exchange under the contract are called interest rate swap parties. One party, the payer of the fixed rate, undertakes to make periodic fixed payments to the other party.

An interest rate swap is an agreement (contract) under which, on terms agreed by the parties, one party pays the other party a lump sum or periodically in an agreed currency, calculated on the basis of the nominal amount in this currency and a floating rate (floating amount), and the other party pays a lump sum or periodically to the first party, either an amount in the same currency calculated on the basis of the same nominal amount and a fixed rate (fixed amount), or a floating amount in the same currency calculated on the basis of the same nominal amount and a different floating rate (in the latter case, such an interest rate swap called basis swap).

The fixed rate payer is the buyer of the interest rate swap. The amount or rate of the fixed payment is set by the parties at the time of the transaction. The other party, the floating rate payer, who is the seller of the interest rate swap, undertakes to make variable payments. As a rule, the amount of floating payments is tied to one or another short-term interest rate, for example, LIBOR or MosPrime Rate. These payments are determined through the rates applied to the conditional principal (nominal) amount (notionalprinciple amount). An interest rate swap does not provide for an exchange of principal between the parties, since the principal amounts for both parties to the contract are equal and expressed in the same currency. The standard payment frequency for a simple interest rate swap is three or six months, although annual payments are also common.

Figure 16.3 schematically shows the flows on a simple interest rate swap, the frequency of payments on fixed and floating interest rates by which it matches.

Rice. 16.3.

The date on which the parties enter into the swap agreement is called the trade date. Interest on the swap starts from the effective date. Settlement date is the day when the parties make settlements based on the respective values ​​of fixed and floating interest rates, i.e., they offset payments and transfer the resulting difference. The values ​​of floating rates are fixed for the next interest period from the date of determining the floating rate (reset dates), as a rule, at the beginning of the corresponding calculation (interest) period (calculation period). The termination / maturity date of a swap is the last day of the swap contract, on which the last swap payment is made.

Interest payments on the swap are made at the end of the periods. The first payment - for example, three months after the start date - is calculated according to the value of the agreed short-term floating interest rate as of the start date. The amount of the next payment after half a year is determined based on the short-term floating interest rate on the date of the previous payment (ie three months after the start date). Therefore, both parties know in advance the size of the next payment.

Let's say February 15, 2011. the two parties enter into a simple interest rate swap that begins on February 18, 2011. The duration of the swap is two years. Thus, the date of conclusion of the transaction is February 15, 2011, the start date of the term is February 18, 2011, and the term end date is February 18, 2013.

The notional nominal value of the interest rate swap is RUB 100 million. Under the terms of the deal, the payer of the fixed rate undertakes to pay a rate equal to 5.5% per annum. The floating rate payer assumes the obligation to pay the three-month MosPrime Rate. The interest rate swap will be settled once every three months. Below, in table. 1, the amounts of payments of each of the parties are given. At the same time, for simplicity, the coefficient of the number of days in the billing period is taken as the ratio of the rounded values ​​of the number of days in the quarter and in the year - 90 / 360.

Interest swap payments

Table 1

date	Three-month MosPrime Rate,%	Fixed payment, million rubles	Floating payment, million rubles	Difference for a fixed rate payer, million rubles

The first payment under the interest rate swap is made three months after the start date, on May 18, 2011. On this date, the amount of the payment at a fixed rate, as well as on all subsequent settlement dates, will be equal to:

Fixed Payment = (Annualized Fixed Rate)(Notional Principal)90 / 360 = (0.0550) (100M) /4 = RUB 1.3750 million

The amount of the floating payment on this settlement date will be calculated based on the value of the MosPrime Rate in effect on the start date, February 18, 2011, equal to 4.0%. This payment will be:

Floating Payment = (Three Months MosPR Annualized) (Notional Principal)90 / 360 = (0.0400)(100M) /4 = RUB 1.0000 mln

The difference between these two amounts of payments for a payer of a fixed interest rate as of May 18, 2011 will be 0.3750 million rubles.

The net payments on this interest rate swap in subsequent settlement periods will be determined in a similar way. The total financial result on this interest rate swap for two years (excluding possible reinvestment) will be RUB 1.0125 million.

The above example shows that a fixed-rate payer loses when short-term interest rates fall and wins when they rise. This side of the swap contract always pays a fixed amount, but in return receives a smaller amount when interest rates fall and a larger amount otherwise. A floating rate payer, on the other hand, wins when interest rates fall and loses when they rise.

The interest rate swap in the example above is the simplest. In today's environment, the parameters of interest rate swaps are very diverse and many swaps have more complex terms, although they retain the same structure. For example, interest payments in the example were calculated based on the rounded value of the coefficient of the number of days in the billing period. However, the terms of the contracts may provide for the calculation of payments at fixed and floating rates based on the actual or approximate number of days in the settlement periods and years taken as the basis for calculating interest. For example, some interest rate swaps require that interest payments be calculated by multiplying the applicable rate by the ratio of the actual number of days in each billing period to the actual number of days in a year. In other interest rate swaps, the floating interest rate can be set as the sum of the floating rate index multiplied by a certain rate multiplier and a positive or negative spread equal to a certain number of basis points. At the same time, the fixed swap rate or the parameters for determining the floating interest rate, including the multiplier, spread, minimum and maximum limits, can discretely change over time in the direction of increasing or decreasing values.

A variety of simple interest rate swaps may include payments that are asymmetrical in terms of the frequency of payments. For example, the terms of an interest rate swap may provide for settlements at an annual fixed rate against a three- or six-month floating rate (Figure 16.4)

Rice. 16.4.

In a basis swap, both parties pay floating rates (Figure 16.5).

Rice. 16.5.

Entity A enters into an interest rate swap with Entity B. Under its terms, company A pays company B every six months 8% per annum, and company B pays company A every six months interest at the rate of L1BOR, which at the time of payments was 7.8%, 8.2%, 8.4%, 8%, 7.8%, 7.6%. The swap amount is $1,000,000. Which company will make a profit and how much?

Solution:

The amount of interest payments that company A pays is -0.1%

Therefore, company B will receive a profit in the amount of:

Answer: 1000 dollars.

There are also more complex varieties of interest rate swaps, for example, cap transactions (cap), fl (floor), collar (collar) - special types of swaps offered to financial institutions in the over-the-counter market. Cap- an instrument that provides protection against an increase in the interest rate on a basic obligation with a floating interest rate above a certain level (maximum rate). When the rate rises above this level, payments are made to the cap party protected under the transaction for the difference in rates. Flo - a similar tool that provides protection against falling floating rates below the stipulated level. Collar is a combination of the first two agreements, guaranteeing the rate on the underlying obligation in the interval between the two levels.

Cumulative swaps(accrual swaps) - swaps for which streams of interest payments from one of the parties appear only when the corresponding floating interest rate is in a set interval, which can be fixed or periodically reviewed.

Swaptions(swap options, swaptions) - options on an interest rate swap that give the right to enter a certain interest rate swap on a specific date in the future. An alternative to them is deferred, or forward, swaps (forward / deferred swaps), which do not incur any initial costs in the form of a premium (like swaptions), but oblige the parties to enter into a swap agreement on a certain forward date.

Swaps with varying notional notional amounts are applied.

Amortized swaps(amortizing swaps) - swaps, the notional nominal amount of which decreases over time.

Growing Swaps(accreting swaps) - swaps, the notional nominal amount of which increases over time.

Swap settlements can be carried out at the beginning of settlement periods, taking into account the discounting of payment amounts at fixed and floating rates - discount swaps. Zero coupon swaps are swaps in which a fixed coupon is discounted or accumulated to pay at the beginning or at the end of the swap, respectively.

And in such a variety of interest rate swaps as overnight index swaps, the index of accumulated daily overnight interest rates is used as a floating interest rate.

In addition to the main exchange trading instruments that a trader can successfully use, there are over-the-counter instruments in the financial market that you also need to know about. For example, currency-interest swaps. In this article, we will discuss what is a cross-currency interest rate swap. plain language, what are its advantages and how it can be used in trading.

FX swap: what it is?

It is worth starting an explanation of this concept with the fact that a swap is, first of all, an agreement. It is concluded between the two parties on mutually beneficial terms.

As you can understand from the name of the swap, currency and interest appear in this agreement. Therefore, it is associated with credit obligations. The essence of a currency-interest swap is easiest to explain with an example.

Let's say you urgently need money, but not rubles, but dollars, and quite large sum. However, you do not have such money, and you decide to take a loan. Only now, in the bank for foreign currency loans, the interest is simply crazy.

Fortunately, at this point you learn that your friend in the US is in dire need of a large amount of Russian rubles, and at a local bank he faced a similar situation. After a little thought, you solve your question. You take a loan in rubles with an acceptable interest rate and send it to a friend, and he takes a loan in dollars for you and sends the amount to you. You agree to return the money to each other, for example, in five years. All this time, you pay interest on a friend’s loan, and he pays on your loan. When five years pass, you again exchange the amounts back - he returns you rubles, and you give him dollars.

In other words, the agreement between you and your friend is a cross-currency interest rate swap. Of course, the example is very simplified to understand the essence, because there are also fixed and floating interest rate swaps, and the amounts of loans in different currencies must be equivalent to each other.

What are the benefits of a currency interest rate swap?

Let's go back to the example with a friend. Deciding to take loans for each other on favorable terms, you significantly save on interest. Thus, you do not have to overpay significant amounts to banks. In addition, such a swap also insures against the likelihood of an increase in the interest rate, as is often the case if loans are taken in foreign currency.

Similarly, when companies enter into cross-currency interest rate swaps, they can save significant amounts on interest.

A currency interest rate swap should not be confused with a currency swap. The first swap provides for two currency exchanges - at the beginning of the agreement and after its expiration. In addition, during the term of the agreement, the parties make regular payments.

A currency dispute implies a one-time currency exchange (purchase and sale or sale and purchase) between the parties without periodic payments.

A currency interest rate swap is a relatively simple and profitable tool for solving financial issues by various companies and financial institutions. But it can be useful not only for them.

By fixing the interest rate, this swap can be used as a tool to hedge risks from falling interest rates. And the counterparty, on the contrary, wins in the event of such a fall.

Also, the currency-interest swap is popular among traders who speculate on the movement of interest rates. Due to the low entry threshold, traders use and lock in the interest rate instead of taking a full short position on the underlying asset that is expected to fall in interest rates.

You can learn how to use a currency-interest swap in your trading at the Alexander Purnov Trading School, and regularly receive valuable information from the financial sector in your mail after subscribing to our blog.

An interest rate swap is an agreement between parties to make a series of payments to each other on agreed dates before the agreement expires. The amount of interest payments of each of the parties is calculated on the basis of different formulas, based on principal amount defined in the swap agreement.

In interest rate swaps, principal rarely passes from counterparty to counterparty - it is used only as reference point for calculating payments. This means that the parties change the bases of interest payments on the debt or investment without changing the principal amount of the loan or investment. Interest payment is made in the same currency.

An example of a simple interest rate swap

In this example, we consider the exchange of an interest payment for fixed rate for the interest payment floating rate.

An enterprise with a BBB credit rating needs a loan (credit) of $50 million for 5 years from fixed interest rate. This rate allows you to plan the future cost of financing - allows the company to hedge the risk of interest rates.

An International Bank with a credit rating of AAA needs a loan (credit) of $50 million for 5 years with a floating interest rate. This rate allows the Bank to manage the profit margin in case of discrepancy between the levels of interest rates on assets and liabilities - allows the Bank to hedge the interest rate risk.

Table 1. Classification of foreign exchange market instruments.

The Company and the Bank enter into a swap agreement that allows them to reduce their interest payments. At the same time, there will be no exchange of principal amounts, $ 50 million will appear as conditional the principal amount on which interest will accrue.

The enterprise and the Bank receive a loan on terms available to them, and then exchange interest payments. The company receives a loan with a floating rate of LIBOR +1%, and the Bank - with a fixed rate of 8.25%. Thus, the two institutions enter into a 5-year fixed/floating rate swap.

Rice. 1. Payment exchange scheme.

In practice, only one payment is made at the due date. Only the net difference between payments in the relevant currency is paid. For this reason, interest rate swaps are often referred to as transactions for difference.

As a result of the exchange of interest payments, the net payments of both parties are lower than in any other cases. Interest rate swaps work in the following way.

• The company receives a loan at a floating rate LIBOR + 1%
• The bank receives a loan at a fixed rate of 8.25%
• The Company and the Bank enter into an interest rate swap with a notional principal amount of $50 million for a period of 5 years, according to which:
  • The company will make payments at a fixed rate of 9.75% in favor of the Bank
  • The Bank will make payments at a floating rate LIBOR + 1% in favor of the Company

The entity pays the Bank a higher fixed rate as compensation for its participation in the swap.

Rice. 2. Scheme of exchange of payments and payment of interest to Creditors.

Table 2. Benefit to the Enterprise and the Bank from a five-year swap.

Conclusion from table 2:

• - no swap The company and the Bank pay 10.00% + LIBOR
• - with the swap, the parties pay 9.25% + LIBOR

Using the swap results in a net savings of 0.75%, which is distributed as 0.25% to 0.50% in favor of the bank as it is the higher credit rating institution.

Features of interest rate swaps

An interest rate swap is an exchange of interest payments, the amount of which is determined using different formulas, based on notional principal agreements.

The swap does not provide for the exchange of principal amounts - the participants in the swap do not lend to each other.

Counter-interest payments are set off, and only the difference between them is paid.

The swap has no effect on the underlying loan or deposit. A swap is a stand-alone transaction.

Example

The point of interest rate swaps is that they allow borrowers to separate the basis on which they pay interest from the underlying money market instrument used to actually borrow.

For example, a borrower who wants to pay a fixed annual interest rate on a loan with a maturity of one year, but can only receive financing in the form of short-term 3-month commercial paper, can use an interest rate swap that allows him to receive a 3-month LIBOR rate and pay an annual fixed rate. Each time the 3-month commercial paper is redeemed, it simply renews itself.

Thus, on the loan, the borrower pays 3-month LIBOR, and on the swap, the borrower receives payment at 3-month LIBOR in exchange for paying an annual fixed interest rate. As a result of this exchange, his net payment is an annual fixed percentage.

Such a swap with a fixed / floating rate is called a simple interest rate swap (plain vanilla interest rate swap).

There are also swaps with a floating / floating rate, which are also called basis (basis swap) or differential (diff swap) swaps.

Conditions and characteristics

Positions that need to be negotiated when entering into an interest rate swap agreement include the following:

Effective date. The date from which interest begins to accrue on both sides of the swap. For simple interest rate swaps, this is the spot rate and the LIBOR rate fixed on the date of the transaction. The conditions here are the same as in the case of money market deposits.

Date of completion. The expiration date of the contract or repayment for which the final interest payment is calculated.

Conditional amount. The amount used to calculate the interest payments of both parties.

Fixed rate payer/beneficiary. Since in most swaps the payments are made by both parties, in one case at a fixed rate and in another at a floating rate, referring to the counterparties as "buyer" and "seller" can be misleading. In this regard, one of the counterparties is usually referred to as the payer of the fixed rate, and the other as the recipient of the fixed rate.

The basis for calculating the interest rate. Includes all the elements needed to calculate interest payments, including:
- benchmark interest rate, for example LIBOR;
- payment periods and dates;
- the number of days in a year to calculate.

Commission for the organization of the transaction.

Operations with interest rate swaps in the market

Interest rate swaps are one of the most actively traded derivatives and an essential element of global capital markets.

According to the International Swap Dealers Association (ISDA), which reviews the market every six months, the total amount of notional principal in active IRS contracts as of June 30, 1997 was $22.115 trillion. In order to visualize the growth rate of this market more clearly, we note that just a year and a half ago, that is, at the end of 1995, this figure was two times lower.

ISDA figures show that the most common currency in interest rate swaps is the US dollar.

Interest rate swap

Structure

In an IRS transaction, each counterparty undertakes to pay a fixed or floating rate, denominated in one currency or another, in favor of the other counterparty. Fixed or floating rate multiplied by notional principal(say $1 million). Sharing this notional amount between counterparties, as a rule, is not carried out, it is used only to calculate the amount of interest cash flows to be exchanged.

Side A currently pays a floating rate but wants to pay a fixed rate. B currently paying a fixed rate, but wants to pay a floating rate.
At the conclusion of the IRS transaction, the net result is such that the parties can " exchange» your current interest obligations to your desired interest obligations.

The most common IRS is a transaction in which one counterparty (counterparty A) pays a fixed rate (swap rate) to the counterparty B, receiving a floating rate in return (usually linked to the base rate, such as LIBOR or MOSPRIME).

• A pays a fixed rate to B (A receives a floating rate)
• B pays a floating rate in favor of A (B receives a fixed rate).

Consider an IRS transaction in which the party A having a loan (to a third party) at a floating rate of LIBOR + 150 (= + 1.50%), undertakes to pay in favor of the party B fixed periodic interest payments at 8.65% ( swap rate) in exchange for periodic interest payments at LIBOR+70 basis points (" bp", \u003d + 0.70 %). That is A has an "amount" from which he receives a fixed income on swap rate, but would like to have income at a floating rate, that is, the same as the loan obligations: LIBOR +. She turns to IN for the purpose of concluding an interest rate swap - a transaction in which A will receive income from the "amount" at the rate of LIBOR + instead of a fixed rate ( swap rate), A IN will receive income from its amount at a fixed rate instead of floating LIBOR+. Benefit for A is that the swap eliminates the discrepancy between the income from the "amount" and the cost of the loan - now they are both linked to the LIBOR rate.

It is worth paying attention to the fact that:

1. there is no exchange of principal between the parties and that
2. interest rates are applied to a "notional" (i.e. imaginary) principal amount.
3. interest payments are not paid in full, but are offset between the parties, after which the netting balance is paid.

, net.

The fixed rate (8.65% in this example) is called swap rate.

Drawing: A receives a fixed income of 8.65% and pays LIBOR+1.50%. A wants to bring both streams to LIBOR+. A enters into a swap with IN- “redirects 8.65% income to him” (in reality, not all, but only the “netting” balance - the difference between 8.65% and LIBOR + 0.70%) and “receives LIBOR + 0.70% income”. Since the return on the asset is not explicitly shown in the figure, this can be misleading.

At the time of the transaction, the pricing of the swap is such that the swap has a current net value of zero (). If one side is willing to pay 50 bp over the swap rate, the other side must pay about 50 bp over LIBOR to make up for it.

Types

As an over-the-counter instrument, IRS transactions can be entered into on a variety of terms to meet the specific needs of the parties to the transaction.

The most common are exchange transactions:

The parties to a transaction can be in the same currency or in two different currencies. (Transactions in one currency are usually not possible, since the entire flow can be predicted from the very beginning of the transaction, and it makes no sense for the parties to enter into an IRS contract, since they can immediately settle on known future interest payments).

Fixed-For-Floating, one currency

Side IN

• A And
• A, indexed by the curve X for a notional amount N for a period of T years.

(in reality, a transfer is made from A to B (or vice versa - depends on whose payment is greater) by the amount of the balance (netting) - the difference in "payments")

For example, you pay a flat rate of 5.32% monthly in exchange for Libor USD 1M also monthly for notional amount$1 million over 3 years.

The party that pays the fixed rate in exchange for the floating rate has a long IRS position. Interest rate swaps are, in fact, a simple exchange of one set of interest payments for another.

Swaps in the same currency are used to exchange

• assets / liabilities with a fixed rate on
• floating rate assets / liabilities and vice versa.

For example, if a company has

1. investment of 10 million USD with a yield of 1M USD Libor + 25bp with monthly fixing and payments

she can contract the IRS

According to him, she will:

1. pay floating USD rate 1M Libor+25 bp
2. receive a flat rate of 5.5%,
   thus fixing a profit of 20 bp.

Fixed-For-Floating, 2 currencies

Side P

• pays (receives) a fixed rate in foreign currency A And
• receives (pays) a floating rate in foreign currency B, indexed by the curve X for a notional amount N for a period of T years.

For example, you pay a flat rate of 5.32% quarterly on a notional amount in exchange for also quarterly on notional amount 1.2 billion yen over 3 years.

For a non-deliverable swap, the dollar equivalent of yen interest payments will be paid/received in accordance with the USD/JPY rate effective on the fixing date for the interest payment value date. There is no exchange of principal amounts. Payments only occur when:

• fixing date and
• the start date of the swap (if the start date of the swap starts in the distant future relative to the date of the transaction).

Swaps in 2 currencies are used to exchange

• assets / liabilities with a fixed rate in one currency per
• assets / liabilities with a floating rate in another currency and vice versa.

For example, if a company

1. It has
   • a loan with a fixed rate of 5.3% for 10 million USD with monthly interest payments and
   • investment of 1.2 billion JPY with a yield of 1M JPY Libor + 50bp with monthly fixing and payments and
2. wants to fix income in US dollars, expecting that
   • JPY 1M Libor will fall or
   • USDJPY will rise (the value of the yen will fall against the dollar)

she can enter into an IRS contract in two currencies, in which she will:

1. pay floating rate JPY 1M Libor+50bp
2. receive a flat rate of USD 5.6%,
   thus fixing a profit of 30bp on the interest rate and currency position.

Floating-For-Floating, one currency

Side P

• A, indexed by the curve X
• receives (pays) a floating rate in foreign currency A, indexed by the curve Y for a notional amount N for a period of T years.

For example, you pay a floating rate monthly in exchange for also monthly notional amount 1 billion yen over 3 years.

Swaps are used to hedge or speculate against widening or narrowing of the spread between two indices.

For example, if a company

If the company

she can enter into an IRS contract in one currency, in which she will, for example:

1. pay floating rate JPY TIBOR + 30 bps
2. receive floating rate JPY LIBOR + 35 bps,
   thus locking in a 35bp return on the interest rate instead of the current 40bp spread and index risk. The nature of the 5bp difference lies in the cost of the swap, which consists of
   1. market expectations of changes in the spread between indices and
   2. bid/offer of the spread, which is the commission of the swap dealer

Swaps are also used when using the same index, but

• with different interest payment dates or
• using different conventions for defining business days.

These swaps are practically not used by speculators, but they have importance for asset and liability management. An example is the 3M LIBOR swap,

• payable prior non-business day convention, quarterly according to the JAJO rule (i.e., January, April, July, October) on the 30th, against
• FMAN (i.e., February, May, August, November) 28 modified following.

Floating-For-Floating, 2 currencies

Side P

• pays (receives) a floating rate in foreign currency A, indexed by the curve X
• receives (pays) a floating rate in foreign currency B, indexed by the curve Y for a notional amount N at the original FX rate for the term T years.

For example, you pay a floating rate of USD 10 million quarterly in exchange for also monthly notional amount 1.2 billion yen (at the original FX rate of USD/JPY 120) over 4 years.

To understand this type of swap, consider an American company operating in Japan. To finance its development in Japan, the company needs 10 billion yen. The simplest solution for a company would be to issue bonds in Japan. Since the company may be new to the Japanese market and may not have the required reputation among Japanese investors, issuing bonds can be an expensive option. In addition to all of the above, a company may not have

• a proper bond issue insurance program in Japan and
• carry out advanced treasury functions in Japan

To solve these problems, the company can issue bonds in the United States and convert dollars into yen. Although these actions solve the first problems, they create new risks for the company:

• FX risk. If USDJPY rises by the maturity date of the bonds, then when the company converts yen into dollars to pay off the debt on the bonds, it will receive less dollars and, accordingly, incur exchange losses
• Interest risk on USD and JPY. If yen rates fall, then the company's return on investment in Japan may fall - this creates interest rate risk.

Currency risk can be eliminated by hedging using forward FX contracts, but this creates a new risk - the interest rate applied to determine the forward FX rate is fixed, while the return on investment in Japan has a floating structure.

Although there are several other options for hedging currency and interest rate risks, the simplest and most effective way is the conclusion of a swap in two currencies. In this case, the company raises funds by issuing dollar bonds and swaps them into US dollars.

As a result, she

• receives a floating rate in USD corresponding to its costs of servicing the bonds issued by it and
• pays a floating JPY rate corresponding to her return on yen investments.

Fixed-For-Fixed, 2 currencies

Side P

• pays (receives) a fixed rate in foreign currency A,
• receives (pays) a fixed rate in foreign currency B for a period of T years.

For example, you pay JPY 1.6% on notional amount 1.2 billion yen in exchange for USD 5.36% for the equivalent notional amount$10 million at the original FX rate of 120 USDJPY.

Other variations

Other options are possible, although they are less common. They are mainly intended for perfect hedging bonds, ensuring full compliance of interest payments - on bonds and swaps. These options can give rise to swaps in which the principal is paid in one or more payments, as opposed to conventional swaps, in which there is a simple exchange of interest flows - for example, to hedge coupon strip transactions.

Application

Hedging

Speculation

Pricing

More Rational pricing information

The value of a fixed leg is defined as the present value of the fixed interest payments known at the time of the transaction or at any time during its existence.

where - the swap rate - the number of fixed interest payment periods, - the nominal amount of the transaction, - the number of days in the interest period, - the financial base of the currency in accordance with the convention, and - the discount factor.

Also, the value of the floating leg of the swap is calculated based on the current value of the floating interest payments determined at the time of the transaction. However, it is only at the start of the swap that only the amounts of future interest payments on the fixed leg are known, while the forward interest rates are used to approximate the interest rates on the floating leg.

Each floating interest payment is calculated based on the forward interest rates for the respective payment dates. Using these rates results in a series of interest payments. Each flow is discounted using a zero-coupon rate. It also uses data from the rate curve available on the market. Zero-coupon rates are used because these rates describe interest-free bonds that generate only one cash flow - as in our case of calculation. Thus, the interest rate swap is treated as a series of zero-coupon bonds.

As a result, the value of the floating leg of the swap is calculated as follows:

where is the number of floating interest payments, is the forward interest rate, is the nominal amount of the transaction, is the number of days in the interest period, is the financial base of the currency in accordance with the convention, and is the discount factor. The discount factor always starts at 1.

The factor is calculated as follows:

.

Fixed rate quoted under a swap transaction - a rate that gives the present value of fixed cash flows equal to the present value of floating interest flows, calculated at forward interest rates in effect on the settlement date:

At the time of the transaction, none of the parties to the contract has no advantage in the value of the legs of the swap, that is.