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Development of the Swaps Market

Development of the Swaps Market. Joseph Di Peri Stephen Asai. Outline. Discussion of currency swap Brief review of an interest rate swap Growth of secondary market Other types of swaps Financial intermediaries Credit default swaps. Introduction to currency swap. How they work

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Development of the Swaps Market

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  1. Development of the Swaps Market Joseph Di Peri Stephen Asai

  2. Outline • Discussion of currency swap • Brief review of an interest rate swap • Growth of secondary market • Other types of swaps • Financial intermediaries • Credit default swaps

  3. Introduction to currency swap • How they work • Plain vanilla currency swap

  4. First swap conducted • World Bank and IBM • Occurred in 1981 • Currency swap through Salomon Brothers • German, Swiss, and U.S markets impact • March 1980, the exchange rate was 1.93 DM/US dollar. August 1981, the rate was 2.52 DM/US dollar. • 100 DM coupon payments were $51.81 and after the exchange rate gains it was $36.68.

  5. IBM – World Bank swap

  6. Interest rate swap • How it works • Plain vanilla interest rate swap

  7. Other examples of swaps • Sallie Mae and IT&T Financial Corporation • Occurred in 1982 • First major domestic interest rate swap • “Plain vanilla” swap • Sears & Roebuck • Hedged against interest rate risk • Secondary market helped the use of the swap

  8. Overview of swaps • Differences between an interest rate swap and a currency swap • Notional principal amount • Players involved • Benefits of the Swap • Achieve lower cost of financing debt • Hedging against risks

  9. Secondary market • Three main functions • Reverse a position • Sell a swap to another party • Buy out counterparty • Swaption • An option to enter a swap • Enter a normal swap • Enter an offsetting swap

  10. Other types of swaps • Amortizing, accrediting, roller-coaster • Forward start swap • Basis rate swap • Credit default swap

  11. Growth of the swaps market

  12. Possible reasons for growth • Hedge against interest rate risk • Efficiency compared with futures • Arbitrage opportunities • Access to different markets

  13. Intermediaries evolve • Banks began strictly as brokers between two parties • Began to fill in swap principal differences • Example • Bid to Ask spreads narrowed, which meant banks would need to increase the volume of swaps to profit off of swaps

  14. Credit default swap • Recent Development • Took interest rate and currency swaps ~17 years to reach same notional principal amount as CDSs did in 7 years

  15. Summary • IBM & World Bank currency swap • Why companies use the swap • Secondary market • Different types of swaps • Role of financial intermediaries • Current state of swap market

  16. Questions?

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