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Swaps &Interest Rates Derivatives

Swaps &Interest Rates Derivatives. Word ‘Swap’ ?. As a word meaning swap means exchange and barter. Word ‘ Derivatives ’ ?. Derivatives are financial instruments whose value is resulting from the value of something else. What is Swap in Finance ?.

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Swaps &Interest Rates Derivatives

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  1. Swaps &Interest RatesDerivatives

  2. Word ‘Swap’ ? • As a word meaning swap means exchange and barter.

  3. Word ‘Derivatives’ ? • Derivatives are financial instruments whose value is resulting from the value of something else

  4. What is Swap in Finance? • An exchange of one type of asset,cash flow,investment,liability, or payment for another.

  5. Swaps are used for; • risk management • investing and speculative purposes

  6. Who use Swaps? • International institutions • Central bank • Multinational company • Local authorities • International Funds • Exporter & Importer Firms • Banks (Direct or as agent)

  7. Most known swaps are; • Interest rate swaps • currency swaps • credit swaps • commodity swaps • equity swaps

  8. Interest rate swaps

  9. Interest Rate Swaps • An exchange of interest payments on a specific principal amount.

  10. Users ?... Interest rate swaps can be used by • hedgers to manage their fixed or floating property and liabilities • speculators to take risks of connection exposures to profit from changes in interest rates

  11. Currency Swaps

  12. Currency Swap • A currency swap is a foreign exchange agreement between two parties to exchange a given amountof one currency for another and, after a specified period of time, to give back the original amounts swapped.

  13. Unlike interest rate swaps, currency swaps involve the exchange of the principal amount.

  14. Uses • Currency swaps are often combined with interest rate swaps.

  15. For example, one company request to swap a cash flow for their fixed rate debt denominated in US dollars for a floating-rate debt denominated in Euro.

  16. This is especially common in Europe where companies "shop" for the cheapest credit in spite of its denomination and then try to exchange it for the credit in desired currency.

  17. credit default swaps

  18. Definition • A two-sided contract in which the seller agrees to make a payment to the buyer in exchange for a fixed payment or series of fixed payments.

  19. A specific kind of two-sided contract which allows transfer of third party credit risk from one party to the other.

  20. One party in the swap is a lender and faces credit risk from a third party,

  21. The other party agrees to cover this risk in exchange of regular periodic payments

  22. If the third party defaults, the party providing insurance will have to purchase from the insured party the defaulted asset.

  23. In turn, the insurer pays the insured the interest left behind on the debt, as well as the principal

  24. commodity swaps

  25. Definition • A swap where exchanged cash flows are dependent on the price of an basic commodity. This is usually used to hedge against the price of a commodity.

  26. In this swap, the user of a commodity would secure a maximum price and agree to pay this fixed price. Then in return, the user would get payments based on the market price for the commodity involved.

  27. equity swaps

  28. Definition • A swap in which at least one party’s payments are based on the rate of return of an equity index(S&P 500). The other party’s payments can be based on a fixed rate, a non-equity variable rate, or even a different equity index.

  29. Equity swaps do have more potential risk than interest rate swaps, since equity returns, unlike interest rates, can be negative.

  30. Thus, If one market used in an equity swap goes down while the other goes up, the responsibility for both sides of the payments could fall on just one of the parties.

  31. INTEREST RATES

  32. Definition • An interest rate is a derivative where the basic asset is the right to pay or receive an amount of money at a given interest rate.

  33. The interest rate derivatives market is the largest derivatives market in the world

  34. Market observers estimate that $60 trillion dollars by notional value of interest rate derivatives contract had been exchanged by May 2010.

  35. Interest Rate Cap An interest rate cap is designed to hedge a company’s maximum exposure to upward interest rate movements. It establishes a maximum total dollar interest amount the hedger will pay out over the life of the cap. Examplefor interest rate problem

  36. General Info About Derivatives http://www.isda.org/

  37. According to the International Swaps and Derivatives Association, 92% of the world's top 500 companies as of April 2010 used interest rate derivatives to control their cash flows.

  38. This compares with 75% for foreign exchange options, 25% for commodity options and 10% for stock options.

  39. “Derivatives allow companies to bear or assume only the risks that they want to take.” • -- James Angel, Associate Professor of Finance, Georgetown University: McDonough

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