unit 5- IF- Financial Swaps2-05-2023.pptx

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1. Unit 5 D. Priyanka Assistant Professor MBA FINANCIAL SWAPS

2. CONTENT Introduction to Financial Swaps. Major types of Swaps. Motivation under Swaps. Application of Swaps. Valuation of swaps.

3. Introduction to Financial Swaps A  swap  is an agreement between two parties, called  counterparties , who exchange sets of cash flows over a period of time in the future Financial swaps are now used by MNCs, commercial banks, world organizations, and sovereign governments to minimize currency and interest rate risks. These swaps compete with other exchange risk management tools, such as currency forwards, futures, and options, but they also complement these other instruments.

4. Major Types of Swap Interest rate swap Currency Swap Commodity Swap Credit Default Swap

5. ff Interest Rate Swap An interest rate swap (IRS) is a type of a derivative contract through which two counterparties agree to exchange one stream of future interest payments for another, based on a specified principal amount..

6. Currency Swap A currency swap contract ( also known as a cross-currency swap contract ) is a derivative contract between two parties that involves the exchange of interest payments, as well as the exchange of  principal amounts  in certain cases, that are denominated in different currencies..

7. Commodity Swap A commodity swap is a type of derivative contract that allows two parties to exchange (or swap) cash flows that are dependent on the price of an underlying asset. In this case, the underlying asset is a commodity.

8. Credit Default Swap A credit default swap (CDS) is a type of credit derivative that provides the buyer with protection against  default  and other risks. Uses of Credit Default Swap Speculation Arbitrage Hedging

9. Application of Swap Risk hedging One of the primary functions of swaps is the hedging of risks. For example, interest rate swaps can hedge against interest rate fluctuations, and currency swaps are used to hedge against currency exchange rate fluctuations. Access to new markets Companies can use swaps as a tool for accessing previously unavailable markets. For example, a US company can opt to enter into a currency swap with a British company to access the more attractive dollar-to-pound exchange rate, because the UK-based firm can borrow domestically at a lower rate.

10. Valuation of Swap As we know, a Swap is nothing but a series or a combination of bonds for both counterparties, so its valuation is also easy. For example, suppose that two counterparties, A and B, enter into a Swaps agreement wherein A pays fixed and receives a float. In this arrangement, if we see, there is a package of two bonds for A. A is short on fixed coupon paying bond and B Long on floating coupon paying a bond .

11. Motivation underlying swap The motivations for using swap contracts fall into two basic categories: commercial needs and comparative advantage The two main motivation for swap Risk Management Comparative advantage

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