TAILIEUCHUNG - Lecture Financial institutions, instruments and markets (6/e): Chapter 21 - Viney

Chapter 21 - Interest rate swaps, currency swaps and credit default swaps. The objectives of this chapter are: Describe the nature of a swap and explain the structure and operation of vanilla and basis interest rate swaps, understand the importance of the interest rate swap market, examine the structure of a cross-currency swap and how they can be arranged, explain the rationale for the cross-currency swap markets,. | Chapter 21 Interest Rate Swaps, Currency Swaps and Credit Default Swaps Websites: 21- Learning Objectives Describe the nature of a swap and explain the structure and operation of vanilla and basis interest rate swaps Understand the importance of the interest rate swap market Examine the structure of a cross-currency swap and how they can be arranged Explain the rationale for the cross-currency swap markets Introduce the concepts and parties to credit default swaps Consider the risks for an intermediary, or a counterparty, to a swap 21- Chapter Organisation Interest Rate Swaps Rationale for the Existence of Interest Rate Swaps Currency Swaps Rationale for the Existence of Currency Swaps Credit Default Swaps Credit and Settlements Risks Associated with Swaps Summary 21- Interest Rate Swaps Notional value of swap market transactions Australian market—about AUD36,013 billion International markets—about USD381,829 billion Swaps may be used to hedge interest risk and exchange rate risk Swaps also enable investors and borrowers to obtain a lower cost of funds or a higher yield 21- Interest Rate Swaps (cont.) Organised between borrowing parties The two parties swap their interest payment obligations No transfer of the principal amount Both parties benefit from the swap Example: Table outlines the current cost of funds for two borrowers Firm A has a credit advantage in both markets 21- Interest Rate Swaps (cont.) 21- Interest Rate Swaps (cont.) Strategy Firm A borrows in a fixed market, where it has comparative advantage (. 12%) Firm B borrows in another market (. floating) at BBSW + . One possible direct swap arrangement negotiable between firms A and B B pays A a fixed rate of A pays B a floating rate of BBSW + Figure illustrates the flow of funds and benefits of this interest rate swap 21- Interest Rate Swaps (cont.) .

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