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SWAP TRANSACTIONS

Types of swaps

Swaps & Deposit markets

Illustrations

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SWAP Transaction

A transaction whereby 2 currencies are exchanged by the partiesinvolved , only to be exchanged back later .

A currency swap is a combination oftwo transactions - one spot

and one forward with exchange of currencies taking place at a

pre-determined exchange rate . OR

A swap can involve two forwards transactions one such as borrowingone currency and lending the other currency.

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Swaps can be of four types:

i) Swap In:Buy the currency in the spot market and sell in the forward market.

ii) Swap Out :

Sell the currency in the spot mkt. and buy in the forward mkt.

iii) Forward - Forward Swap :

Buy a currency 1 month forward and sell it 2 month forward

iv) Rollover Swap:

When purchase and sale is separated by one day .

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SHORT DATE SWAP

In foreign exchange market , one day swap are quotedbetween:

today and tomorrow ( O/N)

tomorrow and the next day ( tom/next or T/N )

spot and next day (spot/next or S/N )

These swap rates are governed by the relevant interest rate

differentials for one day borrowings. These swaps are used for

rolling over maturing positions.

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SWAPS and DEPOSIT MARKET

The bank can manufacture a swap quote from the interbank deposit market .

ILLUSTRATION 1 :

Suppose a customer in Mumbai approaches a bank for a 3-

month INR USD swap . The customer wants to sell INR1 million spot against USD and buy INR1 million 3-month

forward against USD .If the prevailing rates are :

INR / USD Spot : 45 / 47

Interest on INR Deposit : 8 % 8.5%Interest on USD Deposit : 12 % 12.75%

Assume that the inter-bank swap rate of INR / USD is 46.

What swap rate should the bank quote to the customer if thebank desires to earn a profit margin of 1.5%?

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If the inter-bank swap rate of INR / USD is 46.

The bank borrows USD 21739 (10,00,000 / 46) for 3 months at12.75 % and delivers the same to it's customer .

In turn it invests INR 1 million ,received from the customer, a

8% for 3 months.

a) At maturity the bank must pay :

Borrowings [ 1+ rUSD ]

=USD 21739 [ 1+ 0.25 ( 0.1275) ]

= USD 21739 [ 1.031875]

= USD 22431.93

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b) At maturity the INR Deposit will grow to

Investible Funds [1+ r INR]

=INR 10,00,000 [ 1+ 0.25 ( 0.08) ]

= INR 10,00,000 [1.02 ]= INR 10,20,000

c) The bank will break even if it charges a rate of :

Rupee Deposits on Maturity / Dollar Repayment on Maturity

= INR 10,20,000 / USD 22431.93

= INR 45.47 / USD

Swap quote for the customer

= 45.47 (1+.015)

= 46.15205 INR / USD

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ILLUSTRATION 2:

Suppose a customer in Chennai approaches a bank for a 6-

month INR GBP swap . The customer wants to sell INR

1crore spot against GBP and buy INR1 crore 6-month

forward against GBP .If the prevailing rates are :

INR / GBP Spot : 79.7866 / 81.8697

Interest on INR Deposit : 8 % 9.5%

Interest on GBP Deposit : 5 % 6.5%

Assume that the inter-bank swap rate of INR / GBP is 80.

What swap rate should the bank quote to the customer if the

bank desires to earn a profit margin of 1%?

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If the inter-bank swap rate of INR / GBP is 46.

The bank borrows GBP1,25,000 (100,00,000 / 80) for 6months at 6.50 % and delivers the same to it's customer .

In turn it invests INR 1 cr ,received from the customer, a

8% for 6 months.

a) At maturity the bank must pay :

Borrowings [ 1+ rGBP ]

=GBP 1,25,000 [ 1+ 0.50 ( 0.065) ]

= GBP 1,25,000 [ 1.0325]

= GBP 1,29,062.50

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b) At maturity the INR Deposit will grow to

Investible Funds [1+ rINR]

=INR 100,00,000 [ 1+ 0.50 ( 0.08) ]

= INR 100,00,000 [1.04 ]= INR 104,00,000

c) The bank will break even if it charges a rate of :

Rupee Deposits on Maturity / GBP Repayment on Maturity

= INR 104,00,000 / 22431.93

= INR 45.47 / USD

Swap quote for the customer

= 45.47 (1+.015)

= 46.15205 INR / USD

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b) At maturity the INR Deposit will grow to

Investible Funds [1+ r INR]

=INR 10,00,000 [ 1+ 0.25 ( 0.08) ]

= INR 10,00,000 [1.02 ]= INR 10,20,000

c) The bank will break even if it charges a rate of :

Rupee Deposits on Maturity / Dollar Repayment on Maturity

= INR 10,20,000 / GBP 1,29,062.5

= INR 80.5811 / GBP

Swap quote for the customer

= 80.5811 (1+.01)

= 81.3869 INR / GBP

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ILLUSTRATION 3:

A customer in Chennai approaches a bank with a request for a

6-month loan of GBP 10,000. At that time there is no active Euromarket for Pound Sterling . However there is an active spot and

forward USD / GBP market. If the prevailing rate are:

Spot GBP / USD : 0.625 / 0.7006-month swap points : 5 / 20

Euro dollar interest rates : 8% - 8.25% p.a.

If the bank does the swap at a rate of 0.650,what interest rateshould the bank quote for the GBP loan if it wants to earn a profit

margin of 1%?

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Solution:

The bank can work in the following manner :

i) borrow USD

ii) do USD - GBP 6-month swap , i.e. , sell USD spot against GBP

and buy USD 6-month forward .

iii) loan the GBP to the customer

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Suppose the bank does the swap at a spot rate of 0.650and a swap margin of 10 pips .

a) It must borrow :

GBP 10,000 / ( 0.650) = USD15,385 to buy and give a loan

of GBP 10,000

b) At maturity the bank must pay the same amount of Pound

Sterling at a rate of USD 0.660 . In addition it has to pay

interest on Dollar loan which it must buy at outrightforward rate (0.700 + 0.020 i.e. 0.720) :

Interest will be :USD 15,385 [ 0.5 ( 0.0825) ]

) Th t f d t li th t th b k t

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c) The amount of pound sterling that the bank must recoverfrom the customer is :

Loan Amt.{[ swap rate + pip ]+ [r/m (outright forward) ]}

= 15,385 { [ 0.650+0.010] + [(0.5) ( 0.0825) ( 0.720) ]}

= 15,385 [0.660 +.0297]

= GBP 10,611.0345

d) The break even rate of interest is:

= [ (10,611.0345 / 10,000 ) 1 ]

= [0.06110345 (100)] = 6.110345 %

e) Interest rate for the customer should be:

= 6.110345 (1.01)= 6.17144845 %

Annual interest rate =12.34%

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A customer in Calcutta approaches a bank with a requestfor a 3-month loan of EUR 1,00,000. At that time there is no

active Euro market. However there is an active spot and

forward GBP / EUR market. If the prevailing rate are:

Spot GBP / EUR : 0.725 / 0.860

6-month swap points : 5 / 20

Euro dollar interest rates : 5% - 6.25% p.a.

If the bank does the swap at a rate of 0.750,what interest rate

should the bank quote for the EUR loan if it wants to earn aprofit margin of 1%?

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THANK YOU