SWAPS AND INDIAN SWAPS AND INDIAN SWAP MARKETSWAP MARKET

Presented byPresented by:-:-

Rajdeep SainiRajdeep Saini

Roll no:- 47Roll no:- 47

SWAPSSWAPS• A swap is nothing but a barter

or exchange. • A swap is a contract between

two parties in which the first party promises to make a payment to the second and the second party promises to make a payment to the first.

Classification of SwapsClassification of Swaps

• Interest rate swaps

• Currency Swaps

• Commodity swaps • Equity swaps

INDIAN SWAP MARKETINDIAN SWAP MARKET

• At present only swaps are the only types of rupee derivatives which can be traded in India.

• Banks cannot trade in or offer options on rupee interest rates, either stand- alone or embedded in swaps.

There are 3 main categories There are 3 main categories of products, which in turn of products, which in turn

have different benchmarks.have different benchmarks.

• Plain Vanilla Interest Rate Swaps

• Currency Swaps

• G-Sec Linked Swaps

Plain Vanilla Interest Rate Plain Vanilla Interest Rate SwapsSwaps

• Most basic and actively traded instruments in the market.

• Benchmarks are:- - Overnight Index Swaps (OIS) - MITOR - MIFOR

Figure 1: Cash flows for a plain vanilla Figure 1: Cash flows for a plain vanilla

interest rate swapinterest rate swap For example, on December 31, 2006, For example, on December 31, 2006,

Company A and Company B enter into Company A and Company B enter into a five-year swap with the following a five-year swap with the following

termsterms:: • Company A pays Company B an amount equal to 6%

per annum on a notional principal of $20 million. • Company B pays Company A an amount equal to one-

year LIBOR + 1% per annum on a notional principal of $20 million.

Overnight Index Swaps Overnight Index Swaps (OIS)(OIS)

• Most popular and liquid benchmark, especially in the interbank market.

• 1st benchmark that was actively used by banks.

• Known as “MIBOR”.

MITORMITOR (Mumbai Inter (Mumbai Inter Bank Offer Rate)Bank Offer Rate)

• Not popular benchmark as the OIS.

• Underlying overnight floating rupee rate is derived from the USD Fed Funds rate and USD/INR/C/T Premia.

MIFORMIFOR (Mumbai (Mumbai Interbank Forward Offer Interbank Forward Offer

RateRate • Another popular benchmark.

• Derived from USD LIBOR (London Interbank Offered Rate) and the USD/INR Forward Premia.

• Large number of Indian Corporates regularly use this benchmark.

Currency SwapsCurrency Swaps• These are interest rate derivatives

whereby rupee debt held by banks or corporates can be swapped into debt in another currency or vice-versa.

• When there is no optionality permitted on the rupee leg of the currency swap, there is substantial scope for employing more sophisticated hedging strategies.

• There are variants of currency swaps like coupon swaps and Principal only swaps (POS).

For example, Company C, a U.S. firm, and Company D, a European firm, enter into a five-year currency swap for $50 million. Let's assume the exchange rate at the time is $1.25 per euro (i.e., the dollar is worth $0.80 euro). First, the firms will exchange principals. So, Company C pays $50 million, and Company D pays ¬40 million. This satisfies each company's need for funds denominated in another currency (which is the reason for the swap).

Figure 2: Cash flows for a plain vanilla

currency swap, Step 1.

Figure 3: Cash flows for a plain vanilla currency swap, Step 2For this example, let's say the agreed-upon dollar-denominated interest rate is 8.25%, and the euro-denominated interest rate is 3.5%. Thus, each year, Company C pays ¬40,000,000 * 3.50% = ¬1,400,000 to Company D. Company D will pay Company C $50,000,000 * 8.25% = $4,125,000.

Figure 4: Cash flows for a plain vanilla currency swap, Step 3Finally, at the end of the swap (usually also the date of the final interest payment), the parties re-exchange the original principal amounts. These principal payments are unaffected by exchange rates at the time.

G-Sec Linked G-Sec Linked SwapsSwaps

• It is linked to GOI.

•They allow banks and corporates to take views on relative movements of GOI yields and corporate spreads.

CONCLUSIONCONCLUSION

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