Page 128 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Unit 9: Swaps

For example, if an investor wants to hedge for a five-year duration beginning one year Notes
from today, this investor can enter into both a one-year and six-year swap, creating the
forward swap that meets the needs of his or her portfolio. Sometimes swaps don't perfectly
match the needs of investors wishing to hedge certain risks.
9. Roller-Coaster Swap: In this swap, interest rate risk can be shifted by converting floating
rate liability to fixed rate liability or vice-versa. A roller-coaster swap is a seasonal swap
providing flexibility of payments at predetermined periods in order to best meet cyclical
financing needs or other requirements of the counterparty. For example, an international
company that sells lawn mowers might have a keen interest in a roller-coaster swap,
because it can match swap payments with the seasonal demand for lawn mowers.
10. Amortising Swap: An amortising swap is usually an interest rate swap in which the
notional principal for the interest payments declines during the life of the swap, perhaps
at a rate tied to the prepayment of a mortgage, or to an interest rate benchmark such as the
London Interbank Offer Rate (LIBOR).
11. Forex swap: A Forex swap is an over the counter short-term interest rate derivative
instrument. A forex swap consists of a spot foreign exchange transaction entered into at
exactly the same time and for the same quantity, has a forward foreign exchange transaction.
The forward portion is the reverse of the spot transaction, where the spot purchase is offset
by a forward selling. In this reason, surplus funds in one currency are for a while swapped
into another currency for better use of liquidity. Protects against adverse movements in
the forex rate, but favourable moves are renounced. It should not be confused with a
currency swap, which is a much rarer, long term transaction, governed by a slightly
different set of rules. In emerging money markets, Forex swaps are usually the first
derivative instrument to be traded, ahead of forward rate agreements.

12. Constant maturity swap: A constant maturity swap, also known as a CMS, is a swap that
allows the purchaser to fix the duration (see bond duration) of received flows on a swap.
The floating leg of an interest rate swap typically resets against a published index. The
floating leg of a constant maturity swap fixes against a point on the swap curve on a
periodic basis. For example, a customer believes that the difference between the 6mth
LIBOR rate will fall relative to the five-year swap rate for a given currency. To take
advantage of this they buy a constant maturity swap paying the 6mth libor rate and
receiving the three-year swap rate.
13. Credit default swap: The Credit Default Swap (CDS) is a swap designed to transfer the credit
exposure of fixed income products between parties. It is the most widely used credit derivative.
It is an agreement between a protection buyer and a protection seller whereby the buyer
pays a periodic fee in return for a contingent payment by the seller upon a credit event (such
as a certain default) happening in the reference entity. A CDS is often used like an insurance
policy, or hedge for the holder of a corporate bond. The typical term of a CDS contract is five
years, although being an over-the-counter derivative almost any maturity is possible.

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Case Study SBI-HUDCO Enter into Yen-swap Deal

S tate Bank of India has entered into a long-term Rupee-Yen swap deal with Housing
and Urban Development Corporation (HUDCO).

Contd...

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