Page 129 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes According to a press release, HUDCO has swapped its foreign currency liability of Yen
2.89 billions for equivalent Rupee resources with SBI for a tenor of 10 years. Under the
arrangement, HUDCO will deposit its Yen with SBI on the day of transaction, and SBI in
return will pay the equivalent Rupee resources to HUDCO.
According to officials, the swap will be done at the prevailing exchange rate on the day of
the transaction. And HUDCO will use the rupee resources for the purpose of lending to
their projects in India. The overseas branches of SBI in Japan will use Yen to fund their own
assets. As per the swap agreement, SBI would provide the long-term hedge to HUDCO for
a period of 10 years to cover the exchange risk of the foreign liability.

As a result of this, the swap will neutralize both the exchange rate risk and interest risk of
HUDCO on Yen loan by converting the Yen flows into risk neutral-fixed interest rate
Rupee flows for the company. At the end of 10 years, HUDCO will take back the Yen by
giving the Rupee equivalent to SBI.
Earlier SBI had struck a Rupee-Dollar swap of sizable transaction with ICICI. At present,
the bank is considering similar deals with companies, which do not have international
presence to manage the foreign currency risk effectively.

The bank is actively involved in developing the derivative market in India by facilitating
the use of hedging instruments such as currency swaps. This has been possible after the
permission was granted by the Reserve Bank of India to enable corporates to obtain
suitable hedge for their exposures arising out of their foreign currency loans.

Self Assessment

State the following are true or false:

6. In a Basic swap, one party pays a fixed rate calculate at the time of trade as a spread to a
particular.
7. Coupon swaps are also known as deferred swaps.

8. A Puttable swap provides the seller of the swap (the floating rate payer) to cease the swap
at any time before it maturity.
9. The Credit Default Swap (CDS) is a swap designed to transfer the credit exposure of fixed
income products between parties.

9.3 Currency Swaps

Swap contracts also can be arranged across currencies. Such contracts are known as currency
swaps and can help to manage both interest rate and exchange rate risk.
Currency swaps are derivative products that help to manage exchange rate and interest rate
exposure on long-term liabilities. A currency swap involves exchange of interest payments
denominated in two different currencies for a specified term, along with exchange of principals.
The rate of interest in each leg could either be a fixed rate, or a floating rate indexed to some
reference rate, like the LIBOR.
In a typical currency swap, counterparties will perform the following:
1. Exchange equal initial principal amounts of two currencies at the spot exchange
rate,

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