Page 135 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes V = 0.375e –.08 + 5.375 e –.08x2 = $ 0.3461 + $ 4.5802 = $ 4.9263 = ` 221.6835
f
V = 3e –0.03 + 78e –0.03x2 = ` 2.9113 + ` 73.4576 = ` 76.3689
l
Therefore, P = ` 221.6835 - ` 76.3689 = ` 145.3146
c
If ICICI Bank were to pay US$ and receive Indian Rupees, the value of the currency swap would
have been ` 145.3146.

Task Review the annual report of an MNC of your choice. Did the MNC enter into a swap
deal in the recent past? Explain how the MNC benefited from the swap deal. Also perform
a forecasted scenario analysis to show how the MNCs would fare in the coming years.
Self Assessment

Fill in the blanks:
14. The price of the swap is the difference between the values of two ………….
15. Normally, the prevailing LIBOR rate (in India, we use PLR rate) is used for …………. the
cash flows of floating rate and market quoted rate is used for fixed rate.
9.6 Summary

 Swaps are over-the-counter derivative products involving cash payment transfer between
two counter parties with an intermediary bank in between.

 There are primarily two types of financial swaps namely, interest rate swap and currency
swap. Interest rate swap, known in the market jargon as a Plain Vanilla Coupon Swap
(exchange borrowings) is an agreement between two parties in which each contracts to
make payments to the other on particular dates in the future till a specified termination
date.
 The first Interest Swap deal was struck in the year 1981 when Salamon Brothers acted as the
swap intermediary between IBM and World Bank.

 The swaps on currency were initially in the form of back-to-back/parallel loans.
 Unlike futures and option contracts, swaps have longer maturity period. The price of the
swap is the difference between the values of two cash flows.

 Swaps can be priced by determining the values of each stream of cash flows.
 Credit risk or default risk may be defined as the potential that a bank borrower or
counterparty will fail to meet its obligations in accordance with the agreed terms

9.7 Keywords

Basis Swaps: Basis swaps involve an exchange of floating rate payments calculated on different
basis.

Callable Swaps: A callable swap gives the holder, i.e. the fixed-rate payer, the right to terminate
the swap at any time before its maturity.
Commodity Swaps: Innovations in the swap market have enabled users to link the transactions
to various floating indices.

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