Page 149 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes because of the role assumed by a swap dealer (market maker) or swap broker. Collectively,
the swap facilitators are known as ‘Swap Banks’ or simply ‘Banks’.

Swap Broker: When a swap facilitator does not take any financial position in a swap
arrangement he initiates and he dissociates himself from the deal after making an
arrangement between the counter parties who have approached him, then he is called a
swap broker. He charges a fee (commission) for the services provided and he is not a party
to the swap contract. He merely acts as an intermediary. Thus a swap broker is an economic
agent who helps in identifying the potential counter parties to a swap transaction. A swap
broker is also called a market maker.

Notional Principal: It is the principal amount on which the interest calculation is made.
Basis Points (BP): Basis point is 1/100th of 1 % i.e. 10 basis points = 0.1%.
Swap Coupon: It refers to the fixed rate of interest on the swap.

9.3.1 Reasons for Growth of Swap Market

The following reasons are connected with the growth of swap market:
1. Interest rate swaps create a link between distinct markets or firms with differential access
to fund sources creating globalisation of finance markets.
2. Swaps, specially interest rate swaps, provide a way to reduce the total funding cost for
debt. This benefit arises from the differences in the risk premium available to the various
borrowers.
3. Interest rate swap is a flexible and convenient way for companies to manage balance sheet
and reduce the mismatch between the maturities of assets and liabilities.
4. Swaps are desirable because they minimise the costs of regulations and tax loans.
5. The needs of the parties in a swap transaction are diametrically different. Swaps are not
traded or listed on exchanges but they do have an Over-The-Counter (OTC) market and
are traded among dealers.

9.3.2 Limitations of Swap Market

There are some limitations of swap market which are as follows:
1. The Swap deal cannot be terminated without the agreement of the parties involved in the
transactions.
2. Swap are not easily tradable as a result of very slow development of standardised
documentation.

3. It is difficult to identify a counter-party to take the opposite side of the transaction.

9.3.3 Swap Market Terminology

Swap market terminology is mentioned below:
Trade Date: It is the date on which swap is entered into. This is the date when both the
parties have agreed for a swap.

Effective Date: Effective date is the date when the initial fixed and floating payments
begin. Effective date is also called value date. If the effective date falls two days after the
trade date, then it is called spot date. The maturity of a swap contract is computed from the
effective date.

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