Prof. Ian Giddy New York University Swap Financing Techniques SIM/NYU The Job of the CFO.
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Transcript of Prof. Ian Giddy New York University Swap Financing Techniques SIM/NYU The Job of the CFO.
Prof. Ian GiddyNew York University
Swap FinancingTechniques
SIM/NYUThe Job of the CFO
Copyright ©2001 Ian H. Giddy Swap Financing 2giddy.org
Interest Rate and Currency Swaps
Mechanics of swaps Valuation of swaps Credit risk of swaps Pricing swaps Hedging swaps The all-in cost of swap financing Currency swaps vs forwards
Copyright ©2001 Ian H. Giddy Swap Financing 3giddy.org
Swaps: Mechanics and Valuation
IC&TelIC&Tel CIBCCIBC
Fixed ECU 7%
Floating
ECU Libor
Periodic exchanges of interest payments are made during the life of the swap. Remember that the principal amount is not exchanged
Copyright ©2001 Ian H. Giddy Swap Financing 4giddy.org
Interest-Rate Swap Example
CIBC
AA
IC&Tel
BBB Fixed 5.00%Floating 6-MonthLIBOR + 25
Payments to CapitalMarkets
Payments to CapitalMarkets
Copyright ©2001 Ian H. Giddy Swap Financing 6giddy.org
Interest-Rate Swap Example
Exchange of Interest Payments Every 6 Mo
Fixed 5.50%
Floating 6-Month
LIBOR Flat
Fixed 5.00%Floating 6-MonthLIBOR + 25
Cost of Funds After Swap:
- Pay fixed 5.50%- Receive LIBOR Flat- Pay LIBOR + 25- Net Cost: 5.75% Fixed
Cost of Funds After Swap:
- Pay 5.00% fixed - Receive 5.50% fixed - Pay 6-month LIBOR Flat- Net Cost: 6-month LIBOR - 50
Payments to CapitalMarkets
Payments to CapitalMarkets
AABBB
CIBCIC&Tel
Copyright ©2001 Ian H. Giddy Swap Financing 7giddy.org
Swap Quotation Screen
GovPX/GGB SwapPX US Medium Term Swaps vs 3M LIBOR 8/6/96 Page 261Term Cpn Mty TrPrice TrYld-SB SwapSpd-SB SwapRate-SB CBA-TED
2Y 6.250 07/98 100.214 /216 5.952 /948 19.50 21.00 6.143 /162 20.233Y 6.375 05/99 100.174 /176 6.103 /100 22.80 23.00 6.327 /333 22.924Y 6.202 /200 26.00 26.50 6.460 /468 25.665Y 6.625 07/01 100.114 /120 6.302 /299 27.00 27.80 6.569 /580 26.316Y 6.351 /348 30.00 31.00 6.648 /661 29.467Y 6.400 /397 33.00 34.00 6.726 /740 32.478Y 6.449 /446 33.50 34.50 6.781 /794 33.109Y 6.498 /494 34.50 35.50 6.839 /853 34.1610Y 7.000 07/06 103.084 /094 6.547 /543 35.00 36.00 6.893 /907 34.7311Y 6.558 /554 38.00 40.00 6.923 /94712Y 6.569 /565 41.00 43.00 6.953 /97713Y 6.581 /577 44.00 45.00 6.983 /99714Y 6.592 /588 48.00 49.00 7.023 /03715Y 6.603 /599 51.00 52.00 7.053 /06720Y 6.659 /654 53.00 55.00 7.113 /12725Y 6.715 /710 54.00 55.00 7.108 /12230Y 6.000 2/26 90.065 /085 6.771 /766 35.50 37.50 7.121 /146
Copyright ©2001 Ian H. Giddy Swap Financing 8giddy.org
A Currency Swap
FMCFMC BANKBANK
GBP 100
USD 150
Company issues dollar debt, but wants sterling financing
so exchanges its dollars for sterling equivalent
at today’s spot exchange rate
USD 150
Copyright ©2001 Ian H. Giddy Swap Financing 10giddy.org
Three Parts of a Currency Swap
FMCFMC BANKBANK
GBP 100
USD 150
FMCFMC BANKBANK
Fixed GBP 12%
Floating USD
Libor s.a.
FMCFMC BANKBANK
GBP 100
USD 150
Copyright ©2001 Ian H. Giddy Swap Financing 11giddy.org
Valuation Off-market swaps Cancellation Counterparty exposure Hedging swap positions
Swaps: Applications of Valuation
B
O
N
D
FRN
ABBABB BVBBVB
Fixed ECU 7%
Floating
ECU Libor
Copyright ©2001 Ian H. Giddy Swap Financing 12giddy.org
Valuation of an Interest Rate Swap
Valuation of the swap is based on discounting the cash flows over its life.
VALUE OF
INTEREST RATE
SWAP
PRICE OF
BOND WITH
N YEARS
TO RUN
PRICE OF
MONEY MARKET
INSTRUMENT
WITH
M DAYS TO RUN
= -
A RECEIVE-FIXED, PAY-FLOATING SWAP:
Copyright ©2001 Ian H. Giddy Swap Financing 13giddy.org
Labatt’sLabatt’s BankBank
Fixed USD 9%
Floating USD
Libor s.a.
Swap Valuation
The value of a swap equals the "net worth" of the swap cash flows expressed as a balance sheet
Labatt’s swap:Receive floating, pay fixed
“ASSETS”
Receiving floating6-mo US$ LiborSemi-annual for 5 yearsPrincipal US$100mLike a 5-year US$ FRN
“LIABILITIES”
Paying fixed 9%Annual for 5 yearsPrincipal US$100mLike a 5-year bond
Copyright ©2001 Ian H. Giddy Swap Financing 14giddy.org
At Inception, Standard Swap is Worth Zero
Labatt’s swap:Receive floating, pay fixed
“ASSETS”
Receiving floating6-mo US$ LiborSemi-annual for 5 yearsPrincipal US$100mLike a 5-year US$ FRN
Value=$100m
”LIABILITIES”
Paying fixed 9%Annual for 5 yearsPrincipal US$100mLike a 5-year bond
Value=$100m
Copyright ©2001 Ian H. Giddy Swap Financing 15giddy.org
Two Years Later, Rates Have Fallen...
Labatt’s swap:Receive floating, pay fixed
“ASSETS”
Receiving floating6-mo US$ LiborSemi-annual for 3 yearsPrincipal US$100mLike a 3-year US$ FRN
Value still $100m
”LIABILITIES”
Paying fixed 9%Annual for 3 yearsPrincipal US$100mLike a 3-year bond
Swap rate = 6%Value=$108m
Copyright ©2001 Ian H. Giddy Swap Financing 16giddy.org
Interest Rate Swap Calculator value date: 22-Sep-96
swap structure 1 effective date 27-Sep-96
interpolation method 2 maturity date 27-Sep-00
date generation 1 margin (+ -) floating index 0.00%
holidays 6 current reset rate
Pay Leg fixed coupon rate 8.00%
date convention 2 notional principal 1,000,000
cash flow frequency 3
accrual method 2 statistic 1
Receive Leg
date convention 2 Result 10269.29782
cash flow frequency 2 last update 9/22/96 17:07
accrual method 3
next good business day
forward from effective date
quarterly
actual/ 360
pay floating and receive fixed
cubic spline
actual/ 365 (actual)
next good business day
semi-annual
New York
fair value
Calculate
Swap Valuation Spreadsheet(This Uses the Zero-Coupon Approach)
Copyright ©2001 Ian H. Giddy Swap Financing 17giddy.org
Termination of Swaps
Basic principle: cancel or neutralize all future swap cash flows
What are the alternative ways in which this can be done?Offsetting swap with same counterpartyOffsetting swap with new counterpartyCancel swapReassign swap.
Copyright ©2001 Ian H. Giddy Swap Financing 18giddy.org
Default Risk in Swaps
In-the-money swaps entail credit risk—the value of the swap is the amount owed
At initiation, credit risk exposure is based on the potential value of the swap, which depends on potential changes in interest rates and currencies
Credit risk can be mitigated by collateralization and by netting of bilateral exposure.
Copyright ©2001 Ian H. Giddy Swap Financing 19giddy.org
How Swaps are Quoted
US$ INTEREST RATE SWAPS CURRENCY SWAPSYears Treasury Curve
BenchmarkSemi-Annual
Yields
Spread [b.p.]to AA
Counterparties
DEM/USDAnnual
JPY/USDAnnual
23457
10
8.028.018.018.028.138.14
62-6670-7572-7678-8177-8178-81
7.00-7.107.00-7.107.00-7.107.00-7.107.02-7.127.02-7.12
5.35-5.455.35-5.455.35-5.455.35-5.455.40-5.505.45-5.53
CURRENCY SWAPSYears CHF/USD
AnnualGBP/USD
AnnualECU/USD
AnnualAUD/USD
Annual23457
10
6.60-6.706.20-6.306.05-6.106.00-6.105.95-6.055.95-6.05
12.80-12.9012.35-12.4511.90-12.0011.75-11.8511.50-11.6011.26-11.36
9.20-9.309.15-9.259.10-9.209.05-9.159.05-9.159.05-9.15
15.65-15.8015.25-15.4015.1515.3014.78-15.13
NANA
Copyright ©2001 Ian H. Giddy Swap Financing 22giddy.org
Swap Spreads are Tied to TED Spreads
Treasury
bonds
Treasury
bills
TED
spread
Swap
spreadInterest rate
swaps
Corporate
bonds
FRAs and
futures
Libor:
E$ market
+
+
=
=
LONG TERM
SHORT TERM
Copyright ©2001 Ian H. Giddy Swap Financing 23giddy.org
FRAs and Friends
FRA: A contract to lock in a rate for a future period
Futures: A daily recontracted FRA Swap: A strip of FRAs at a blended rate
Copyright ©2001 Ian H. Giddy Swap Financing 24giddy.org
Estimating the Cost of Funds in a Swap
Problem: Convert existing 4 year floating rate dollar sub-LIBOR funds into fixed rate sterling funds. Pay sterling fixed annually; receive dollar floating semi-annually.
What is the all-in sterling cost? Swap Quote Indication Sheet
Swap Quote: Standard four year sterling/dollar swap quote would be sterling 11.90-12.00 against 6 month $ LIBOR flat. If client wants a non-standard swap such as sterling fixed against 6-month $ LIBOR-25, bank might quote: “You pay sterling 11.73% annual, we pay 6-mo LIBOR less 25."
Years Treasury Yields Spread [s.a.] GBP/USD [ann]2345
8.028.018.018.02
62-6670-7572-7678-81
12.80-12.9012.35-12.4511.90-12.0011.75-11.85
Copyright ©2001 Ian H. Giddy Swap Financing 25giddy.org
A Standard Currency Swap
FMCFMC BANKBANK
GBP 100
USD 150
FMCFMC BANKBANK
Fixed GBP 12%
Floating USD
Libor s.a.
FMCFMC BANKBANK
GBP 100
USD 150
Copyright ©2001 Ian H. Giddy Swap Financing 26giddy.org
FMCFMC BANKBANK
Fixed GBP 12%
Floating USD
Libor s.a.
Estimating the Cost of Funds in a Swap
Fixed GBP 11.73%
Floating USD
Libor s.a.
-0.25%
Floating USD
Libor -0.25%
Copyright ©2001 Ian H. Giddy Swap Financing 27giddy.org
Basis Point Conversion:The quote of Sterling 11.73% annual fixed payments
against LIBOR - 25 required conversion from dollar basis points to sterling basis points.
How to do this:1. Find present value of 25 U.S. dollar basis points paid
semi-annually at 8.77% interest.
2. Find the sterling annuity equivalent of 82.84 at the sterling swap rate of 12.00% paid annually.
Annuity value of 82.84 @ 12% [annual] = 27.27bpGBP
Estimating the Cost of Funds in a Swap
PV bp bpUS tt[ ]
.
( ..$25
12 5
1 4 385%)82 84
1
8
Copyright ©2001 Ian H. Giddy Swap Financing 28giddy.org
Kalamazoo needs $60 million. Receiving Euro, the European Currency unit.
Whose Zoo?
K’zoo could borrow five-year money at semi-annual LIBOR + 3/4%, and Dresdner agreed to enter into a currency swap with the company. Diagram the swap with little boxes. What would K’zoo's cost of capital be if it
did the swap? (US 5-yr swap rate = 10%) Effect of a rise in ST & LT rate? How would a 0.75% up front commitment
fee affect K’zoo's cost of capital?
DRESDNERSWAP
QUOTATIONS
Years
Euro Fixedvs USD Libor
sa23457
10
8.00 - 8.108.00 - 8.108.20 - 8.308.20 - 8.358.25 - 8.358.40 - 8.50
Copyright ©2001 Ian H. Giddy Swap Financing 29giddy.org
Kalamazoo
K’ZOOK’ZOO DRESDNERDRESDNER
Fixed ECU 8.35%
Floating USD
Libor s.a.
Fixed EURO 8.35+0.73%=9.08%
Floating USD Libor +0.75%
Floating USD
Libor +0.75%
75bpUSD=73bpEuro; swapped cost is 9.08% ST rate: no effect. LT rate rise: value of swap will
change by duration. K’zoo gains, Dresdner loses. Amortize the up-front fee of 0.75% over the period of the
financing, and add it to swapped cost..
Euro revenues
Copyright ©2001 Ian H. Giddy Swap Financing 30giddy.org
BP Conversion: Excel Spreadsheet
Basis Point ConversionEnter the blue numbers
First currencyNUMBER OF BASIS POINTS (US$) 75US$ INTEREST RATE 10.00%NUMBER OF PAYMENT PERIODS PER YEAR 2NUMBER OF YEARS 5
PRESENT VALUE OF BASIS POINTS (US$) 290
Second currencyEuro INTEREST RATE 8.35%NUMBER OF PAYMENT PERIODS PER YEAR 1NUMBER OF YEARS 5
NUMBER OF BASIS POINTS (Euro) (ANNUITY EQUIV) 73.2
Basis Point ConversionEnter the blue numbers
First currencyNUMBER OF BASIS POINTS (US$) 75US$ INTEREST RATE 10.00%NUMBER OF PAYMENT PERIODS PER YEAR 2NUMBER OF YEARS 5
PRESENT VALUE OF BASIS POINTS (US$) 290
Second currencyEuro INTEREST RATE 8.35%NUMBER OF PAYMENT PERIODS PER YEAR 1NUMBER OF YEARS 5
NUMBER OF BASIS POINTS (Euro) (ANNUITY EQUIV) 73.2
Copyright ©2001 Ian H. Giddy Swap Financing 31giddy.org
INVESTORINVESTOR
Asset Swaps: The Same Idea
Fixed GBP 12.73%
Investor buys cheap fixed-rate bond But wants a floating-rate note.
Copyright ©2001 Ian H. Giddy Swap Financing 32giddy.org
INVESTORINVESTOR BANKBANK
Fixed GBP 12%
Floating USD
Libor s.a.
Asset Swaps: The Same Idea
Fixed GBP 12.73%
Floating USD
Libor s.a.
+0.75%
Fixed GBP 12.73%
Copyright ©2001 Ian H. Giddy Swap Financing 33giddy.org
Currency Swaps vs Long-dated Forwards
SF
SFSF
£
£
LONG-DATED FORWARD
SPOTRATE
End-period exchange occurs atforward rate, which representsthe spot rate plus thecumulative interest tatedifferential.
FORWARDRATE
Copyright ©2001 Ian H. Giddy Swap Financing 34giddy.org
Currency Swaps vs Long-dated Forwards
SF SF
SFSFSF
£ £
££
LONG-DATED FORWARD CURRENCY SWAP
SPOTRATE
SPOTRATE
PERIODICINTERESTRATEDIFFERENTIAL
End-period exchange occurs atforward rate, which representsthe spot rate plus thecumulative interest tatedifferential.
End-period exchange occurs atspot rate , since thecumulative interest tatedifferential is paid duringinterim periods.
FORWARDRATE
SPOTRATE
Copyright ©2001 Ian H. Giddy Swap Financing 35giddy.org
A Basis Swap
Fuji
Bank
Fuji
Bank CitiCiti
Fuji makes a loan at Prime + Spread, but gets funding in the Eurodollar interbank market
Prime + Spread
Floating
Libor
Copyright ©2001 Ian H. Giddy Swap Financing 36giddy.org
A Basis Swap
Fuji
Bank
Fuji
Bank CitiCiti
Prime
Floating
Libor
Fuji makes a loan at Prime + Spread, but gets funding in the Eurodollar interbank market
Fuji wants to lock in its spread, so does a basis swap with Citibank
Prime + Spread
Floating
Libor
Copyright ©2001 Ian H. Giddy Swap Financing 37giddy.org
Basis Swap Quotations
GovPX/GGB GovPX Index Basis Swaps vs 3M LIBOR 8/6/96 Page 262 Prime vs LIBOR Fix LIBOR Fed Funds vs LIBOR
Term Pay Prime Rec Prime 1M 5 7/16 Term Pay FF Rec FF1Y P- 271 P- 267 3M 5 1/2 1Y FF+ 21 1/2 FF+ 23 1/22Y P- 268 P- 264 6M 5 11/16 2Y FF+ 23 FF+ 253Y P- 267 P- 263 Mkt LIBOR 3Y FF+ 23 1/2 FF+ 25 1/24Y P- 265 P- 261 1M 5 7/16 4Y FF+ 24 1/2 FF+ 26 1/25Y P- 263 P- 259 3M 5 1/2 5Y FF+ 25 FF+ 277Y P- 260 P- 255 6M 5 11/16 7Y FF+ 26 FF+ 2810Y P- 259 P- 254 10Y FF+ 26 FF+ 28 3M T-Bill vs LIBOR Prime 8.25 CP vs LIBOR
Term Pay T-Bill Rec T-Bill Term Pay CP Rec CP1Y B+ 37 B+ 40 Fed Funds 1Y CP+ 4 3/4 CP+ 6 3/42Y B+ 39 B+ 42 5 1/16-1/8 2Y CP+ 5 CP+ 63Y B+ 40 1/2 B+ 43 1/2 3Y CP+ 5 1/4 CP+ 6 1/24Y B+ 43 B+ 47 3M T-Bill Yld 4Y CP+ 5 1/2 CP+ 6 3/45Y B+ 44 B+ 48 5.171-166 5Y CP+ 6 CP+ 77Y B+ 45 B+ 49 7Y CP+ 6 1/2 CP+ 810Y B+ 46 B+ 50 30D CP 5.32 10Y CP+ 7 CP+ 9
Alert Line
Copyright ©2001 Ian H. Giddy Swap Financing 38giddy.org
A Basis Swap
Fuji
Bank
Fuji
Bank CitiCiti
Prime-263
Floating
3-mo Libor
Fuji makes a 3-year loan at Prime + 1%, and swaps at P-2.63%
Fuji thus locks in a spread of 3.63%
Prime + 1%
Floating
Libor flat
Copyright ©2001 Ian H. Giddy Swap Financing 39giddy.org
Commodity Swap Example: Qantas
QANTASQANTAS
US$ LIBOR +1/4%
SEMIIANNUAL
PASSENGER
REVENUES
FUEL
COSTS
Copyright ©2001 Ian H. Giddy Swap Financing 40giddy.org
Example: Qantas
QANTASQANTAS PARIBASPARIBAS
US$ LIBOR +1/4%
SEMIIANNUAL
PASSENGER
REVENUES
FUEL
COSTS
Copyright ©2001 Ian H. Giddy Swap Financing 41giddy.org
Example: Qantas
QANTASQANTAS PARIBASPARIBAS
US$ LIBOR +1/4%
SEMIIANNUAL
US$ FIXED 10%
+/- $30 M X (1-%CH AW INDEX)
US$ LIBOR +1/4%
SEMIIANNUAL
Copyright ©2001 Ian H. Giddy Swap Financing 42giddy.org
Summary
Mechanics of swaps Valuation of swaps Credit risk of swaps Pricing swaps Hedging swaps The all-in cost of swap financing Swap around the clock
Copyright ©2001 Ian H. Giddy Swap Financing 44giddy.org
Ian H. Giddy
Stern School of Business
New York University
44 West 4th Street, New York, NY 10012, USA
Tel 212-998-0332
Fax 917-463-7629
http://giddy.org