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The role and importance of swaps
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Financing: fixed and variable rates.The role of swap contracts.
19 Novembro 2013
Presentation by:
• Paulo Martins 65929 METI
• António Junior 57699
METI
• Vilma Jordão 59056 MEIC
• António Alves 65872
MEIC
Swaps
• Has Grown alot in the past 20 years
• Protection from financial risks
• Balancing operational costs
• Financing in moments of low market liquidity
Swap Dealer
• Swap contracts aren’t made with well defined rules.
• There is always some entity in the midle called Swap Dealer.
Types of Swaps
• Interest Rate Swaps
• Currency Swaps
• Comodity Swaps
• Credit Default Swaps
• Equity Swaps
Interest Rate Swaps
• In this kind of swap there is an exchange between fixed and variable interest rates.
• It implies a great risk and results in great losses for one of the parts.
• One of the parts pays the difference between the fixed and the variable interest rate.
Interest Rate Swaps - Example
Two entities (α and β) need funding.
• α wishes to get financed with a variable interest rate.
• β wishes to get financed with a fixes interest rate.
Interest Rate Swaps - Example
Fixed rates Variable rates
Company α 6% Euribor 3 months + 1.25%
Company β 7% Euribor 3 months + 1.50%
α gets a loan of 10 m€, at a fixed rate of 6%, for 10 years;
β gets a loan of 10 m€, at the variable rate Euribor 3 months + 1.5%, for 10 years.
Rates offered to company α and β
Interest Rate Swaps - Example
1. α will have a loan at a variable rate, as wished, with a rate of: Euribor 3months + (6%-5.25%) = Euribor 3month + 0.75%
2. β will have a loan at a fixed rate, with a rate of: 5.25%+(Euribor 3months+1.5%)-Euribor 3 months = 6.75%
Interest Rate Swaps - Example
If α had a loan at a variable rate, it would pay Euribor 3months + 1.25%, meaning a profit of 0.5%;If β had a loan at a fixed rate, it would pay 7%, meaning a profit of 0.25%.
Taxa Valor Juro
Empresa α 4.5% € 450 000
Empresa β 5.25% € 525 000
Currency Swaps
This kind of swap consists on the deal between two
entities, in the exchange for the obligations of a loan in
one currency for another loan obligations of equal net
value in another currency.
Currency Swaps - Types
• FX-Swaps
• Back-to-back
• Cross currency swaps
Currency Swaps - Example
1M
1.4M
Currency Swaps - Example
Commodity Swaps
The buyer and the seller both accept to exchange periodic payments, one with a fixed value and the other with a variable value, calculated over a predeterminated commodity amount
Commodity Swaps – Advantages and Goals
• Allow to establish a limit to the volatility of the commodity prices
• This way the raw material price stays immune to the market price flutuations
Commodity Swaps - Example
Credit Default Swaps
CDS Seller CDS Buyer
Credit Default Swaps
Credit Default Swaps
CDS Seller CDS Buyer
-1.000.000€+49.200€ x 3+1,049.200€
-38.600€ x 4
42.900€
1.000.000€ - Valor actual das obrigações
Equity Swaps
In an equity swap, two parties agree to exchange a set of future cash flows periodically for a specified period of time.
Equity Swaps - Example
• Notional Principal: $100 million• Alpha Fund pays: Total returns on the S&P 500
Index• Goldman Sachs pays: Fixed 6%• Swap maturity: 3 years• Payments to be made at the end of every six
months, that is, 30th June and 31st December
Equity Swaps - Example
Alpha Pays Goldman Pays
30th June
Return on index = 2600/2500 = 4% = 100,000,000*0.04 = $4,000,000
=100,000,000 * 182/365 * 6% =$2,991,780
31st December
Return on index = 2570/2600 = -1.154% Alpha pays nothing.
Fixed payment=100,000,000 * 183/365 * 6%=$3,008,219 Floating payment= 100,000,000*0.01154= $1,154,000 Total payment= $3,008,219+$1,154,000=$4,162,219
Let’s see how the cash flows turn out in the first year.At the beginning, the S&P Total Return Index was at 2500 level, on 30th June it was 2600, and on 31st December it was at 2570.
Thank You Questions?