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Learn about the following: What currency swaps are. How currency swaps can be used. How currency swaps are priced. The risks that currency swaps can produce.
Learn about the following: What a currency basis swap is. How currency basis swaps work. How to read the price quotation. How these swaps influence the price of other deals.
12th October 2009
Introduction Foreign exchange is defined as "a claim to a foreign currency payable abroad and may be funds held, bills or cheques". A foreign exchange transaction is, "a contract agreed today between two parties to trade an agreed amount of one currency for an agreed amount of another currency on a future date". When you travel you may be familiar with buying currency at the airport. Because the sums involved are small and paper money is exchanged the differences between buying and selling prices can be wide. You may also be unfortunate enough to pay a dealing fee. Banks, corporates and speculators deal in the professional market. Trades are transacted across electronic platforms and each trade can run into millions of dollars. As a consequence dealing spreads are very narrow and the money is exchanged by credits and debits to bank accounts. Let's find out about the spot and forward markets and the risks involved.
20th September 2009
When two parties agree to enter an interest rate swap (IRS) one party pays a fixed rate of interest and the other a variable rate. The variable rate is often referenced to Libor or Euribor. The interest payments are based on a notional amount, (with IRS no principal amount changes hands). In the market there are conventions for calculating the interest payments. For example USD IRS use an annual actual 360 interest rate calculation for the fixed payment and a quarterly or semi annual actual 360 calculation for the floating payment. Maturities are normally between 2 and 20 years but it is possible to trade swaps that have maturities exceeding 50 years. Customers using swaps to hedge can expect a dealer to quote a dealing spread. The dealer will want to receive a higher fixed rate than the one they pay. It's one way the dealer makes money from trading. Dealers will insist before trading that the appropriate documentation is signed. For swaps standard documentation is provided by the International Swaps and Derivatives Association (ISDA). This document is called a master agreement. It covers all swaps between the two parties. Individual transactions are then agreed by confirmation which refers to the master agreement.