Interest Rate & Currency Swaps, (One Day)

Interest rate and currency swaps have widely been used as hedging and trading instruments for nearly three decades. Since the financial crisis emphasis has been placed on price transparency, clearing and reporting. This is not suprising. Whilst these products make ideal tools to offset risk they also facilate leverage and may increase unreported exposures.

This course explains how the products work and how they are priced and evaluated, their main uses and the all important question unhedged risk. It is designed for staff working in the treasury and also those who work in risk and administration roles supporting the dealing team.

Training will be in a workshop format. This will include a mixture of presentation and case study material. The course is designed for up to ten staff.

Below is a summary of the workshop. The content has been placed in a logical sequence and addresses the products, mechanics, methodologies, practical uses and risks.

**Swaps: **An introduction to what they are and how the market has changed.

- Market development
- Bilateral trades
- Potential credit exposures
- Regulation, trading, clearing and reporting

**Interest rate swaps:** The calculations and payments made when you enter an interest rate swap.

- Nominal or notional amounts fixed and floating payments
- The swap yield curve, swap prices, pay and receive rates
- How dealers make money and how much that can be
- How interest rates influence the value of a swap and the profit or loss

**Discounting and present value:** Swap pricing and valuation relies on discounting future cash flows. This can be done using the appropriate market interest rates.

- Discount factors and their use
- The zero coupon model
- Cash, swap and futures rates
- Swap spreads

**Profits & losses:** Valuation leads to profits and losses on individual trades. These profits and losses can be realised in a variety of ways.

- Is a profit or loss real money?
- Cancellation, matching, novation
- How swaps are valued

**Hedging with swaps: **Swaps are used to hedge fixed and variable interest rates, in theory this is straight forward but problems are often encountered.

- Matching the hedged item, forward starting, amortising and accreting swaps
- How banks hedge fixed rate retail funding
- How companies hedge variable rate borrowing
- How borrowing in the bond market is hedged
- Asset swaps, what they are and how they work with premium and discounted bonds
- How asset swap prices indicate relative value
- How banks hedge fixed rate loan portfolios
- The risks swaps don’t hedge

**Swaps and credit risk: **The credit risk swaps can create is a concern for banks and regulators alike. This risk can be difficult to manage and its management can create further operational and liquidity risks.

- Why swaps create credit risk
- How counterparty credit risk can run in both directions
- Collateral and margining to reduce credit exposures

**Swap trading: **Dealers can use swaps to trade interest rate risk, the shape of the yield curve and swap spreads.

- Outright trades
- Spread (yield curve trades)
- Trades involving the swap spread

**Foreign Exchange: **This huge market is dominated by the major banks and currencies. It is estimated that 70%-90% of trading is speculative.

- Market volumes and market shares
- Infrastructure & how foreign exchange risk can arise
- Spot deals and what influences the spot rate
- Forward foreign exchange and the forward rate
- Forward points
- Foreign exchange swaps and their use

**Cross currency swaps: **These are widely associated with hedging longer dated assets or liabilities. They normally involve principal exchange at the start and at maturity. The credit risks that can be incurred reduce their usage.

- Fixed/fixed currency swaps
- Fixed/floating currency swaps
- Floating/floating currency swaps

**Basis swaps:** These swaps involve the exchange of two different indices. They can therefore be used to hedge risks incurred on the balance sheet. The market price of basis swaps can have important implications for the returns on the transactions they hedge.

- Examples of basis swaps and their prices
- How a cross currency basis swaps can influence asset swap returns
- How cross currency basis swaps can influence forward foreign exchange prices

Learn about the following: What interest rate swaps are and how they work. How dealers make (and lose) money with swaps. How swaps can be used to manage risk. The key risks with swaps. How these risks can be controlled.

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.