Foundations of Multinational Financial Management Alan Shapiro John

Foundations of Multinational Financial Management Alan Shapiro John Wiley & Sons Power Points by Joseph F. Greco, Ph. D. California State University, Fullerton 1

Special Financing and Interest Rate Risk Management Vehicles Chapter 13 2

INTEREST RATE AND CURRENCY SWAPS I. INTEREST RATE AND CURRENCY SWAPS A. INTEREST RATE SWAPS 1. Definition an agreement between 2 parties to exchange US$ interest payments for a specific maturity on an agreed notional amount. 3

THE CLASSIC SWAP a. Notional principal: a reference amount used only to calculate interest expense but never repaid. b. Maturities: less than 1 to over 15 years 4

THE CLASSIC SWAP 2. Types a. Coupon swap b. Basis swap 3. Usage: to reduce risk potential and costs. 5

THE CURRENCY SWAP B. Currency Swaps 1. Definition two parties exchange foreign-currencydenominated debt at periodic intervals. 2. Purpose: similar to parallel loan 6

THE CURRENCY SWAP 3. Differences of a Currency Swap: a. Currency swap is not a loan b. No interest expense; no balance sheet entry c. The right to offset any nonpayment is more firmly establish 7

THE CURRENCY SWAP 4. Similarities between Interest Rate and Currency Swaps a. Avoid exchange rate risk b. Exchange rate is only a reference to determine amounts exchanged 5. Economic Benefits of Swaps when arbitrage prohibited, they provide long-term financing. 8

INTEREST RATE FORWARDS AND FUTURES I. Forward and futures contracts: II. - three types used to manage interest rate risk III. A. Forward forwards IV. B. Forward rate agreements V. C. Eurodollar futures 9

INTEREST RATE FORWARDS AND FUTURES A. Forward forwards 1. a contract that fixes an interest rate today on a future loan or deposit. 2. Contract conditions: - specific interest rate - principal amount of future loan - start and ending dates of future interest rate period 10

INTEREST RATE FORWARDS AND FUTURES B. Forward rate agreements (FRAs) C. 1. cash-settled, D. 2. over-the-counter forward contract 3. company fixes an interest rate E. applied to a specified future interest period on a notional amount. 11

INTEREST RATE FORWARDS AND FUTURES C. Eurodollar Futures D. 1. a cash-settled futures contract for E. a 3 -month eurodollar deposit F. paying LIBOR G. 2. Contracts traded on: H. a. Chicago Mercantile Exchange I. b. London International Financial Futures Exchange J. c. Singapore International Monetary Exchange 12