FI - Overview of Cross Currency Swaps Via Swap Pricer

Overview of Cross Currency Swaps
via Swap Pricer

(vincent.chia@thomsonreuters.com)

Last updated on 23
th
Jan 2014

2

Overview of Cross Currency Swaps via Swap Pricer
Agenda
1. What is a Cross Currency Swap, CRS/CCS ?

2. How to get indicative data on CRS/CCS rates ?

3. How to price a new CRS/CCS deal ?

4. How to mark-to-market an existing CRS/CCS deal ?

5. Conclusion

What is a

Cross Currency Swap ?

4

1. Loans : to borrow at a lower interest rate ?
Interest Rate Swap may give you the flexibility to switch from fixed to float,
or vice versa, for a single currency.
But, Cross Currency Swap provides another degree of freedom.
The currency to pay may be different from the currency to be received.

Interest Rate Swap, IRS
USD
floating
rate
USD
Fixed
rate
Cross Currency Swap, CRS or CCS
USD
floating
rate
USD
Fixed
rate
KRW
floating
rate
KRW
Fixed
rate

5

1.1 Cross Currency Swap Basics
A Cross Currency Swap (EUR/JPY) has the features of an Interest Rate Swap while
giving each counterparty access to a different foreign currency.

For example,
Currency principal amounts may be exchanged at the outset and re-exchanged at
maturity at the same Exchange Rates.

As a result, Exchange Risk on the principal amounts is eliminated, while retaining
1. the Interest Rate Exposure and
2. Currency Exposure on the Interest flows and
3. on the Net Result of any transaction that has been closed out prior to Maturity.

6

1.2 Different Combinations
These cashflows (interest payments) could be:
1. Fixed against floating
2. floating against floating
3. Fixed against Fixed
4. Linked with the Returns on an Asset
(example, Standard Chartered Banks Islamic Swap)

KRW Principal
KRW Principal
Floating KRW Interest payments

7

1.3 Cross Currency Swap, graphically

USD fixed rate
5.86%
KRW floating rate

KRW fixed rate
3.7%
USD floating rate
Middle Earth

KRW Zero coupon curve
or discount factors
USD Zero coupon curve
or discount factors

Currency
Basis swap
spread

8

1.4.1 Fixed/Fixed Cross Currency Swap vs FX Swap
Notional : USD 1 million
: KRW 920 million
Tenor : 5 years
FX ref : 920 (same rate : begin & end)
USD fixed : 4.9%
KRW fixed : 5.4%

Corp pays KRW 5.4%
Corp receive USD 4.9%

Corp receives KRW 920 mio
Corp pays USD 1 mio

Swap
Bank
Corporate
Corp pays KRW 920 mio
Corp receives USD 1 mio
Notional : USD 1 million
: KRW 920 million
Tenor : 5 years

USD fixed : 0%
KRW fixed : 0%

Corp receives KRW 920 mio
Corp pays USD 1 mio

Corporate
Corp pays KRW at 5Y outright rate
Corp receives USD 1 mio
Now
5 years
Swap
Bank
Difference in FX rate
= swap points

9

1.4.2 Fixed/Fixed Cross Currency Swap vs FX Swap

time

+
-

time
+
-

FX Swaps = Near leg + Far leg
Cross Currency Swaps = S (FX swaps) assuming same frequency payment
Borrow in KRW interest rate
Lend in USD interest rate

= e.g. borrow KRW & lend USD
Cross Currency Swaps = e.g. long USD bond & short KRW bond
Long USD bond
Short KRW bond

How to get indicative data

on CRS or CCS rates ?

11

2.1 How to get quotes on Cross Currency Swap ?

12

2.2.1 How to understand Cross Currency Swap quote ?

KRW 2.025%
semi-annually
USD 6 month
Libor flat

Swap
Desk
Corporate
Corporate pays KRW fixed

KRW 1.425%
semi-annually

Swap
Desk
Corporate
Corporate receives KRW fixed
USD 6 month
Libor flat
Ignoring the exchange of principals for simplicity

For 5Y CRS

13

2.2.2 How to understand Currency Basis Swap quote ?

USD
6 month Libor flat

Swap
Bank
Corporate

SGD 6M SOR
- 9 bp

Swap
Bank
Corporate
Corporate receives SGD 6M SOR
USD
6 month Libor flat
Corporate pays SGD 6M Swap Offer Rates
SGD 6M SOR
+1 bp
For 1Y CBS,

14

2.2.3 Understand Currency Basis Swaps from CRS & IRS

CRS
Corporate

Swap
Bank

Market

IRS
SGD Fixed CRS
tenor
USD
6 month Libor flat
SGD Fixed IRS
tenor
SGD 6 month
SOR flat
SGD 6 month SOR +CBS

USD
6 month Libor
flat

Market
Currency
Basis
Swap

Assume the same notional amount for all structures, in yields perspective :

Example, Fixed rate of CRS
tenor
= Fixed rate of IRS
tenor
+ CBS
tenor

( CBS : Currency Basis Spread )

15

2.2.4 Understand Currency Basis Swap from CRS and IRS
Assume the same notional amount for all structures, in yields perspective :
Fixed rate of CRS
1Y
= Fixed rate of IRS
1Y
+ CBS
1Y
where CBS : Currency Basis Spread
0.519% = 0.508% + (1.1/100)%

IRS CBS
in bp
CRS
Prices are presented from the
Brokers Swap Desk perspective,
that is, ask followed by bid

16

2.2.5 Bird-eye View on Basis Spread & Currency Basis Spread

Term
Yield(t
0
) %
Tenor

Term
Tenor
Yield(t
0
) %
CBS(t
0
)

SGD fixed / SGD 6M SOR IRS Curve

SGD fixed / USD floating CRS Curve

17

2.2.6 Usefulness of CBS : To construct the full FX outright Term Structure
For the shorter term of the FX outright term structure (till 1 year) , we may use
spot FX and swap points to construct it.

For the longer term of the FX outright term structure (more than 1 year) , we will
use CBS spreads and other relevant information to construct it.
USD/KRW curves

Term

swap points
USD/KRW outrights curve
1 year

USD/KRW CBS spread curve
30 years

0

18

2.2.7 Usefulness of CBS : To construct the full FX outright Term Structure
USD/KRW curves

Term

swap points
1 year

10 years

0

19

2.2.8 Construct the full FX outright Term Structure
CBS spread term structure
USDs discount factors
KRWs discount factors
Spot USD/KRW

long term
USD/KRW
swap point
+

Spot
USD/KRW

long term
USD/KRW
outrights

short term USD/KRW
swap point

How to price

a new CRS/CCS deal ?

21

3.1 Cross Currency Swap Model
The model provides two way for valuating a Cross Currency Swap. CRS or CCS.

1. Spot : CBS adjustment are not applied (using 2 or more zero-coupon curves)
i. Discount all expected cashflows using their own zero-coupon curves
(e.g. USD, KRW)
ii. Convert the second currency to the first currency using FX spot rate.

2. FX Curve : CBS adjustment are applied (using only 1 zero-coupon curve)
< Financial Market preferred method and is adopted by Thomson Reuters
in the design of Currency Swap Pricer >

For example, CBS quotes are applied for first leg :
i. Convert all expected cashflows of first leg into the currency of the
second using all the relevant FX outrights (that is, adjusted by CBS).
ii. Discount all cashflows (include the converted ones) using the zero coupon
curve of the second leg.

Note
CBS spread adjustment : Currency Basis Swap spread adjustment

22

3.1.1 Cross Currency Swap Pricing Methodology
CBS quotes are not applied CBS quotes are applied
A few Zero Curves
will be used for
discounting purpose

Pricing of Cross Currency Swap

Only 1 Zero Curves will be used for
discounting purpose.
(first legs or second legs)

23

3.1.2 Currency Swap Pricing with 2 curves & 1 FX conversion

time
1. Get forecasted future USD cashflows (floating rate) from forward curve implied out
from current US zero coupon rates. Present value the USD cashflows.

time
2. Guess a reasonable KRW Fixed rate. Generate the KRW cashflows. Present value
the KRW cashflows.

+
-
+
-

NPV
USD
via
Spot USD/KRW
NPV
KRW

NPV
USD

3. Check the total present value from two cashflows but in only 1 currency,
if the value is not equal to zero, go back to step 2.

24

3.2.1 Currency Swap Pricing Methodology
CBS quotes are not applied CBS quotes are applied
2 or 3 Zero Curves
will be used for
discounting purpose
Only 1 Zero Curves will be used for
discounting purpose
<Thomson Reuters approach>
(first legs or second legs)

Pricing of Cross Currency Swap
(tenor that is not standard,
example, 25m, 25 months)

Calculate CBS quotes from
Market Currency Swaps Quotes
Market Interest Rate Swaps Quotes
(standard tenors)

Market CBS quotes

25

3.2.2 Currency Swap Pricing with 1 zero coupon curve

time
1. Get forecasted future USD cashflows (floating rate) from forward curve implied out
from current US zero coupon rates. Present value the USD cashflows.

time
2. Guess a reasonable KRW Fixed rate. Generate the KRW cashflows.
Convert each with its relevant FX outrights. Present value the USD cashflows.

+
-
+
-

NPV
USD

3. Check the total present value of the new set of cashflows, if the value is not equal
to zero, go back to step 2.

CBS spread translated to relevant FX outrights

26

USD/KRW curves

Term

For the shorter term of the FX outright term structure (till 1 year) , we may use
spot FX and swap points to construct it.

For the longer term of the FX outright term structure (more than 1 year) , we will
use CBS spreads and other relevant information to construct it.
swap points

1 year


30 years

0

27

CBS spread term structure
USDs discount factors
KRWs discount factors
Spot USD/KRW

long term
USD/KRW
swap point
+

Spot
USD/KRW

long term
USD/KRW
outrights

short term USD/KRW
swap point

28

3.2.5 Summary : Cross Currency Swap Pricing Methodology

29

3.3 Locate Currency Swap calculator and understand the calculation

Received Leg
USD 3M Libor flat
Paid Leg
SGD Fixed rate 0.5971%
semi-annually

Swap
Bank
Corporate
For 5Y CRS,

30

3.4.1 Target Markets for Cross Currency Swaps, CRS or CCS
There are 4 clear target markets :

1. Investors who wish to purchase foreign assets but seek to eliminate foreign
currency exposure (The search for higher yield)

2. Debt issuers who can achieve more favourable rates by issuing debt in foreign
currency (The search for lower cost of capital)

3. Liability managers seeking to create synthetic foreign currency liabilities.
( Example : Currency loss on the assets will be offseted by
a corresponding Currency gain on the Cross Currency Swap)

4. Convert from float to fixed or vice versa in Structured Notes

31

3.4.2 Create Synthetic USD floating rate notes
A US Fund Manager is seeking to purchase 3 year USD assets with a minimum credit
rating of AA and a yield in excess of USD 6M Libor+12bp. However, there may be no
such asset exist in reasonable volume at this time.

To create this asset synthetically, the Fund Manager may :
US Fund
Manager

GBP FRN
Issuer

GBP 6M Libor+ 18bp

Swap
Bank
GBP 6M Libor + 18bp

USD 6M Libor + ???
> USD 6M Libor + 12bp
Investor buys Bond -GBP 10 million
Currency Swap +GBP 10 million
-USD 20 million
Initial cashflows
Bond Redeems to
Investor
+GBP 10 million
Currency Swap -GBP 10 million
+USD 20 million
At Maturity cashflows
(irrespective of the prevailing exchange rate)
Note : US Fund Manager bears the full credit risk of the underlying bond and should the bond
default, the investor is still obliged to make all remaining payments under the Swap or reverse
the swap at the book value at that time.
If there is a GBP FRN that offers 6M Libor + 18bp, Fund Manager will take it.

32

3.4.3 Day Count Basis (per year) for onshore & offshore

Domestic for onshore banks computation.
(for example, citibank in USA)

Euro for offshore banks computation.
(for example, citibank in Singapore)

33


For 3 years, Corporate will
pay GBP 6 month Libor + 18bp &
receive USD 6 month Libor + 22.05bp
that is, better than expected
US Fund
Manager
GBP 6M Libor + 18bp

USD 6M Libor + 22.05bp
> USD 6M Libor + 12bp

34


US Fund
Manager

Swap
Bank

Market

IRS
GBP 6 month Libor
+ 18bp
USD 6 month Libor
+ 22.05bp
USD Fixed
USD 6 month Libor
GBP 6 month Libor USD Fixed

CRS

Market

Currency Basis Swap

pay GBP 6 month Libor + 18bp &
receive USD 6 month Libor + 22.05bp

35






36

3.5.2 Create Synthetic NZD debt or loan
A New Zealand company is looking to raise NZD 100 million by issuing 9 years bonds.
In the New Zealand domestic market, it would issue at a yield of
NZD 6M bank bill + 300bp. Alternatively it can issue in Australia where there is a
shortage of quality bonds, at a yield of 8%.

To create this liability synthetically, the New Zealand company may :
NZ
Company

AUD straight bond
Investors

Swap
Bank
NZD 6M bankbill+??? bp <
NZD 6M bankbill+300bp

AUD 8%
Company issues Bond +AUD 80.2 million
Currency Swap -AUD 80.2 million
+NZD 100 million
Initial cashflows
Bond Redeems to
Investor
-AUD 80.2 million
Currency Swap +AUD 80.2 million
-NZD 100 million
At Maturity cashflows
(irrespective of the prevailing exchange rate)
AUD 8%

37


pay NZD 6 bankbill + 433.26bp &
receive AUD 8% semi-annually.
this is worse, so forget about AUD arrangement
NZ
Company
NZD 6M bankbill + 433.26bp >
NZD 6M bankbill + 300bp

AUD 8%

38


CRS
NZ
Company
Swap
Bank

Market

Market
IRS
NZD 6 month Bankbill
+ 433.26 bp
AUD 8%
semi-annual
AUD 6 mth Bankbill
AUD Fixed

NZD 6 month Bankbill
+ CBS
AUD
6 mth Bankbill

Currency
Basis
Swap
pay NZD 6 month Bankbill + 433.26bp &
receive AUD 8% semi-annually.

39






40

3.6.2 Motivation : Reduce the Volatility of Earnings
A US company uses USD as its base currency but has Assets denominated in INR.
The Board of Directors are concerned that any fluctuations in the spot FX will lead to an
increase in the volatility of earnings.

In total, there are INR 40 billion Asset with no corresponding INR liabilities.
The majority of company liabilities are denominated in USD.

The currency exchange rate is 1 USD = 54 INR.

Liabilities
Balance Sheet before Cross Currency Swap

Equity
Present Value in USD

Asset
Market Value
= INR 40 bn

41

The Company has considered raising INR debt in the India market and repaying USD
debt as a way to hedge this exposure and would need to pay INR 1Y Mifor ??? bp

Multi-national
company

INR 1Y Mifor + ??? bp

USD 1Y Libor
USD 1Y Libor

Swap
Bank
Banks

42

There is no new requirement to generate cash and so the company elects not to
exchange principal at the start of the deal, so there are no initial cashflows.

In effect, the company has transferred some of its USD liabilities into INR liabilities to
offset the INR assets it owns and thereby reduce its currency exposure.

Liabilities
Balance Sheet after Cross Currency Swap

Equity
Present Value in INR

Asset
Market Value
= INR 40 bn
From this point on, any Currency loss on the assets will be offseted by a corresponding
Currency gain on the Cross Currency Swap.

Thus, the Cross Currency Swap has been used as an effective FX hedge much like the
use of a FX swap contract.

43

3.6.5 Hedge FX risk

pay INR 1 year Mifor 486.37bp &
receive USD 1 year Libor flat

Multi-national
company
INR 1Y Mifor 486.37bp

USD 1Y Libor flat

44

3.6.6 Motivation : hedge FX risk

Multi-National
Company

Swap
Bank

Market

IRS
INR 1 year Mifor
- 442.25bp
USD 1 year Libor flat
USD Fixed
USD 1 year Libor flat
INR 1 year Mifor USD Fixed
CRS

Market

Currency Basis Swap
pay INR 1 year Mifor 442.25bp &
receive USD 1 year Libor flat

45






Reverse engineering
on Lehman Brothers Minibond
series 9 & 10

47

3.7.2 Reverse Engineering on Minibond series 9 & 10
Credit Protection
on Aviva PLCs bonds
Credit Portfolio

CDS
premiums

Single Tranche
(e.g. AAA)

Cash comes
from Noteholders
( some are
Vulnerable
Investors)
No Default scenario
Series 9 : SGD 4.3% pa for 4.75 years
payable on 14 Feb, May, Aug, Nov

Investors

Funded credit link notes

possibly,
US Treasury Bonds
ELIGIBLE COLLATERAL
FX
converted
cash to
purchase
Coupon
Interests
Credit Event
Loss
Payments
(Par)
Credit Portfolio contains mainly six 5Y CDS (physical settlement).

Credit Protection
on PRC of Chinas bonds
Credit Protection
on HSBC banks bonds
Credit Protection
on Malaysias bonds
Credit Protection
on Prudentials bonds
Credit Protection
on Singtels bonds
Coupon Interests
after CRS
+ CDS premium

Funded

Default scenario
Recovery Values

Protection Buyers
IRS may be utilised to convert from fixed to floating and vice versa in series 10 (USD)
Currency Swap may be utilised to convert multi-period cashflow, from 1 currency to another in series 9.
Credit Events (should follow CR doc)
Failure to Pay,
Debt Restructuring,
for Sovereign for other entities
Repudiation/Moratorium Bankruptcy
SP/Moody
A+/A2
A/A1
AA/Aa1
A-/A3
A+/A2
A+/Aa2
INVESTMENT RISK & RISK FACTORS you could lose all or a substantial part of your investment in the Notes
Minibond Limited
is theSPC

(with USD 1000
in capital)
Swap Counterparty
(Lehman)
Swap Guarantor
(Lehman)

48

3.7.3 The Incomplete Journey
Sophisticated & vulnerable investors
waiting in vain for the delivery
The Titanic (Swap Counterparty/Guarantor)
called Lehman Brothers
riskfree
US Treasury Bonds Yield
Aviva,
PRC of China,
HSBC bank,
Govt. of Malaysia,
Prudential,
Singtels
CDS premiums

49

3.7.4 There are 2 Cross Currency Involved : First one is

Lehman
Brother

Swap
Desk

CRS
USD Fixed 1.5%, semi
SGD Fixed rates, qtr

For 4Y9M years, the Lehman Brother will
pays USD fixed rates same as the 5Y USD government Treasury Notes
receive SGD fixed rates

5Y USD
Treasury Notes
USD Fixed 1.5%, semi

50

3.7.5 The first Cross Currency Swap deal is

51

3.7.6 There are 2 Cross Currency Involved : Second one is

Lehman
Brother

Swap
Desk

IRS
USD Fixed ???, qtr
SGD Fixed rates, qtr

For 4Y9M years, the Lehman Brother will
pays USD fixed rates = All 5Y CDS premium collected
receive SGD fixed rates = 4.3% - the SGD fixed rate calculated from the first CRS or CCS

All
5Y CDS premiums
USD Fixed ???, qtr

52

3.7.7 The second Cross Currency Swap deal is

Mark-to-Model/Market

for a Cross Currency Swap

54

4. Mark-to-Model/Market for an existing Cross Currency Swap deal

Company
Agree to pay KRW 0.28%
quarterly on an earlier
trade date 17 Jan 2012
(1 year ago)

USD 3M Libor flat
To unwind this position,
Company will get KRW 675400.48
Locking the Maturity Date
Locking the Agreed Fixed Rate

55

5.1 Conclusion
1. Learn how to get indicative data on IRS or CCS rates, <SWAP/1>

2. Learn how to price a new IRS or CCS deal with the Swap Pricer model.
3. Learn how to Mark-to-Model(Market) an existing IRS or CCS deal.
- Key in (lock) the maturity date.
- Key in (lock) contracted swap rate in the Fixed Rate cell
- Mark-to-Model(Market) = Net Present Value (NPV)

56

5.2 Where are CRS (CCS) in the Grand Scheme of Things ?
Yield(t)
%

Term

Investors hope to lend at higher rate.

Debtors hope to borrow at lower rate.
Libor curve

6M Libor(t) + ASW

10Y IRS(t) +CMS

Benchmark curve

Zero-coupon curve
(constructed from US Treasury curve)

5Y Zero rate(t) + Z spread

20Y Bmk(t) + credit spread
Callable Bond Yield

3Y Bmk(t) +CMT

ASW: Asset Swap spread, CDS: Credit Default Swap spread, CMS: Constant Maturity Swap spread
CMT: Constant Maturity Treasury Swap spread, Z-spread: static spread, CBS: Currency Basis Swap spread
Convertible Bond Yield
Straight Bond Yield
CDS curve
CDS

Currency Swap curve (CRS)
CBS

Interest Rate Swap curve (IRS)

57


58

Asset Swap (ASW : Asset Swap spread) : Transformer

Bond
Holder

Swap
Desk

IRS
USD Fixed 5%
USD 6M Libor + ASW

Due to this arrangement,

Bond holder is not owning straight bond but a Floating Rate Notes which yields USD 6M Libor + ASW

Straight
Bond
USD Fixed coupon 5%

59

Cross Currency Asset Swap : Transformer

Bond
Holder

Swap
Desk

CRS
USD Fixed 5%
SGD 6M SOR + ASW

Due to this arrangement,

Bond holder is not owning USD straight bond but a SGD Floating Rate Notes
which yields SGD 6M SOR + ASW

Straight
Bond
USD Fixed coupon 5%

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