Managing Interest Rate

Risk with Cross Currency

Swaps
Saniye Atak
Chintan Shah
Eddie Warner
NYU-SCPS. Interest Rate Swaps. X51.9204
26 July 2010

Some Tools to Manage Interest

Rate Risk
Refinancing go back to lender and
restructure/refinance the agreement. Not
always possible and usually expensive.
Forward Rate Agreement lock in future
interest rate payment. OTC market.
Interest Rate Futures lock in future
interest rate payments by taking a position in
an interest rate futures position.
Interest Rate Swaps enter into an
agreement with a bank or swap-dealer to
exchange cash flows in such a way that
interest rate payments on a floating loan
would become fixed.

Cross Currency Swaps

An agreement between two counterparties
to exchange future cash flows.
Cross Currency Swap involves the exchange of
cash flows from one currency for those in
another with an agreement to reverse that
transaction at a future date.
Interest Rate swaps changes the basis on
which income streams or liabilities are
received or paid on a specified principal
amount.

Cross Currency Swaps

Two cash-flow schedules in different
currencies.
Two notional amounts in different currencies.
Motivation to enter in a cross currency swap is
the desire to pay interest in a currency with
lower rates such as JPY or CHF and receive
interest in a currency with higher rates.
Gives companies extra flexibility to exploit
their comparative advantage in their
respective borrowing markets.
Allows companies to explain advantages
across a matrix of currencies and maturities.

Cross Currency Swaps

Advantages
Beneficial interest rate payments, i.e. receiving
higher coupons or paying lower coupons than
market
Liquid and transparent product
Zero/Low cost product
(Partial) protection of the notional possible

Disadvantages
Long term FX forward risk
Long term view on the FX rate impossible

Structure of a Cross
Currency Swap
Exchange notional amounts at inception
Use current spot rate (CHF = Swiss Francs)
$10m USD at 1.1138 CHF, Sfr 11.138m

Pay/Receive intermediate cash flows

Use bid/ask swap rates

Re-exchange notional amounts at expiration

Using agreed upon spot rate, 1.1138 CHF

CHF stands for Confoederatio Helvetica

Franc

Initial Exchange of Notional

Pay/Receive Intermediate Cash

Flows

Re-exchange notional at
expiration

Cross Currency Swap Case

Study
Carlton Corporation
Recently took out a 3Y floating-rate loan for
$10M
Was worried interest rates would rise
Used an Interest Rate Swap to convert to fixed

Carlton recently signed a contract with a

Swiss buyer that will be paying Francs to
Carlton
Incoming Swiss Francs cash flows
Good motivation for Cross Currency Swap

Interest Rate and Currency Swap

Quotes
Years
1
2
3
4
5
6
7
8
9
10
12
15
20
25
30
LIBOR

Euro -
Bid
Ask
2.99
3.02
3.08
3.12
3.24
3.28
3.44
3.48
3.63
3.67
3.83
3.87
4.01
4.05
4.18
4.22
4.32
4.36
4.42
4.46
4.58
4.62
4.75
4.82
5.00
5.04
5.13
5.17
5.19
5.23
3.0313

3.0938

Swiss Franc - Sfr

Bid
Ask
1.43
1.47
1.68
1.76
1.93
2.01
2.15
2.23
2.35
2.43
2.54
2.62
2.73
2.81
2.91
2.99
3.08
3.16
3.22
3.30
3.45
3.55
3.71
3.81
3.96
4.06
4.07
1.17
4.16
4.26
1.3125

1.4375

US Dollar $
Bid
Ask
5.24
5.27
5.43
5.46
5.56
5.59
5.65
5.68
5.73
5.76
5.80
5.83
5.86
5.89
5.92
5.95
5.96
5.99
6.01
6.04
6.10
6.13
6.20
6.23
6.29
6.32
6.29
6.32
6.28
6.31
4.9373

5.0625

Japanese
Bid
0.23
0.36
0.56
0.82
1.09
1.33
1.55
1.75
1.90
2.04
2.28
2.51
2.71
2.77
2.82

Yen -
Ask
0.26
0.39
0.59
0.85
1.12
1.36
1.58
1.78
1.93
2.07
2.32
2.56
2.76
2.82
2.88

0.1250

0.2188

Setting up the Cross Currency

Swap
Carlton enters into a three-year receive
US Dollars and pay Swiss francs.
Carlton pays 3Y CHF Ask rate (2.01%)
Carlton receives 3Y USD Bid rate (5.56%)

Target currency is CHF. $10M = 11.138M

Sfr
Interest Payment: 2.01% 11.138M Sfr =
223,873.80 Sfr

Receiving currency is USD.

Interest Received: 5.56% 10M = $556,000

Pay CHF & Receive USD

Accounting practices will require mark-to-market

If CHF appreciates, Carlton would record a loss.
If CHF interest rates were rising, Carlton
committed to a fixed 2.01% and would record a
gain.
P&L will persist over course of swaps life.

How to price a currency swap

swap with SWPM

SWPM is the main interest rate derivatives pricing function

in the Bloomberg professional system, allowing users to
price a wide range of vanilla and exotic interest rate swaps,
interest rate options, swaptions and interest rate / hybrid
structured notes.

We will use SWPM to price a cross currency interest rate

swap transaction and calculate a mark to market price with
current markets or historicized curves.

Example
Receive 4.5% on 10MM USD and pay floating
Euribor 3M

To have a quick price of a new Interest Rate Swap transaction user has to
- open SWPM;
- enter the IRS details in the Main Screen relevant input fields;
- select Calculate Premium from Calculate menu field;
- refresh for price

In Curves Screen user can:

- visualize and export in Excel the par or zero coupon curve used for swap
evaluation;
- manually override curve values;
- apply shifts to the whole curve or to defined buckets;
- choose interpolation method used;

Use the Cashflow Screen to visualize and export to an Excel spreadsheet deal
cash
flows, with the ability to choose between Net, Pay, Receive and Historical cash
flows.

The Risk Screen shows for each leg some key risk measures :
- DV01: the dollar value of a 1-basis-point negative shift in the curve.
- Risk: the risk for each leg and the deal is calculated according to the
following
equations:
Risk = [DV01 / Notional] x 10,000