Swaps meaning, types and uses financial markets binary converter to text

.

A swap in simple terms can be explained as a transaction to exchange one thing for another or ‘barter’. In financial markets the two parties to a swap transaction contract to exchange cash flows futures markets quotes. A swap is a custom tailored bilateral agreement in which cash flows are determined by applying a prearranged formula on a notional principal. Types of Swap:

Where cash flows at a fixed rate of interest are exchanged for those referenced to a floating rate usd inr rate today. An interest rate swap is a contractual agreement to exchange a series of cash flows. One leg of cash flow is based on a fixed interest rate and the other leg is based on a floating interest rate over a period of time.

It is easy to compute the present value of the fixed rate leg as risk free zero rates for various maturities are easily available from, say, govern­ment securities yield curve.


It is not so easy to compute the present value of floating leg payments as one does not know what the rates are likely to be in future.

Hence using the zero rates, an implied forward yield curve is developed and these rates are used to discount the floating leg payments euro conversion rate today. The present values of fixed and floating legs thus obtained are equated and the rate that makes them equal is computed. This rate will be base rate for pricing the swap on which mark up may be made to offer it to the market.

(The Yield to Maturity or YTM has a drawback in that it assumes that future cash flows will be invested at the same rate “y” – the YTM itself, which is a wrong assumption for no one knows what the interest rates are likely to be in future).

If we are able to eliminate the intermediary cash flows by some means, then there will be no reinvestment risk and hence the assumption of same rate for future periods can also be done away with.

This may be achieved by arriving at the Zero rates (also known as Spot Rate) by a mathematical process known as Boot Strapping asian pre market futures. This process eliminates intermediary cash flows and hence the wrong assumption of the same rate for reinvestment as well.

Let us say Paradise Bank has entered into an OIS on a notional principal of Rs. 10 crores and has agreed to receive Mibor overnight floating rate for a fixed payment of 8% on the notional principal. The swap was entered into on 1 April, 2006 and was to commence on 2 April, 2006 and run for a period of 7 days.

The amount payable by Paradise Bank on the floating rate will be calculated on the notional principal everyday at the respective Mibor rate and will be compounded on a daily basis as shown below. (Please note the rate for Saturday and Sunday are the same as the market is closed on Sundays).

The fixed leg interest payment is worked in the normal way for 7 days at 8% and the difference between the two is the amount Paradise Bank has to pay or receive on maturity usd to inr converter. It may be noted that the interest payments are not exchanged on a daily basis but are exchanged only on maturity.

This is the simplest form of Interest rate swaps where a fixed rate is exchanged for a floating rate or vice versa on a given notional principal at pre-agreed intervals during the life of the contract.

In a floating to floating swap, it is possible to exchange the floating rates based on different benchmark rates hkd to usd converter. For example, we may agree to exchange 3m Mibor for 91 days T Bills rate. Such a swap is called a Basis Swap.

As the name suggests, swaps that provide for reduction in notional principal amount corre­sponding to the amortisation of a loan, are called amortising swaps.

When one of the counter parties has the right to extend the maturity of the swap beyond its original life, the swap is said to be an extendable swap.

When it is agreed between the counter parties that the swap will come into effect on a future date, it is termed as a delayed start swap or deferred swap or a forward swap.

Interest rate swaps which are structured in such a way that one leg of the swap provides for payment of interest at a rate pertaining to a currency other than the currency of the underlying principal amount hkd to usd conversion. The other leg provides for payment of interest at the rate and currency of the underlying principal.

For example, a corporate can choose to enter into a differential swap by which it could bind itself to pay 3m USD Libor on a principal of Rs. 100 crores and receive 12% fixed in the Indian currency. The interest on both the legs will be computed on the notional principal of Rs. 100 crores. The swap is thus a combination of currency and plain interest rate swaps british pound to usd chart. There is no cur­rency risk in this arrangement.

1. Scheduled commercial banks (excluding Regional Rural Banks), Primary Dealers and all India Financial Institutions are free to undertake IRS as a product for their own balance sheet management for market making.

5 usd pound exchange rate. The parties are free to use any domestic money or debt market rate as benchmark rate provided the methodology of computing the rate is objective, transparent and mutually acceptable.

6. There is no restriction on the minimum or maximum size of notional principal amounts. Size norms are to emerge in the market with the development of the market.

9. Transactions for hedging and market making purposes should be recorded separately usd to gbp conversion rate. Positions on account of market making activities should be marked to market at least at fortnightly intervals. Transactions entered into for hedging purposes should be accounted for on accrual basis.

The product thus obtained shall be assigned risk weightage at 20% for banks and financial institutions and at 100% for others (except governments).

3. An Interest Rate Swap is a contract between two parties whereby they agree to exchange a stream of interest pay­ments on a notional principal for a given period at pre-agreed intervals of time.

Where cash flows in one currency are exchanged for cash flows in another currency. A currency swap is contractually similar to an interest rate swap.

The major difference between a generic interest rate swap (IRS) and a generic currency swap is that the latter includes not only the exchange of interest rate payments but also the exchange of principal amounts both initially and on termination. Since the payments made by both parties are in different currencies, the payments need not be netted.

Where cash flows on both the legs of the swap are referenced to different floating rates A Basis swap could be an Interest Rate Swap or a currency swap where both legs are based on a floating rate.

A basis swap involves a regular exchange of cash flows, both of which are based on floating interest rates. Most swaps are based on payment of a fixed rate against a floating rate, say, LIBOR. In the basis swap both legs are calculated on floating rates.

In the Indian market Banks are allowed to run a book on swaps which have an Indian Rupee leg. Banks can offer swaps, which do not have an Indian Rupee leg, to their customers but have to cover these with an overseas bank on a back-to-back basis.


banner