Risk management

Submitted to: Sir Imtiaz askari

By: MUHAMMED NISAR(3105)

TARIQ ANIS(3234)

Risk Management

Definition: In a swap, two counterparties agree to exchange

or swap cash flows at periodic intervals.

Nature of Swaps: A swap is an agreement to exchange cash flows at

specified future times according to certain specified rules

There are two types of swaps:Interest rate swap Currency swap

SWAPS

Definition:An exchange of fixed-rate interest payments for

floating-rate interest payments. Reason: One party actually wants fixed rate debt, but can get a better deal on floating rate; the other party wants floating rate debt, but can get a better deal on fixed rate.  Both parties can gain by swapping loan payments, usually through a bank as a financial intermediary (FI), which charges a fee to broker the transaction.

Interest Rate Swap

SWAP BANK o Broker bank

Arranges the deals but does not assume any of the risk

Charges a commission/fee for structuring and servicing the swap.

o Dealer bank Dealer willing to take a position in one side, therefore

assume some risk Dealer would not only receive a commission for arranging

the swap Take a position in the swap

MARKET MAKER

Typical Uses of an Interest Rate Swap

Converting a liability from

fixed rate to floating rate

floating rate to fixed rate

Converting an investment from

fixed rate to floating rate

floating rate to fixed rate

Swaps

FINANCIAL INSTITUTION

SWAP MARKET MAKERMaturity Bid (%) Offer (%) Swap Rate (%)

2 years 6.03 6.06 6.045

3 years 6.21 6.24 6.225

4 years 6.35 6.39 6.370

5 years 6.47 6.51 6.490

7 years 6.65 6.68 6.665

10 years 6.83 6.87 6.850

Swaps concerns comparative advantages, use of interest rate swap to transform a liability

Co. argued they have an when borrowing in fixed rate, whereas other companies have a comparative advantage in the floating rate

Company may borrow fixed when it wants floating or borrow floating when it wants fixed

The swap is used to transform a fixed rate loan into floating rate loan and vice versa.

COMPARATIVE ADVANTAGE ARGUMENT

Definition:An exchange of interest payments in one

currency for interest payments in another currency.

One party swaps the interest payments of debt (bonds) denominated in one currency (USD) for the interest payment of debt (bonds) denominated in another currency (SF or BP), usually on a "fixed-for-fixed rate" basis.  Currency swap is used for cost savings on debt, or for hedging long term currency risk.

Currency swap

General Electric wants to borrow POUNDQantas wants to borrow USD

COMPARATIVE ADVANTAGE ARGUMENTS FOR CURRENCY SWAPS

FINANCIAL INSTITUTION

Interest Rate Swap:In an interest rate swap the

principal is not exchanged

Currency Swap:In a currency swap the principal is

usually exchanged at the beginning and the end of the swap’s life

EXCHANGE OF PRINCIPAL

Thank You