1. 1 Foundations of Multinational Financial Management 5 th Edition Alan Shapiro J.Wiley & Sons Power Points by Joseph F. Greco, Ph.D. California State University, Fullerton

2. 2 CHAPTER 9 SWAPS AND INTEREST RATE DERIVATIVES

3. 3 CHAPTER OVERVIEW I.Interest Rate and Currency Swaps II.Interest Rate Forwards and Futures III.Structured Notes

4. 4 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.

5. 5 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.

6. 6 THE CLASSIC SWAP 2. Types a. Coupon swap b. Basis swap 3.LIBOR: The most important reference rate in a swap 4.Swap Usage: To reduce risk potential and costs.

7. 7 THE CURRENCY SWAP B.Currency Swaps 1. Definition Two parties exchange foreign currency- denominated debt at periodic intervals. 2. Purpose: similar to parallel loan

8. 8 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 non-payment is more firmly established

9. 9 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.

10. 10 II. INTEREST RATE FORWARDS AND FUTURES Forward and futures contracts: - three types used to manage interest rate risk A.Forward forwards B.Forward rate agreements C.Eurodollar futures

11. 11 INTEREST RATE FORWARDS AND FUTURES 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.

12. 12 INTEREST RATE FORWARDS AND FUTURES Forward rate agreements (FRAs) 1. Cash-settled 2. Over-the-counter forward contract 3. Company fixes an interest rate applied to a specified future interest period on a notional amount.

13. 13 INTEREST RATE FORWARDS AND FUTURES Eurodollar Futures 1. A cash-settled futures contract for a 3- month Eurodollar deposit paying LIBOR 2. Contracts traded on: a.Chicago Mercantile Exchange b.London International Financial Futures Exchange c.Singapore International Monetary Exchange

14. 14 III.STRUCTURED NOTES Interest-bearing securities whose interest payments are determined by reference to a formula set in advance and adjusted on specific reset dates.

15. 15 STRUCTURED NOTES Inverse Floaters: A floating-rate instrument whose interest rate moves inversely with market interest rates.