1. 1 Multinational Financial Management Alan Shapiro 10 th Edition John Wiley & Sons, Inc. PowerPoints by Joseph F. Greco, Ph.D. California State University, Fullerton

2. Chapter 9 Swaps and Interest Rate Derivatives

3. INTEREST RATE AND CURRENCY SWAPS 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. 3

4. HOW THE CLASSIC SWAP WORKS A. INTEREST RATE SWAPS (con’t) 2. Notional principal: a reference amount used only to calculate interest expense but never repaid. 3. Maturities: less than 1 to over 15 years 4

5. THE CLASSIC SWAP 4. Types a. Coupon swap b. Basis swap 5.LIBOR: the most important reference rate in a swap 6. Swap Usage: To reduce risk potential and costs. 5

6. THE CURRENCY SWAP B.Currency Swaps 1. Definition two parties exchange foreign currency- denominated debt at periodic intervals. 2. Purpose: similar to parallel loan 6

7. 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 7

8. 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. 8

9. INTEREST RATE FORWARDS AND FUTURES I.Forward and futures contracts: - three types used to manage interest rate risk A.Forward forwards B.Forward rate agreements C.Eurodollar futures 9

10. INTEREST RATE FORWARDS AND FUTURES A. 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 10

11. INTEREST RATE FORWARDS AND FUTURES B. Forward rate agreements (FRAs) 1. cash-settled 2. over-the-counter forward contract company fixes an interest rate applied to a specified future interest period on a notional amount. 11

12. INTEREST RATE FORWARDS AND FUTURES C. Eurodollar Futures 1.A cash-settled futures contract for a 3- montheurodollar deposit paying LIBOR 2.Contracts traded on: a.Chicago Mercantile Exchange b.London International Financial Futures Exchange c.Singapore International Monetary Exchange 12

13. STRUCTURED NOTES A. Definition Interest-bearing securities whose interest payments are determined by reference to a formula set in advance and adjusted on specific reset dates. 13

14. STRUCTURED NOTES B. Inverse Floaters a floating-rate instrument whose interest rate moves inversely with market interest rates. 14

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