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The Core Components of Cross Currency Swaps

WHAT ARE CROSS CURRENCY SWAPS? A cross currency is an over the counter(OTC) derivative in the form of an agreement between two parties to exchange the interest payments and principal on loans denominated in two different currencies.The payment of interest can be made at different rates, like either fixed or floating rates and at different frequencies.They are motivated by comparative advantage.At the initial or origin of swap through an agreement, the counter parties exchange notional principals in two currencies of their choice.During the life of the agreement, each party pays interest to the other.For example,if a India-based company is looking forward to acquire some dollars and a US-based company is looking forward to acquire some Indian rupees these companies could perform a swap. A currency swap should be distinguished from a central bank liquidity swap.There is an increase and a wide range of acceptance as essential risk management tools by financial institutions,corporations engaged in foreign direct investment.  etc.It is purely composed of two legs- receiving and paying leg.Cross currency swaps is one of the best way to fully hedge a loan transaction as their  terms can be structured to exactly mirror the underlying loan..They are said to be an alteration of the cash flows that is associated with the payments and not a source of capital itself.There is no physical exchange of two currency flows in a non-deliverable swap(NDS).Instead,the USD equivalent of  the local currency, which is determined at the spot rate on the date of payment and the net is paid to the appropriate party. Theoretical swap rate= present value of future rate cash flow                                               n                                                Σ,  national price x days  x  df                                            1-1                            360           1               Market value that effect swap pricing includes changes in the level of interest rates,changes in swap spreads,change in shape of interest rate yield curve and exchange rates.Also, like forward and futures contracts, swaps are priced to have a value of zero at inception. There are a number of swaps namely- amortizing swap, step-up swap, credit default swap, compounding swap, fixed or floating currency swap, equity swap, puttable swap and swaptions. Finally, if the buyer is wishing to exit the swap, he can enter into an offsetting swap with the original counter party or whoever offers the best price.The swap involves three important elements: The initial exchange of principal: In the initial exchange, decisions on the mode of coupon payments method are made. It can be fixed vs fixed, fixed vs floating, floating vs floating and is usually driven by the demand of international funds flow.They have significant settlement risk exposure from the high value of the initial and final principal exchange.Interest payment:Here, the value is derived from current spot rate and forward interest rates.If the firm thought that the price would rise or fall, it would enter into a swap agreement and pay fixed to receive floating, or floating to receive fixed, in order to protect it from rising debt service payments or to take advantage of lower debt service payments respectively. Here no principal is swapped only the coupon payments.As said earlier,swap itself is not a source of capital, but can be put across as the alteration of cash flows associated with payments. Interest rates are interrelated to foreign exchange forward rates and foreign exchange spot rates by interest rate parity(IRP) principle. The final exchange of principal:The total return of assets in periodic cash flow includes floating or fixed rates such as LIBOR rates.Since most swaps are executed on large notional amounts, this could put the payer at a risk of hedge fund’s default if the fund is not sufficiently capitalized.   RISKS ASSOCIATED WITH SWAPS  Interest rates changes can cause the gap position of a bank or a firm to change.Thus, the  swap’s effectiveness can change.In other cases, the  other party may not want to exchange the same amount of cash flows.  PROS AND CONS There is no upfront cost, meanwhile it is highly credit intensive.These arrangements expose users to interest risk and credit risk, but at the same time reduce transfer risk.Client is hedged against foreign  exchange risks in terms of both principal  and coupons as the swap locks in current market price,but liability risk and interest rate risk comes into picture when the swap payments are due and floating rate on payment leg is higher than receiving  leg.  For simple and better understanding, refer to the images below:  In the above structure,there is a cross currency swap between USA and INDIA in USD(dollars) and INR(rupees).USD of 10 million dollars is  exchanged at a rate of 6%  paid by US banks to INR value of 450 million as per the spot rates at 7% paid by Indian banks.It is a simple example of  currency swaps between countries that help them to enter into foreign markets and have a standard place globally.  THESE ARE THE STATISTICS OF CROSS CURRENCY TRANSACTIONS  The statistics above explains the annual growth of international liabilities and assets of banks in India.The red line indicates total international assets and the blue line indicates the total international liabilities.We can notice that the liabilities are high in 2010, and with the efforts made to reduce them, there has been a significant decrease in 2012-2013, which has been maintained with an average of 25-30%.The total assets had a significant growth from the past few years. These statistics establish how cross currency transactions are gaining importance and are having a rapid growth in India and globally .The RBI  in India has taken steps to increase cross currency pairs in order to facilitate efficient hedging.This also has a major role in shaping the global market in a more efficient manner.     
The Core Components of Cross Currency Swaps
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Kranthi

Kranthi Tilak Reddy

Blog Author

Kranthi Tilak Reddy is one of the co founders and COO of White Matter Advisory services P Ltd. He is an Engineering graduate from SRM University and has done his Masters in finance.Being a true go-getter and an optimist to the core he has grown up the ranks in banking industry at an astonishing rate, his last stint being Associate Director, Business Clients -South with Standard Chartered Bank. With over 10 years of association with SME businesses and clients he certainly brings rich vein of expertise to the WMA table but more importantly his alluring passion towards great and customer service” the foundation on which he asserts WMA has been built.

The Core Components of Cross Currency Swaps

WHAT ARE CROSS CURRENCY SWAPS? A cross currency is an over the counter(OTC) derivative in the form of an agreement between two parties to exchange the interest payments and principal on loans denominated in two different currencies.The payment of interest can be made at different rates, like either fixed or floating rates and at different frequencies.They are motivated by comparative advantage.At the initial or origin of swap through an agreement, the counter parties exchange notional principals in two currencies of their choice.During the life of the agreement, each party pays interest to the other.For example,if a India-based company is looking forward to acquire some dollars and a US-based company is looking forward to acquire some Indian rupees these companies could perform a swap. A currency swap should be distinguished from a central bank liquidity swap.There is an increase and a wide range of acceptance as essential risk management tools by financial institutions,corporations engaged in foreign direct investment.  etc.It is purely composed of two legs- receiving and paying leg.Cross currency swaps is one of the best way to fully hedge a loan transaction as their  terms can be structured to exactly mirror the underlying loan..They are said to be an alteration of the cash flows that is associated with the payments and not a source of capital itself.There is no physical exchange of two currency flows in a non-deliverable swap(NDS).Instead,the USD equivalent of  the local currency, which is determined at the spot rate on the date of payment and the net is paid to the appropriate party. Theoretical swap rate= present value of future rate cash flow                                               n                                                Σ,  national price x days  x  df                                            1-1                            360           1               Market value that effect swap pricing includes changes in the level of interest rates,changes in swap spreads,change in shape of interest rate yield curve and exchange rates.Also, like forward and futures contracts, swaps are priced to have a value of zero at inception. There are a number of swaps namely- amortizing swap, step-up swap, credit default swap, compounding swap, fixed or floating currency swap, equity swap, puttable swap and swaptions. Finally, if the buyer is wishing to exit the swap, he can enter into an offsetting swap with the original counter party or whoever offers the best price.The swap involves three important elements: The initial exchange of principal: In the initial exchange, decisions on the mode of coupon payments method are made. It can be fixed vs fixed, fixed vs floating, floating vs floating and is usually driven by the demand of international funds flow.They have significant settlement risk exposure from the high value of the initial and final principal exchange.Interest payment:Here, the value is derived from current spot rate and forward interest rates.If the firm thought that the price would rise or fall, it would enter into a swap agreement and pay fixed to receive floating, or floating to receive fixed, in order to protect it from rising debt service payments or to take advantage of lower debt service payments respectively. Here no principal is swapped only the coupon payments.As said earlier,swap itself is not a source of capital, but can be put across as the alteration of cash flows associated with payments. Interest rates are interrelated to foreign exchange forward rates and foreign exchange spot rates by interest rate parity(IRP) principle. The final exchange of principal:The total return of assets in periodic cash flow includes floating or fixed rates such as LIBOR rates.Since most swaps are executed on large notional amounts, this could put the payer at a risk of hedge fund’s default if the fund is not sufficiently capitalized.   RISKS ASSOCIATED WITH SWAPS  Interest rates changes can cause the gap position of a bank or a firm to change.Thus, the  swap’s effectiveness can change.In other cases, the  other party may not want to exchange the same amount of cash flows.  PROS AND CONS There is no upfront cost, meanwhile it is highly credit intensive.These arrangements expose users to interest risk and credit risk, but at the same time reduce transfer risk.Client is hedged against foreign  exchange risks in terms of both principal  and coupons as the swap locks in current market price,but liability risk and interest rate risk comes into picture when the swap payments are due and floating rate on payment leg is higher than receiving  leg.  For simple and better understanding, refer to the images below:  In the above structure,there is a cross currency swap between USA and INDIA in USD(dollars) and INR(rupees).USD of 10 million dollars is  exchanged at a rate of 6%  paid by US banks to INR value of 450 million as per the spot rates at 7% paid by Indian banks.It is a simple example of  currency swaps between countries that help them to enter into foreign markets and have a standard place globally.  THESE ARE THE STATISTICS OF CROSS CURRENCY TRANSACTIONS  The statistics above explains the annual growth of international liabilities and assets of banks in India.The red line indicates total international assets and the blue line indicates the total international liabilities.We can notice that the liabilities are high in 2010, and with the efforts made to reduce them, there has been a significant decrease in 2012-2013, which has been maintained with an average of 25-30%.The total assets had a significant growth from the past few years. These statistics establish how cross currency transactions are gaining importance and are having a rapid growth in India and globally .The RBI  in India has taken steps to increase cross currency pairs in order to facilitate efficient hedging.This also has a major role in shaping the global market in a more efficient manner.     
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The Core Components of Cross Currency Swaps

The Core Components of Cross Currency Swaps

Kranthi Tilak Reddy
WHAT ARE CROSS CURRENCY SWAPS? A cross currency is an over the counter(OTC) derivative in the form of an agreement between two parties to exchange the interest payments and principal on loans d...
Continue reading

Ways To Eliminate Additional Costs In Your Company

There isn’t an idiom which is more relevant today than “A penny saved is a penny earned “ that is claimed to be quoted by Benjamin Franklin, a wise man! This sounds simple & benefits of implementing this are obvious, but studies have shown that a large number of businesses operating today are nowhere near maximising their cost saving opportunities.  Why is cost cutting important? This may seem like a fairly obvious question, however, there have been countless successful businesses that have failed because they let the costs of operating their business spiral out of control.  In fact, some of the biggest global corporate collapses have occurred due to this very reason. So, if it can happen to billion dollar corporate giants, it can also happen to small & medium business operations. It’s one of the main reasons why 80% of all businesses fail. Cost cutting can be a very quick way to boost your bottom line.Where do you start?Banking See if your banking & related costs are optimised.  It’s imperative to know if your bank is charging you right. Your interest rates on CC/Overdraft, FX, & trade fees- are they at par with what your industry peers pay?  Try identifying if your product mix is on the money & in line with what your business needs that could save you lots of money, adding to your bottom line. If possible, hire professional consultants who could handle this efficiently and stream line costs.Paying staff the right wayIs there a better way you can be rewarding your staff? A lot of business owners are now looking at restructuring the way they pay their staffs in order to reduce costs and provide greater incentive for greater output.  It’s a well known fact that sales staffs have been paid increased commissions based on increased sales for many years, but there are a growing number of astute business owners who are now starting to pay their other non-sales people based on the level of sales an organisation generates.  This has the effect of having everyone focused on increasing sales so it becomes a far greater team effort across the board.  Companies that have started to do this have noticed an increase in customer satisfaction levels, faster delivery times, more efficient debt collection procedures, greater efficiency in communications, a higher level of office morale and countless other benefits.Are you getting the best from your vendors When was the last time you sat down with them and attempted to negotiate better payment terms or an improved volume discount?  You should sit down on a regular basis and analyse all your suppliers.  Make sure you competitively quote your suppliers for everything your business needs.  You will be amazed how quickly people will negotiate with you.  Remember, it costs at least six times more to find a new client than it does to do business with an existing one.  Your suppliers know this and simply asking them for better terms or cheaper rates can save you a lot of money.Working Hours There are countless businesses that open too early or stay up too late just because that’s what everyone else is doing.  Have a closer look when you’re making the majority of your sales or when you receive most of your customer enquiries, (the daily journal in the Time Management section will help you to track this).  Once you have done this for a few weeks, it will become apparent that there are certain time periods that are costing you money simply to be open.  For a lot of retail stores this can be between 9 and 10 on a Monday or Tuesday morning.  Even if you reduced your work week by these two hours, that can result in significant savingsChoose the right business premisesWhere you choose to locate your business will have a major impact on your operating costs.  It is one of the most important things to consider, even if your business is well established.  When looking at locating or relocating your business it’s important to ask the following questions:Will customers be coming to the business or will I be going to them?If customers are visiting me, what impression do I want to create?Where do my customers come from?Do they need easy parking facilities?Do I need to be highly visible?Will I be employing staff?Is it easy for staff to find car parking or public transportation?How far away are your business premises from where you live?Does your business require partitioning? Offices? Storage space?Can you access your business premises after hours?What is your budget?How long is the lease for?What happens if I break the lease?Is it better to buy the business premises?When you’re thinking of locating your business you need to be very clear on all of the above questions.Small can be cumulatively big !Once you have had a close look at some of the major expenses in your business, it’s then time to have a very close look at minor expenses.  These are the incidentals you may be spending money on which your customers or people are indifferent to.  A lot of business owners spend money on incidental items that don’t really add any value to the business.  Have a look at the following list of items and ask yourself if they would really be missed if they disappeared from your business tomorrow.Magazines and newspapersExpensive tea and coffeeCouriers and express post servicesExpensive packagingWhat are some of the items in your business you could be living without?Similarly, have a closer look at various other operational costs that could be avoided without affecting the productivity or efficiency of the company. Always remember “A penny saved is a penny earned”.
Rated /5 based on 20 customer reviews
Ways To Eliminate Additional Costs In Your Company

Ways To Eliminate Additional Costs In Your Company

Kranthi Tilak Reddy
There isn’t an idiom which is more relevant today than “A penny saved is a penny earned “ that is claimed to be quoted by Benjamin Franklin, a wise man! This sounds simple & benefits of implemen...
Continue reading

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