chapter 6 currency futures and swaps. copyright 2004 mcgraw-hill australia pty ltd ppts t/a...
TRANSCRIPT
Chapter 6
Currency Futures and Swaps
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 2
Objectives
• To describe futures contracts and show how they circumvent the problems of forward contracts.
• To compare forward and futures markets.
• To describe swaps and introduce some terminology.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 3
Definition
• Currency futures contracts represent an obligation of the seller to deliver a certain amount of a specified currency in the future at an exchange rate determined now.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 4
Problems of Forward Contracts
• Non-standard contract dimensions• Default risk• Lack of liquidity
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 5
Using a Forward Contract
C
A
Forward contract
JPY Goods
B
AUD
JPY
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 6
Tendency to Default on a Forward Contract
A tends to default
A B
USD 1 million
Forward rate = 1.80
AUD 1.8 million
C
Spot rate = 1.90USD 1 million
AUD 1.9 million
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 7
Tendency to Default on a Forward Contract (cont.)
B tends to default
USD 1 million
Forward rate = 1.80
AUD 1.8 millionSpot rate = 1.70 USD 1
millionAUD 1.7 million
A B
C
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 8
Tendency to Default on a Forward Contract (cont.)
Neither tends to default A B
USD 1 million
Forward rate = 1.80
AUD 1.8 million
C
Spot rate = 1.80
Spot rate = 1.80 USD 1
million
AUD 1.8 million
USD 1 million
AUD 1.8 million
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 9
Unwinding a Forward Contract
C
A
Compensation
JPY Compensation
DAUD
(a) Assigning the obligation to another counterparty (D)
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 10
Unwinding a Forward Contract (cont.)
C
A
(b) Cancelling the forward contract
Cancellation fee
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 11
Unwinding a Forward Contract (cont.)
C
A
(c) Entering an offsetting position with E
E
AUD
AUD
JPY
JPY
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 12
How Futures Contracts Solve These Problems
• Standardised contract dimension• Default risk is controlled by the
clearing corporation and some regulations
• They are liquid
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 13
The Role of the Clearing Corporation in Futures Trading
A B
USD USD
AUDAUD
Clearing corporation(exchange)
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 14
A Comparison of Forward and Futures Markets
• Market size • Market structure• Contract size• Traded currencies
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 15
A Comparison of Forward and Futures Markets (cont.)
• Cross rates • Exchange rate fluctuations• Maturity dates• Maturity lengths
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 16
A Comparison of Forward and Futures Markets (cont.)
• Credit risk • Cash flows • Hours of trading• Eligible dealers• Major users
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 17
Futures Exchanges
• The Philadelphia Stock Exchange• The Chicago Mercantile Exchange• The Sydney Futures Exchange
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 18
Definition of Swaps
• Currency and interest rate swaps involve the exchange of interest and foreign currency cash flows. They differ from swaps in the forward FX market (FX swaps).
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 19
Currency Swaps
• A currency swap is a transaction in which two counterparties exchange specific amounts of two different currencies at the outset and repay over time according to a predetermined rule.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 20
Some Features of Currency Swaps
• They emerged in the 1980s with the World Bank playing a major role.
• They have evolved as a successor to parallel loans.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 21
Stages of Currency Swaps
• The counterparties exchange the principal amounts.
• On specific dates, they exchange interest payments.
• On maturity, the principal amounts are re-exchanged.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 22
Currency Swaps with Notional Principals
• A notional principal is not exchanged. Only compensatory payments are made by one counterparty to the other.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 23
A Swap without Exchanging Principals
A B1
A B2
A B3
A Bn
0KS
1KS
2KS
0KS
0KS
0KS
3KS
nKS
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 24
Interest Rate Swaps
• A fixed-for-floating swap involves the exchange of cash flows by applying fixed and floating interest rates to a notional principal in a specific currency.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 25
Fixed-for-Floating Interest Rate Swap
A B
ik (floating)
ik (fixed)
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 26
Other Kinds of Interest Rate Swaps
• A basis swap involves two floating interest rates.
• A zero-coupon swap involves a zero fixed rate.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 27
Cross-Currency Interest Rate Swaps
• Involve the exchange of payments in different currencies, one of which is calculated on the basis of a fixed interest rate and the other on the basis of a floating rate.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 28
Cross-Currency Interest Rate Swaps
A B
Fixed JPY
Floating AUD
(a) Dealing with one counterparty
C A B
(b) Dealing with two counterparties
Fixed JPYFloating AUD
Fixed AUDFixed AUD
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 29
Swap Terminology
• Money market and term swaps• Spot-start, delayed-start and forward
swaps• Option on swap, swaption and swap
buyout• Amortising swap