The currency swap market is the oldest and most creative sector of the swap market. This is not distinguished in market terms between the fixed rate currency swap and the currency coupon swap. There is no distinction in market terms between these two types of currency swaps because the only difference is whether the counter currency receipt/payment is on a fixed or floating basis – in structure and result, the two types of swaps are identical and it is a matter of taste (or preference) for one or both counter-parties to choose a fixed or floating payment. When the dollar is involved on one side of a given transaction, the possibility to convert a fixed rate preference on one side to a floating rate preference on the other side through interest rate swap market makes any distinction even more irrelevant.… Read the rest
Forex Investments
Swaps Risk and Exposure
The great bulk of swap activity of date has concentrated on currencies and interest rates, yet these do not exhaust the swap concept’s applicability. As one moves out the yield curve, the primary interest rate swap market becomes dominated by securities transactions and in particular the Eurodollar bond market. The advent of the swap market has meant that the Eurodollar bond market now never closes due to interest rate levels: issuers who would not come to market because of high interest rates now do so to the extent that a swap is available. Indeed, the Eurodollar bond market owes much of its spectacular growth to the parallel growth of its swap market.… Read the rest
Basis Rate Swaps
A fast developing area in the international swap markets is the basis rate swap. The structure of the basis rate swaps is the same as the straight interest rate swaps, with the exception that floating interest calculated on one basis is exchanged for floating interest calculated on a different basis. The forerunner of this type of swap was the US Dollar Prime Rate LIBOR swap. However, an even larger market has developed for the exchange of 1 month US Dollar LIBOR for 6 month US Dollar LIBOR and more recently US Dollar LIBOR for US Dollar commercial paper at much finer rates than those available on the foreign exchange market.… Read the rest
Fixed-Rate Currency Swaps and Currency Coupon Swaps
Fixed-Rate Currency Swaps
A fixed rate currency swap consists of the exchange between two counter-parties of fixed rate interest in one currency in return for fixed rate interest in another currency. Following are the main steps to all currency swaps:
- Initial Exchange for the Principal: The counter-parties exchange the principal amounts on the commencement of the swap at an agreed rate of exchange. Although this rate is usually based on the spot exchange rate, a forward rate set in advance of the swap commencement date can also be used. This initial exchange may be on a notional basis of alternatively a physical exchange.
Interest Rate Parity (IRP) Theory of Exchange Rate
When Purchasing Power Parity (PPP) Theory applies to product markets, Interest Rate Parity (IRP) condition applies to financial markets. Interest Rate Parity (IRP) theory postulates that the forward rate differential in the exchange rate of two currencies would equal the interest rate differential between the two countries. Thus it holds that the forward premium or discount for one currency relative to another should be equal to the ratio of nominal interest rate on securities of equal risk (and duration) denominated in two currencies.
For example, where the interest rate in India and US are respectively 10% and 6% and the dollar-rupees spot exchange rate is Rs.42.50/US $.… Read the rest
Factors Affecting the Forex Market
The exchange value of a currency, or the rate of exchange, fluctuates with changes in demand and supply. The factors which affect the demand for and the supply of a currency are many and varied. There are some factors which operate in the short period and have influence on day-to-day- fluctuations in rates of exchange. The commercial and financial relationship between trading countries is now extensive and payments on various accounts fall, due for early settlement. These payments constitute the short-term demand and supply in regard to currencies. There are, however, changes in currency and credit conditions and political and industrial conditions which have their influence on exchange rates only in the long period.… Read the rest