Tài chính doanh nghiệp - Chapter nine: Currency swaps

1CHAPTER NINE CURRENCY SWAPS 0 DEBT RATING BY MOODY’S INVESTORS SERVICE & STANDARD AND POOR’S CORPORATION GENERAL DESCRIPTION Moody’s S&P’s INVESTMENT GRADE Maximum safety Aaa AAA High quality Aa1 AA+ Aa2 AA Aa3 AA- Upper medium grade A1 A+ A2 A A3 A- Lower medium grade Baa1 BBB+ Baa2 BBB Baa3 BBB- 1 DEBT RATING BY MOODY’S INVESTORS SERVICE & STANDARD AND POOR’S CORPORATION GENERAL DESCRIPTION Moody’s S&P’s NONINVESTMENT GRADE Low grade, speculator Ba1 BB+ Ba2 BB Ba3 BB- Highly speculator B1 B+ B2 B B3 B- Substantial risk CCC+ Caa CCC CCC- Extremely speculative Ca CC Very extremely speculative C C Default D 2 SWAPS CONTRACTS: DEFINITIONS • In a swap, two counterparties agree to a contractual arrangement wherein they agree to exchange cash flows at periodic intervals. • There are two types of interest rate swaps: – Single currency interest rate swap • “Plain vanilla” fixed-for-floating swaps are often just called interest rate swaps. – Cross-Currency interest rate swap • This is often called a currency swap; fixed for fixed rate debt service in two (or more) currencies. 2THE SWAP BANK • A swap bank is a generic term to describe a financial institution that facilitates swaps between counterparties. • The swap bank can serve as either a broker or a dealer. – As a broker, the swap bank matches counterparties but does not assume any of the risks of the swap. – As a dealer, the swap bank stands ready to accept either side of a currency swap, and then later lay off their risk, or match it with a counterparty. AN EXAMPLE OF AN INTEREST RATE SWAP • Consider this example of a “plain vanilla” interest rate swap. • Bank A is a AAA-rated international bank located in the U.K. and wishes to raise $10,000,000 to finance floating-rate Eurodollar loans. – Bank A is considering issuing 5-year fixed-rate Eurodollar bonds at 10 percent. – It would make more sense to for the bank to issue floating- rate notes at LIBOR to finance floating-rate Eurodollar loans. 6 SWAP TRANSACTION Situations confronting counterpart B before swap • A is a AAA rated bank • A is funding its loan portfolio with funds generated by Eurobond carrying an 10% $10 million portfolio 5 year maturity Eurodollar loans A Eurodollar bond LIBOR 10% $10 million loan 5 year maturity AN EXAMPLE OF AN INTEREST RATE SWAP • Firm B is a BBB-rated U.S. company. It needs $10,000,000 to finance an investment with a five-year economic life. – Firm B is considering issuing 5-year fixed-rate Eurodollar bonds at 11.75 percent. – Alternatively, firm B can raise the money by issuing 5-year floating-rate notes at LIBOR + ½ percent. – Firm B would prefer to borrow at a fixed rate. 38 SWAP TRANSACTION Situations confronting counterpart A before swap • Counterpart B: BBB rated • B is a company that invests in project $10 million portfolio 5 year maturity Eurodollar bond B Eurodollar Notes 11.75% LIBOR +0.5% $100 million loan 5 year maturity AN EXAMPLE OF AN INTEREST RATE SWAP The borrowing opportunities of the two firms are: COMPANY B BANK A Fixed rate 11.75% 10% Floating rate LIBOR + .5% LIBOR AN EXAMPLE OF AN INTEREST RATE SWAP The swap bank makes this offer to Bank A: You pay LIBOR – % per year on $10 million for 5 years and we will pay you 10 % on $10 million for 5 years SWAP BANK LIBOR – % 8 1 8 3 8 1 Eurodollar loans BANK A Eurodollar bond LIBOR 10% 8 310 % COM PAN Y B BANK A Fixed rate 11.75% 10% Floating rate LIBOR + .5% LIBOR AN EXAMPLE OF AN INTEREST RATE SWAP Here’s what’s in it for Bank A: They can borrow externally at 10% fixed and have a net borrowing position of -10 + 10 + (LIBOR – ) = LIBOR – ½ % which is ½ % better than they can borrow floating without a swap. 10% ½% of $10,000,000 = $50,000. That’s quite a cost savings per year for 5 years. SWAP BANK LIBOR – % 10 % BANK A 8 1 8 3 8 3 8 1 4AN EXAMPLE OF AN INTEREST RATE SWAP SWAP BANK 10 ½% LIBOR – ¼% COM PAN Y B BANK A Fixed rate 11.75% 10% Floating rate LIBOR + .5% LIBOR Eurodollar bond B Eurodollar Notes 11.75% LIBOR +0.5% COM PAN Y B BANK A Fixed rate 11.75% 10% Floating rate LIBOR + .5% LIBOR AN EXAMPLE OF AN INTEREST RATE SWAP They can borrow externally at LIBOR + ½ % and have a net borrowing position of 10½ + (LIBOR + ½ ) - (LIBOR - ¼ ) = 11.25% which is ½% better than they can borrow floating. LIBOR + ½% Here’s what’s in it for B: ½ % of $10,000,000 = $50,000 that’s quite a cost savings per year for 5 years. SWAP BANK COMPANY B 10 ½% LIBOR – ¼% AN EXAMPLE OF AN INTEREST RATE SWAP The swap bank makes money too. ¼% of $10 million = $25,000 per year for 5 years. LIBOR – – [LIBOR – ¼ ]= 1/8 10 ½ - 10 = 1/8 ¼ SWAP BANK COMPANY B 10 ½% LIBOR – ¼%LIBOR – % 10 % BANK A COM PAN Y B BANK A Fixed rate 11.75% 10% Floating rate LIBOR + .5% LIBOR 8 1 8 3 8 1 8 3 AN EXAMPLE OF AN INTEREST RATE SWAP SWAP BANK COMPANY B 10 ½% LIBOR – ¼%LIBOR – % 10 % BANK A B saves ½%A saves ½% The swap bank makes ¼% COM PANY B BANK A Fixed rate 11.75% 10% Floating rate LIBOR + .5% LIBOR 8 3 8 1 5AN EXAMPLE OF A CURRENCY SWAP • Suppose a U.S. MNC (A) wants to finance a £10,000,000 expansion of a British plant. – They could borrow dollars in the U.S. where they are well known and exchange for dollars for pounds. • This will give them exchange rate risk: financing a sterling project with dollars. – They could borrow pounds in the international bond market, but pay a premium since they are not as well known abroad. AN EXAMPLE OF A CURRENCY SWAP • If they can find a British MNC (B) with a mirror-image financing need they may both benefit from a swap. • If the spot exchange rate is S0($/£) = $1.60/£, the U.S. firm needs to find a British firm wanting to finance dollar borrowing in the amount of $16,000,000. AN EXAMPLE OF A CURRENCY SWAP Consider two firms A and B: – firm A is a U.S.–based multinational and – firm B is a U.K.–based multinational. Both firms wish to finance a project in each other’s country of the same size. Their borrowing opportunities are given in the table below. $ £ Company A 8.0% 11.6% Company B 10.0% 12.0% $9.4% AN EXAMPLE OF A CURRENCY SWAP $ £ Company A 8.0% 11.6% Company B 10.0% 12.0% Firm B $8% £12% Swap Bank Firm A £11% $8% £12% 6AN EXAMPLE OF A CURRENCY SWAP $8% £12% $ £ Company A 8.0% 11.6% Company B 10.0% 12.0% Firm B Swap Bank Firm A £11% $8% $9.4% £12% A’s net position is to borrow at £11% A saves £.6% AN EXAMPLE OF A CURRENCY SWAP $8% £12% $ £ Company A 8.0% 11.6% Company B 10.0% 12.0% Firm B Swap Bank Firm A £11% $8% $9.4% £12% B’s net position is to borrow at $9.4% B saves $.6% AN EXAMPLE OF A CURRENCY SWAP $8% £12% $ £ Company A 8.0% 11.6% Company B 10.0% 12.0% Firm B The swap bank makes money too: At S0($/£) = $1.60/£, that is a gain of $124,000 per year for 5 years. The swap bank faces exchange rate risk, but may be they can lay it off (in another swap). 1.4% of $16 million financed with 1% of £10 million per year for 5 years.Swap Bank Firm A £11% $8% $9.4% £12% 23 AN EXAMPLE OF CURRENCY SWAPS Borrowing rates Motivating currency swap USD AUD General Motor 5.0% 12.6% Qantas Airways 7.0% 13.0% A currency swap motivated by comparative advantage Financial Institution General Motor Qantas Airways 724 AN EXAMPLE OF CURRENCY SWAPS Borrowing rates Motivating currency swap USD AUD General Motor 5.0% 12.6% Qantas Airways 7.0% 13.0% A currency swap motivated by comparative advantage Financial Institution General Motor Qantas Airways $5% $5% $6.3% A$11.9% A$13.0% A$ 13.0% 25 AN EXAMPLE OF CURRENCY SWAPS Alternative arrangement for currency swap: Qantas Airways bears some foreign exchange risk Alternative arrangement for currency swap: General Motor bears some foreign exchange risk Financial Institution General Motor Qantas Airways Financial Institution General Motor Qantas Airways 26 AN EXAMPLE OF CURRENCY SWAPS Alternative arrangement for currency swap: Qantas Airways bears some foreign exchange risk Alternative arrangement for currency swap: General Motor bears some foreign exchange risk Financial Institution General Motor Qantas Airways $5% $5% $5.2% A$11.9% A$11.9% A$13% Financial Institution General Motor Qantas Airways $5.0% $6.1% $6.3% A$ 13% A$ 13% A$13% RISKS OF INTEREST RATE AND CURRENCY SWAPS • Interest Rate Risk – Interest rates might move against the swap bank after it has only gotten half of a swap on the books, or if it has an unhedged position. • Basis Risk – If the floating rates of the two counterparties are not pegged to the same index. • Exchange Rate Risk – In the example of a currency swap given earlier, the swap bank would be worse off if the pound appreciated. 8RISKS OF INTEREST RATE AND CURRENCY SWAPS • Credit Risk – This is the major risk faced by a swap dealer—the risk that a counter party will default on its end of the swap. • Mismatch Risk – It’s hard to find a counterparty that wants to borrow the right amount of money for the right amount of time. • Sovereign Risk – The risk that a country will impose exchange rate restrictions that will interfere with performance on the swap. PRICING A SWAP • A swap is a derivative security so it can be priced in terms of the underlying assets: • How to: – Plain vanilla fixed for floating swap gets valued just like a bond. – Currency swap gets valued just like a nest of currency futures. SUMMARY & CONCLUSIONS • Swaps can be used to hedge; a swap can be viewed as a portfolio of futures with different maturities. 31 BID-OFFER QUOTATIONS IN THE SECONDARY MARKET FOR LDCS DEBT (% face value of loans) Argentina Brazil Chile Mexico Peru 7/85 60-65 75-81 65-69 80-82 45-50 1/86 62-66 75-81 65-69 69-73 25-30 1/87 62-65 74-76.5 65-68 64-67 16-19 1/88 30-33 44-47 60-63 50-52 2-7 1/89 21-22 38-40 58-60 40-41 5-8 932 Illustration • Citicorp Structure a Debt Swap for Nissan. In 1986, Citicorp learned that Nissan Motors wanted to invest the equivalent of 54 million to expand its truck factory in Mexico. When Citicorp offered to get them the $54 million in pesos for much less than $54 million through a debt equity swap, Nissan liked idea. • Citicorp went to the Mexican government and got their approval for the swap. The Mexican government agreed To pay $54 million in pesos for approximately $60 million of their external debt, a 10% discount. Citicorp went out and bought the $60 millions in Mexican bank debt for about $38 millions. Nissan wound up with the peso equivalent of $54 millions at a price of only $40 millions. Mexican retired about $60 million in bank debt. And Citicorp was paid about $2 millions for structuring the deal and assuming the risk. LDCs DEBT SWAPS