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International Finance - Essay Example

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International Finance

Interest rate swaps are over the counter (private) transactions; and they are highly liquid financial derivatives that can be used by hedgers to manage both their fixed and floating assets and liabilities. A party that pay fixed rate is referred to as the payer and the receiving party is called the receiver. For example, X agrees to pay fixed rate of interest under specified time intervals to W and in return, X receives variable or floating interest on notional principle from W. The types of currency swaps include fixed for floating swap for same currency, fixed for floating rate for different currencies, floating for floating swap for same currency, floating for floating rate for different currencies and fixed for fixed rate swap for different currencies. Currency swap refers to a foreign-exchange currency agreement entered into by two parties in relation to principle alone or with interest for payment of a specified loan sum in one currency for an equivalent principle and interest of a specified loan sum in another currency (Shamah, 2003). Payments are made periodically and at maturity or termination of the contract, the principle amounts are re-exchanged. Currency swaps are over the counter financial instruments. Foreign currency swaps are long term because they involve high costs associated with finding counterparty. Currency swap are further divided into two. Principle only currency swap and principle plus interest currency swap. Principle only currency swap is appropriate for contract that are up to ten years and involves exchange of principle with another party in a specific time in future at a rate agreed at the present. It is used to secure cheap loan and reduce exposure to exchange rate fluctuations. Principal plus interest currency swap considers both principal and interest payments. In currency swap, principal is exchanged on national amounts at market rates, often using the same rate for the transfer at inception and at maturity. Credit default swaps refers to contracts between two parties, where one who buys credit default swap, pays a seller and receives a payoff if loan is defaulted. Credit default swaps can be compared to Insurance because the buyer pay a premium, which make the party to receive specific sum of money if events specified in the contract matures (occur). However unlike in insurance, the buyer can make a profit from the contract and covers assets that the buyer does not have direct exposure. [b] Evaluate the usefulness of these swaps for issuers of and investors in debt. First, swaps are flexible. Swaps are over the counter transactions. This means that the terms and conditions such as maturity dates and the amount involved is decided upon by the two counterparties at their convenience. It also allows parties involved to freely exploit their comparative advantage in their respective markets. Secondly, the cost of transaction is lower in swaps. The transaction is over the counter meaning that, there are no brokerage fees which could have been charged by a clearing house. In addition, the transaction is based on comparative advantage of both parties. Therefore, both parties are able to obtain funds at cheaper rates Third, swaps minimize risks associated with foreign exchange, interest rates changes as well as changes in credit facilities following occurrence of an event. If a company issues fixed bond rates and expects interest rates ...Show more


1. [a] The main characteristics of interest rate, currency, and credit default swaps Interest rate swaps refer to an agreement entered into by two parties. One party undertakes to make interest payment to another party according to the terms of the agreement on scheduled dates in future…
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International Finance Essay
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