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Sir
i found some point in the answer section of exam kit that i do not understand which are related to currency swap. Can you explain me this points1) Currency swap might be used to avoid a country’s exchange control restrictions (How and what are exchange control restriction???)
2) Currency swap offer the opportunity to restructure the company’s debt profile without physically redeeming debt or issuing new debt (How???)
3) If swap is arranged directly with corporate counter parties then the potential default risk of counter party should be taken into consideration. Swap arranged with a bank as the direct counter party tends to be much less risky (“swap is arranged directly with corporate counter parties” does it mean that arranging swap without having bank as intermediary and what are the default risk of counter party means???)
4) With a floating to floating swap, basis risk might exist if the two floating rates are not pegged to the same index. (Explain and what are the basis risk in currency swap???)
1. Some countries impose restrictions on conversion of money into foreign currencies. Swapping borrowing in the home currency for borrowing in a foreign currency might avoid these restrictions.
2. Suppose a UK company has borrowing in pounds, but wants to borrow US dollars instead. Instead of repaying the pound borrowing and then issuing new dollar borrowing, they could maybe swap the existing borrowing for dollar borrowing.
3. The risk is that the other party to the swap goes bankrupt and cannot complete the swap arrangement. If the swap is done through an intermediary then the intermediary will give guarantees.
4. If floating rate borrowing is swapped for floating rate borrowing in another currency, then as interest rates change the interest rates on the two different currencies might not change in exactly the same way – for example on might increase by 1% whereas the other might increase by 1.5%. If the changes are not the same then it creates more risk – this is the basis risk.
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