How to value a cross-currency swap

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How to value a cross-currency swap

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On swap valuation and overnight rates In the past, deriving the market value of an interest rate swap was considered fairly easy. Nowadays, things have changed. Things which once seemed stable are now unstable and a risk-free rate is no longer without risk. For this reason, the valuation of any type of swap has to change. This article aims to throw some light on the major developments in the interest-rate derivatives markets, the emergence of a new methodology, and the underlying complexities in valuing diff erent kinds of swaps.

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Will Basel III force disintermediation? Implications for high risk/high yield banking activities By: Pierre Wernert Published: April 22, 2011 Tags: corporates, financial institutions, public sector, value, market value, CCS, cross-currency swap, swap, credit default swap Since the first transaction in 1981 between the World Bank and IBM, the market of cross-currency swaps has grown rapidly. It represents, according to the Bank of International Settlements, an outstanding notional amount of USD 16,347 billion as per June 2010. In this article we will discuss how cross-currency swaps work, and how to value them. A cross-currency swap (CCS), can have different objectives. It can reduce the exposure to exchange rate fluctuation or it can provide arbitrage opportunities between different rates. It can be used for example, if a European company is looking to acquire some US dollar bonds but does not want to expose itself to US dollar risk. In this case it is possible to do a CCS transaction with a US-based bank. The European company is paying in euros and receives a (fixed) US dollar cash flow. With these flows the European company can meet its US dollar obligations. The valuation of a CCS is quite similar to the valuation of an interest-rate swap. The CCS is valued by discounting the future cash flows for both legs at the market interest rate applicable at that time. The sum of the cash flows denoted in the foreign currency (hereafter euro) is converted with the spot rate applicable at that time. One big difference with an interest-rate swap is that a CCS always has an exchange of notional. Looking at a CCS with a fixed-fixed structure (both legs of the swap have a fixed rate), the undiscounted cash flows are already known at the start of the deal, they are simply the product of the notional, the fixed rate and the year fraction.

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24/06/2013