FINA 470 Lecture Notes - Lecture 7: Credit Risk, Risk-Free Interest Rate, Substitute Good
5 Mar 2016
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Document Summary
Loans exceeding one year are multi- payment: interest is due often multiple times during year, and principal amortized gradually. To swap this loan you need as many forward hedges as there are future payments. Currency swap contract, both parties agree on spot conversion, and reverse conversions for all service payments. Time pattern of final payments lines up with original payments. Can transform a currency floating rate into a fixed rate loan in currency b. Swaps can transform one loan into another that is different in terms of currency or interest payments, or both. Swaps were frowned upon because could be used to package back-to-back loans for shady reasons like shirking taxes, laundering. Ibm and world bank set up contract to avoid transaction costs that changed that. 1981, ibm"s dem and chf debt"s interest rate had increased while usd appreciated. Ibm wanted to lock in cap gains by replacing with us debt.
