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Swap
Diana Gloria Lavanda [email protected]

1. Introduction
2.Objectives
3.Definition
4.What are they used for?
5. What are they for?
6.What do they consist of?
7.What is its purpose?
8.What are they based on?
9.Who issues them?

10.How are transactions conducted?

11.How do Swap markets originate?
12.What is the general structure of the Swap?
13.How is the Swap classified?
14.What type of risk do they present?
15.How has the swap evolved in Peru?
16.Conclusions
17.Bibliography

INTRODUCTION
All countries with developed financial markets have created
derivatives markets where futures contracts on interest rates are traded,
currencies and stock indices and options contracts on currencies, interest rates, stock indices,
stocks and futures contracts.
Derivatives are defined as the family or set of instruments
financial, whose main characteristic is that they are linked to an underlying value or of
reference. The main derived products are futures, options, warrants, the
options on futures and swaps.
The derivatives market can thus be defined as financial operations.
for which a commitment is made to buy or sell on a future date, or are contracts
that allow market participants to buy protection against price changes in the
assets.
The main application of all these instruments is the coverage of risks.
financial and market, to which economic agents are subjected, mainly
originating from changes in interest rates, exchange rates, and commodity prices
securities. In addition, both parties will go to the markets where they obtain an advantage and will be
agreement to change the payments and collections between them, which will allow for a better outcome than if
both parties would have gone directly to the desired market.

OBJECTIVES
General objective:
Know the SWAP CONTRACT.
Specific objectives:
- To know what a swap is and what it is used for.
- Know who issues them.
- Learn how transactions are carried out.
- To know how the swap originated.
- Learn how swaps are classified.
- Know the types of risks they present.
- To know how it has evolved in Peru.
 SWAP CONTRACT
I. DEFINITION
The swap is a contract through which both parties agree to exchange cash flows
about a certain principal at regular intervals of time during a given period. Still
There are cases of swaps used on exchange rates, interest rates, stock indices.
or stock market, etc.
Example of a currency swap made between IBM and the World Bank in 1981: IBM converted to
dollars from previous debt issuances in Swiss francs and German marks by IBM. The
swap allowed IBM to take advantage of the dollar's rise in the early 80s and set the rate
to change the repayment of your debt. For its part, the World Bank issued bonds in dollars that
they provided the necessary dollars for the swap, and in return, he/she obtained financing in
Swiss francs and marks.
Therefore, the contract known as a swap is an instrument with broad possibilities of use and
it is not as specific as it is usually used, it is simply misinformation or that in some
underdeveloped stock markets, they do not offer it much.

II. WHAT ARE THEY USED FOR?

Swaps are used to reduce or mitigate interest rate risks, risk on the
exchange rate and in some cases they are used to reduce credit risk.
These instruments are OTC (Over The Counter), that is to say, made at the
measure. But, they always incur a certain level of credit risk due to their operation.

III. WHAT ARE THEY FOR?

These types of swaps are used to manage credit risk through measurement and
determination of the price of each of the underlying assets (interest rate, term, currency and
credit). These risks can be transferred to a holder more effectively, allowing
thus, access to credit at a lower cost. Adjusting to the relationship between supply and demand
of credit. It could be said that credit risk is nothing more than a risk of
possible noncompliance.

IV. WHAT DO THEY CONSIST OF?

Swaps consist of a financial transaction in which the two parties agree
contractually exchange monetary flows for a specified period and following
some agreed rules.

V. WHAT IS ITS PURPOSE?

Mitigate the fluctuations of currencies and interest rates.
Reduce credit risk.
Restructuring of portfolios, where added value is provided for the user.
Reduce liquidity risks.
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VI. WHAT ARE THEY BASED ON?
Swaps are based on the comparative advantage that some participants enjoy in
certain markets, which allows them to access specific currencies or obtain interest rates in
more advantageous conditions.

VII. WHO ISSUES THEM?

The people or institutions responsible for their issuance are:
Currency market intermediaries.
Brokers members of the clearinghouses of futures and options exchanges
from abroad, classified as first category according to general regulations.
that adopted by the Bank of the Republic.
Foreign financial entities rated as first category according to
general regulations adopted by the Bank of the Republic.
-
VIII. HOW ARE TRANSACTIONS CARRIED OUT?
 By phone or Internet, and the deal is closed when an agreement is reached on the rate.
cupón, la base para la tasa flotante, la base de días, fecha de inicio, fecha de vencimiento,
rotation dates, applicable law and documentation.
The transaction is confirmed immediately by fax followed by a confirmation.
writing.

IX. HOW SWAP MARKETS ORIGINATE?

An exchange rate (foreign) is the number of units of a currency that can be purchased.
in exchange for one unit of another currency. These exchange rates became extremely
volatile in the early seventies. The drastic increase in volatility of
The exchange rate created an ideal environment for the proliferation of a document similar to the swap.
that could be used by multinationals to cover long-term currency operations.
Swaps were a natural extension of the loans called parallel, or back-to-back,
they originated in the United Kingdom as means to avoid the rigidity of currency exchange,
which sought, in turn, to prevent an outflow of British capital. During the seventies, the
the British government taxed currency transactions, including its own
currency. The intention was to raise the cost of capital outflows, believing that this would encourage investment
domestic making investment abroad less attractive.
The parallel loan became a widely accepted vehicle through which it could
avoid these taxes. The back-to-back loan was a simple modification of the loan
parallel, and the currency swap was an extension of the back-to-back loan.
The type of loan mentioned involves two corporations based in two different countries.
One firm agrees to raise funds in its domestic market and lends them to the other firm.
The second firm, in exchange, requests funds in the domestic market and loans them to the first.
Through this simple agreement, each party is able to access markets of
capital in a country different from yours without any exchange in the foreign exchange markets. The
Parallel loans work similarly, but involve four firms.
The cash flows from the initial currency swaps were identical to those associated with
back-to-back loans. For this reason, initial currency swaps were often
called loan exchanges. However, and contrary to what happens with the agreements
what characterizes back-to-back and parallel loans, swaps involve an agreement
simple.
The agreement specifies all cash flows and states that the first counterparty can
to be relieved of her obligations to the second, if the latter does not fulfill her obligations to
the first. Therefore, swaps provide the solution to the problem of rights.
establishment.
It is important to note that relieving a counterpart of their obligations after the
non-compliance by the other party does not mean, and in no way prevents, that the
counterparty that did not fulfill its obligations is free to make claims for damages to the
defaulting party.
The other problem associated with parallel and back-to-back loans was solved through the
intervention of swap brokers and market makers who saw the potential of
this new financing technique.
The first currency swap is believed to have been signed in London in 1979. However, the
true initial currency swap, the one that arrived at the nascent currency swap market,
involved the World Bank and IBM as counterparts. The contract allowed the World Bank
obtain Swiss francs and German marks to finance their operations in Switzerland and Germany
from the West, without the need to go directly to these capital markets.
Although swaps originated from an effort to control currency exchange, they do not
It was only much later that the cost reduction benefits were recognized.
of risk management that such instruments meant. From this moment on, the market
grew quickly.

X. WHAT IS THE GENERAL STRUCTURE OF THE SWAP?

The basic structure of a swap is relatively simple and is the same for any of the
types of swaps that exist. The apparent complexity of swaps lies more in the large
amount of documentation that is necessary to fully specify the terms of
 contract and the provisions and special clauses that may be included to adjust the
swap to a specific need.
All swaps are built around the same basic structure. Two agents,
called counterparts, agree to make payments to each other based on certain amounts
of assets. These payments are known as service payments. The assets may or may not
to exchange and are referred to as notional. In the generic form of the swap, the agreement establishes
a real or hypothetical exchange of notions from the beginning of an exchange until the
termination.
The swap begins on its effective date, which is also known as the value date.
It will end on its due date. Throughout this period, service payments will be made.
in periodic intervals, as specified in the swap agreement. In its most
common, these payment intervals are annual, semi-annual, quarterly, or monthly. The payments
service start to accumulate from the effective date and stop on the date of
termination.
The fixed payment or flow does not change throughout the duration of the swap. The floating payment, on the other hand,
is checked periodically. The current dates on which payment exchanges occur are
they call payment dates.
It is very difficult to arrange a swap directly between other end users. A more
efficient involves engaging a financial intermediary that serves as a counterparty in
said users.

XI. HOW IS THE SWAP CLASSIFIED?

1. Interest rate swaps
This type of contract is the most common in financial markets.
A normal interest rate swap is a contract through which one party of the transaction
commits to pay the other party a predetermined interest rate on a
a nominal amount also fixed in advance, and the second party agrees to pay the
first at a variable interest rate on the same nominal.
Interest rate swaps are financial exchanges in which
they exchange payment obligations related to loans of a different nature,
referred to a certain notional value in the same currency. Normally they
they exchange fixed interests for variable ones, although fixed interests can also be exchanged for
variable type over two different reference bases.
That is to say, a swap is not a loan, as it is exclusively an exchange of cash flows.
interest rates and no one lends the nominal to anyone, that is to say, the principal amounts are not
they exchange.
- Currency swaps: it is a variant of the interest rate swap, in which the nominal over the
that a fixed interest rate is paid and the nominal rate on which the interest rate is paid
the variable refers to two different currencies. The traditional form of a currency swap,
generally denotes a combination of a purchase (sale) in the spot market
"spot" and a compensatory sale (purchase) for the same party in the futures market.
"forward", but this can sometimes refer to compensatory transactions to different
expiration dates or combinations of both.
Currency swap is an agreement between two economic agents to exchange,
for an agreed period of time, two flows of interest denominated in different
currency and generally, upon the expiration of the agreement, the principal of the operation, at a rate
of a predetermined exchange rate at the beginning of it, normally the cash rate for that day.
Such exchange of principals is what precisely allows us to cover ourselves from the
unfavorable evolution of exchange rates.
Regarding the simplest classes of existing currency swaps, they will vary depending on
the exchanged types, distinguishing between:
Fixed versus variable currency swap.
Variable currency swap against variable.
Fixed against fixed currency swap.
Among the advantages of swaps, it is worth noting the absence of risk due to the
principal of the contract, since its possible non-compliance only affects the differential of rates or
 prices; or the change in the debt structure provided by the swaps
interest rates.
Regarding its drawbacks, it is important to highlight the high level of its main notions.
the high costs of intermediation and implementation and, finally, the difficulty in undoing
the operation before its expiration, as there was no counterpart to assume the
specific conditions of the contract in question.
2. Commodity Swaps
A classic problem in finance is the financing of producers through
of raw materials, since global raw materials markets are often
high volatility.
For example, international oil prices can drop in just a few days to
a 30%.
For this reason, companies that produce raw materials are generally companies of
high risk, both for loans and for investments.
Therefore, this type of swaps are designed to eliminate price risk and thus
way to achieve the reduction of financing costs.
The operation of a commodity swap is very similar to that of an interest rate swap.
interest, for example: a three-year swap on oil; this transaction is an exchange
of money based on the price of oil (A does not deliver oil to B at any time)
therefore the swap is responsible for compensating any existing difference between the price
market variable and the fixed price established through the swap. That is, if the price of
oil falls below the established price, B pays A the difference, and if it rises, A pays B
the difference.
3. Stock index swaps
These allow exchanging the return of the money market for the return of a
stock market. This stock market return refers to the sum of received dividends,
gains and/or losses on capital. Example on a nominal of USD 100 million: 'At first
from the swap the initial value of the index in question is recorded, for example, the value of the S&P 500 at
the beginning of the period could be 410.00. Each quarter A pays B three-month LIBOR in
dollars over USD 100 million. In turn, B pays A a fixed amount of money each quarter.
to the dividends that A would have received if he had invested USD 100 million in the shares that
they make up the S&P 500, with the index at its initial value of 410.00 at the time of the
investment.
In addition to the above, if the S&P 500 index is above its initial value at the end of
In the first quarter, B will pay A the difference on a number of shares corresponding
To the initial investment of USD 100 million at an index of 410.00, and if it is below, A will pay B.
the difference. This process is repeated every quarter, always taking the end of the quarter
previously as a difference but maintaining the number of shares defined at the beginning of the
transaction always fixed
Through this mechanism, the same profitability is achieved as if one had invested in
actions and is financed in turn, but always conserving its capital, and this allows it to
invest it in other assets.
4. Currency swaps
In this type of contract (or financial swap), 'one party commits to settle interest
on a certain amount of principal in a currency. On the other hand, receives interest on a certain
amount of principal in another currency.
This is a variant of the interest rate swap, 'in which the nominal on which payment is made
the fixed interest rate and the nominal on which the variable interest rate is paid are two
different coins.
Unlike the previous swap (interest rate swap), in this one, the amounts of
The principal is exchanged at the beginning and end of the life of the swap.
This, in turn, can be used to transform a loan in one currency into a loan in another.
another currency. Since it can be asserted that a swap is a long position in a liability
combined with a short position in another obligation. A swap can be considered as
a portfolio of futures contracts.
For example, currently financial institutions frequently receive as
deposit a swap.
 To expand the idea of how a swap works, here is an example of a swap of
currency exchange carried out between IBM and the World Bank in 1981:
IBM converted previous debt issuances in Swiss francs and marks into dollars.
IBM Germans. The swap allowed IBM to take advantage of the dollar's rise in early
the 80s and set the exchange rate at which to repay its debt. For its part, the World Bank
issued dollar bonds that provided it with the necessary dollars for the swap, and
secured financing in Swiss francs and marks in exchange.
5. Credit swaps
These types of swaps are used to manage credit risk through measurement and
determination of the price of each of the underlying assets (interest rate, term, currency and
credit).
These risks can be transferred to a holder more effectively, thus allowing for a
access to credit at a lower cost. Adjusting to the relationship between supply and demand of
credit.
One could say that credit risk is nothing more than a risk of
possible non-compliance.
There are two options for swaps: the default swap and the swap of
total return (total return swap).
In a credit default swap contract, a credit risk seller pays another party
for the right to receive payment in the event that the agreed change occurs between
they in the credit status of the reference credit, usually a corporate bond. The
total return swaps, on the contrary, allow the credit risk seller to retain
the asset and receive a return that fluctuates as credit risk changes. The
the seller pays a total return rate on a reference asset, generally a security
which includes any price consideration, in exchange for periodic payments at a floating rate
more any price reduction.
When this type of swaps was invented, they were usually used only by banks.
to protect bank credits.
Currently, they have become very popular hedging instruments as they allow
retain the asset while segmenting and distributing the risk.
This allows a bank to free up lines of credit and continue lending money to its
clients, even when it exceeds their exposure limits for that company or industry,
through the transfer of credit risk (in whole or in part) via a return swap
total or of non-compliance.
In addition, you can focus on loans to the sectors where you have a greater presence or
experience, without worrying about excessive risk concentration. The banks more
small businesses, whose margins are impacted by the high cost of money, could obtain a
higher returns and exposure to better credits using credit derivatives and not
direct loans.

XII. WHAT TYPE OF RISK DO THEY PRESENT?

Differential risk: If a swap is covered with a bond, and a change occurs in the
The differential of the swap compared to the bond can cause a loss or a gain in the
profitability of the swap.
Basis risk: When a swap is covered with a futures contract and there is a difference
between the reference rate and the implicit rate in the futures contract, resulting in a loss or
a utility.
Credit risk: The probability that the counterparty will not fulfill its obligations.
Reinvestment risk: It is derived from credit risk when there are changes in the dates.
to pay, it is necessary to reinvest at each turnover date.
Exchange rate risk: If a positive fluctuation occurs in the
currency(ies) that will be settled when the transaction (purchase or sale) is carried out, that is,
if at the end of the commercial operation they have to pay more than their own currency (or any
another) to acquire the same amount of currency that was agreed upon in the contract. What affects
the final cost of transactions.

XIII. HOW HAS SWAP EVOLVED IN PERU?

 The financial derivatives market in Peru is becoming increasingly relevant.
because they allow to eliminate or reduce the risks associated with fluctuations in rates
interest, exchange rate, etc.
In Peru, the most developed market is the currency forwards market, which reached in May
In 2006, a balance of US$ 787 million and US$ 2,233 million in purchases and sales.
respectively, which represents a growth of 79% and 128%, respectively,
relación a mayo del 2005.
It is worth remembering that, in a Currency Forward, two counterparts commit to
exchange, on a future date, a specified amount in different currencies at a rate of
specific change.
Additionally, three other financial derivatives are traded in Peru:
Currency Swap: two parties agree to exchange interests and
amortizations on nominal amounts agreed upon in two currencies. For example, a
A company with income in soles and debts in dollars can convert its debt to soles.
entering into a Swap in which it pays soles and receives dollars.
Interest Rate Swap: two counterparties agree to exchange a rate of
fixed interest for a variable. For example, a company can set the variable rate of its
debt agreeing on a Swap in which it pays a fixed rate and receives a variable rate.
Forward Interest Rates: similar to a Swap but with a single exchange.
Despite the fact that the derivatives market in Peru is becoming increasingly important,
this still has potential to grow. The volumes agreed upon over-the-counter, in April of
2004, they represented only 1.4% of GDP, while in Brazil, Chile, Colombia, and Mexico
represented 7.8%, 22.5%, 5.5% and 19.1%, respectively. It is worth mentioning that the
The global over-the-counter market in December 2005 was found to be US$ 284.8 trillion,
approximately 28 times the GDP of the U.S. and 13 times the market capitalization of the
companies listed on the New York Stock Exchange.
Likewise, in December 2005, Cahua (Cahua Electric Generation Company S.A.) signed
a swap contract with BCP, in which US$13.2 million of its debt is fixed at a fixed rate of
4.92%. Therefore, the Company would be setting a total of US$20.0 million in fixed-rate debt,
decreasing vulnerability to changes in the Libor rate. The maturity of that contract
swaps in November 2015.

CONCLUSIONS
Some of the most internationally known derivative instruments are forwards, the
futures contracts, financial swaps, and options; these have the great virtue of
offer a wide potential for leverage because, in comparison to the market of
counted, they allow with the same capital to carry out a greater number of operations. The above is possible
thanks to the fact that the derivative operation can be carried out through an equivalent deposit of a
percentage of the total operation, called margin and in the OPCF guarantee system, in a way
that it is not necessary to state the total amount of the investment made.
Swap contracts are less commonly used instruments, the most common in their use and number of
operations by modern entrepreneurs are usually futures and options.
Swaps are even more specific tools (unlike futures and options
which are usually about other financial assets), swaps are used to hedge credit risk.
this type of contract is more commonly used by financial institutions (banks, insurers, savings banks
savings, etc.) of all sizes.
A swap contract obliges both parties to exchange specified cash flows.
specified intervals. In an interest rate swap, cash flows are determined by
an average of two different interest rates, e.g. a fixed rate of 8% for a floating rate of LIBOR +
2%. In a currency swap, cash flows are determined by two exchange rates,
euros per American dollars.
The efficiency of using a swap, regardless of its use, will depend on knowledge of
global capital market and the market efficiency in which we are participating. Choosing a
A good agent or broker is also of utmost importance, as they will be responsible for ensuring that the
the return on our capital is positive.
So the swap is an instrument that can be very helpful in contingency plans.
the company, to protect against unexpected events, only if we know how to use these instruments,
we will take advantage of them.
Since unlike forwards, which are contracts that end on a particular date, the
swaps can be used for scheduled hedges, which can protect a business from
certain cyclical phenomena of the same macroeconomics.
Since most coverage is designed to offset the risk associated with a
volatility in the price to which a producer, a consumer, or an investor is exposed.
By entering into a swap or some other form of derivative instrument, one party can
cover the risk associated with fluctuations in a price under the assumption that the quantity is
known.

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Diana Gloria Lavanda Reategui

[email protected]