Posted in Finance, Accounting and Economics Terms, Total Reads: 401
Definition: Macroeconomic Swap
A swap is an agreement wherein two parties exchange cash flows at regular intervals of time according to a predetermined basis. The basis is usually a macroeconomic factor such as Forex Rate, Interest rate, Gross Domestic Product (GDP) or commodities.
The variable cash flows are converted into fixed line of payments to reduce the business cycle risk.
If the cash flows are exchanged on the basis of foreign exchange rate, it is known as a Currency Swap or a Financial Swap
If the cash flows are exchanged on the basis of interest rates, it is known as an Interest Rate Swap.
A Swap transaction started initially to overcome international capital flow controls. This was done by granting parallel loans to the other country. Consider the following EXAMPLE:
Say, Country A is Great Britain and Country B is US. The firm A in Country A extends a loan in pounds to US Subsidiary of US MNC based in London. At the same time, the firm B in country B grants an equivalent amount of loan to firm A’s Subsidiary in New York in dollars. A swap can occur between end user and a swap dealer.
Indian Situation wrt to Swaps:
• it is only used for hedging
• there is no ceiling on the rates or principal amounts
• Transactions in India are only MIBOR based
Swaps can be implemented in two ways:
a. Swap IN: Buy forward currency in Spot and sell foreign currency in Forward- (BUY-SELL)
b. Swap OUT: Sell foreign currency in the first period i.e. Spot and buy foreign currency in Forward
Applications of Macroeconomic Swap:
-Hedging: Investor can start a SWAP IN transaction and eliminates exchange rate risk