instruments in interest-rate, currency and ... - Volksbank AG

CROSS CURRENCY SWAPWhat is a cross currency swap?A cross currency swap is a special form of interest-rate swap. It is an instrument of interest-rate and currencymanagement whereby the focus is once again on the swap of different interest payments.The first difference between the two flows of interest payments running in opposite directions is theirdenomination in different currencies. Moreover, the principal amounts are usually swapped at the beginningand at the end of the agreement; however, these principal amounts are in differing currencies. Interest paymentobligations of the swap partners resulting from possible underlying transactions are not affected. As in the caseof interest-rate swaps, only the payments between the parties involved are regulated.A cross currency swap can be illustrated in three steps:nStep 1: Swap of principal amounts upon entering into the transactionUpon entering into the transaction, principal amounts in the underlying currencies are swapped,usually at the current spot rate.Party 1principal currency Ix spot rate =principal currency IIParty 2An actual swap of the principals among the parties is not mandatory. What is, however, decisive is to fix therate of exchange because this is the only way to determine interest payments and the re-exchange ratio of the principalamounts. As a rule, the swap takes place in the vicinity of the current spot rate, with rates rounded up or down –to smooth out the principal amounts.nStep 2: Interest-rate swap before maturityInterest on the respective principal amounts received is swapped before maturity.Party 1principal currency Ix interest-rate currency Iprincipal currency IIx interest-rate currency IIParty 217