Is a cross currency swap an interest rate swap?

Cross-currency swaps are an over-the-counter (OTC) derivative in a form of an agreement between two parties to exchange interest payments and principal denominated in two different currencies. Cross-currency swaps are highly customizable and can include variable, fixed interest rates, or both.

How do you value a cross currency 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.

How does a cross currency basis swap work?

A cross currency swap occurs when two parties simultaneously lend and borrow an equivalent amount of money in two different currencies for a specified period of time. It entails an exchange of interest payments in one currency for interest payments in another.

What is interest swaps example?

Generally, the two parties in an interest rate swap are trading a fixed-rate and variable-interest rate. For example, one company may have a bond that pays the London Interbank Offered Rate (LIBOR), while the other party holds a bond that provides a fixed payment of 5%.

What is the difference between FX swap and forward?

Swaps and Forwards A Swap contract compares best to a Forward contract, although a Forward has only a single payment at maturity while a Swap typically involves a series of payments in the futures. In fact, a single-period Swap is equivalent to one Forward contract.

What is cross currency basis risk?

Without giving too much away, what is cross currency basis risk? It is basically the risk that the banks have when they fund mainly USD assets with liabilities in different currencies.

Why does cross currency basis exist?

Why does the cross currency basis arise? The cross currency basis exists because the balance of supply and demand in the interest rate markets differs from that in the foreign exchange market. This is due to the different participants in each market having different underlying objectives.

How to calculate cross currency basis swaps quantitatively?

I generally understand what they are (essentially swapping one currency for another currency on a floating interest rate basis) but not how to calculate the basis. I have read quite a bit on them and understand the basis exists because the forward rate is higher/lower than justified by the interest rate differential according to CIP.

How are interest rates fixed in FX swaps?

In an FX swap agreement, one party borrows one currency from another party and, at the same time, lends another currency to the same counterparty. Each party utilizes the repayment obligation as the collateral. Moreover, the repayment amount is fixed at the FX forward rate as of the beginning of the contract.

How is the euro interest rate calculated on a cross currency basis?

The two values calculated are approximately equal; thus, the covered interest rate parity holds. Given a spot rate of interest of 2.26 USD/EUR, with a U.S dollar interest rate of 3% and Euro currency interest rate of 5%, calculate the forward exchange rate for one year, if the covered interest rate parity holds.

What happens at the end of a cross currency swap?

At the end of the agreement, they will swap back the currencies at the same exchange rate. They are not exposed to exchange rate risk, but they do face opportunity costs or gains. For example, if the USD/JPY exchange rate increases to 100 shortly after the two companies lock into the cross-currency swap.