Fixed for Floating Currency Swap

CFA Level II
#1

Hi,

Can someone explain how fixed for floating currency swap is equivalent to a fixed-for-fixed currency swap and a floating-for-fixed interest rate swap?

Thanks!

#2

Suppose you have a USD50 million / GBP40 million semiannual-pay, fixed-for-floating _ floating-for-fixed _ currency swap, the USD fixed rate is 3.0% and the GBP fixed rate is 4.0%; 6-month GBP LIBOR is 3.5%.

At inception you hand over USD50 million and receive GBP40 million. In 6 months you pay GBP700,000 (= GBP40 million × 3.5% / 2) and receive USD750,000 (= USD50 million × 3.0% / 2). Six-month GBP LIBOR resets to 3.8%, and you start all over.

Suppose, instead, that you have a USD50 million / GBP40 million semiannual-pay, fixed-for-fixed currency swap (swap 1) and a GBP40 million fixed-for-floating _ floating-for-fixed _ interest rate swap (swap 2); the USD fixed rate is 3.0%, the GBP fixed rate is 4.0%, and 6-month GBP LIBOR is 3.5%.

At inception you hand over USD50 million and receive GBP40 million on swap 1; no money changes hands on swap 2. In 6 months you pay GBP800,000 (= GBP40 million × 4.0% / 2) and receive USD750,000 (= USD50 million × 3.0% / 2) on swap 1; on swap 2 you receive GBP100,000 (= GBP40 million × (4.0% − 3.5%) / 2), . Net, you receive USD750,000 , and you pay GBP700,000 (= GBP800,000 − GBP700,000), the same as in a USD/GBP fixed-for-floating swap. Six-month GBP LIBOR resets to 3.8%, and you start all over.

#3

@S2000magician

Another clarification: so fixed-for-floating is receive fixed and pay floating?

Also for the second swap yours is fixed-for-floating interest rate swap while the CFAI book shows floating-for-fixed interest rate swap?

Thanks!

#4

Normally you list what you pay first, so fixed-for-floating would mean paying a fixed rate and receiving a floating rate.

I wrote it backwards, above. Sorry about that. I’ve corrected it.

However, the general idea should be clear.

#5

@s2000magician

Thanks, i understand the concept however in the cfai text it says fixed for floating currency swap is the same as fixed for fixed currency swap and “FLOATING for FIXED” interest swap.the part i dont understand is why isnt it a fixed for floating interest swap for the second part?

#6

I suspect that it’s just sloppiness on their part. I wouldn’t worry about it.

#7

What I am struggling to understand is what’s driving the demand for 10y SWAP rates. If we assume that we are at the start of an increasing interest rate environment, who would want to pay floating rates and receive fixed rates? Wouldn’t everyone want to fix low interest payments (=pay low fixed rates)?