Currency and Interest Rate Swap: A Case Study of the Australian Foreign Exchange Market

Only available on StudyMode
  • Download(s): 249
  • Published: May 31, 2010
Read full document
Text Preview
2184465 Risk Management �PAGE � �PAGE �1� Treasury Risk Management

CURRENCY AND INTEREST RATE SWAP

_A CASE STUDY OF THE AUSTRALIAN FOREIGN EXCHANGE MARKET_

ABSTRACT

Business transactions occur on the international front and there are laws and regulations regarding the pricing of the long-term forward exchange contracts. It is noted that the violation of the traditionally covered interest arbitrage pricing relation has been rampant and that the activity in the international currency and interest rate swap markets offers a substantial explanation for the continued and prevalent wrong pricing. In essence, it will be clearly noted that the fixed-to-fixed currency swaps provide another form of arbitrage which can influence long-term forward exchange pricing.

This paper will discuss how the violation of the traditionally covered arbitrage pricing activity is always practiced by the international currency and the interest charge swap markets who are reported to be inappropriately placing the prices, the interest rate swap market is found to be providing some kind of arbitrages which actually affects the long term forward exchange pricing process. The application of both the currency and the interest rate swaps providing a market for the bonds and contracts in the international market will be critically analyzed and discussed in this paper.

INTRODUCTION

A swap is always defined as an agreement made between two parties with an intention of exchanging a particular good, this good may be something of money value, we find under this agreement one party is always willing to make some payments for the good while the other one intends to purchase basing on some interests that are to be gained.

In this case we find that as from the year 2000 the swaps has been reporting a number of growth this coming up as a result their outstanding amount of the swaps in the market (Price and Henderson, 2009). The growth of the swaps in the market, we find that there has also been an increment in the marketing of the long-term forward currency contracts; this includes other major currencies found in the international market. Therefore this paper will look at the importance of legal tender and interest rate swap in the determination of the long term forward exchange rates.

_Statement of the Problem_

Considering the economic factors, it can be noted that in 2000s national economy was actually growing at the desired economic growth rate which facilitated opening of more commercial banks in anticipation of earning normal profits by the investors. For instance, even after the worst economic depression of the years 2000 to 2002; the overall economic growth continues to thrive which witnessed the decrease in unemployment rates, little interest rates as well as declining rate of inflation (Price and Henderson, 2009). However, it should be noted that the problems experienced by the commercial banks in 2000s were either indirectly or directly related to the instabilities of banking environmental challenges of the 1990s.

For instance, in the 1990s the exchange rates floated thus leading to main currencies being volatile. Further there were several peripheral economic shocks such as changing interest rates due to inflation aspects as well as lack of clear monetary policies which led to escalating price levels; the later was mainly caused by the policies adopted and effects of oil embargoes of the 1990s. These failures engaged many organisations to engage in the long term forward exchange contracts

_Aims_

The aim of study is to shed more light on the issue of interest rate and currency swaps as a mode of financing in the foreign exchange market, the paper also aims at discussing the types and importance of swapping in the attaining of the organisations objectives. This will essentially facilitate the stability in the financial rates offered by the different financial organizations world wide and therefore lead to the...
tracking img