Currency Swaps - Explained in Hindi - YouTube

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Namaskar, my name is Mukul, and welcome to asset Yogi.

Friends, in our last video we talked about interest rate swaps.

In this video, we will talk about currency swap

This video is part of a series in which we discuss Financial Derivatives

Currency swaps are also a type of financial derivative.

if you haven't seen other videos of Financial Derivatives

you can watch, you will find the link in the description below

In this video, we will understand the mechanics of currency swaps

how is it calculated

How does any party engage in this, A or B

And how do they gain or lose when they engage in currency swaps?

So stay tuned in this video, let's go straight to the blackboard.

Music

Let us take an example to understand currency swaps.

Suppose there is a company in the USA.

Whose name is ABC incorporated

And let's say in India

It wants to make some investments through its subsidiary in India.

want to set up a project

Let's say its requirement is 7 crores Rs.

If ABC company takes a loan in India

So it cost an interest rate of 14%.

In the USA, ABC incorporated gets a loan only at 6%.

ABC Incorporated has two options.

Either it can take a loan of 14% here.

Or by taking a loan of 6% from the USA

And transfer this money to ABC India but if it does so

Takes a loan of 6%

then they have to do remittance, they have to sell dollars

And then it will be converted into Rupees.

So in this case there is exchange rate risk.

This company also does not want to take the risk of the exchange rate.

The company wants to get an ABC India rupee loan but at a low-interest rate.

So they find the third option

In India, they found another such company whose requirement is similar.

Understand what its requirement.

There is an XYZ Limited Company in India

which wants to invest in the USA through a subsidiary of X Y Z America.

Its requirement here is that it wants to invest one million dollars.

If XYZ America takes a loan in America,

then they get an 8% interest rate.

If they take this loan in India,

then they get an interest rate of 12%

They also want to take a dollar loan in the USA.

These people also do not want to take the risk of the exchange rate.

So they have the same option

Either take this 8% loan here.

Or by taking a loan at 12% in India

And transfer it to the USA.

I have oversimplified here, here we have kept the requirement the same.

There is a requirement of one million dollars here.

There is a requirement of 7 crores here.

And we have assumed that $1 is equal to 70 Rs

So here the requirement of both is the same.

So in such a case, the USA company says that

The requirements of both the companies are the same so let us sign a swap agreement.

You can take a loan on our behalf.

You get us this loan at 12%. We will take a loan of 6% on your behavior.

Both will benefit, X Y Z also understands this.

Both sign a swap agreement

And understand how this agreement itself will work.

ABC Incorporated takes money from a lender in the USA.

1 million dollars.

At 6% for 5 years.

Takes a loan of 5 years at 6%.

And they transfer all this amount to XYZ America.

Same conditions, it is a back-to-the-back agreement.

1 million dollars at 6% for 5 years, This is also a loan of 5 years only.

And on the other hand, the same arrangement happens in India too.

XYZ takes a loan at 12% for ABC India.

So here comes lender 2. There was a requirement of 7 crores,

then a loan of 7 crores is taken at 12% for 5 years

And the same money is transferred to ABC India

Now how will the interest payment be done here?

Let's see this

The interest payment for 1 year will be $60,000 at the rate of 6%

So this company will give ₹ 60,000 to the lender every year.

And will take ₹60,000 every year from XYZ America.

Similarly, If the interest rate is 12% then

So this company with 84 lakhs every year for 5 years will give it to Lender 2.

ABC India will pay interest of 84 lakhs every year to X Y Z Ltd.

This is how ABC India got a loan at 12%

And XYZ America got the loan at 6%.

Both got a profit of 2% at both the places.

Now let's see how the cash flow will be generated

I have written dollar payment here

Above with the red colour This company will pay ABC Incorporated.

So see, in the first year ₹ 60,000 will be paid.

and ABC Incorporated will transfer to Lender 1

So in the first year, 60,000 is being paid

Similarly, interest payments will be made in the second year as well.

And here I have written 1.06M

There was a principal of 1 million

This too plus 60,000 interest will be paid.

So in this way, I have written Dollar Payments with red color

Similarly, if you look over here.

So this is the payment of interest of rupees 85 lakhs.

1,2,3,4 for 4 years, till four yeas

And in the fifth year the principle of 7 crores

plus 8400000 interest will be paid in one go in the fifth year.

So it is a simple cash flow.

I oversimplified in the example

But if we look in the real world then

How would ABC Incorporated know that XYZ limited has the same requirement?

So in such case, ABC Incorporated or XYZ Limited

or any other company

Do not find any company by themselves.

It goes to a bank.

So third party will always be intermediary in such an arrangement

So let's assume they will say that we have a requirement that we need a rupee loan.

Of 7 crores and what is the minimum interest rate, you can provide us.

And on the other hand, XYZ Ltd may also go to the bank.

And say I too have a similar requirement, I want a dollar loan as cheap as possible.

How much you can provide for us.

So the swap bank deals like this. It becomes the dealer which executes the currency swap.

So how is it arranged?

Swap banks are making arrangements so it will also make its commission there.

So instead of an interest rate of 6%, it will quote 6.25% to XYZ America.

And it will further pass 6% to ABC Incorporated

So here's a margin of 0.25

Swaps Bank will earn.

Margin and interest rates may vary.

I am explaining this to you just for example

Similarly, it will charge an interest rate of 12.25% from ABCD India

And will pass on to XYZ Ltd.

So even here it will earn a margin of 0.25%.

So that's how this whole arrangement of currency swaps works.

And pay attention that here we are talking about interest rates.

Here we talked about 12% so it can be a fixed rate as well as a floating rate.

If there is a floating rate then generally LIBOR+Premium

Let's say 1%

Or 2% or other,

in this way it can be quoted

If it is a fixed rate then the fixed rate can be quoted.

Similarly, LIBOR is an international arrangement, Mibor runs in India.

MIBOR stands for Mumbai interbank offer rate

LIBOR stands for London interbank offer rate.

So it could be MIBOR plus 2%

So in this way, if your interest rate is a floating rate, it can be quoted.

Otherwise, there may also be a fixed rate.

So fixed or floating rate can be quoted on both sides

And remember one more thing

In this case, both principal and interest are paid Which I showed in the cash flow.

First, the interest was being paid, and finally, the principal was also paid.

As we saw in the previous video of interest swaps, there is no payment only.

There is no real payment, there is only a notional amount.

And the actual difference gets transferred.

Here real payments take place.

I hope your concepts are clear after watching this video.

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