Currency derivatives experts, please help!

According to the CFAI textbook, fixed rates on a currency swap are equal to fixed rates on plain vanilla interes rate swaps in the respective countries. Thereofe, if I have a swap where e.g.I pay EUR float and I receive USD float, EUR leg is made out of EURIBOR, USD leg is made out of LIBOR. The question I have is: if the EUR leg is made out of EURIBOR+200bp, does that mean that the USD leg is made of LIBOR +200bp? If that is not the case, why not?

Swaps are usually individually negotiated agreements traded OTC. The terms can be whatever the two parties settle upon.

No, it does not mean that “if the EUR leg is made out of EURIBOR+200bp, does that mean that the USD leg is made of LIBOR +200bp?” Not at all! The 200bp is the spread added to the reference index and reflects the relative riskiness of the counterparty. If you were a triple A-rated subsidiary trading with an A-rated counterpart, you might have a spread of 75 bp while your counterparty had to pay 200 bp.

^ correct

DoubleDip Wrote: ------------------------------------------------------- > No, it does not mean that “if the EUR leg is made > out of EURIBOR+200bp, does that mean that the USD > leg is made of LIBOR +200bp?” Not at all! The > 200bp is the spread added to the reference index > and reflects the relative riskiness of the > counterparty. If you were a triple A-rated > subsidiary trading with an A-rated counterpart, > you might have a spread of 75 bp while your > counterparty had to pay 200 bp. But I think the point/question assumes that you are looking at equally rated counterparties, and if the spread would be different due to other reasons. I’d agree with the fact that since swaps are OTC individually negotiable contracts you never would really know. OP, where in CFAI books is this? I haven’t gotten there yet I guess.

CFA=NOLIFE Wrote: ------------------------------------------------------- > DoubleDip Wrote: > -------------------------------------------------- > ----- > > No, it does not mean that “if the EUR leg is > made > > out of EURIBOR+200bp, does that mean that the > USD > > leg is made of LIBOR +200bp?” Not at all! The > > 200bp is the spread added to the reference > index > > and reflects the relative riskiness of the > > counterparty. If you were a triple A-rated > > subsidiary trading with an A-rated counterpart, > > you might have a spread of 75 bp while your > > counterparty had to pay 200 bp. > > But I think the point/question assumes that you > are looking at equally rated counterparties, and > if the spread would be different due to other > reasons. I’d agree with the fact that since swaps > are OTC individually negotiable contracts you > never would really know. > > OP, where in CFAI books is this? I haven’t gotten > there yet I guess. how would an auditor know how to value swaps? Go count your beans and tick and tie your spreadsheets.

The question was based on the assumption, that both counterparties have same credit risk. If that’s the case, could spreads still be widley different (and have a fair market value of 0)? CFAI level 2 covered this stuff.

BBA, Basis cross-currency swaps (floating for floating currency swaps) pricing reflects the credit risk of the counterparty as well as global demand for the reference currencies. As such, even if two counterparties have the same credit risk (let’s assume we are talking about the Fed and the ECB as usually basis currency swaps of long tenor are entered into by central banks, but the parties can be corporates as well), differences in liquidity can force the spreads quoted on dollar LIBOR and Euribor to differ materially. Because floating rates in different currencies are an average of offered rates from different financial institutions (in our example, central banks) a USD LIBOR may have better liquidity than Euribor due to the depth and size of the market. Further, the spread is also affected by supply and demand (you may think of this as a factor that influences market liquidity) to receive floating rates in different currencies. As such, investors may be less willing to receive Euribor, thus requiring a larger spread to convince them to swap for dollar LIBOR. Of course in today’s economic climate, the steepness of the Euro curve indicates that investors may well prefer to receive Euribor over dollar LIBOR although demand for Bunds has recently picked up and eased the backup in shorter yields…