Can someone explain a real world example of a currency swap? (LOS 74)
McDonald’s needs to build a restaurant in Tokyo. McD’s can borrow money in the US, but not in Japan. Ocha Sushi needs to build a restaurant in Stamford. Ocha can borrow money in Japan but not the US. McD’s will have an income stream in Yen and Ocha will have an income stream in $. So they each borrow $1M (or the equivalent in Yen) and swap. Now McD’s has $1M in YEN and Ocha has 1M in Dollars so they can start their restaurants. Now McD's has an obligation in Yen to go with their yen income stream. They are very happy. Ocha has a obligation to go with their $ income stream. They are also very happy.
Clarify further why McD’s has an obligation in Yen, since it borowed in $'s?
Because McD’s is going to get the $1M back from Ocha when the swap matures which they will use to pay back the bank. This will make the bank very happy. In the meantime, they need to make regular payments in yen to Ocha and then they have a big yen payment they have to make to Ocha at maturity.
So every month (lets say) McD’s has to come up with yen to pay Ocha, and Ocha has to find dollars to pay McD’s? But since McD’s is doing business in Japan, its cash flows are already in yen. Interesting, thanks.
I’m still having a hard time grasping this. For some reason it seems similiar to a bankers acceptance. I’m going to need to reread this a few times. Also Joey, I think I have seen posts where you personally invest in Swaps? How does an individual get into something like this?
Unless you are a very rich individual you can’t do FX and interest rate swaps on your own. You pretty much need a prime brokerage account with > $20M in it. I think I posted some tongue-in-cheek thing about the Joey swap theorem the other day… A bankers acceptance is a much different thing than an FX swap. A BA is a money market instrument which is about funding something which has no currency component.