Having Trouble Understanding Swaps

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doobsmeister

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Guys, I’m having trouble with swaps that involve different currencies. Any tricks to remember the sequence?
 
Do you mean the valuation of the swap after T =1, as an example?
 
Magician, thanks.. would you mind sharing these tricks? I actually went through some examples but it is very tedius, and it is difficult to remember after studying all other topics.
 
Galli, yes… I know how to do it for a single currency, but when you have to involve multiple currencies, i have a hard time remember the sequence.. Especially the bit about how you should first convert to notional and then current. Trying to understand why that is
 
Think about any swap as an exchange of bonds; for example:
  • A plain vanilla, pay fixed, receive floating swap is equivalent to issuing a fixed-rate bond (for the notional amount) and purchasing a floating-rate bond (same amount)
  • A currency swap is equivalent to issuing a bond in one currency and purchasing a bond in another currency
So, for a currency swap, look at what would happen if you actually did it with bonds. Suppose that you want to receive payments in GBP and make payments in CHF; this is just as if you’d bought a GBP bond and sold a CHF bond:
  • Initially, you pay the GBP notional and receive the CHF notional, as if you’d bought a GBP bond and sold a CHF bond
  • Periodically, you receive GBP interest and pay CHF interest, as if you’d bought a GBP bond and sold a CHF bond
  • At expiration, you receive GBP interest plus GBP notional and pay CHF interest and CHF notional, as if you’d bought a GBP bond and sold a CHF bond.
 
Thanks so much magician.. and how about the bit where you convert back to solve for the returns in a particular currency. Do you just convert each payment to that currency at each date and match them? and then get the PV of those differences?
 
Yes. You convert the payments at the exchange rate extant on the date you’re valuing the swap.
 
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