Cross Currency Swap

Question

1) What is the difference between Cross Currency Swap and Cross Currency Basis Swap? Appreciate if this can be explained in layman's terms.

2) Could you advise me which swap rate to be used for the following scenario?

Selangor Bhd, a Malaysian company, would like to tap the Singapore bond market by issuing 10 years SGD100 million bond in Singapore. The YTM is 3.00% p.a. and currency SGD/MYR exchange is 3.00. The proceeds will be used in Malaysia, hence Selangor Bhd would like to hedge its forex exposure (both the principal and interest). Which swap rate should Selangor Bhd use to calculate the coupon payment in MYR? Also, which swap rate should Selangor Bhd use to hedge the principal sum, so that it repays the equivalent amount of proceeds it receive in MYR?

3) Is there a public source where I can find these swap rates?

Answer 1

Firstly, some instruments:

FX Swap, also known as an FX Forward: exchange of principals at start, and exchange back at end. The back exchange is at an adjusted FX rate, which differs from the spot rate by the quoted number of forward points.

Non-Deliverable Forward FX (NDF): much the same as an FX Forward above, but delivery is of the USD (usually) equivalent of the net payment, not the currency itself. There is no exchange of principal because there is no currency delivery.

Cross currency Swap (fixed/float): A series of regular fixed rate payments in one currency (usually the minor currency) is swapped for floating rate payments in the other. For example, 3% MYR vs USD Libor flat. There is generally a fixed spot rate for the principals of the two legs, and exchange of principal front and back. You can also trade fixed/fixed.

Cross currency basis swap: a series of floating rate payments in one currency (e.g. USD 3m Libor) is exchanged for a series of floating rate payments plus basis in the other (e.g. Euribor + 30bp). There is generally an exchange of principal, and some have embedded resets of the principals to mitigate the spot rate effect.

As I understand it, you want to sell bonds in ccy A, and receive ccy B. So you want to receive fixed on ccy A to pay as coupons on the bond. Doing a fixed/fixed cross currency swap receiving fixed on Ccy A, and paying fixed on Ccy B would achieve that. It would mean you only need to post collateral to one bank, and only in ccy B.

Alternatively, you could do a fixed/float swap receiving fixed in ccy A and paying float in ccy B. You either accept that variability or swap the ccy B float for ccy B fixed by doing an IRS in ccy B.

Finally you could do an IRS in A receiving fixed and paying float, a cross currency basis swap A to B receiving float A, paying float B, and a B IRS paying fixed and receiving float. But for a corporate it would be hard to justify doing 3 trades instead of 1, with the associated bilateral risks and collateral needs.

Often going directly between A and B for minor currencies is illiquid and thus less competitive, so you could go via USD, either with an A/USD fixed/float and a B/USD fixed/float or two fixed/fixed. This approach, while being two trades instead of one, uses two relatively liquid instruments which you will find quoted on Bloomberg, Reuters and can be quoted by multiple banks. In the event of a counterparty default, a replicating trade can be more easily done with a new bank for the broken half. More transparent and easier on everyone from Treasury to compliance.

The choice of instruments is then determined by which are the liquid markets in the currencies involved, at the maturities you are seeking.

Answer 2

In an FX swap you exchange SGD and MYR payments at the beginning of the swap, and then again (in the opposite direction) at the end of the swap 10 years later.

In a Cross Currency Basis Swap, in addition to these payments you also make interest payments quarterly. The party that initially received (i.e. borrowed) the SGD makes interest payments based on SGD Libor and the party that received MYR makes payments based on MYR Libor plus/minus a spread. It is what you use if you want to hedge both principal and interest. It is essentially a swap of one [floating rate] coupon bond-like payment structure against another; the FX swap is more like a swap of zero coupon bonds.

The word "cross currency" implies that two currencies are involved (SGD and MYR), the word "basis" refers to different references for interest calculation (one references SGD interest rates, the other references MYD interest rates).

Answer 3

They need to do 3 swaps (1) Singapore IRS: Receive fixed SGD vs Singapore floating rate for 10yrs on SGD 100mm (2) Currency Basis swap: Receive Singapore floating versus paying MYR floating for 10 yrs. This swap includes an exchange of principal at the start of the swap (pay SGD 100mm/ receive 33mm MYR) and an exchange of principal at the end in the opposite direction (3) MYR IRS: receive MYR floating versus paying MYR fixed on 33mm

The data required is the 10yr IRS rates in SGD and MYR, and the 10yr basis swap between SGD floating rate and MYR floating rate.