Can you pls explain how the payoff of an NIRS is calculated and what collateral is usually posted (USD or local ccy)? I am especially interested on how the FX risk is incorporated in the pay off and how it differs from a local ccy bond?


1 Answer 1


In an IRS, there are two legs denominated in the same currency. Typically one leg is fixed, and the other is floating - getting reset from some index not known at the time of the trade, but observable later, when the payments are set.

Suppose for concreteness/simplicity that you're paying fixed 15% RUB and you're receiving Moscow PRIME index, annual frequency. Or IRR or some other sanctioned/terrorist currency.

If this were physical delivery, then for each coupon, you pay 15% of the notional, and you receive MOSPRIME $\times$ the notional. Netting, if MOSPRIME>15%, then you receive net MOSPRIME-15%, and conversely if MOSPRIME<15%, then instead you pay net 15%-MOSPRIME.

The goal of an IRS is always to change one's sensitivity to interest rates. You hope (with this swap) that MOSPRIME will go up, and your counterparty hopes that MOSPRIME will go down. Perhaps you're speculating, or perhaps you're trying to hedge away an unwanted interest rate sensitivity arising from your other activities, e.g. owning a local bond.

Because this swap is ND, you settle in some other currency, like EUR or USD or CNY/CNH, which can be physically delivered. Your term sheet must say very specifically when and how you will observe the exchange rate of the denomination currency to the settlement currency. It is similar to how the term sheet specifies where the reset index for the floating leg is observed. Typically, the official currency exchange rate is published by a central bank and uses a 2 business day lag. You multiply the local currency amount by the observed exchange rate to get the amount that you will pay or receive in the settlement currency.

The collateral is whatever your margin agreements say. Since people trade ND when physically delivering the currency is too difficult, I doubt that it would require collateral in the currency of the swap. Probably the settlement currency is one of the choices.

The IRS differs from a cross-currency swap (CCS) - there is no exchange of notionals. In a CCS, the two legs are denominated in different currencies and so both legs may be fixed - the future exchange rate is uncertain.

Swaps differ from cash local currency bond in many ways: you usually need an ISDA agreement to trade swps, a swap's mark to market is near 0 at inception, and the bond pays principal/notional at maturity, so has much more currency rate risk. In theory, the IRS is similar to two local currency bonds - one fixed, one floating and one long, one short, with exactly the same coupon schedules an offsetting principal repayments. But you can't achieve this practically.

Note that you can often find someone to sell you a total return swap (TRS) or global depositary note (GDN) on a local currency bond: the counterparty owns the bond, receives physical local currency for coupons and principal, pays you the equivalent amount of hard currency.

Edit note also that the non-delivery-ness doesn't change pricing, but affects the risk in a subtle way. If you have a physically delivered cash flow in the local currency, then tou have both the counterparty credit risk and the currency exchange rate risk until the cash flow occurs. But if the cash flow is ND, then once the exchange rate for this cash flow is observed and "frozen", there is no more local currency exchange rate risk. If the interest rate risk were material, then that too would be affected.

  • $\begingroup$ thanks. Hence the FX risk is lower for NIRS because payoff for a NIRS is given by (Dv01 in LCY * bps_move) * FX rate at trade expiry. By contrast for a local bond the payoff is given by Bond_price in LCY at expiry * FX rate currency. In essence, the FX rate is applied only the gain/loss of the swap and instead is applied to the full notional for the local bond? $\endgroup$
    – mark resen
    Commented Jun 24 at 22:20
  • $\begingroup$ for example if I pay fixed in a 5y BRL NIRS (settled in USD), with Dv01 BRL10k, FX rate at termination BRLUSD = 0.5, assuming 5y tenor up 20bps, payoff would be: (move_bps * Dv01) * FX rate = (20 * 10k) * 0.5 = USD 100k $\endgroup$
    – mark resen
    Commented Jun 24 at 22:33
  • $\begingroup$ Yes. Given an (ND)IRS and a bond, both having the same interest rate sensitivity, the ir swap has much smaller mark ro market and hence fx rate sensi. But in Brazil, why use ir swaps, rather than exchange traded DI futures $\endgroup$ Commented Jun 25 at 0:54
  • $\begingroup$ are DI futures easily accessible for offshore investors? $\endgroup$
    – mark resen
    Commented Jun 25 at 7:46
  • $\begingroup$ I'm not the best person to ask that, but from the Investment Climate Statements and b3 Guide for Non-Resident Invetors, exchange-traded products sound easier than an exotic swap. it may have been harder in the past, so be sure to look at the current rules. $\endgroup$ Commented Jun 25 at 11:49

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