Ch18-b.1
Rauli Susmel FINA 4360 – International Financial Management
Dept. of Finance
Univ. of Houston
11/16
Chapter 18 – Long term financing (continuation)
Last lecture
Long term financing is done through the World Bond Market.
Three segments:
1. Domestic
2. Foreign
3. Eurobond
Foreign Mkt + Eurobond Mkt form the International Bond Market.
Eurobond is 85% of Intl Market because it is unregulated, etc.
• Pricing Bonds: Review
P = Discounting of the cash flows.
P = C1/(1+YTM) + C2/(1+YTM)2 + C3/(1+YTM)3 + … + CT/(1+YTM)T
CFs for bonds (C1, C2, …, CT) are the coupon payments.
Note: There is a 1:1 relation btw price of bond and yield to maturity.
If we get YTM, then we know Price of bond
Investment Bankers set the YTM
YTM = Base Rate (kf) + Spread (Risk of Company)
• Q: How do we get the spread?
1. Look for outstanding debt
2. benchmark(similar companies/industry)
3. Analyze the firm, phone calls (lots of research)
This Lecture
This class introduces a new debt instrument, a swap, which is very flexible and allows companies
to change the profile of CFs.
1. Swaps
Definition: Swap
A swap represents a periodic exchange of CFs between 2 parties. In general, one of the parties is a
swap dealer (SD). Each payment to the counterparty is called a leg.
Typical exchange of CFs between 2 counterparties:
leg
leg
A usual swap contract has to specify:
⋄ Frequency of the payments (f)
⋄ Duration of the swap (T),
⋄ How the legs (payments) are calculated. (In general, one leg is a fixed payment and the other
leg is a floating (market price) payment. The fixed payment is based on a fixed rate called the
coupon of the swap).
There are different types of swaps. They differ in how the payments (legs) are indexed. For
example, if the legs are denominated in different currencies: currency swap.
• Market Organization
– Most swaps are tailor-made contracts.
⋄ Swaps trade in an OTC type environment.
⋄ Swap specialists fill the role of broker and/or market maker.
⋄ Brokers/market makers are usually large banks.
⋄ Prices are quoted with respect to a standard, or generic, swap.
A B (SD)
