CCS Analytics
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The document discusses offshore bond issuance and the role of cross currency swaps in managing risk and optimizing pricing across markets. It emphasizes the differences between domestic and offshore issuances, various methodologies for valuing cross currency swaps, and examples of arbitrage opportunities in international debt markets. Key points include the impact of market conditions on bond issuance strategies and investor choices between different currency-denominated bonds.
![USD JPY 5 Year Basis Swap USD 20MMToyota Corp(JPY Libor0 -46bps)xΔtx¥1.6834B(JPY Libor1- 46bps)xΔtx¥1.6834B(JPY Libor2 -46bps)xΔtx¥1.6834B(JPY Libor3- 46bps)xΔtx¥1.6834B(JPY Libor4 - 46bps)xΔtx¥1.6834B(JPY Libor18 -46bps)xΔtx¥1.6843B[(JPY Libor19 -46bps)xΔtx¥1.6716B]+¥1.6834B¥1.6716B123419520(USD Libor0)xΔtX$20MM(USD Libor2)xΔtx$20MM(USD Libor3)xΔtX$20MM(USD Libor4)xΔtx$20MM(USD Libor5)xΔtx$20MM(USD Libor18)xΔtX$20MM[(USD Libor19)xΔtx$20MM]+$20MM$20MMSwap CounterpartyFX spot rate (JPY/USD)= 0.0118807](https://image.slidesharecdn.com/ccsanalytics-13176842846796-phpapp01-111003184036-phpapp01/85/CCS-Analytics-18-320.jpg)
CCS Analytics
- 1. Focus on Offshore Bond Issuance-Cross Currency Swap & BasisFrançois ChoquetApplication Specialist
- 2. Domestic Vs International Debt Securities Issuance+8% p.aSource: BIS
- 3. Motivations for Offshore IssuanceManage RiskPrice ArbitrageMarket CompletenessSub Investment gradeMaturitySizeCouponStructured Notes
- 5. Factors Driving the BasisShort term: FX swapsMedium to Long Term: Bond IssuanceLong term: Exotics, dual currency bondsActive markets: EUR, JPY, AUD, GBP vs. USD
- 6. Distribution of Bond Types: AU Domestic vs. AU OffshoreStructured NotesMaturity
- 7. Australia Offshore Issuance (Size in USD)
- 8. Bond Distribution: Japan Domestic vs. Offshore
- 9. Japan offshore Issuance(size in USD)
- 10. Eurodollar and Eurobond Issuance5 year EUR basis
- 11. Distribution of Eurobonds (EU vs. US)RatingsMaturityStructured Notes
- 13. Korean Debt Market Composition
- 14. Asset/LiabilityCurrency MatchesOrganizational Structure: ToyotaCredit Card receivables, auto Loans USDToyota Financial Services AmericasCorp (ForeignSubsidiary) USDToyota Motor Credit Corp (Intercompany issuer)USDToyota CorpJPY Debt$$$¥$¥JN Parent with Matching Currencies through a CCS for its LT assets and LiabilitiesMatching USD Assets vs. Liabilities for the SubsidiarySwap Counterparty
- 15. Cross Currency Swap (basis)At inceptionDuring the termAt maturityJapanese Counterparty AJapanese Counterparty AJapanese Counterparty A X.S (JPY) X (USD)USD Libor X (USD)USD Libor ¥ Libor + α ¥ Libor + α X.S (JPY)Foreign Counterparty BForeign Counterparty BForeign Counterparty BS : FX spot rate (JPY/USD)X: Principal Amount
- 16. Cross Currency Swap PricingAt inception a cross currency basis swap is similar to two floating rate bonds priced at par. The notional principal amounts in the two currencies is set according to the spot exchange rate e.g. JPY N1 = JPYUSD.N2The market prices a basis to keep this fundamental relationship. In the market, it is expressed in terms of spread to the benchmark rates. For example a 5 year cross currency basis swap of 3 month USD Libor flat against JPY Libor is “fair” with a spread of -42.9 basis points if USD Libor is received and a spread of -48.75 basis points is USD Libor is paid.
- 17. Toyota USD Issue (Swap Covered)
- 18. USD JPY 5 Year Basis Swap USD 20MMToyota Corp(JPY Libor0 -46bps)xΔtx¥1.6834B(JPY Libor1- 46bps)xΔtx¥1.6834B(JPY Libor2 -46bps)xΔtx¥1.6834B(JPY Libor3- 46bps)xΔtx¥1.6834B(JPY Libor4 - 46bps)xΔtx¥1.6834B(JPY Libor18 -46bps)xΔtx¥1.6843B[(JPY Libor19 -46bps)xΔtx¥1.6716B]+¥1.6834B¥1.6716B123419520(USD Libor0)xΔtX$20MM(USD Libor2)xΔtx$20MM(USD Libor3)xΔtX$20MM(USD Libor4)xΔtx$20MM(USD Libor5)xΔtx$20MM(USD Libor18)xΔtX$20MM[(USD Libor19)xΔtx$20MM]+$20MM$20MMSwap CounterpartyFX spot rate (JPY/USD)= 0.0118807
- 19. Valuation PrincipleCross currency swaps requires discounting the cash flows with the discount factors of the respective currency. E.g. USD leg with USD DF and JPY leg with JPY DF. Using DF from standard curves show a profit or loss which should be non existentIt is therefore required to include a spread on the less “liquid” benchmark to bring the initial PV to zeroFor the leg to which the basis applies, two curves are required: One to project cash flows (forward) and the other to discount cash flows (basis adjusted discount curve)
- 20. Bootstrapping Discount Factors and Zero Rates from Swap RatesA swap Rate is the coupon rate which the fixed side is going to pay for the par swap. The procedure to solve the discount factor from a quoted swap rate is called bootstrapping. As shown above, To solve the 2-year discount factor, we need 1 year discount factor. To solve 6-year discount factor, we need 1 year, 2 year, 3 year, 4 year, 5 year discount factors. Thus we have to go step by step to solve the discount factors.*Par coupon adjusted for intra-currency basis for most cross currency swaps e.g JPY
- 21. Basis Adjusted Discount CurveObjective: Incorporate the cross currency basis spread into the valuation method to be consistent with the market.Sm the market quoted fair cross currency spread for maturity Tmon top of the floating rate for the given currency relative to chosen liquidity preference i.e. USD LiborThe fact that Sm is the fair spread is equivalent to a floating rate bond with maturity Tm in the given currency which pays Libor plus or minus a spread Sm valued to par. DF* is the basis adjusted discount factor to ensure that the floater is at par. It is obtained by recursive bootstrapping as in the formula:The discount Factors DF* are used for discounting any fixed or floating cash flows in a cross currency swaps. The valuation is thus consistent with the cross currency quotes provided by dealers. See following slides for excel prove-out and comparison with BBG screens.
- 22. JPY Basis Adjusted Discount Curve*Flat interpolation for currency basis** Mid point used for all market rates
- 23. USD JPY Basis Swap Valuation
- 24. USD Leg ValuationPV inflows = PV outflows = USD20,000 = USD20,000/0.011897 = JPY1,681,096,074.64
- 27. Appendix: Valuation of JPY leg in USD using FX Forwards Basis=-46.4bps
- 28. Basis Adjusted Curve vs. FX ForwardsThe large difference in valuation shows that forwards quoted by the market do not fully incorporate the CIP. Therefore, the valuation of CCS using this method is unsatisfactory!The valuation methodology for one and same cash flow should not depend on the type of originating trade for that cash flow. E.g USD or JPY Evaluating cross currency swap requires discounting the cash flows with the discount factors for the respective currency.In the basis adjusted curve approach, we must use TWO discount curves: one for projecting cash flows and the other for discounting all cash flows.
- 29. Study CasesBond CIP Arbitrage in AUD and CNHSwap Covered “Bargain”--------
- 30. Eurodollar FRNCBA issued 1.6bln FRN in the eurodollar market on 3/17/2011 to obtain domestic funding through swap-covered borrowing. It was issued at par with a floating coupon referenced to the 3 month Libor + 73 basis points. The quoted margin of FRN issued by other AA Banks and financial institutions issued in 2011 with similar maturity ranges from 38 bps to 145 basis points.
- 31. Cross Currency SwapThe cash flows are swapped; CBA exchanges the principal at the onset of the trade receiving AUD. Throughout the life of the swap, CBA receives Libor Flat and pays quarterly cash flows referenced to the bank bill swap rate (BBSW). The principal flow is reversed at maturity. SWPM solves for the cross currency swap spread which represents what the issuer pays as a margin over the bank bill swap rate in the AUD domestic market. Libor +73 bps converts into BBSW + 97.45 bps. Note that for floating for floating swap, because the respective currency NPVs of each side of the swap remain unchanged as swap curve shifts, changes in the value corresponds ONLY to changes in the basis (BR01).
- 32. Achieving covered “Bargain” AUD Domestic FRN vs. Eurodollar FRNComparing the spread resulting from the swap covered FRN and an outright FRN issued by CBA in the domestic market at the end of 2010, we can see that the difference is about 7 basis points at issuance. -> Research from BIS show that savings between 4 and 18 basis points can be gained through opportunistic foreign currency bond issuance among major currencies.
- 33. Eurodollar Fixed Rate BondThe swap covered issuance in USD through a fixed rate bond issued by CBA in the eurodollar market. The coupon is 25bps higher than that of equivalent eurodollar issues (par yield of fair market curve {C1525Y index} is ≈3% at the time of issuance).
- 34. USD/AUD Cross Currency SwapBond Fixed Equivalent rate in AUDThe fixed to fixed swap is akin to a bundle of two fixed rate bonds. The two back to back “bonds” are exchanged and have equivalent NPVs when valued in a common currency. For fix-to-fix swaps, since the interest payments are locked in at initiation, changes in the value reflect changes in the IR curve as well as the cross currency basis.The fixed equivalent rate in AUD is 6.81%. When compared to the average yield of AUD AA rated bond at the time of issuance of 6.87% (see FMC 358 C3585Y index HP) the advantage is 6bps.
- 35. Offshore Fixed Rate bond vs Domestic Fixed Rate bondAUD AA Domestic 5 Year FMC Rate
- 36. AUD vs. USD Swap Covered Arbitrage (Recap) These calculations are based on the AUD basis (see previous presentation for methodology).The process help Aussie issuers identify the cheapest funding opportunity between Eurodollar and domestic markets. Based on our calculations, CBA’s bonds in USD provides a lower cost of funding in both the fixed rate and floating rate euro-dollar markets than in the domestic market; the cost saving is greater in the FRN (7.15bps) than in the Fixed Rate market. (6bps) . Summary The difference in funding cost between the USD and AUD reflects the arbitrage opportunity “covered bargain” arising from the departure of the FX market from the covered interest parity “CIP” . It is measured by the basis which reflects the credit spread differential that exists between Australian and offshore issuers in both AUD (Aussie domestic vs. kangaroo) and USD (Eurodollar vs. US domestic).
- 37. Investor Arbitrage : Dim Sum vs. US DollarLimited opportunities due to lack of liquidity of CNH CCS marketChoice between dim sum and US Dollar bonds depends more on investors’ view on RMB appreciation. Can apply cross currency yield calculator YAX <go> (Theoretical and based on forward rate in CNH but sufficient to identify higher yielding bond amongst US dollar and dim sum bonds.Comparison of two bonds from the same issuer – Evergrande- with both USD and Synthetic RMB Bonds O/S.
- 38. Dim Sum Bond: EVERGRANDE 2014
- 39. Cross Currency Swap Rate CNH/USD
- 40. USD Bond
- 41. Cross Currency Swap USD/CNH
- 42. Summary of Evergrande’s Yield DifferenceThese calculations are theoretical and based on the forward rate in CNH. The process help investors identify the higher yielding bond amongst US Dollar and Dim Sum Bonds. Based on our calculations, Evergrande’s RMB bonds 2015 provides a higher yield than the RMB 2014 which reflects the difference in duration of the bonds (150bps)The difference between the yield in the RMB and USD reflects the market expectations of the RMB appreciation at the time of issuance.
- 43. Investor : PAR-PAR CCS Asset SwapAt inception, the bondholder pays the swap counterparty 100-Price of the bond to enter the swap.
- 44. During the holding period, the investor pays the swap counterparty all the coupon cashflows and receives Libor + spread in return.
- 45. Reduces interest rate and currency exposure – Separates interest and currency risk which allows views on credit quality more clearly. In the event of default, the swap does not terminate.
Editor's Notes
- #16: There are numerous types of cross-currency swap contracts, among which the most widely used in recent years is a type of contract named the cross-currency basis swap. A typical cross-currency basis swap (hereafter “currency swap”) agreement is a contract in which Japanese banks borrow U.S. dollars (USD) from, and lend yen (JPY) to, non-Japanese banks simultaneously. The figure illustrates the flow of funds associated with this currency swap. At the start of the contract, bank A (a Japanese bank) borrows X USD from, and lends X× S JPY to, bank B (a non-Japanese bank), where S is the FX spot rate at the time of contract. During the contract term, bank A receives JPY 3M LIBOR+α from, and pays USD 3M LIBOR to, bank B every three months. When the contract expires, bank A returns X USD to bank B, and bank B returns X× S JPY to bank A.At the start of the contract, both banks decide α , which is the price of the basis swap. In other words, bank A (B) borrows foreign currency by putting up its home currency as collateral, and hence this swap is effectively a collateralised contract.