9.13.2005

Q&A: A Bank issues 1,000 dual currency bonds...

Principal: USD $1,000, sold and redeemed in USD
Coupon: JPY 6.5 million, semiannual.
Maturity: 5 years.

How can the bonds be synthesized?

  • The Bank's Cash flows
    • At issue: Bank receives USD 1 M.
    • Every 6-mo: Bank pays JPY 6.5 M.
    • At maturity: Bank pays USD 1 M.
  • Cash flows can be synthesized using a corporate USD straight bond and a fixed-for-fixed currency swap. Consider the following instruments available in the market
    • 7.5% corp Bonds with 5 years to maturity
    • A currency swap dealer offers USD 7.5% against JPY 6.5% (swap dealer pays USD 7.5% interest payments and receives JPY 6.5%).
  • The Bank can:
    • sell short USD 1,000,000 worth of corp bonds.
    • Enter a fixed-for-fixed currency swap and make JPY payments.

Bonus Points

  • Foreign exchange exposure: dual-currency bonds are purchased in terms of one currency but pay coupons or repay principal at maturity in terms of a second currency.
  • By having the currency forward attached to the bond, fixed-income portfolio managers who might otherwise be restricted from trading in FX have the potential to enhance their performance if their beliefs about future market conditions prove correct.

Category: C++ Quant > Derivatives

1 comment:

  1. Anonymous11:36 AM

    Really cool!

    Stephen

    ReplyDelete