fx funding and cross currency

Martinghoul · Post by **Martinghoul** » Fri Sep 16, 2011 5:42 pm

Yeah, I am a big fan of Macro Man...

granchio · Post by **granchio** » Fri Sep 16, 2011 8:22 pm

thanks Cheng, useful. I wonder how much in the interbank is unsecured vs the secured?

dgn2 · Post by **dgn2** » Sun Sep 18, 2011 6:14 pm

Some information about the composition of collateral can be found here: http://www2.isda.org/functional-areas/research/surveys/margin-surveys

I know I came across something providing an indication of secured vs unsecured interbank activity recently, but now I can't find it. If I come across it again I will post it.

meteor · Post by **meteor** » Mon Sep 19, 2011 2:23 am

This BIS paper is pretty good: http://www.bis.org/publ/qtrpdf/r_qt0803h.pdf

Or their short note on xccy basis: http://www.bis.org/publ/qtrpdf/r_qt0803z.htm

fxtyro · Post by **fxtyro** » Tue Sep 20, 2011 9:59 pm

Sorry a very basic question -

If I think about what drives the value of an existing cross currency swap, its simply preference for a particular currency?

My logic is both 3m floating legs have effectively no duration.

Historically I keep reading usd/jpy cross currency has been jpy minus a spread reflecting lower creditworthiness of bank of japan. I dont understand this reasoning?

dgn2 · Post by **dgn2** » Tue Sep 20, 2011 10:45 pm

fxtyro, you have little duration because you are only exposed on the piece that has already rateset and you discount with the same curve that you project forward floating payments. You still have counterparty credit risk for all expected floating payments. If you have to post/receive collateral you also have interest received/paid on that collateral (CSA). Because of the collateral you now don't discount with the same curve as you project floating rate payments. As soon as you have differing counterparty credit risks you need lots of different curves / adjustments. Replacement cost for a floater is not zero because you need credit lines and collateral to transact.

The other issue is FX. You are exposed to the forward FX rate for each future payment date.

fxtyro · Post by **fxtyro** » Tue Sep 20, 2011 11:18 pm

Hi dgn,

Yes thanks vm..

I am aware on a basic level of the ois discounting/csa/discounting using collateral rate..

Lets assume I am a foreign corporate trading with a bank and I have no CSA in place, and simply using libor discounting (which is the way banks discounted both legs when trading with each other pre-2008, is that accurate?)

So I have FX risk on this cross currency swap obviously. That FX risk can be decomposed into the fx forward on each floating payment date AND the FX forward at maturity for the exchange of notionals? Doesn't the latter dominate the FX risk part of this trade?

Beside FX, I have no interest rate risk. I.e. if the FED raises rates by 500bps tomorrow and ECB stay on hold, by cross-currency swap value doesnt change at all cos they still price to par??

HOWEVER if we assume OIS discounting and if both overnight/risk free stay the same (ECB AND FED DO NOT MOVE) BUT dollar libor goes up by 500bps , whilst EURIBOR stays the same, then my cross currency swap would have a huge change in PV right??!

dgn2 · Post by **dgn2** » Tue Sep 20, 2011 11:41 pm

Yes notional exchange dominates the FX risk.

dgn2 · Post by **dgn2** » Wed Sep 21, 2011 3:01 am

You have some interest rate risk on the next payment because you fix, then pay x months later. You have risk in the 0-x month bucket.

Re discounting with OIS and generating forward payments with LIBOR - Yes the risk is way bigger especially if you have a notional exchange.