NuclearPhynance Archive

A major bank is pitching us on a specific cross-currency swap and is very insistent that both an initial and final exchange of principal payments occur. We would much prefer to omit the initial exchange entirely and net USD settle the final exchange instead of physically exchanging the currencies. We think the bank should be indifferent (assuming it has no dire need for the currency in question) yet it is insistent. Any rationale why they would demand the final exchange of principal in lieu of net settlement? Thanks

You changed from `initial exchange' to `final exchange' in your question. If it's the former, then the answer might be that they don't want to take your credit risk up front.

On the initial exchange: if it is omitted it leaves quite a large spot exposure i.e. the mtm of the initial exchange counteracts the mtm of the remaining future cashflows to a large degree, especially between quoting and the trade going through etc



My thoughts on a net settlement of final exchange are: if fx at maturity exactly matches the fx on trade date, the net settlement at maturity for nominal exchange would be zero - however, on the other side of this transaction the bank has likely got another trade that they are hedging. Under that transaction they will likely have to exchange actual nominal and it would be ideal to just close it out directly with you guys ... a net settlement leaves a bit too much exposure to spot at maturity to close out the cashflows that they will be receiving at maturity

Some emerging markets currencies have separate quotes for delivery forwards (the currency is physically delivered) and non-delivery forwards (pay or receive USD, the amount is determined from the FX rate observed typically 2 days before settlement).



Your counterparty may be worried that some EM government will do what Thailand recently did to its currency.