TREASURY CLASSROOM VOLUME 123

TRIGGER SWAPS

Generally, it is used by banks. It is a kind of interbank swap.

Suppose there is an MNC bank XYZ and wanted to convert their floating liability into fixed liability and also they are long on the swap. The exposure on which they are taking swaps is around $400 million. And on the alternative side suppose there is another swap counterpart which is also an MNC bank ABC but they wanted to convert their fixed liability into floating liability and they are short on the swap. The exposure on which they are taking swaps is around $400 million. Suppose the deal is of 5 years and net settlement has to happen every quarter.

Although the float and fix swaps depend on the view of the corporate treasurer how the corporate treasurer is viewing the interest rate going forward.

Suppose in the above example bank XYZ's view is that the Interest rate in the market will not increase in the near future. And the bank ABC believes that Interest rates in the market will go up. So accordingly the swap will take place.

Now bank XYZ would pay fix interest rate to bank ABC which is supposed 10 years USD Interest rate swap is 2.5% to the bank ABC and in return, the bank ABC would pay a floating interest rate to the bank ABC which is (Secured overnight funding rate) SOFR+100 basis.

The trigger that the banks have chosen is the 10-year UST (US Treasury Yield) as their benchmark. Now it means that if the 10-year UST crosses the value that is agreed by both the banks then they have to wind the deal. Suppose the trigger value is 3.6% There are two types of trigger swaps one is periodic trigger swaps and permanent trigger swaps. Suppose in 5 years if in any of the quarters the UST touches 3.5% or it crosses that value then for that particular quarter the deal is wind up. Deal wind up means that both the banks will not exchange any settlements for that quarter. And now both the banks will see in the next quarter whether the trigger had happened or not. In permanent trigger, swaps suppose in 5 years if in any of the quarters the UST crosses or touches 3.5% then for the remaining years the deal is wind up. Now in these permanent trigger swaps deal to wind up means that suppose in the fourth quarter only the trigger happened as it crosses 3.5% so from there only both the banks will not exchange any settlements for that quarter.

So there are other trigger swaps like direct trigger swaps in which both the sides' currency is the same. But in the case of Quanto trigger swaps on both sides, the currency is different. For eg the bank XYZ is transacting in dollars and bank ABC is transacting in Euros.