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{{Quote|{{divhelvetica|
{{Quote|{{divhelvetica|
====Scenario====
[[Hackthorn Capital Partners]] owns USD10m of [[Lexrifyly]] and wishes to buy USD10m of Stock [[Cryptöagle]]. It can either: '''sell''' Lexrifyly and use the proceeds to buy Cryptöagle, or '''keep''' Lexrifyly, borrow USD10m and use that to buy Cryptöagle.
[[Hackthorn Capital Partners]] owns USD10m of [[Lexrifyly]] and wishes to buy USD10m of Stock [[Cryptöagle]]. It can either: '''sell''' Lexrifyly and use the proceeds to buy Cryptöagle, or '''keep''' Lexrifyly, borrow USD10m and use that to buy Cryptöagle.
=====Sale=====
 
If it sells Lexrifyly, Hackthorn’s position is as follows:
'''Sale'''<br>
If it sells Lexrifyly outright, the position is as follows:
:Sold: 10m Lexrifyly
:Sold: 10m Lexrifyly
:Borrowed: -
:Borrowed: -
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:Bought: 10m of Cryptöagle
:Bought: 10m of Cryptöagle
:Amount due: [[total return swap|total return]] on 10m Cryptöagle
:Amount due: [[total return swap|total return]] on 10m Cryptöagle
=====Loan=====
'''Loan'''<br>
If it keeps Lexrifyly and borrows money, Hackthorn’s position is as follows:
If it keeps Lexrifyly and borrows, the position is as follows:
:Sold: -
:Sold: -
:Borrowed: USD10m
:Borrowed: USD10m
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:Amount due: [[total return swap|total return]] on 10m Lexrifyly and 10m Cryptöagle}}}}
:Amount due: [[total return swap|total return]] on 10m Lexrifyly and 10m Cryptöagle}}}}


Note the cashflows in the loan scenario: Pay Floating Rate on 10m, receive total return on Cryptöagle. These are the same cashflows you would expect under a delta-one equity derivative on [[Cryptöagle]]. Like a loan, an equity swap allows a customer to create a new exposure to [[Cryptöagle]] while not giving up its existing portfolio of exposures, which it would have to do if it were to buy Cryptöagle outright.  
Note the cashflows in the loan scenario:
 
{{Quote|{{divhelvetica|
'''During loan''':
:Customer pays floating rate on USD10m
:Customer receives total return on Cryptöagle. <br>
'''To terminate loan''': Customer repay USD10m <br>
'''To finance loan repayment''': Customer sells Cryptöagle. <br>
:If Cryptöagle sale proceeds are not enough to repay the entire USD10m, customer finances the difference from its general assets. If they are, customer keeps excess sale proceeds after repayment of USD10m.
:⇒ Customer’s net exposure is ''USD10m - Cryptöagle spot price''
}}}}
 
These are the same cash flows you would expect under a delta-one equity derivative:
 
{{Quote|{{divhelvetica|
'''During swap''':
:Customer pays floating rate on USD10m <br>
:Broker pays total return on Cryptöagle. <br>
'''To terminate swap''': ''USD10m - Cryptöagle spot price''  <br>
:If termination amount is negative, customer pays broker.
:If termination amount is positive, broker pays customer.
}}}}
 
Like a loan, the equity swap gives the customer exposure to [[Cryptöagle]] without having to give up its existing portfolio of exposures, which it would do were it to buy Cryptöagle outright. The customer is using its existing capital to gain exposure to a new capital asset. This is a form of ''[[leverage]]''. The floating rate the customer pays is implied funding. The dealer will only accept this if it is satisfied the customer has enough capital to finance its swap payments and settle any differences at termination. This is exactly the risk calculation a lender makes.
 
But in a bilateral swap arrangement, isn’t the converse also true of the dealer? Isn’t the dealer paying a rate to get exposure to the synthetic cashflow of an asset in the same way, so in a sense borrowing? Is not a “short” equity derivative, for a dealer, exactly the same as a “long” equity derivative for a customer?
 
Generally not, because the dealer is delta-hedging: it is not changing its market exposure. At the moment it puts on a trade with the customer, it executes an exactly offsetting one as a hedge. The clearest case is in a delta-one equity derivative: Customer buys swap on Cryptöagle with an implied loan; dealer buys Cryptöagle outright, which involves actually funding that acquisition.


were it t by paying you a rate I am deploying my capital assets to gain access to a new capital asset, without having to get rid of the old one. Me paying a fixed rate implies I have a corresponding asset which will finance my swap payments. I am able to hold on to that and get synthetic exposure to a new asset paying say a floating rate, because my dealer has funded that asset for me.


Isn't that also true of the dealer? No, generally not, because the dealer itself will be hedged. To pay your return it will have an offsetting transaction. It is not “keeping“ that floating rate risk, but offsetting it, perhaps with another client position.
To pay your return it will have an offsetting transaction. It is not “keeping” that floating rate risk, but offsetting it, perhaps with another client position.


In recent years — ironically, just as the “dealer” vs “customer” dynamic has become more pronounced<ref>After the [[GFC]], bank proprietary trading fell away to almost nothing.</ref> — the global regulatory-industrial complex,<ref>This label is not just sardonic: there really is a cottage industry of of “regulatory change management professionals” who owe their last decade’s livelihood to ''accommodating'' quixotic regulatory initiatives like this. They are a powerful lobby with a direct interest in maintaining the rate of regulatory churn.</ref> still fighting last decade’s war, has forged rules which overlook this.
In recent years — ironically, just as the “dealer” vs “customer” dynamic has become more pronounced<ref>After the [[GFC]], bank proprietary trading fell away to almost nothing.</ref> — the global regulatory-industrial complex,<ref>This label is not just sardonic: there really is a cottage industry of of “regulatory change management professionals” who owe their last decade’s livelihood to ''accommodating'' quixotic regulatory initiatives like this. They are a powerful lobby with a direct interest in maintaining the rate of regulatory churn.</ref> still fighting last decade’s war, has forged rules which overlook this.
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