Template:M intro isda a swap as a loan: Difference between revisions

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Template:M intro isda a swap as a loan (view source)

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During a typically turgid disquisition about the ostensible “[[The bilaterality, or not, of the ISDA|bilaterality]]” of the {{isdama}}, the JC remarked rashly that despite ''looking like'' a bilateral, even-stevens, un-[[loansome]] sort of a thing, in practical fact most swaps are really implied financing arrangements.
During a typically turgid disquisition about the ostensible “[[The bilaterality, or not, of the ISDA|bilaterality]]” of the {{isdama}}, the JC remarked rashly that despite ''looking like'' a bilateral, even-stevens, un-[[loansome]] sort of a thing, in practical fact most swaps are implied financing arrangements.


Hotly justifying this stance somewhat sidetracked the original article, so we have “[[Let’s take it offline|taken things offline]]” and started a whole new article where the JC can properly make a tit of himself without spoiling the other article.
Hotly justifying this stance somewhat sidetracked the original article, so we have “[[Let’s take it offline|taken things offline]]” and started a whole new article where the JC can properly make a tit of himself without spoiling the other article.
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So here goes: at least beyond the galaxy of inter-dealer arrangements, a ''swap is a synthetic loan''.
So here goes: at least beyond the galaxy of inter-dealer arrangements, a ''swap is a synthetic loan''.


You could analyse an interest rate swap as off-setting fixed rate and floating rate loans. Seeing as the same amount of principal in the same currency flows in both directions at the same time, the principal flows cancel each other out — they “net” to zero.  
You could analyse an interest rate swap as off-setting fixed-rate and floating-rate loans. Seeing as the same amount of principal in the same currency flows in both directions at the same time, the principal flows cancel each other out — they “net” to zero.  


“Aha, JC: quite so. But this implies, does it not, that the parties are ''not'' lending to each other? Do not the “loans” cancel out too?”  
“Aha, JC: quite so. But this implies, does it not, that the parties are ''not'' lending to each other? Do not the “loans” cancel out too?”  
====The difference between customers and dealers====
Well, yes: but the difference is in how the two sides manage their respective positions. Beyond that cramped star system of inter-dealer relationships, there is a boundless universe where one party is a “dealer” and the other a “customer”. This is the great majority of all swap arrangements.


Well, yes: but the difference is in how the two sides manage their respective positions. Beyond that cramped star system of inter-dealer relationships, there is a boundless universe where one party is a “dealer” and the other a “customer”. This is the great majority of all swap arrangements.  
The difference between ''customer'' and ''dealer'' is not who is “long” and who “short” — one of the beauties of swap contracts is that customers can easily go long ''or'' short — nor on who pays “fixed” and who “floating”. 
 
For the ''customer'' the object of transacting is to ''change its overall market exposure'': to get into positions it did not have before, or get out of ones it did. This sounds obvious.  


The difference between ''customer'' and ''dealer'' is not who is “long” and who “short” — one of the beauties of swap contracts is that customers can easily go long ''or'' short — nor on who pays fixed and who pays floating.
Being a bilateral contract, is it not so that the dealer is changing its overall market position, too? No. The dealer ''provides'' exposure without taking any itself, and thereby earns a commission. This is all the dealer intends to do. The dealer intends to say ''flat''. The dealer hedges its market risk away.


For the customer the object of transacting is to ''change'' its market exposure: to get into a positions it did not have before, or get out of one it did. This sounds obvious. But, being a bilateral contract, you might think it follows that the dealer is changing its position, too. But it is not. A dealer is there to provide exposure without taking any itself, and thereby to earn a commission. The dealer intends to say ''flat''.     
But how does that turn a bilateral swap into a “synthetic loan” from the dealer to the customer?


==== Swaps are usually synthetic loans ====
Let’s take an example. Imagine the JC’s in-house [[hedge fund]] [[Hackthorn Capital Partners]] owns USD10m of [[Lexrifyly]], and wants to get into the fabulous new start-up [[Cryptöagle]]. It can do one of three things:  
But how does this make a swap into a “synthetic loan” from the dealer to the customer? Let’s take an example. The JC’s fictional hedge fund [[Hackthorn Capital Partners]] owns USD10m of [[Lexrifyly]], and wants to get into the fabulous new start-up [[Cryptöagle]]. It can do one of three things:  


(i) sell [[Lexrifyly]] outright and buy [[Cryptöagle]];  
(i) sell [[Lexrifyly]] outright and buy [[Cryptöagle]];  
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