Swaps are largely used to hedge specific cashflows against floating rate exposure. Since banks make money out of the intr rate differential on their assets against liabilities (thats their main busn) they will tend to move both depo rates n lending rates in tandem with mkt rates.

However if such a bank takes a long term loan or issue a note or bond on a floating rate, they enter into a swap to hedge should rates rise.

If rates fall, a fixed rate payer will still be comitted at the fixed rate but will register a negative mark to market (loss on revaluation)

My 2 cts

Hi Emlyn,

All derivatives can be used to hedge interest rate risk exposure. Swaps are however preferred, as opposed to other derivatives, due to the fact that the major players in the market (and their customers as well) have a role in setting the benchmark rate (the LIBOR).

In the case of KCB, the interest rates on the loans are mainly floating rates. The base rates for the loans do fluctuate depending on various factors like the cost of getting deposits in the market and the CBR rate. So the use of swaps would best manage the exposure as you have intimated – but on its net exposure.

The impact of a decline in interest rates to KCB largely depends on the change in the shape of the yield curve and its net interest rate exposure. (I’ll use the table on Page 93 of the 2011 Annual Report).

A parallel reduction in interest rates could reduce the bank’s net income this year. A casing point is that the interbank rate in December was 27% while the current interbank rate is around 20% (as of 22 June 2012).

But the real impact of the reduction depends on what KCB is doing to manage its net exposure like reducing its loan book and increasing its investment in government securities.

And yes, the swaps are usually marked to market.

Hope this helps.

Regards

Yeah they are, since theyre usually longterm and in line with ias'

My thinking of marking to market implies that

1.There must be a clearing house for that pupose (SWAPS dont have a clearing house)

2.SWAPS are generally unregulated and the marking to market feature applies to regulate markets such as FUTURES.

kindly fill me in as to marking to market feature for swaps?

rgds

@ Emyln,

I think anyone can benefit by undertaking some form of risk management, hedging in a key risk management technique and swaption is one form of managing risk however the decision that goes into deciding whether to pursue these techniqueS depend alot on the business and the underlying exposures. Otherwise hedging could turn into a big lose!

Having say that, most Kenyan bankS have net liability exposure to the Euro Market so not hedging against the Euro is a good strategy at the moment.


Drunkard!