Xccy Swaps
Hi guys I got 2 questions regarding xccy swap:
1) Is it true that given e.g. the 1Y FX swap point, I can use interest rate parity to come up with the rate for a 1Y fixed-for-floating xccy swap?
2) Regarding ytd's Bloomberg article (How Global Investors Turn Negative Japan Yields Into Big Returns), it mentioned after paying basis in 5Y USDJPY xccy basis swap, a 5Y JGB actually yields 94bp more than 5Y Treasury. Given 5Y Treasury yield 1.39%, 5Y JGB yield -0.16%, 3M USD LIBOR 0.63%, 3M JPY Libor close to 0% and basis -102.5bp, how did it come up with the 94bp yield advantage?
1) IMHO, sort of... If you have the rates and the fwd points, you should be able to imply the basis.
2) You just need to perform the basic exercise along the lines of this basic chain: 5y JGB -> 5y JPY 6mL IRS (drop 9bps) -> 5y JPY 3s6s basis (drop 2bps) -> 5y USDJPY x-ccy basis (pick 100bps) -> 5y USD 3mL IRS. In the end, with the mids I see at the moment, I am getting smth like 3mL + 89bps or T + 77bps.
This is assuming I have got all the directions and done all the arithmetic correctly, which is by no means certain.
Thanks for the reply!
I am not clear about how we go from 5y JGB to 5y JPY 6mL IRS... Suppose I have 1m yen 5Y JGB with coupon = 10bps. If the 5y JPY 6mL IRS is quoted 12bps then do i do the IRS with notional 10/12=0.83m yen?
And by 'arithmetic' do u mean the basic way of discounting bond cashflows equal to the bond px to get the equivalent yield? i.e. instead of the original 10bps coupon cashflow we use (100bps+fixed rate on the 5y USD 3mL IRS) as coupon cashflow?
Well, if you want to think about it in sorta perfect terms, imagine a structure normally known as "par-par asset swap" (par-par asw). Essentially, leaving aside the finer details, the derivative leg of such a transaction is where all bond cashflows are exchanged for LIBOR + spread cashflows. The notional of the bond is used as the notional of the derivative (since you fudge things to make it look as if you bought the bond at par, flat of accrued). The spread on the LIBOR leg is what determines how much you pick up/drop. I used 9bps for this as a fudge, since that's where regular matched-maturity 5y JGB asw trades.
Nah, by arithmetic I meant the simple addition of all the pickups/drops along the way and their signs. Obviously, I am doing this the quick 'n dirty way, so I am skipping/trivializing a lot of things.
What do you guys think of the trade, especially from a levered account perspective? For real money it seems like a good opportunity.
As the article alludes, there's no reason xccy basis can't move deeper into negative territory, as it's primarily driven by need of foreign banks to borrow dollars, e.g. to buy Treasuries. In this case you can suffer on a MTM basis. But the trade is directly analogous to repo specials trading, as a comparable loan of JPY secured through JGBs, rather than USD, would at best be funded thru JGB 5y repo (at worst GC). You capture the basis by lending USD which are squeezed in the foreign local markets. Of course if USD 3ML blows out that would only compound problems, but for the intermediate horizon (e.g. till June), that seems unlikely.
If you're a fast money type and want to do this trade, you just buy USDJPY x-ccy basis. People used to love doing that, since the carry is just so attractive. However, it's fundamentally the wrong way arnd at the moment. It's probably reasonably attractive for domestic Japanese real money.
Personally, as a leveraged guy, I wouldn't dream of playing these particular games.
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