Circus Swap

What Is a Circus Swap?

A circus swap is a common forex strategy that includes the combination of a interest rate swap and a currency swap in which a fixed-rate loan in one currency is swapped for a floating-rate loan in another currency. A circus swap consequently changes over not just the basis of the interest rate liability, yet additionally the currency side of this liability. The term is derived from the abbreviation CIRCUS, which represents Combined Interest Rate and Currency Swap. This transaction is an illustration of a cross-currency swap or currency coupon swap.

Understanding Circus Swaps

Organizations and institutions use circus swaps to hedge currency and interest rate risk, and to match cash flows from assets and liabilities. They are ideal for hedging loan transactions since the swap terms can be tailored to match the underlying loan boundaries impeccably. The transactions ordinarily include three gatherings — two counterparties who go into the deal and the institution, most frequently a bank, that works with it.

Multinational corporations utilize these instruments to make wagers and hedges, particularly utilizing currencies that don't have a robust swap market. These are transactions with two primary moving parts to consider — currency fluctuation and interest rate movements. Be that as it may, there's even more moving when you consider movement in the two currencies, LIBOR movement, as well as interest rate swings in the two countries.

Banks that regularly work with these transactions charge a commission, normally around 100 basis points or 1% of the deal. Note that the floating rate utilized in a circus swap is generally indexed to the London Interbank Offered Rate (LIBOR).

As per a declaration by the Federal Reserve in November 2020, LIBOR is currently being phased out and will be supplanted by SOFR (Secured Overnight Funding Rate) as of June 2023. Banks were told to stop composing contracts utilizing LIBOR after Dec. 31, 2021. The Intercontinental Exchange, the authority responsible for LIBOR, stopped distributing one-week and two-month LIBOR after Dec. 31, 2021. All contracts utilizing LIBOR must be wrapped up by June 30, 2023.

Illustration of a Circus Swap High Wire

For instance, consider XYZ PLC, an European company that has a $100 million loan with a floating interest rate (LIBOR + 2%) on its books. The company is worried that U.S. interest rates might start to rise, which would lead to a more grounded U.S. dollar against the euro, making it more costly to make future interest and principal reimbursements.

XYZ might hence want to swap into a fixed-rate loan in Japanese yen, since interest rates in Japan are low and the company accepts the yen might devalue against the euro. It in this manner goes into a circus swap with a counter-party that converts its U.S. dollar floating-rate debt into a fixed-rate loan in Japanese yen.

On the off chance that the company's perspectives on future interest rates and currencies are right, it can save two or three million dollars on servicing its debt obligations over the term of the loan.

Features

• CIRCUS represents Combined Interest Rate and Currency Swap, and trades over-the-counter (OTC).
• These swaps are utilized as hedges by international corporations, allowing them to lock in an exchange rate on a set amount of currency with a benchmarked interest rate.
• A circus swap integrates both a plain vanilla interest rate swap with a currency swap into a similar contract.