What is ‘Quanto Swap’
A swap with varying combinations of interest rate, currency and equity swap features, where payments are based on the movement of two different countries’ interest rates.
This is also referred to as a differential or “diff” swap.
Explaining ‘Quanto Swap’
Though they deal with two different currencies, payments are settled in the same currency. For example, a typical quanto swap would involve a U.S. investor paying six-month LIBOR in U.S. dollars (for a US$1 million loan), and receive payments in U.S. dollars at the six-month EURIBOR + 75 basis points.
Fixed-for-floating quanto swaps allow an investor to minimize foreign exchange risk. This is achieved by fixing both the exchange rate and interest rate at the same time. Floating-for-floating swaps have slightly higher risk, since each party is exposed to the spread between each country’s currency interest rate.
- Multi currency credit default swaps: Quanto effects and FX devaluation jumps – papers.ssrn.com [PDF]
- Pricing quanto equity swaps in a stochastic interest rate economy – www.tandfonline.com [PDF]
- Sovereign credit risk and exchange rates: Evidence from CDS quanto spreads – www.nber.org [PDF]
- The “end of geography” in financial services? Local embeddedness and territorialization in the interest rate swaps industry – www.tandfonline.com [PDF]
- Pricing equity swaps in an economy with jumps – www.tandfonline.com [PDF]
- Credit Default Swaps: A Primer and Some Recent Trends – www.annualreviews.org [PDF]
- Hedging quantos, differential swaps and ratios – www.tandfonline.com [PDF]