Glossary

  • Quanto product

    An asset or liability denominated in a currency other than that in which it is usually traded, typically equity index futures, equity index options, bond options and interest rate swaps (differential swaps). Quanto products can be hedged with an offsetting position in a local currency product. Variable asset and foreign exchange exposures will arise with changes in the foreign exchange rate and in the underlying, so the structures must be continually dynamically hedged in a similar fashion to option products.

  • Quanto swap

    Also called a differential swap. A quanto swap is a fixed-floating or floating-floating interest rate swap. One of the floating rates is a foreign interest rate, but is applied to a notional amount denominated in the domestic currency. For example, a US investor may enter into a five-year swap in which he makes payments in US dollars at the six-month USD Libor plus a spread semi-annually, and receives payments in US dollar at JPY Libor. The payments are calculated by applying the respective interest rates to a notional amount of US$100 million. However, the notional principal can also be denominated in the Japanese yen, or in a third currency such as the British pound. A quanto swap enables the investor to avoid exchange rate risk while taking advantage of interest rate differentials. A corporate borrower with debt in a discount currency can use a quanto swap to lower his borrowing costs, while portfolio managers can use a quanto swap to enhance yield with higher interest rates in a discount currency.

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