The basic structure we consider is that of a commodity swap – see Hull (1997, p.131). Floating-for-fixed interest rate swaps, sometimes known as “plain vanilla swaps”, are the most widely traded interest rate derivative instruments. Commodity swaps extend this principle from interest rates to commodity prices. The commodity swap proposal is an extension of the practice, which already exists for some multilateral lending, of structuring a loan in terms of a basket of currencies. The currency basket approach allows the borrower to match the currency composition of its debt service obligations to the currency exposure of its export revenues. This is formally equivalent to augmentation of the original loan with a set of currency swaps (typically euros or yen for dollars).
We consider commodity-exporting countries as possessing an asset (their primary commodity export revenues) which is exposed to one or more floating commodity prices. Their liability structure is currently fixed, in the sense that debt service is independent of the commodity prices. This suggests that they may benefit by swapping out this fixed rate exposure for a floating rate exposure which matches their floating commodity price exposure. In what follows, we confine attention to the most important exports and to oil imports.
This is on the basis that many less important commodity exports lack clearly defined international prices, and also that a focus on a small number of major export and import commodities works towards a simple and easily understood structure. Inclusion of less important export and import commodities would have a relatively small effect on outcomes.
Consider a floating price Pt with initial level (at loan inception) P0. A corresponding floating rate loan overlay relative to the structure defined by the repayment schedule (1) would require payments of
with the consequence that repayments would be higher than on the corresponding fixed loan when P is high and lower when low. More generally, suppose a fraction ? = 0 of the original loan is swapped into the floating loan. Repayments are
where
.
Equation (3) makes explicit the equivalence of the swap overlay and the price-dependent loan.
By Prof. Christopher L. Gilbert, Prof. Alexandra Tabova
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Summary: Index