Marked-to-Market Interest Rate Swaps: A Solution to the Interest Rate Risk Management Problem of Indebted Developing Countries
- Peter Wickham, Jacob Frenkel, and Michael Dooley
- Published Date:
- March 1989
- DAVID FOLKERTS-LANDAU*
Indebted developing countries have been prevented from hedging their exposure to volatility in short-term international interest rates by a lack of creditworthiness, a shortage of international reserves, and a lack of financial expertise. This paper uses the conventional interest rate swap contract—a contract between two parties to exchange a fixed payment stream for a floating payment stream without an exchange of principal—to construct an interest rate risk management tool that can overcome these difficulties. The proposed swap contract aims to reduce the credit risk borne by the counterparty in the swap transactions by shortening the performance period of the country through periodic resettlement of capital gains and losses on the existing swap contract combined with a recontracting at the prevailing market swap rate.