A tesobono swap places both parties in the same risk position as a repurchase agreement. Table 2 indicates the positions taken if the financing of the Mexican bank’s tesobono position takes the form of a tesobono swap. Suppose the New York firm swaps tesobono yield in return for LIBOR plus 100 basis points against a US$1 billion notional principal. It requires US$200 million as collateral from its Mexican counter party, i.e. a margin deposit of 20 percent to guarantee compliance with the contract. The payoffs to the two counter parties are identical to those of the repurchase agreement. To hedge, the New York firm will purchase US$1 billion in tesobonos directly from the market, paid from the $200 million margin and $800 million borrowed at LIBOR. As before, the tesobonos will be held by a foreign addresses, although Mexican domestic residents will bear the tesobono risk.
In either form, these operations serve to channel a net flow of capital of $800 million into Mexico, which ultimately finances the government. Gross flow data picked up in the normal balance of payments operation will measure an inflow of $1 billion worth of tesobono purchases and an outflow in the form of bank deposits for the collateral of $200 million. The swap, however, disguises the nature of the flow. Superficially, it appears that foreign lenders are buying Mexican government debt in the form of tesobonos—i.e. they are satisfied to hold the indexed T-bills at the maturities offered by the managers of the Mexican public debt. In fact, they are making short term dollar loans, while Mexican residents are holding the tesobono risk. On the national balance sheet—consolidating the government and domestic banking sector—Mexico is a short term borrower of dollars.
Table 3 presents an example to show that an equity swap establishes a leveraged position in shares, with funding coming from an offshore source. Again, a Mexico-based example will be used with an eye on later exposition, but such cross-border deals are commonplace.
Suppose that a Mexican bank agrees to swap the total return over one year on Telmex for dollar LIBOR plus 300 basis points on a notional amount of USS1 billion. Its offshore counter party, a New York securities house, requires US$200 million in collateral. To hedge its short equity position, the New York firm then directly buys US$1 billion worth of Telmex shares, thereby appearing as a foreign investor in Mexican shares. The New York firm is taking a long position in short-term dollar loans while the Mexican bank has a long position in Telmex shares and a short position in short-term dollar loans. The Mexican bank has acquired $1 billion of Telmex risk by putting up $200 million of collateral in New York.