What is a Performance Index Paper (PIP)
Breaking Down Performance Index Paper (PIP)
PIP interest rates are determined by the exchange rate of the base currency with an alternate currency. It is a commercial-paper variation of the currency coupon swap. PIPs are structured products that can be tailored to meet the specific requirements of a company, although the minimum thresholds generally are high. Performance index paper is one way to hedge currency risk. For example, a large U.S. exporter concerned about a plunge in the value of the euro versus the USD could employ a PIP that hedges the downside risk of the euro.
A currency coupon swap, also called a cross currency swap or a combined interest rate and currency swap (CIRCUS), has one side that is a fixed rate currency and the other is a floating rate payment. In these swaps, a loan denominated in one currency and booked at a fixed rate typically is swapped for a floating rate loan denominated in another currency. It usually is employed where the two currencies do not have active swap markets. Companies and institutions use such swaps to hedge currency and interest rate risk, and to match cash flows from assets and liabilities. They are ideal for hedging loan transactions because the swap terms can match the underlying loan parameters. The transactions typically involve two counterparties and the financial institution that facilitates it. Multinational corporations use such instruments to take speculative positions and as hedges, especially in currencies that do not have liquid swap markets. Currency and interest rate movement in both currencies and countries would influence swaps outcomes.
Other Related Swaps
A basic foreign currency swap is an agreement to exchange currency between two parties. Principal and interest payments on a loan made in one currency are swapped for principal and interest payments of a loan of equal value in a different currency. The Federal Reserve System offered such swaps to several developing countries in 2008 at the time of The Great Recession. The World Bank first introduced currency swaps in 1981. Such swaps can be made on loans with maturities up to 10 years. Currency swaps differ from interest rate swaps in that they also involve principal exchanges. In a currency swap, each counterparty continues to pay interest on the swapped principal amounts until the loan matures. Upon maturity, principal amounts are exchanged at the initially agreed upon rate, which avoids transaction risk at the spot rate.