DEFINITION of Rollercoaster Swap

A rollercoaster swap is a seasonal swap providing flexibility of payments at predetermined periods to best meet the counterparty's cyclical financing needs or other requirements. Usually referring to interest rate swaps, a rollercoaster swap allows the time (tenor) between regular payments to be extended or shortened in order to match seasonally fluctuating cash flows. In addition, the size of its notional amount of the swap is adjustable, although the net present value (NPV) of the transaction remains unchanged.

The rollercoaster swap is also known as an accordion swap, concertina swap (typically in reference to currency swaps), or NPV swap.

BREAKING DOWN Rollercoaster Swap

A rollercoaster swap has fluctuating or adjustable payment terms so that each counterparty can match cash flows to transfers, periodic financing obligations, or seasonal factors.

A rollercoaster swap allows a firm to roll unrealized profits or losses forward or backwards. Therefore. due to the accounting and taxation implications, many banks maintain special approvals, rules and limits for the use of such products, which mean that such products may not be appropriate and/or available for all users. Independent tax and accounting advice should be sought before using such products.

Example of a Rollercoaster Swap

For example, an international company that sells lawn mowers might have a keen interest in a rollercoaster swap because it can match swap payments with the seasonal demand for lawn mowers that arises primarily in the summertime and wanes in the winter. Likewise, a clothing company that specializes in ski wear and winter clothes would face the opposite seasonal fluctuations and prefer to match its cash flows accordingly.

Here is a more concrete example: A company has a USD $100 million pay-fixed swap on its books with a final maturity in 7 years at a rate of 8.00%. The current 7-year swap rate is 8.75%, so the swap is "in-the-money" by 75 basis points per year. Using a rollercoaster swap, there are are several adjustments that the firm can implement. They might, for instance:

    (1) shorten the swap to 3 years, and increase the size to $260 million, maintaining the rate of 8.00%, below the 3-year rate of 9.10%
    (2) shorten the swap to 3 years, and increase the size to $350 million, and also increase the rate to 8.25%
    (3) lengthen the swap to 10 years, maintain the size at $100 million, but reduce the rate to 7.75%, below the 10-year rate of 8.25%

The important point is that the net present value of the swap before and after the changes must remain the same, therefore the range of possibilities is multiple but at the same time constrained by the original NPV.