re: What is the purpose of swaps?

quote:

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Auditor states it loses money every year on the deal.

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I don't know any details about their SWAP position but it is not unusual for a holder of a SWAP to lose money on the position.

A SWAP's proper purpose is NOT to make a profit. It is to mitigate interest rate risk which the SWAP holder has in its "on balance sheet" position.

If Hinds County has been losing money in its SWAP contract, it sounds like they purchased a variable rate swap when rates were higher. As rates have declined over the last few years they receive a lower amount of interest on their variable SWAP while continuing to pay the fixed rate they agreed to pay when they entered into the contract.

The reason they MAY have bought the SWAP is they issued some long term variable rate bonds or they issued some short term fixed rate bonds which they anticipated having to roll over (renew) for a number of years.

Either of those types of issues would have left the county exposed to interest rate risk if rates went up over the life of the bonds or until the bonds could be called.

So to lessen this risk, they bought a variable rate SWAP so if rates increased the county's increased interest expense on the bonds would be cancelled out by the increase in the variable income they would receive on the SWAP position.

Again, I don't know any details of their reason for buying the SWAP but if they did so based on my hypothesis above, the auditor should be fired if all he does is note the loss in the SWAP position if he does not explain the interest rate risk mitigation the SWAP provides.

A SWAP is an insurance policy against interest rates in the market moving against the balance sheet position of the holder of the SWAP.

Does the auditor also point out the county loses money every year on paying its casualty insurance premiums when there are no covered damages to county property for which the insurance company reimburses the county? It's the same principle as a properly used SWAP.

It may cost the county a little money but it prevents the county from losing A LOT of money.

Is it possible the auditor does not understand the purpose of SWAPS? And perhaps you, too?