Introduction
For a compressed overview please read my article at Wikipedia. With this article I will expand the subject further and attempt at explaining it in plain English without using financial and mathematical jargon.
Personal experiences
While working for the Derivatives Analysis team at CitiGroup, I designed and implemented a trading and risk management system to handle exotic structured products such as various swaps, swaptions, currency options, range forwards, forward rate notes, futures, quantos and Power Reverse Dual Currency Bonds (PRDCB).
Typical issuer
PRDC has been the main instrument for financing Sweden besides the issue of Swedish Government Bonds and collecting taxes. PRDCs are used when Swedish institutions need financing based on foreign currencies such as EUR,USD,AUD,JPY,etc and in order to minimize the cost of borrowing. Since the credit ratings of issuers must be AAA, Swedish or German corporations and banks cannot act on their own. Thus, institutions have to establish a legal entity that is guaranteed by its members. Swedish Export Kredit (SEK) of Sweden and Kommunalkredit of Germany are such entities.
Typical investors
Local banks in low interest rate countries, such as Japan, that are seeking higher yields on their liquid financial assets.
Who deals with currency risk
Major investment banks sell a sort of insurances (eg currency option strips) to issuers as protection against currency risk. The insurance is not easy to see as it is included in the structure and not a separate product. The premium institutions, such as SEK, is paying for the protection is a fee (spread) on top of current money market rates such as LIBOR. SEK may thus acquire low cost financing by taking advantage of low interest rates in foreign countries without exposing itself to currency risk.
Interest rate risk
Currency volatility risk
Interest volatility risk
Correlation risk
Credit risk
Basis risk
Systems and operational risk
Adding more features, such as digital cash-flows caps, interest rate caps, knock-ins and knock outs.
Trade flow chain - from negotiations to financial statements
Reducing manual entry and hence human generated errors.
How to represent PRDC in a computer system
Designing infrastructure and systems for trading in PRDC
