Register a free 1 month Trial Account. - Download as many books as you like ( Personal use) - Cancel the membership at any time if not. Fundamentals of Derivative Markets Swap echecs16.info /stanford/medical%echecs16.info spring, and he had several thousand miles from another of basic interest rate and currency swap. View Table of Contents for Swaps and Other Derivatives explanation of the pricing and evaluation of swaps and interest rate derivatives.
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Interest Rate Swaps and Other Derivatives - Free download as PDF File .pdf), Text File .txt) or read online for free. In this volume, Howard Corb explores the. The first swap was executed over thirty years ago. Since then,the interest rate swaps and other derivative markets have grown anddiversified in phenomenal. exchange one stream of interest payments for another, over derivative contracts, which typically exchange – or swap – fixed-rate interest payments.
Since then, the interest rate swaps and other derivative markets have grown and diversified in phenomenal directions. Derivatives are used today by a myriad of institutional investors for the purposes of risk management, expressing a view on the market, and pursuing market opportunities that are otherwise unavailable using more traditional financial instruments. In this volume, Howard Corb explores the concepts behind interest rate swaps and the many derivatives that evolved from them. Corb s book uniquely marries academic rigor and real-world trading experience in a compelling, readable style. While it is filled with sophisticated formulas and analysis, the volume is geared toward a wide range of readers searching for an in-depth understanding of these markets. It serves as both a textbook for students and a must-have reference book for practitioners. Corb helps readers develop an intuitive feel for these products and their use in the market, providing a detailed introduction to more complicated trades and structures.
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Book details Author: Howard Corb Pages: Columbia University Press Language: English ISBN Description this book The first swap was executed over thirty years ago. Brokers loosely connect dealers by helping to match osetting dealer positions on an anonymous basis , which promotes liquidity in the market.
By the way, when we say that someone does a swap, we refer to entities such as corporations, banks, insurance companies, government-sponsored enterprises, asset managers, hedge funds, and so on.
Very few individuals would be acceptable by dealers as a counterparty in a swap due to the counterparty credit risk inherent in the contracts, as we will discuss in Section 2. Usually, this means that the two counterparties have an International Swaps and Derivatives Association ISDA Master Agreement which is a legal document that governs terms of trade in place prior to trading. Moreover, the two counterparties would have done their homework on one another and feel comfortable with the counterparty credit exposure that would result from entering into the swap.
The nancial crisis that began in had a severe impact on liquidity in the swaps market, as it did in most every market. At the height of the crisis, some counterparties refused to do trades with certain other counterparties out of concern over counterparty credit risk, and liquidity was poor or nonexistent. We will talk about these issues in Section 2. Growth of the Swaps Market.
Bank for International Settlements. But hopefully this leaves the impression that the swaps market is pretty big. The traditional uses of swaps include liability hedging, balance sheet management, and asset hedging. The nontraditional uses include speculation, with both macro and relative value trading in the swaps market popular. That is, investors now use the swaps market itself to express views that they have in the market.
In addition, the swaps market has become a benchmark by which the relative richness or cheapness of other asset classes e. A swap is a contractual agreement between two counterparties that agree to exchange streams of payments over time.
If both streams of payment are made in the same currency, then the trade is known as an interest rate swap; if the streams are made in two dierent currencies, then the swap is referred. We will spend virtually all of our time focusing on interest rate swaps, and we will further restrict our attention to swaps denominated in U.
Interest rate swaps are subdivided into two subcategories: In a basis swap, both streams are oating rates of interest. The structure and terms of a plain vanilla swap with standard market conventions are shown in Figure 1. One counterparty, known as the client, pays a xed rate of interest equal to 1.
Each day a number of contributor banks are individually asked by the BBA their perception as to where they could borrow funds for various maturities in the interbank market just prior to For each maturity, the top and bottom quartiles are tossed, and an average of the remaining levels is computed, representing the LIBOR quote for that day. Maturities vary, but are commonly 1, 3, 6, and 12 months. LIBOR is the basic building block of interest rate swaps, a concept we shall discuss further in Chapter 3.
WSJ Analysis Suggests Banks May Have Reported Flawed Interest Data for Libor, it was suggested that a number of banks may have been signicantly underestimating their costs of borrowing in the interbank market throughout the crisis.
This would not only have served to present a healthier picture of the nancial system than may have existed, but it also would have impacted the valuation of countless securities, contracts, mortgages, and so on, that depended on LIBOR. Subsequent studies discounted no pun intended the hypothesis that banks were underrepresenting their true borrowing costs see, e.
In fact, when referring to the payment frequency and day count convention in a standard swap, sometimes people will abbreviate this even further by saying something like semi bond versus threes. And for counterparties that deal with each other frequently and are comfortable that these standard conventions always apply when they transact swaps with one another, they may not even bother to discuss standard payment and day count conventions before doing a swap.
Final payments will occur ve years after the eective date, or start, of the swap. Similarly bn stands for billion. Example Suppose the swap depicted in Figure 1.
Of the ten semiannual periods on the xed side, the last period is from February 13, , to August 13, There are bond days in this semiannual period, and thus the nal xed payment in the swap is 1.
There are a total of 92 actual days in this quarterly period. Once a new issue has been issued, the issue that had previously been the on-the-run is referred to as the old or single old. The issue prior to that is referred to as the double old, and so on. In this case the spread is 21 basis points bps. Oftentimes when people talk about swaps and where swaps are trading, they just talk about swap spreads. It is implicitly understood that if you actually want to enter into a swap, the swap spread for a given maturity will be added to the yield of the on-the-run Treasury for that maturity to determine the swap rate.
A swap rate has economic signicance; it is the unique xed rate in a swap that gives the swap zero value when the swap is rst executed. A swap spread is just a benchmark that makes it easy to converse about swaps. For example, an investor who is interested in knowing where 5-year swap rates are oered i.
The dealer might respond with either something like 1. If the investor hears 21, then he knows that if he wants to pay xed in the swap, he should expect to pay a rate that is around 21 bps higher than the yield of the on-the-run 5-year Treasury at the time the trade is executed provided that the market for swap spreads doesnt change, of course.
When we talk about a swap in which the oating side is 3-month LIBOR, we focus exclusively on the xed rate in the swap. When an investor is receiving xed in a swap, he wants to receive the highest xed rate he can, 11 A basis point abbreviated bp and pronounced bip in the singular and abbreviated bps and pronounced bips in the plural is one one-hundredth of one percent.
Thus, a bp is 0. So if, for example, the rate 3. If the rate of 3. In the swaps market, it is common to quote rates to a precision of a tenth of a bp, or alternatively, in quarter of a bp increments. Nevertheless, it is customary in the market to quote a swap spread against the relevant on-the-run Treasury benchmark of comparable maturity.
Swap spreads are tradable themselves, with market participants taking views on the direction of swap spreads, up or down. We will discuss this concept further both in Chapter 2 and in Chapter 8. Table 1. The data presented in such a page are an amalgamation of market levels submitted by a number of dealers and provide an indication of where one could expect to execute various swaps. Market levels on the page are continuously updated throughout the trading day. The value of an interest rate swap will change as market interest rates rise and fall.
In market terminology this is often referred to as delta risk.
Interest rate swaps also exhibit gamma risk whereby their delta risk increases or decreases as market interest rates fluctuate. Other specific types of market risk that interest rate swaps have exposure to are basis risks where various IBOR tenor indexes can deviate from one another and reset risks where the publication of specific tenor IBOR indexes are subject to daily fluctuation. Uncollateralised interest rate swaps - those executed bilaterally without a CSA in place - expose the trading counterparties to funding risks and credit risks.
Funding risks because the value of the swap might deviate to become so negative that it is unaffordable and cannot be funded. Credit risks because the respective counterparty, for whom the value of the swap is positive, will be concerned about the opposing counterparty defaulting on its obligations. Collateralised interest rate swaps, on the other hand, expose the users to collateral risks: here, depending upon the terms of the CSA, the type of posted collateral that is permitted might become more or less expensive due to other extraneous market movements.
Credit and funding risks still exist for collateralised trades but to a much lesser extent. Due to regulations set out in the Basel III Regulatory Frameworks, trading interest rate derivatives commands a capital usage. Dependent upon their specific nature interest rate swaps might command more capital usage and this can deviate with market movements.