FMP20 - Swaps Flashcards
Explain the mechanics of a plain vanilla interest rate swap and compute it’s cashflows
Party A will pay fixed x% to party B, B will pay floating rate to A
Explain how a plain interest rate swap can be used to transform an asset or liability and calculate the resulting cash flows
Interest rate swap can be used to transform asset to liability or reversed, for example a company with a floating rate loan to make it a floating rate liability
Describe the role of confirmation in the swaps market
Specifies conventions, dates payments are exchanged, holiday calendars etc
Describe the comparative advantage argument for the existence of interest rate swaps and evaluate some of the criticisms of this arguement
A company should always raise money in a market where it has a comparative advantage and then swap it into the market it wants (fixed and floating)
Calculate the value of a plain vanilla interest rate swap based on two simultaneous bond positions
Find net interest rate to give period-ly payment, discount using risk free rate
Explain the mechanics of a currency swap and compute its cashflows
Principals exchanged in opposite direction of swap and returned at the end
Calculate the value of a currency swap based on a sequence of forward exchange rates
- calc pv of remaining cashflows in X in currency X
- pv of remaining cashflows in Y in currency Y
- Convert pv(Y) to X using current FX
- value = 1 - 3
Identify and describe other types of swaps, including commodity, volatility, credit default, and exotic swaps
Commodity swap is were fixed amount of commodity is periodically swapped for the same amount at a floating price
Volatility swap is where fixed volatility swapped for floating volatility at the end of a period
Credit default swap provides insurance against a defaulting company
Describe the credit risk in a swap position
If X defaults and has outstanding defaults with positive value to Y, Y may experience a loss
