Interest Rate Risk And Swaps

Question 1

What are the sources if interest rate risk

Answer 1

Volatility of interest rates

Extensive use if shirt term loans and floating rate debt

Question 2

What is a FRA and how does it work

Answer 2

Forward rate agreement, an interbank traded contract between two parties locking in an interest rate for a future period

The buyer of an fra obtains the right to lock in an interest rate for a desired term that begins at some future date

The buyer pays to the seller the differential interest expense on s notional sum if actual future interest rate is smaller than the agreed rate

The contract is settled in cash at the beginning of the fra period

Question 3

What is the definition of an interest rate swap

Answer 3

It is an agreement between two parties to exchange interest payment at pre specified intervals based on agreed upon indexes

One index is usually a fixed rate, the second index is tied to a certain segment of the market and is adjusted periodically

Question 4

What is the generic plain vanila swap

Answer 4

The generic swap has a combination of characteristics of both:

A traditional fixed income security on the fixed side

A traditional floating rate note on the floating side