Interest Rate Swaps Flashcards
What is a Swap?
A swap is an agreement between two parties to
exchange cash flows in the future.
The agreement defines the dates when the cash
flows are to be paid and the way that they are to
be calculated. Usually, the calculation of the
cash flows involves the future values of one or
more market variables (e.g. interest rates, asset
prices, exchange rates etc.).
Swaps vs Forwards
A forward is an simple example of a swap
A forward contract is the equivalent of the
exchange of cash flows on just one future date
Swaps typically lead to cash flow exchanges on
several future dates
‘Plain Vanilla’ Interest Rate Swap
In an interest rate swap, party B agrees to pay party A cash
flows equal to interest at a predetermined ‘fixed’ rate on a
notional principal (not exchanged) for a number of years. At
the same time, party A agrees to pay party B cash flow equal
to interest at a ‘floating’ rate on the same notional principal
for the same period of time.
The currencies of the two sets of cash flows are the same.
(This is typically referred to as a ‘plain vanilla’ interest rate
swap).
Note that the notional principal is used only for the
calculation of interest payments. The principal itself is not
exchanged! - Implications for credit risk
What is amortising?
Amortising – Notional reduces over the life of the
swap
What is accreting
Accreting – Notional increases over the life of the
swap
What is a rollercoaster?
Rollercoaster – Notional continually changes
What is a forward start?
Forward start – swap commences on future date
What is the Basis Point Value (BPV) of a position?
How
much you make or lose with a one basis point
move in a particular interest rate
Swaps vs Bonds
- Swaps are similar and comparable to Bonds in
terms of exposure to fixed interest rates - The floating part of the swap typically has no
NPV and the NPV of the swap is the NPV of
the fixed leg which is similar to the cash flows
coming from a bond - Swap rates versus Bond yields
