Swap Markets And Contracts Flashcards
Diff between pricing and valuing swaps
Price at initiation = 0
Value after initiation is zero sum
Ie positive value to one is negative value to other
Pricing of plain vanilla is fixed rate that makes ________ equal _______
PV of fixed rate payments
PV of floating rate payments
Calc Value of a swap
PV of payments received - PV of payments made
What bond transaction equals plain vanilla interest swap
Issue fixed coupon bond
Invest proceeds in floating rate bond
Same params
What transaction equals equity swap
Borrowing at fixed rate
Investing in stock/port/index
What transaction equals currency swap
Issuing bond in currency
Exchanging proceeds for another currency at spot exchange
Purchasing bond denominated in other currency
Same params
How to price plain vanilla int rate swap
Use combo of issued fixed rate and buying floating w/same initial value
Calc fixed periodic rate on N period swap at initiation
Cn = 1-Zn
—————
Z1+Z2+…+Zn
Zn = PV $1 received on nth payment date
Calc mkt value of vanilla swap
Value of replicating floating rate bond - Value of fixed rate bond
Value floating rate between payments
Fixed rate value = PV of floating - PV of fixed
Floating rate value = PV of fixed - PV of floating
How to price a currency swap
Same method - use replicating bonds in both currencies but with two term structures and two swap rates
Difference between valuing a currency swap and plain vanilla swap
Must deal with exchange rate between two currencies that changes over time
Value an equity swap using…
Same process as plain vanilla
Notional amount * (1+% appreciation )
Use difference in values to value swap
Types of credit risk associated with swaps
Current credit risk (payment due now)
Potential credit risk (future credit risk remaining over life; greatest in middle /after middle for currency)
Ways of reducing credit risk
Netting
Marking to market
Payer swaption
Right to enter swap at future date as fixed rate payer
If fixed rates increase, option valuable
Value of payer swaption
At expiration: PV strike for swap fixed - PV new higher rate
Zero if lower rate
Receiver swaption
Right to enter swap at date as floating payer
If rates decrease, more valuable
Value of receiver swaption
At expiration: PV swap fixed payments on higher strike and lower existing rate
Or zero if higher existing rate
Use swaptions to
Hedge expected fixed or floating exposure
Speculate int rate direction
Exiting swap prior to normal termination
Swap spread
Swap rate - comparable maturity T-notes
