Swaps & Swaptions Flashcards
What is an interest rate swap?
Two parties agree to exchange interest payments on a nominal amount.
What is the reset date? When do payments begin?
If an interest rate swap is a fixed vs 6 month floating. The reset date is every 6 months.
At the reset date the interest rate begins to acrue once the rate is known.
What is a swaption?
The buyer of a swaption has the right to enter into a swap by an agreed date (effectively the expiry date of an option)
What is exchanged in a currency swap?
Principal and Interest
What are the 3 cash flows in a currency swap
FX 1 Principal -> FX 2 Principal
Interest Payments
FX 2 Principal -> FX 1 Principal
What 4 forms can currency swaps come in?
1) Fixed to Fixed
2) Fixed to Floating
3) Floating to Floating
4) Floating to Fixed
What are the uses of currency swaps?
1) Access FX cheaper than in the direct market
2) Hedge existing FX risk from outstanding loans
What is exchanged in an equity swap?
1) Party will pay a floating rate (e.g. Libor +2%)
2) Party will pay the gain or loss on an index or equity
What happens if the return is negative in an equity return?
The equity receiver will have to pay the loss and the floating rate in the period the loss was recorded.
What is a basis swap?
A floating to floating swap where each leg is calculated on a different basis/index
What is an asset swap?
Swapping the exposure from an asset.
Usually a bond e.g. FRN -> Fixed Rate
Can also swap FX exposure
What does an asset swap allow an investor to do?
Create a synthetic exposure to a security which does not exist.
E.g. want a 10yr Govt FRN but it is only available in fixed
Allows a better choice of asset (e.g. better credit rating - without being constrained by fixed/floating)
What is a total return swap?
A modified equity swap.
Works on the same basis but includes all returns - e.g. dividends and interest (and any fees)
What are Amortising, Accreting and Rollercoaster Swaps?
1) Amortising - Nominal amount of swap decreases
2) Accreting - Nominal amount of swap increases
3) Rollercoaster - Nominal amount of swap varies (can help to meet cyclical financing needs)
What are inflation swaps?
One leg of the swap is an inflation index, e.g. RPI +1%.
The other leg is either
1) Fixed Rate
2) Floating Rate
3) Another Inflation Index (e.g. CPI vs RPI)
Why would someone use an inflation swap?
Hedge against price rises (inflation)
What is a constant maturity swap?
One leg is fixed or floating
The other leg is reset periodically against a spot on a maturity index.
GIve an example of a maturity index
the Federal Reserve maintains yields for treasury issues of various constant maturities.
What is the prime factor behind a CMS?
The shape of implied forward rates
What is an arrears swap?
In an arrears swap, the period for which payment is due elapses, and then at the end of the period, the rate is observed and retroactively paid.
What is a forward start swap?
A forward start swap is one that is agreed today, e.g., the rates to be used and the principal, however, the swap and exchange of funds start later.
For example, a forward start swaps with a 5-year tenor that starts in two years, would expire in 7 years’ time. For the first two years, no payments will be exchanged.
What is an overnight index swap?
A fixed for floating swap where the floating index is an overnight interest rate.
1) not paid overnight
2) amount is accumulated and compounded (adjusts for the fact compounding can’t take place)
What is a use case of an OIS?
A bank which funds itself overnight but borrows on a longer time horizon.
e.g. borrowing at 1yr and funding overnight - swap the 1yr borrowing for overnight payments to hedge interest and liquidity risk
