Test 3- Chapter 15: Swap Markets Flashcards
Security/ asset based on an underlying asset
has value but it’s value is based on another asset
financial contracts used for hedging risk and speculating
derivatives
Hedging does what?
reduces risk
Agreement by two parties to make periodic payments to each other over time (ex: interest rate, currency, and equity)
swamps
Bank profitability measure
Difference between interest income received and interest paid to depositors
Net Interest Margin (NIM)
What is the NIM equation?
NIM=(total interest income-total interest expense)/total earning assets
We always want the NIM to be ________ and for it to be _______ or ______
positive,
steady
rising
Buyers and sellers of swamps contracts
Banks, pension funds, securities companies, insurance companies, manufacturing companies, municipalities, etc
counterparties
An agreement by two parties to exchange periodic payments based on interest rate
interest rate swaps
The _________ or ____________ amount is the base amount, and usually in millions
notional or principal
What is the driving interest rate in swaps?
LIBOR
What is the goal of swaps?
to neutralize the impact of interest rate changes on the NIM
Interest rate ______:
pay upfront, receive payments when a specified interest rate index exceeds a specified ceiling
cap
Interest rate ______:
pay upfront, receive payments when interest rates drop below a specified floor
floor
Interest rate ______: simultaneous purchase of a cap and sale of floor
collars
Periodic exchange of fixed rate-payments for floating rate payments
plain vanilla swap
What kind of swap variation is this?
Make agreement today, won’t start until a future date
forward
What kind of swap variation is this?
fixed payment is paid at the end
zero coupon
What kind of swap variation is this?
Either party can terminate agreement early
swaption
What is the credit risk ins swaps?
counterparty may not meet its obligations
What kind of risk does this describe?
if interest rate proxy (represents what’s happening in market place with interest rates, LIBOR) for swap doesn’t move in close tandem with party making the floating payment
basis risk
What kind of country risk is associated with swaps?
if a political party adversely affects payments
What kind of swap is this
1-10 year contract used by firms to protect against bond defaults, and by speculators
credit default swaps
How are credit default swaps a type of financial insurance?
if bond defaults you get your money back
Who uses credit default swaps?
banks, institutions, corporations, and municipalities
