1 / 6

Chapter 30 – Swaps and More

Chapter 30 – Swaps and More. Interest Rate Swaps Objective: Control Interest Rate Risk What is Interest Rate Risk? It is the loss incurred by a company (i.e. bank) when interest rates change Example, a bank is lending long term but borrowing short term

Download Presentation

Chapter 30 – Swaps and More

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Chapter 30 – Swaps and More • Interest Rate Swaps • Objective: Control Interest Rate Risk • What is Interest Rate Risk? • It is the loss incurred by a company (i.e. bank) when interest rates change • Example, a bank is lending long term but borrowing short term • If short term rates increase over the set long-term rates, payment stream from loans is insufficient to meet interest promise to investors, loss $$$ • This was the case in the 80s with many Savings and Loan Associations

  2. Chapter 30 – Swaps and More • Mechanics of an Interest Rate Swap • Fixed Payment Stream “exchanged” with a Floating Payment Stream • Party A has a fixed stream (Savings and Loan with a set of Mortgages) • Party B has a floating stream (Insurance company with investment portfolio in floating rate bonds) • Party A and Party B swap payoff streams… • Only the difference changes hands

  3. Chapter 30 – Swaps and More • Numbers of the mechanics of swap • Notional Amount of the Swap $50 Million • Fixed flow 8% • Floating flow LIBOR plus 2.5% • If LIBOR at 4%: • Fixed at $4,000,000 • Floating at $3,250,000 • If LIBOR at 7% • Fixed at $4,000,000 • Floating at $4,750,000 • Payment flow is $750,000 to counter-party

  4. Chapter 30 – Swaps and More • Swap is series of Forward/Futures Contracts • Benefits of Swap over Forward • One time negotiation vs. negotiation of all forward contracts • Longer maturities than futures • Liquid Secondary Market • Lock in a spread profit against liability of the company • Why didn’t the two parties just contract correctly in the first place? • Availability of Contracts, Competition, and Arbitrage Across Markets

  5. Chapter 30 – Swaps and More • Development of the Market • Bankers first were brokers • Bankers taking positions to finish swaps (difference in party notional amounts) • Bankers moving to dealers • Bankers acting solely as dealers as spreads narrow through competition • Bankers active dealers with standing quotes • Floating Rates matched with available Fixed Rates by Banks

  6. Chapter 30 – Swaps and More • Secondary Markets for Swaps • Getting Out of the Contract • Swaptions • The option to swap • Interest Rate Caps and Floors • An options contract • Seller and Buyer Positions • Option on an Option • Captions and Flotions

More Related