5.4.Hull Ch 7

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5.4.Hull Ch 7
2011-02-19 12:16:36

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  1. Swap
    Agreement btwn 2 parties to xchg a series of cash flows at different points in time
  2. Plain vanilla swap
    • Fixed-for-floating swap
    • For the floating rate payer, the rate is set at the beginning of each period but the actual pmt is made at the end of the period
  3. Major use of interest rate swap
    Allows efficient mgmt of interest rate sensitivity
  4. Swap dealer
    • Connects one party to the other in a swap transaction
    • Assumes credit risk of each party
    • Usually charges a fee of a few basis points
  5. Swap rate
    • Fixed rate paid in a plain vanilla swap such that value of fixed & floating are equal to notional principal amt.
    • Usually not risk free, but close to because is reflects credit risk of highly rated financial institutions
  6. Swap spread
    Difference btwn swap rate and US Treasury bonds
  7. Comparative adv argument
    • Since different parties may have to pay diff rates to borrow, they could possibly enter a swap to borrow in a more efficient way
    • This argument is a bit flawed as the swap mkt is very big and efficient
  8. 2 ways to value a swap
    • As an xchg of bonds
    • As a series of FRAs
  9. Other types of swap
    • Currency
    • Variation of interest (forward, alternative floating, floating-for-floating, amortizing principal, ...)
    • Variation in currency (cross currency, quanto, ...)
    • Equity swaps
    • Options
    • Commodity swaps
    • Volatility swaps