SwapContracts
Swaps
•Swap: An agreement between two parties(“counterparties) to exchange a series of cashflows in the future
–Essentially a series of forwards
–Settle at each swap maturity date (often netted out)
–Payments generally determined so swap initially haszero market value
•Common are
–Interest rate swaps
–Currency swaps
Swaps vs. Futures
•Futures
–Standardized
–Exchange-traded
–Short horizons
•Swaps
–Custom tailored between counterparties
–Less regulation; potential for privacy
–Term flexibility
Interest Rate Swaps
•One party pays a fixed interest rate andreceives a floating rate
•The other party pays a floating rate andreceives a fixed rate
•Floating rates involve greater exposure tointerest rate risk
•“Notional principal” is amount on which theinterest payments are determined
Interest Rate Swaps (cont.)
•Principal is not actually exchanged -- onlyinterest payments
•Often, only net interest payments aretransacted
–Avoids unnecessary transactions
–Helps credit risk
•At each “settlement date,” a net payment ismade, based on the difference between thetwo interest rates (applied to the notionalprincipal)
Types of Swaps
•Swap curve
–Swap rates for different maturities
–Analogous to yield curve
•Deferred swap
–Begins in future
•Amortizing swap
–Covers loan with declining balance
•Accreting swap
–Covers loan with increasing balance
Q: Swaps – Fixed rate Calculation(From Exam FM Fin Econ Sample Questions)
Q: Swaps – Cash Flow Calculation(From Exam FM Fin Econ Sample Questions)
Q: Swaps – Cash Flow Calculation(From Exam FM Fin Econ Sample Questions)
