Beruflich Dokumente
Kultur Dokumente
and Derivatives
Lecture 07:
Forward Rate Agreements
(FRAs)
and Swaps
1
Unit Outline
Week 1: Introduction to Risk, Risk Management and Derivatives
Week 2: Financial Statistics
Week 3: Value-at-Risk 1
Week 4: No Classes Ekka Public Holiday
Week 5: Value-at-Risk 2
Week 6: Forwards and Futures 1
Week 7: Forwards and Futures 2
Week 8: Mid-Semester Exam
Week 9: Forward Rate Agreements (FRAs) and Swaps
Week 10: Reflective Practice and Options 1 (intro and binomial model)
Week 11: Options 2 (Black-Scholes model)
Week 12: Options 3 (trading strategies and risk management)
Week 13: Derivative Disasters
Week 14: Revision
2
Lecture Content
Interest Rates
Zero-Coupon Rates
Forward Rates
FRAs
Interest Rate Swaps
Readings:
Hull et al. (2014), Ch. 4 and Ch. 7: 7.1 7.7
Interest Rates
Interest Rates:
The amount charged, expressed as a percentage of principal, by
a lender to a borrower for the use of assets. (Investopedia
http://www.investopedia.com/terms/i/interestrate.asp ).
defines the amount of money a borrower promises to pay a
lender (Hull et al., 2014, p.80).
Rate Types
Treasury Rate: rates on government bonds and notes.
LIBOR: London Interbank Offered Rate (more next slide)
REPO Rate: Repurchase agreement where a dealer sells a security
but agrees to repurchase the security at a higher price at a later
date. Reserve Bank provides overnight liquidity to banks through
the repo window where the repo rate is Cash Rate + 25 basis
points where banks provide acceptable security for repo-ing.
4
Interest Rates
LIBOR
At 11am each day, a group of banks contribute their
interbank borrowing rates (the rate at which they are
willing to trade with other banks) for 15 maturities from
overnight to 12 months to Reuters.
They answer the survey questions,
"At what rate could you borrow funds, were you to do
so by asking for and then accepting inter-bank offers in a
reasonable market size just prior to 11 am?"
For derivative markets, LIBOR is often considered the
true risk-free because of tax and regulatory issues
related to treasury rates.
Can you manipulate LIBOR for your own gain? Ask
Barclays Bank
In Australia, BBSW (Bank Bill Swap reference rate) is the 5
equivalent of LIBOR and is set in a similar manner to
Interest Rates
Equivalent
Annual Interest Rates
Note that the zero rate is note the same as the yield on a
bond with n years to maturity that is, generally .
It is important to note, there are no interest payments
between 0 and n, hence why it is referred to as a zerocoupon rate and why .
7
To
calculate yield, solve for
8
Time to
Maturity
Coupon
(S/A)
Bond
Price
zt
100
0.25
97.5
100
0.50
94.9
100
1.00
90.0
0.10681
100
1.50
96.0
0.10808
100
2.00
12
101.6
0.10127
0.10469
0.10536
10
Forward Rates
are the rates of interest implied by the current
zero rates for periods of time in the future (Hull
et al., 2014, p.89).
Best shown with an example, note rates are quoted per
0
1
2
period.
z0,1
R1,2
z0,2
Taking logs
11
Forward Rates
Example 1-year forward rates, Hull et al. (2014) p.
90
z0,1 =
3.0%
R1,2
z0,2 =
4.0%
R2,3
z0,3 =
4.6%
R3,4
z0,4 = 5.0%
R4,5
z0,5 =
5.3%
12
Forward Rates
cause the zero coupon curve is upward sloping, the 1-year forward sits above the
o coupon curve relates to market expectations theory of interest rates.
13
Forward Rates
Example 2-year forward rates, Hull et al. (2014) p.
90
z0,1 =
3.0%
R1,3
z0,3 =
4.6%
Remember:
R1,2=
0.050
R2,3 =
0.058
14
Forward Rates
Example 2-year forward rates, Hull et al. (2014) p.
90
z0,1 =
3.0%
R1,3
z0,2 =
4.0%
R2,4
z0,3 =
4.6%
R3,5
z0,4 =
5.0%
z0,5 =
5.3%
15
Forward Rates
General
form of Formula from Hull et al. (2014)
16
FRAs
A forward rate agreement (FRA) is an over-thecounter agreement that a certain interest rate will
apply to either borrowing or lending a certain
principal (amount) during a specified future period
of time (Hull et al., 2014, p.91).
Notation:
RK: the rate of interest agreed to in the FRA
RF: the forward LIBOR between T1 and T2, calculated
today
RM: the spot LIBOR between T1 and T2, at T1
L: principal amount
17
FRAs
Example:
Hull et al. (2014) p. 91
FRAs
FRA valuation at settlement
Example:
FRA to receive RK = 4.00%, L = $100m, T1 = 3.00 and T2
= 3.25.
Note that the future period is 3 months, 3.25 3.00 = 0.25
If RM = 4.50%,
19
FRAs
FRA
valuation prior to settlement:
20
FRAs
The
Australian FRA market
Term
1-month
3month
6-month
12-month
Minimum
Principal
$1b
$500m
$200m
$100m
FRAs
Example:
Hull et al. (2014) p.95.
22
BBSW + Margin
Fixed
Counterpar
ty
B
Need to set:
Notional Principal, L
Fixed Rate, RK
Floating Interest Rate, e.g. 6-month BBSW, R M
Floating Rate reset dates, e.g. every 6-months
Margin above Floating Rate
Settlement dates: generally on reset dates
23
ALCOA
BBSW
Fixed Pay
5/3/12
4.20
7/9/12
BBSW2
+2.10
-2.50
5/3/13
BBSW3
BBSW2/2
-2.50
7/9/13
BBSW4
BBSW3/2
-2.50
5/3/14
BBSW5
BBSW4/2
-2.50
7/9/14
BBSW6
BBSW5/2
-2.50
24
BBSW
Float Rec.
Fixed Pay
5/3/12
4.20
7/9/12
BBSW2
+2.10
-2.50
5/3/13
BBSW3
BBSW2/2
-2.50
7/9/13
BBSW4
BBSW3/2
-2.50
5/3/14
BBSW5
BBSW4/2
-2.50
7/9/14
BBSW6
BBSW5/2
-2.50
5/3/15
100+BBSW6/
Long Floating-rate Bond2
-102.50
Short Fixed-rate Bond
25
5%
BBSW
ALCOA
5.2%
Wesfarmers
Pays BBSW + 0.1%, receives BBSW and pays 5%, net pays fixed 5.1%
Alcoa
Pays 5.2%, receives 5% and pays BBSW, net pays floating BBSW +
0.2%
26
Wesfarmer
s
5%
BBSW
ALCOA
BBSW - 0.2%
Wesfarmers
Receives 4.7%, pays 5% and receives BBSW, net receives floating
BBSW 0.3%
Alcoa
Receives BBSW 0.2%, pays BBSW and receives 5%, net receives fixed
4.8%
27
5.015%
Financial
BBSW
Institutio
n
4.985%
ALCOA
5.2%
Wesfarmers
Pay BBSW + 0.1%, receive BBSW and pay 5.015%, net pays 5.115%
ACLOA
Pay 5.2%, receive 4.985% and pay BBSW, net pays BBSW + 0.215%
Financial Institution
Pay BBSW, receive 5.015%, receive BBSW and pay 4.985%, net receives 0.03%.
The additional 3 basis points come from Wesfarmers and ALCOA paying 1.5 basis
points more than the earlier example.
28
Maturity
Bid
Offer
6.03
6.06
6.045
6.21
6.24
6.225
6.35
6.39
6.370
6.47
6.51
6.490
6.65
6.68
6.665
10
6.83
6.87
6.850
Confirmations
ISDA (International Swaps and Derivatives Association)
Master Agreement
Sets out terms and conditions between two parties.
e.g. the closing-out of contacts and the netting of payments on a
swap (loser pays)
It allows for confirmation documents to cover brief information
related to the transaction at hand.
30
4.0%
BBSW 0.1%
BBBCorp
5.2%
BBSW + 0.6%
Difference
1.2%
0.7%
AAACorp
4.35
BBBCorp
BBSW+0.6%
31
Value at Inception
The value of the swap at inception is zero or close to zero
given that fixed rate side is set at around the swap rate.
32
where:
is the value of the swap
is the standard fixed coupon bond valuation
equals par-value () at each coupon payment as the
coupon resets to be equal to the current 6-month in
the next
interest period. In between periods where
it is to the next
coupon of and is the rate that
corresponds to , then
33
Time
Bfix CF
Bfloat CF
Disc. Fact.
PV Bfix
CF
PV Bfloat
CF
0.25
4.00
105.100
0.9753
3.901
102.505
0.75
4.00
0.9243
3.697
1.25
104.00
0.8715
90.640
Total
98.238
102.505
34
Time
Fixed
CF
Floating
CF
Net CF
Disc. Fact.
PV of CF
0.25
4.0
-5.100
-1.100
0.9753
-1.073
0.75
4.0
-5.522
-1.522
0.9243
-1.407
1.25
4.0
-6.051
-2.051
0.8715
-1.787
Total
-4.267
35