Swaps: Course: FINC6073 Lab Trading Simulation Effective Period: September 2016

Course : FINC6073 Lab Trading
Simulation
Effective Period : September 2016
Swaps
Session 6
Acknowledgement
If you are using PowerPoint from textbook, please

use this slide to give information about the source
of the slides.
Example:
These slides have been adapted from:
John C. Hull. (2014). Fundamental of Futures and Options Markets.

08. Pearson Education. New Jersey. ISBN: ISBN-10: 0-13-338285.
(JC Hull1)
Swaps
Chapter 7
Options, Futures, and Other Derivatives, 8th Ed, Ch 7, Copyright © John C. Hull 2013 3
Nature of Swaps
A swap is an agreement to
exchange cash flows at specified
future times according to certain
specified rules
An Example of a “Plain Vanilla”
Interest Rate Swap
 An agreement by Microsoft to receive 6-
month LIBOR & pay a fixed rate of 5%
per annum every 6 months for 3 years
on a notional principal of $100 million
 Next slide illustrates cash flows that
could occur (Day count conventions are
not considered)
Cash Flows to Microsoft
(See Table 7.1, page 160
---------Millions of Dollars---------
LIBOR FLOATING FIXED Net
Date Rate Cash Flow Cash Flow Cash Flow
Mar.5, 2013 4.2%
Sept. 5, 2013 4.8% +2.10 –2.50 –0.40
Mar.5, 2014 5.3% +2.40 –2.50 –0.10
Sept. 5, 2014 5.5% +2.65 –2.50 +0.15
Mar.5, 2015 5.6% +2.75 –2.50 +0.25
Sept. 5, 2015 5.9% +2.80 –2.50 +0.30
Mar.5, 2016 6.4% +2.95 –2.50 +0.45
Typical Uses of an
Interest Rate Swap
 Converting a liability from
 fixed rate to floating rate
 floating rate to fixed rate
 Converting an investment from

 fixed rate to floating rate
 floating rate to fixed rate
Intel and Microsoft (MS)
Transform a Liability
(Figure 7.2, page 161)
5%
5.2%
Intel MS
LIBOR+0.1%
LIBOR
Financial Institution is Involved
4.985% 5.015%
5.2%
Intel F.I. MS
LIBOR+0.1%
LIBOR LIBOR
Intel and Microsoft (MS)
Transform an Asset
5%
4.7%
Intel MS
LIBOR−0.2%
LIBOR
Financial Institution is Involved
(See Figure 7.5, page 163)
4.985% 5.015%
4.7
Intel F.I. MS %
LIBOR−0.2%
LIBOR LIBOR
Quotes By a Swap Market Maker
(Table 7.3, page 164)
Maturity Bid (%) Offer (%) Swap Rate (%)

2 years 6.03 6.06 6.045
3 years 6.21 6.24 6.225
4 years 6.35 6.39 6.370
5 years 6.47 6.51 6.490
7 years 6.65 6.68 6.665
10 years 6.83 6.87 6.850
Day Count
 A day count convention is specified for for
fixed and floating payment
 For example, LIBOR is likely to be
actual/360 in the US because LIBOR is a
money market rate
Confirmations
 Confirmations specify the terms of a
transaction
 The International Swaps and Derivatives
has developed Master Agreements that
can be used to cover all agreements
between two counterparties
 Central clearing is used for most standard
swaps
The Comparative Advantage
Argument (Table 7.4, page 166)
 AAACorp wants to borrow floating

 BBBCorp wants to borrow fixed
Fixed Floating
AAACorp 4.00% 6-month LIBOR − 0.1%

BBBCorp 5.20% 6-month LIBOR + 0.6%
The Swap (Figure 7.6, page 167)
4.35%
4%
AAACorp BBBCorp
LIBOR+0.6%
LIBOR
The Swap when a Financial
Institution is Involved
4.33% 4.37%
4%
AAA F.I. BBB
LIBOR+0.6%
LIBOR LIBOR
Criticism of the Comparative
Advantage Argument
 The 4.0% and 5.2% rates available to AAACorp
and BBBCorp in fixed rate markets are 5-year
rates
 The LIBOR−0.1% and LIBOR+0.6% rates
available in the floating rate market are six-
month rates
 BBBCorp’s fixed rate depends on the spread
above LIBOR it borrows at in the future
The Nature of Swap Rates
 Six-month LIBOR is a short-term AA
borrowing rate
 The 5-year swap rate has a risk
corresponding to the situation where 10 six-
month loans are made to AA borrowers at
LIBOR
 This is because the lender can enter into a
swap where income from the LIBOR loans is
exchanged for the 5-year swap rate
Overnight Indexed Swaps
 Fixed rate for a period is exchanged for the
geometric average of the overnight rates
 Should the OIS rate equal the LIBOR rate? A
bank can
 Borrow $100 million in the overnight market, rolling
forward for 3 months
 Enter into an OIS swap to convert this to the 3-
month OIS rate
 Lend the funds to another bank at LIBOR for 3
months
Overnight Indexed Swaps continued
 ...but it bears the credit risk of another bank in this
arrangement
 The excess of LIBOR over the OIS rate is the
LIBOR-OIS spread. It is usually about 10 basis
points but spiked at an all time high of 364 basis
points in October 2008
OIS vs LIBOR discounting
 Traditionally LIBOR rates (and swap rates
determined from swaps where LIBOR is
exchanged for fixed) have been used as risk-
free rates when derivatives are valued
 Most market participants now use the OIS rate
as the discount rate when collateralized deals
are valued, but continue to use LIBOR rates for
discounting cash flows in non-collateralized
deals
Using Swap Rates to Bootstrap the
LIBOR/Swap Zero Curve when
LIBOR discounting is used
 Consider a new swap where the fixed rate is the swap
rate
 When principals are added to both sides on the final
payment date the swap is the exchange of a fixed rate
bond for a floating rate bond
 The floating-rate rate bond is worth par. The swap is
worth zero. The fixed-rate bond must therefore also be
worth par
 This shows that swap rates define par yield bonds that
can be used to bootstrap the LIBOR (or LIBOR/swap)
zero curve
Example of Bootstrapping the
LIBOR/Swap Curve (Example 7.3, page 173)
 6-month, 12-month, and 18-month
LIBOR/swap rates are 4%, 4.5%, and 4.8%
with continuous compounding.
 Two-year swap rate is 5% (semi-annual)
2.5e 0.040.5  2.5e 0.0451.0  2.5e 0.0481.5  102.5e 2 R  100
 The 2-year LIBOR/swap rate, R, is 4.953%
Valuation of an Interest Rate
Swap
 Initially interest rate swaps are worth
close to zero
 At later times they can be valued as a
portfolio of forward rate agreements
(FRAs)
Example
 Receive six-month LIBOR, pay 3% (s.a.
compounding) on a principal of $100 million
 Remaining life 1.25 years
 LIBOR rates for 3-months, 9-months and 15-
months are 2.8%, 3.2%, and 3.4% (cont comp)
 6-month LIBOR on last payment date was 2.9%
(s.a. compounding)
Valuation Assuming LIBOR
Discounting
 Each exchange of payments in an interest

rate swap is an FRA
 The FRAs can be valued on the
assumption that today’s forward rates are
realized
 The forward rates can be calculated
directly from the LIBOR/swap zero curve
Forward Rates
 The forward rates with semiannual
compounding are
 3.429% for the 3 to 9 month period
 3.734% for the 9 to 15 month period
Valuation of Example Using FRAs
and LIBOR discounting (Example 7.2 ,
page 172)
Time Fixed Floating Net Cash Disc PV

cash flow cash flow Flow factor Bfl
0.25 -1.5 +1.4500 -0.0500 0.9930 -0.0497
0.75 -1.5 +1.7145 +0.2145 0.9763 +0.2094
1.25 -1.5 +1.8672 +0.3672 0.9584 +0.3519
Total +0.5117
Valuation in Terms of Bonds
using LIBOR discounting
 The fixed rate bond is valued in the usual
way
 The floating rate bond is valued by noting
that it is worth par immediately after the
next payment date
Value of Floating Rate Bond
(L=Principal)
Value = PV
of L+k* at t*
Value = Value = L
L+k*
0 t*
Valuation First Pmt Second

Date Date Pmt Date Maturity
Floating Date
Pmt =k*
Example (Example 7.6, page 177)
Time Bfix cash Bfl cash Disc PV PV

flow flow factor Bfix Bfl
0.25 1.5000 101.4500 0.9930 1.4895 100.7423

0.75 1.5000 0.9763 1.4644
1.25 101.5000 0.9584 97.2766
Total 100.2306 100.7423
Swap value = 100.7423 − 100.2306 = 0.5117
Valuation of Swaps Using OIS
discounting
 Zero rates are bootstrapped from OIS
rates (This is similar to the way the
LIBOR/swap zero curve is produced)
 Forward LIBOR rates are then calculated
so that so that swaps entered into at the
current swap rate are worth zero (See
Example 7.5, page 176)
Valuation of Swaps Using OIS
discounting continued
 The swap is valued by assuming that
forward LIBOR is realized and discounting
at the OIS rate
 There is no simple way of valuing the
swap in terms of bonds
An Example of a Fixed-for-Fixed
Currency Swap
An agreement to pay 5% on a sterling

principal of £10,000,000 & receive 6%
on a US$ principal of $15,000,000
every year for 5 years
Exchange of Principal
 In an interest rate swap the
principal is not exchanged
 In a currency swap the
principal is exchanged at the
beginning and the end of the
swap
The Cash Flows (Table 7.5, page 180)
Date Dollar Cash Flows Sterling cash flow
(millions) (millions)
Feb 1, 2011 -15.00 +10.00

Feb 1, 2012 +0.90 −0.50
Feb 1, 2012 +0.90 −0.50
Feb 1, 2014 +0.90 −0.50
Feb 1, 2015 +0.90 −0.50
Feb 1, 2016 +15.90 −10.50
Typical Uses of a
Currency Swap
 Conversion from a liability in one currency to

a liability in another currency
 Conversion from an investment in one

currency to an investment in another currency
Comparative Advantage May Be
Real Because of Taxes
 General Electric wants to borrow AUD
 Quantas wants to borrow USD
 Cost after adjusting for the differential
impact of taxes
USD AUD
General Electric 5.0% 7.6%
Quantas 7.0% 8.0%
Valuation of Fixed-for-Fixed
Currency Swaps
Fixed for fixed currency swaps can
be valued either as the difference
between 2 bonds or as a portfolio of
forward contracts
Example (pages 182-184)
 All Japanese LIBOR/swap rates are 4%
 All USD LIBOR/swap rates are 9%
 5% is received in yen; 8% is paid in dollars.
Payments are made annually
 Principals are $10 million and 1,200 million yen
 Swap will last for 3 more years
 Current exchange rate is 110 yen per dollar
Valuation in Terms of Bonds
(Example 7.7, page 183)
Time Cash Flows ($) PV ($) Cash flows (yen) PV (yen)

1 0.8 0.7311 60 57.65
2 0.8 0.6682 60 55.39
3 0.8 0.6107 60 53.22
3 10.0 7.6338 1,200 1,064.30
Total 9.6439 1,230.55
Value = 1230.55/110−9.6439 = 1.5430
Valuation in Terms of Forwards
(Example 7.8, page 184)
Time $ cash Yen cash Forward Yen cash Net Present

flow flow Exch rate flow in $ Cash value
Flow
1 -0.8 60 0.009557 0.5734 -0.2266 -0.2071
2 -0.8 60 0.010047 0.6028 -0.1972 -0.1647
3 -0.8 60 0.010562 0.6337 -0.1663 -0.1269
3 -10.0 1200 0.010562 12.6746 +2.6746 2.0417
Total 1.5430
Other Currency Swaps
 Fixed-for-floating: equivalent to a fixed-for-
fixed currency swap plus a fixed for
floating interest rate swap
 Floating-forfloating: equivalent to a fixed-
for-fixed currency swap plus two floating
interest rate swaps
Swaps & Forwards
 A swap can be regarded as a
convenient way of packaging forward
contracts
 When a swap is initiated the swap has
zero value, but typically some forwards
have a positive value and some have a
negative value
Credit Risk
 A swap is worth zero to a company initially
 At a future time its value is liable to be either positive or negative
 The company has credit risk exposure only when its value is
positive
 Some swaps are more likely to lead to credit risk exposure than
others
 What is the situation if early forward rates have a positive value?
 What is the situation when the early forward rates have a negative
value?
Credit Default Swaps: A Quick
First Look
 Notional principal (e.g. $100 million) and
maturity (e.g. 5 yrs) specified
 Protection buyer pays a fixed rate (e.g. 150 bp)
on the notional principal (the CDS spread)
 If the reference entity (a country or company)
defaults protection seller buys bonds issued by
the reference entity for their face value and the
spread payments stop. Total face value of bonds
bought equals notional principal
Other Types of Swaps
 Amortizing/ step up
 Compounding swap
 Constant maturity swap
 LIBOR-in-arrears swap
 Accrual swap
 Equity swap
Other Types of Swaps continued
 Cross currency interest rate swap
 Floating-for-floating currency swap
 Diff swap
 Commodity swap
 Variance swap

Swaps: Course: FINC6073 Lab Trading Simulation Effective Period: September 2016

Hochgeladen von

Dokumentinformationen

Originaltitel

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

Swaps: Course: FINC6073 Lab Trading Simulation Effective Period: September 2016

Hochgeladen von

Copyright:

Verfügbare Formate

Course : FINC6073 Lab Trading

If you are using PowerPoint from textbook, please

John C. Hull. (2014). Fundamental of Futures and Options Markets.

 Converting an investment from

Maturity Bid (%) Offer (%) Swap Rate (%)

 AAACorp wants to borrow floating

AAACorp 4.00% 6-month LIBOR − 0.1%

 The 2-year LIBOR/swap rate, R, is 4.953%

 Each exchange of payments in an interest

Time Fixed Floating Net Cash Disc PV

Valuation First Pmt Second

Time Bfix cash Bfl cash Disc PV PV

0.25 1.5000 101.4500 0.9930 1.4895 100.7423

Swap value = 100.7423 − 100.2306 = 0.5117

An agreement to pay 5% on a sterling

Feb 1, 2011 -15.00 +10.00

 Conversion from a liability in one currency to

 Conversion from an investment in one

General Electric 5.0% 7.6%

Quantas 7.0% 8.0%

Time Cash Flows ($) PV ($) Cash flows (yen) PV (yen)

Value = 1230.55/110−9.6439 = 1.5430

Time $ cash Yen cash Forward Yen cash Net Present

Das könnte Ihnen auch gefallen