Zvi Wiener - PowerPoint PPT Presentation

1 / 35
About This Presentation
Title:

Zvi Wiener

Description:

http://pluto.huji.ac.il/~mswiener/zvi.html. 972-2-588-3049. FRM. Zvi Wiener. Following. P. Jorion, ... A. Pay fixed in an interest rate swap for 1 year ... – PowerPoint PPT presentation

Number of Views:45
Avg rating:3.0/5.0
Slides: 36
Provided by: plutoMsc
Category:
Tags: apay | wiener | zvi

less

Transcript and Presenter's Notes

Title: Zvi Wiener


1
Financial Risk Management
  • Zvi Wiener
  • Following
  • P. Jorion, Financial Risk Manager Handbook

2
Swaps
  • Zvi Wiener
  • 02-588-3049
  • http//pluto.mscc.huji.ac.il/mswiener/zvi.html

3
Interest Rate Swaps Concept
  • An agreement between 2 parties to exchange
    periodic payments calculated on the basis of
    specified interest rates and a notional amount.
  • Plain Vanilla Swap

Based on a presentation of Global Risk Strategy
Group of Deutsche Bank
4
IRS
  • In a standard IRS, one leg consists of fixed
    rate payments and the other depends on the
    evolution of a floating rate.
  • Typically long dated contracts 2-30 years
  • Sometimes includes options, amortization, etc.
  • Interest compounded according to different
    conventions (eg 30/360, Act/Act. Act/360, etc.)

5
IRS Origins
  • AAA wants to borrow in floating and BBB wants to
    borrow in fixed.
  • Fixed Floating
  • AAA 7.00 LIBOR5bps
  • BBB 8.50 LIBOR85bps
  • difference 1.5 0.8
  • Net differential 70bps 0.7

6
Comparative Advantage
7.0
Libor85bp
BBB
AAA
  • Cost of funds for AAALibor - 40bp (45bps saved)
  • Cost of funds for BBB8.25 (25bps saved)
  • Swap rate 7.40
  • Swap rate is the fixed rate which is paid against
    receiving Libor.

7
Basic terms of IRS
  • Notional amount
  • Fixed rate leg
  • Floating rate leg
  • Calculated period
  • Day count fraction

8
Basic terms of IRS
  • Payer and receiver - quoted relative to fixed
    interest (i.e. payer payer of fixed rate)
  • buyer payer, seller receiver
  • Short party payer of fixed, (buyer)
  • Long party receiver of fixed, (seller)
  • Valuation net value NOT notional!!

9
Various swaps
  • Coupon swaps - fixed against floating.
  • Basis or Index swaps - exchange of two streams
    both are computed using floating IR.
  • Currency swap - interest payments are
    denominated in different currencies.
  • Asset swap - to exchange interest received on
    specific assets.
  • Term swap maturity more then 2 years.
  • Money Market swap - less then 2 years.

10
Payments
  • Fixed payment
  • (notional)(Fixed rate)(fixed rate day count
    convention)
  • Floating payment
  • (notional)(Float. rate)(float. rate day count
    convention)

11
Time Value of Money
  • present value PV CFt/(1r)t
  • Future value FV CFt(1r)t
  • Net present value NPV sum of all PV

12
(No Transcript)
13
Swap Pricing
  • A swap is a series of cash flows.
  • An on-market swap has a Net Present Value of
    zero!
  • PV(Fixed leg) PV(Floating leg) 0

14
Pricing
  • Floating leg is equal to notional amount at each
    day of interest rate settlement (by definition of
    LIBOR).
  • Fixed leg can be valued by standard NPV, since
    the paid amount is known.

15
(No Transcript)
16
(No Transcript)
17
Forward starting swaps
  • interest starts accruing at some date in the
    future.
  • Valuation is similar to a long swap long and a
    short swap short.

18
  • Zero coupon swap (reinvested payments)
  • Amortizing swap (decreasing notional)
  • Accreting swap (increasing notional)
  • Rollercoaster (variable notional)

19
Amortizing swap
Decreasing notional affects coupon payments
20
Unwinding an existing swap
  • Enter into an offsetting swap at the prevailing
    market rate.
  • If we are between two reset dates the offsetting
    swap will have a short first period to account
    for accrued interest.
  • It is important that floating payment dates
    match!!

21
Unwinding
Net of the two offsetting swaps is 2 for the
life of the contract. (sometimes novation)
22
Risks of Swaps
  • Interest rate risk - value of fixed side may
    change
  • Credit risk - default or change of rating of
    counterparty
  • Mismatch risk - payment dates of fixed and
    floating side are not necessarily the same
  • Basis risk and Settlement risk

23
Credit risk of a swap contract
  • Default of counterparty (change of rating).
  • Exists when the value of swap is positive
  • Frequency of payments reduces the credit risk,
  • similar to mark to market.
  • Netting agreements.
  • Credit exposure changes during the life of a swap.

24
Duration of a swap
  • Fixed leg has a long duration (approximately).
  • Short leg has duration about time to reset.
  • Duration is a measure of price sencitivity to
    interest rate changes (approximately is equal to
    average time to payment).

25
IRS Markets
  • Daily average volume of trade (notional)
  • 1995 1998 2001
  • 63B 155B 331B

26
Mark to market
  • daily repricing
  • collateral
  • adjustments
  • reduces credit exposure

27
Reasons to use swaps by firms
  • Lower cost of funds
  • Home market effects
  • Comparative advantage of highly rated firms

28
(No Transcript)
29
(No Transcript)
30
(No Transcript)
31
Global Derivatives Markets 1999
OTC Instruments 88T
Exchange traded 13.5T
  • IR contracts 60,091
  • FRAs 6,775
  • Swaps 43,936
  • Options 9,380
  • FX contracts 14,344
  • Forwards 9,593
  • Swaps 2,444
  • Options 2,307
  • Equity-linked contr. 1,809
  • Forw. and swaps 283
  • Options 1,527
  • Commodity contr. 548
  • Others 11,408

IR contracts 11,669 Futures 7,914 Options 3,756
FX contracts 59 Futures 37 Options 22 Stock-in
dex contr. 1,793 Futures 334 Options 1,459
World GDP in 99 30,000 All stocks and bonds
70,000 Liquidation value 2,800
Source BIS
32
FRM-GARP 0047
  • Which one of the following deals has the largest
    credit exposure for a 1,000,000 deal size.
    Assume that the counterparty in each deal is a
    AAA-rated bank and there is no settlement risk.
  • A. Pay fixed in an interest rate swap for 1 year
  • B. Sell USD against DEM in a 1 year forward
    contract.
  • C. Sell a 1-year DEM Cap
  • D. Purchase a 1-year Certificate of Deposit

33
FRM-GARP 0047
  • Which one of the following deals has the largest
    credit exposure for a 1,000,000 deal size.
    Assume that the counterparty in each deal is a
    AAA-rated bank and there is no settlement risk.
  • A. Pay fixed in an interest rate swap for 1 year
  • B. Sell USD against DEM in a 1 year forward
    contract.
  • C. Sell a 1-year DEM Cap
  • D. Purchase a 1-year Certificate of Deposit

34
Global Derivatives Markets 1999
OTC Instruments 88T
Exchange traded 13.5T
  • IR contracts 60,091
  • FRAs 6,775
  • Swaps 43,936
  • Options 9,380
  • FX contracts 14,344
  • Forwards 9,593
  • Swaps 2,444
  • Options 2,307
  • Equity-linked contr. 1,809
  • Forw. and swaps 283
  • Options 1,527
  • Commodity contr. 548
  • Others 11,408

IR contracts 11,669 Futures 7,914 Options 3,756
FX contracts 59 Futures 37 Options 22 Stock-in
dex contr. 1,793 Futures 334 Options 1,459
World GDP in 99 30,000B All stocks and bonds
70,000 Liquidation value 2,800B
Source BIS
35
Global Derivatives Markets 2001
OTC Instruments 111T
Exchange traded 23.5T
  • IR contracts 77,513
  • FRAs 7,737
  • Swaps 58,897
  • Options 10,879
  • FX contracts 16,748
  • Forwards 10,336
  • Swaps 3,942
  • Options 2,470
  • Equity-linked contr. 1,881
  • Forw. and swaps 320
  • Options 1,561
  • Commodity contr. 598
  • Others 14,375

IR contracts 21,614 Futures 9,137 Options 12,47
7 FX contracts 89 Futures 66 Options 23 Stock-i
ndex contr. 1,838 Futures 295 Options 1,543
Source BIS
Write a Comment
User Comments (0)
About PowerShow.com