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Swaps and Interest Rate Derivatives

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... Notional principal: a reference amount used only to calculate interest expense but never repaid. ... to a formula set in advance and adjusted on specific ... – PowerPoint PPT presentation

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Title: Swaps and Interest Rate Derivatives


1
Chapter 9
  • Swaps and Interest Rate Derivatives

2
INTEREST RATE AND CURRENCY SWAPS
  • I. INTEREST RATE AND CURRENCY SWAPS
  • A. INTEREST RATE SWAPS
  • 1. Definition
  • an agreement between 2 parties to
  • exchange US interest payments for a
    specific maturity on an agreed notional amount.

3
HOW THE CLASSIC SWAP WORKS
  • a. Notional principal a reference amount
    used only to calculate interest expense but
    never repaid.
  • b. Maturities less than 1 to over 15
    years

4
THE CLASSIC SWAP
  • 2. Types
  • a. Coupon swap
  • b. Basis swap
  • 3. LIBOR the most important reference rate
    in a swap
  • 4. Swap Usage
  • To reduce risk potential and costs.

5
THE CURRENCY SWAP
  • B. Currency Swaps
  • 1. Definition
  • two parties exchange foreign currency-
  • denominated debt at periodic intervals.
  • 2. Purpose similar to parallel loan

6
THE CURRENCY SWAP
  • 3. Differences of a Currency Swap
  • a. Currency swap is not a loan
  • b. No interest expense no balance sheet
    entry
  • c. The right to offset any non-payment is
    more firmly established

7
THE CURRENCY SWAP
  • 4. Similarities between Interest Rate and
  • Currency Swaps
  • a. Avoid exchange rate risk
  • b. Exchange rate is only a reference to
  • determine amounts exchanged
  • 5. Economic Benefits of Swaps
  • when arbitrage prohibited, they provide
  • long-term financing.

8
II. INTEREST RATE FORWARDS AND FUTURES
  • Forward and futures contracts
  • - three types used to manage interest rate risk
  • A. Forward forwards
  • B. Forward rate agreements
  • C. Eurodollar futures

9
INTEREST RATE FORWARDS AND FUTURES
  • Forward forwards
  • 1. a contract that fixes an interest rate today
    on a future loan or deposit.
  • 2. Contract conditions
  • - specific interest rate
  • - principal amount of future loan
  • - start and ending dates of future interest
    rate period

10
INTEREST RATE FORWARDS AND FUTURES
  • Forward rate agreements (FRAs)
  • 1. cash-settled
  • 2. over-the-counter forward contract
  • 3. company fixes an interest rate applied to
    a specified future interest period on a
    notional amount.

11
INTEREST RATE FORWARDS AND FUTURES
  • Eurodollar Futures
  • 1. A cash-settled futures contract for a
    3- month eurodollar deposit paying LIBOR
  • 2. Contracts traded on
  • a. Chicago Mercantile Exchange
  • b. London International Financial Futures
    Exchange
  • c. Singapore International Monetary
    Exchange

12
III. STRUCTURED NOTES
  • Interest-bearing securities whose interest
    payments are determined by reference to a formula
    set in advance and adjusted on specific reset
    dates.

13
STRUCTURED NOTES
  • Inverse Floaters
  • a floating-rate instrument whose interest rate
    moves inversely with market interest rates.
  • Problems 2, 3, 5
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