An interest rate swap is an agreement between two parties to exchange future interest rate payments over a set period of time. It consists of a series of payment periods, called swaplets. The most popular form of interest rate swaps is the vanilla swaps that involve the exchange of a fixed interest rate for a floating rate, or vice versa. There are two legs associated with each party: a fixed leg and a floating leg. Swaps are OTC derivatives that bear counterparty credit risk beside interest rate risk.
Interest rate swaps are the most popular OTC derivatives that are generally used to manage exposure to fluctuations in interest rates. Swaps can be also used to obtain a marginally lower interest rate. Thus they are often utilized by a firm that can borrow money easily at one type of interest rate but prefers a different type. They also allow investors to adjust interest rate exposure and offset interest rate risks. Speculators use swaps to speculate on the movement of interest rates. More and more swaps are cleared through central counterparties nowadays (CCPs). This presentation gives an overview of interest rate swap product and valuation model. You can find more information at http://www.finpricing.com/lib/IrSwap.html

Comments

Posting comment...

Premium member

Presentation Transcript

slide 1:

Interest Rate Swap
Vaulation Pratical Guide
Alan White
FinPricing
http://www.finpricing.com

slide 2:

Swap
Summary
◆ Interest Rate Swap Introduction
◆ The Use of Interest Rate Swap
◆ Swap or Swaplet Payoff
◆ Valuation
◆ Practical Notes
◆ A real world example

slide 3:

Swap
Interest Rate Swap Introduction
◆ An interest rate swap is an agreement between two parties to exchange
future interest rate payments over a set period of time.
◆ An interest rate swap consists of a series of payment periods called
swaplets.
◆ Vanilla Interest Rate Swaps involve the exchange of a fixed interest rate
for a floating rate or vice versa.
◆ There are two legs associated with each party: a fixed leg and a floating
leg.
◆ Swaps are OTC derivatives that bear counterparty credit risk.

slide 4:

Swap
The Use of Interest Rate Swap
◆ Swaps are the most popular OTC derivatives that are generally used to
manage exposure to fluctuations in interest rates.
◆ Swaps can also be used to obtain a marginally lower interest rate. Thus
they are often utilized by a firm that can borrow money easily at one
type of interest rate but prefers a different type.
◆ Swaps allow investors to adjust interest rate exposure and offset
interest rate risk.
◆ Speculators use swaps to speculate on the movement of interest rates.
◆ More and more swaps are cleared through central counterparties CCPs
nowadays.

slide 5:

Swap
Swap or Swaplet Payoff
◆ From the fixed rate payer perspective the payoff of a swap or swaplet at
payment date T is given by
−
where
◆ N- the notional
◆ – accrual period in years e.g. a 3 month period ≈ 3/12 0.25 years
◆ R – the fixed rate in simply compounding.
◆ F – the realized floating rate in simply compounding
◆ From the fixed rate receiver perspective the payoff of a swap or swaplet
at payment date T is given by
−

slide 6:

Swap
Valuation
◆ The present value of a fixed rate leg is given by
1
where t is the valuation date and is the discount factor.
◆ The present value of a floating leg is given by
+ 1
where
−1
−1/ is the forward rate and s is the floating spread.
◆ The present value of an interest rate swap can expressed as
◆ From the fixed rate receiver perspective
−
◆ From the fixed rate payer perspective
−

slide 7:

Swap
Practical Notes
◆ First of all you need to generate accurate cash flows for each leg. The cash
flow generation is based on the start time end time and payment frequency
of the leg plus calendar holidays business convention e.g. modified
following following etc. and whether sticky month end.
◆ We assume that accrual periods are the same as reset periods and payment
dates are the same as accrual end dates in the above formulas for brevity.
But in fact they are different due to different market conventions. For
example index periods can overlap each other but swap cash flows are not
allowed to overlap.
◆ The accrual period is calculated according to the start date and end date of
a cash flow plus day count convention

slide 8:

Swap
Practical Notes Cont
◆ The forward rate should be computed based on the reset period index reset
date index start date index end date that are determined by index
definition such as index tenor and convention. it is simply compounded.
◆ Sometimes there is a floating spread added on the top of the floating rate in
the floating leg.
◆ The formula above doesn ’t contain the last live reset cash flow whose reset
date is less than valuation date but payment date is greater than valuation
date. The reset value is
0
0
0
where 0
is the reset rate.

slide 9:

Swap
Practical Notes Cont
◆ The present value of the reset cash flow should be added into the present
value of the floating leg.
◆ Some dealers take bid-offer spreads into account. In this case one should
use the bid curve constructed from bid quotes for forwarding and the offer
curve built from offer quotes for discounting.

slide 10:

Swap
A Real World Example
Leg 1 Specification Leg 2 Specification
Currency USD Currency USD
Day Count dcAct360 Day Count dcAct360
Leg Type Fixed Leg Type Float
Notional 5000000 Notional 5000000
Pay Receive Receive Pay Receive Pay
Payment Frequency 1M Payment Frequency 1M
Start Date 7/1/2015 Start Date 7/1/2015
End Date 3/1/2023 End Date 3/1/2023
Fixed Rate 0.0455 Spread 0
Index Specification
Index Type LIBOR
Index Tenor 1M
Index Day Count dcAct360

slide 11:

Thanks
You can find more details at
http://www.finpricing.com/lib/IrSwap.html

You do not have the permission to view this presentation. In order to view it, please
contact the author of the presentation.

Send to Blogs and Networks

Processing ....

Premium member

Use HTTPs

HTTPS (Hypertext Transfer Protocol Secure) is a protocol used by Web servers to transfer and display Web content securely. Most web browsers block content or generate a “mixed content” warning when users access web pages via HTTPS that contain embedded content loaded via HTTP. To prevent users from facing this, Use HTTPS option.