SWAPS AND INTEREST RATE DERIVATIVES

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CHAPTER 9

• SWAPS AND INTEREST RATE DERIVATIVES

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CHAPTER OVERVIEW

• I. Interest Rate and Currency Swaps
• II. Interest Rate Forwards and Futures
• III. Structured Notes

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I. 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.

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THE CLASSIC SWAP

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

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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.

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THE CURRENCY SWAP

• B. Currency Swaps
• 1. Definition
• Two parties exchange foreign currency-
• denominated debt at periodic intervals.
• 2. Purpose similar to parallel loan

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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

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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.

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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

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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.