Interest Rate Derivatives

1
Interest Rate Derivatives
2
Interest Rate Derivatives

• Swaps
• Forward Rate Agreements (FRAs)
• A one-period, future swap
• EuroDollar Futures
• Bond Options (Black-76)
• Caps/Floors/Collars(CapFloor Combo.)
• Buy Cap Get CFs if Mkt RategtCap Rate
• Buy Floor Get CFs if Mkt RateltFloor Rate
• Swaptions Get/Give CF on both sides of Mkt Chg

3
All-In-Cost

• Lay out cash-flows on a timeline and solve for
  IRR. Looking for least cost.
• Exercise 1
• Fixed Bond at 7 annual, 3yrs
• 0 1 2 3
• 100 -7 -7 -107
• IRR 7 gt All-in-Cost

4
All-In-Cost

• Issue Fltg Rate Note and Swap
• Swap Fixed(T-Note, 4.50.32) for
  Floating (LIBOR2)
• 0 1 2 3
• 100 -6.8 -6.8 -106.8
• IRR 6.8 gt All-in-Cost

5
All-In-Cost

• FRAs
• (12/24 has 1 year (in 1 year) at 5 vs. LIBOR,
  or 7 vs. LIBOR2)
• (24/36 has 1 year (in 2 years) at 8 vs.
  LIBOR2)
• Issue Fltg Rate Note and FRAs
• 0 1 2 3
• 100 -5.7 -7 -108
• First year CF5.7 as known at FRA contract.
• IRR 6.85 gt All-in-Cost

6
All-In-Cost

• Cap/Floor Strikes vs LIBOR so add 2
• Buy Cap (-Prem), Sell Floor (Prem), Net combined
  with 100 t0, borrowing
• 0 1 2 3
• 97.95 -6 -6 -106
• 100 -6.8 -6.8 -106.8
• 100.41 -7 -7 -107
• 103.14 -8 -8 -108
• AICs 6.78, 6.80, 6.84, 6.81