全英文国际金融风险管理师（FRM）培训课程

FRM Training07-A.ppt

FRM Training07-B.ppt

FRM Training07-C.ppt

FRM Training07-D.ppt

FRM Training07-E.ppt

FRM Training07-F1.ppt

FRM Training07-F2.ppt

FRM Training07-F3.ppt

FRM Training07-F4.ppt

Outline of This Lecture

What is a swap

Interest rate swaps

Mechanics of interest rate swaps

Pricing interest rate swaps

Currency swaps

Mechanics of currency swaps

Pricing currency swaps

1. What is a swap? Example

Company A buys electricity from wholesalers and provides power service to consumers in California

The electricity price selling to consumers is fixed, while the purchasing price from wholesalers is variable

For A, the cash inflows are quite stable, but the outflows are uncertain

In case such as the high oil price, the electricity price in wholesale market become very high, and the company may bankrupt.

To manage the risk, the company may want to exchange their floating (variable) outflows with a fixed outflow or to exchange their fixed inflows with a floating inflows.

The company can do it by using a swap.

What is a swap?

A swap is an OTC agreement between two parties (called counterparties) to exchange a series of cash flows over a period of time.

Four major types of swaps:

Interest rate swaps (IRS)

Currency swaps

Equity swaps

Commodity swaps

Some terminologies about swaps

Notional principal: the amount of money used to determine the payments or the sizes of swap contracts. It may or may not be exchanged

Initially, the value of a swap is zero. Thus, no payment is needed at the beginning

Settlement date: the date on which a payment occurs.

Settlement period: the period between two consecutive settlement dates

Tenor: time to maturity

Features of the swaps market

Pros:

Privacy: only the counterparties know your position

Virtually no government regulation in U.S.

Industrial self-regulation. Major regulator:

ISDA: The International Swap and Derivatives Association

Three concerns or limitations

Difficult to find counterparties

Now swap dealers make markets, and this problem has been solved

Difficult to close before maturity: liquidity risk

Counterparty default risk:

This is an important concern in dealing with swaps.

Swap rates depend on credit ratings

Only deal with large firms

2. Interest rate swaps (IRS)

IRS are swaps to exchange interest payments in the same currency

The most popular IRS is fixed-for-floating swap, also called plain vanilla interest rate swap

1) Mechanics of IRSs

In a plain vanilla interest rate swap, there are two counterparties: A and B.

A: agrees to pay B a sequence of interest rate payments based to a fixed rate and a “principal”, called the notional principal.

A is called the fixed payer

B: agrees to pay A a sequence of interest rate payments based to the market rates, or floating-rates and the notional principal.

B is called the floating payer

No fund is exchanged initially.

The fixed-rate is predetermined, called the swap rate.

The floating rate in many IRS is LIBOR rate.

Example: A Plain Vanilla IRS

Company A entered an agreement with Bank B initiated on Sept.1, 2000

Company A:

Pays Bank B a fixed rate of 5% per annum every 6 months for 3 years on a notional principal of $100 million.

Receives 6-month LIBOR every 6 months for 3 years on a notional principal of $100 million.

The notional principal is not exchanged.

There is no fund exchange at t=0.

The actual payments are the net payments.

Tenor: (the time to maturity): three years

Plain Vanilla IRS

Example: A Plain Vanilla IRS

Cash flow to company A:

Date LIBOR Inflow Outflow Net Cash Flow

receive-floating pay-fixed

09/01/2000 4.2%

03/01/2001 4.8% 2.10 -2.50 -0.40

09/01/2001 5.3% 2.40 -2.50 -0.10

03/01/2002 5.5% 2.65 -2.50 +0.15

09/01/2002 5.6% 2.75 -2.50 +0.25

03/01/2003 5.9% 2.80 -2.50 +0.30

09/01/2003 6.4% 2.95 -2.50 +0.45

On Sept. 1(time t=0): the first LIBOR rate was known, and so the first cash flow was known. The subsequent cash flows are unknown, because the LIBOR rates are uncertain.

Gain or loss: Depend on the difference between the floating rates and the fixed-rate.

Zero-sum game.

Note:

The fixed-rate in a plain vanilla IRS is set so that the initial value of the agreement is zero

Swap pricing is referred to determine the fair value of a fixed rate, called a swap rate.

In this example, the floating payment is determined in advance and paid in arrears. Most swaps are of this type.

e.g.:

The payment paid on Mar. 01, 2003, $2.80 million, is determined on Sept. 01, 2002, based on the spot 6-month LIBOR rate quoted on Sept. 1, 2002, 5.6%.

Some swaps are paid in advance, called in-advance swaps

Some motivations of using an IRS

Converting a liability:

From fixed rate to floating rate

From floating rate to fixed rate

Converting an investment or asset

From fixed rate to floating rate

From floating rate to fixed rate

Taking comparative advantages

Example 1: Converting a liability

Company A has a floating rate liability to pay a LIBOR+0.8% interest rate on a loan, and wishes to convert it into a fixed rate loan.

A can enter into a plain vanilla IRS with a bank to pay a fixed rate of 5.5% in exchange of receiving LIBOR rate.

Thus, in net, A pays a fixed rate of 6%.

Converting a liability

Example 2: Converting an asset

Mr. Li has an investment which pays a fixed rate of 5.2%. Li wishes to receive a market rate.

Li can enter into a plain vanilla IRS with a bank to pay a fixed rate of 5.5% in exchange of receiving LIBOR rate.

Thus, in net, A receives LIBOR-0.3%.

Converting a liability

Example 3. Comparative advantages

Company A wants to borrow $10 million for 5 years at a

floating rate

Company B wants to borrow $10 million at fixed rate for 5

years

The interest rates offered by banks:

Comparative advantages

The difference between the two fixed rates is:

11.20-10.00 =1.20%

The difference between the two floating rate is

(LIBOR+1.00%)-(LIBOR+0.30%) =0.70%

Though B has always to pay higher rate than A, B could pay a relatively lower rate at floating than at fixed, comparing to the rates A pays.

That is, though A has absolute advantages in two markets, B has comparative advantage in floating.

The comparative advantage is 1.20-0.70=0.50%

A should borrow at fixed and B should borrow at floating, then, they exchange the loans to meet their needs.

Comparative advantages

To take the comparative advantage:

A borrows at the fixed rate, paying: 10%

B borrows at the floating rate, paying:

LIBOR + 1%

A and B enter a swap in which A pays LIBOR to B, and B pays fixed 9.95% to A.