Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
3 Cards in this Set
- Front
- Back
|
Distinguish between a swap's value and a swap's price. pg 100, derivs |
This is conceptually similar to a forward contract. At initiation, the rate paid by both parties in a swap transaction net out to be zero over the life of the contract. As rates change, one of the two parties will benefit from the change and another will lose money because of it. For example, at the initiation of a swap market interest rates are 5%, the swap is created so that the expected present value of the floating rate payments is equal to that of the fixed rate payments. However, if over the life of the swap market rates increase to 7%, the payer of fixed rate will receive a better rate and make the 2% spread. The payer of floating will lose the 2% spread because they will receive the fixed 5% rate. |
|
|
Explain the similarities and differences between (1) an interest rate swap and a series of FRA's and (2) a plain vanilla swap and a combination of interest rate call and put options pg 101-102, derivs |
Interest rate swaps and a series of FRA's is very very similar, and a useful tool for valuation, but there are two differences: 1) At the end of a payment period for a swap, there will be a variety of FRAs that are expiring, all will differing values. This means that there may be imperfections with the rates on the two scenarios. 2) With a swap, the next period payment is known at the beginning of the period, which is not the case with an FRA. With an FRA, all payments are made at expiration and the rate is unknown until that point. An investor could also use options to recreate the payoffs of a swap. By entering into a mix of call and put options, the investor can create a scenario where a payment is received when there is an advantageous movement in interest rates and owed when there is a disadvantageous move. |
|
|
a |
a |
