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38 Cards in this Set

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  • Back
What is an interest rate swap?
an agreement in which two parties agree to exchange periodic interest payments
What is the notional principal amount?
the dollar principal amount upon which the interest payments in an interest rate swap or interest rate agreement are based
What is the fixed-rate payer?
in the most common form of interest rate swap, the party that pays the other fixed interest payments at designated dates for the life of the contract; if interest rates rise, fixed rate payer will realize a profit
What is the floating-rate payer?
party that agrees to make interest rate payments that float with some reference interest rate; if interest rates rise, the floating-rate payer will realize a loss
What are the 2 ways to interpret an interest rate swap?
1. as a package of forward/futures contracts; except interest rate swaps have longer maturities; more liquid than forward contracts; more efficient, forward contracts would have to be negotiated separately
2. as a package of cash flows from buying and selling cash market instruments
What are plain vanilla swaps?
generic interest rate swap in which the counterparties exchange a fixed rate for a floating rate, and the notional principal amount is the same over the life of the swap
What is an asset swap?
the use of an interest rate swap to change the cash flow characteristics of assets
What is a liability swap?
the use of an interest rate swap to change the cash flow characteristics of liabilities
What are the two important functions of interest rate swaps?
1. it can change the risk of a financial position by altering the cash flow characteristics of assets or liabilities
2. it also can be used to enhance returns
What is the swap spread?
the difference between the swap's fixed rate and the rate on a Treasury whose maturity matches the swap's maturity
What factors influence swap spreads?
1. credit spreads
2. the level and shape of the Treasury yield curve
3. the relative supply of fixed- and floating-rate payers in the interest rate swap market
4. the level of asset-based swap activity
5. technical factors that affect swap dealers
What are the 3 general types of transactions in the secondary market for swaps?
1. a swap reversal
2. a swap sale (or assignment)
3. a swap buy-back (or close-out or cancellation)
What is a swap reversal?
one party wants out of the transaction; arranges for an additional swap with maturity equal to the time remaining for the original swap, reference rate and notional priniciple amount are the same; risk is that reversing party is now liable to two parties instead of one and takes on more default risk
What is a swap sale or swap assignment?
party that wishes to close out finds another party willing to accept its obligations under the swap; none of the risk of swap reversal; counterparty must accept- new party must have a comparable credit rating to the terminating party
What is a buy-back or close-out sale (or cancellation)?
involves the sale of the swap to the originial counterparty
What is a bullet swap?
a generic plain vanilla or interest rate swap; notional principal amount does not vary over the life of the swap
What is an amortizing swap?
the notional principal amount decreases in a predetermined way over the life of the swap; used to hedge loans that amortize (the outstanding principal declines)
What is an accreting swap?
the notional principal amount increases at a predetermined way over time
What is a roller-coaster swap?
the notional principal amount can rise or fall from period to period
What is a basis rate swap?
both parties exchange floating-rate payments based on a different money market reference rate
What are swaptions?
grant the option buyer the right to enter into an interest rate swap at a future date
What is a payer swaption?
entitles the option buyer to enter into an interest rate swao in which the buyer of the option pays a fixed rate and recieves a floating rate
What is a reciever swaption?
buyer of the swaption has the right to enter into an interest rate swap that requires paying a floating rate and recieving a fixed rate
What is a forward start swap?
swap wherein the swap does not begin until some future date that is specified in the swap agreement; beginning date some time in the future and maturity date for the swap
What are interest rate/equity swaps?
a swap in which one party pays a fixed or floating interest rate, while the other party pays a rate based on the return on some equity index
What is the reference rate?
benchmark rate used in a swap or interest rate agreement
What is an interest rate cap or ceiling?
when one party agrees pay the other if the reference rate exceeds a predetermined level
What is an interest rate floor?
when one party agrees to pay the other if the reference rate falls below a predetermined level
What is the strike rate?
the predetermined level of the reference interest rate
What is an interest rate collar?
done by buying an interest rate cap and selling an interest rate floor
What are captions?
options on caps
What are flotions?
options on floors
What are the 3 types of credit risk?
1. default risk
2. credit spread risk
3. downgrade risk
What are the 3 types of credit derivatives?
1. credit options
2. credit forwards
3. credit swaps
What are credit options?
two types:
1. credit option written on an underlying issue; no payment is default does not occur; payout if there's a default; can also be written if bond is downgraded
2. payoff is determined by the level of the credit spread over a referenced security; value of payoff is determined by a risk factor
What are credit forward contracts?
underlying is the credit spread; payoff depends on the credit spread at the settlement date of the contract
What are credit swaps?
two types:
1. credit default swaps- shift credit exposure to a credit protection seller;
2. total return swaps- used by an investor to increase credit exposure; investor pays all cash flows from the referenced asset including changes in value to recieve a floating rate plus any depreciation of the referenced asset
What are the two types of credit default swaps?
1. credit insurance- buyer pays a fee; recieves a payment every period for the life of the contract if a referenced credit defaults on a payment
2. swapping risky credit payments for certain fixed payments- investor exchanges total return on a credit risky asset for known periodic payments from the counterparty