Fabozzi Chapter 30

Front 1

What is an interest rate swap?

Back 1

an agreement in which two parties agree to exchange periodic interest payments

Front 2

What is the notional principal amount?

Back 2

the dollar principal amount upon which the interest payments in an interest rate swap or interest rate agreement are based

Front 3

What is the fixed-rate payer?

Back 3

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

Front 4

What is the floating-rate payer?

Back 4

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

Front 5

What are the 2 ways to interpret an interest rate swap?

Back 5

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

Front 6

What are plain vanilla swaps?

Back 6

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

Front 7

What is an asset swap?

Back 7

the use of an interest rate swap to change the cash flow characteristics of assets

Front 8

What is a liability swap?

Back 8

the use of an interest rate swap to change the cash flow characteristics of liabilities

Front 9

What are the two important functions of interest rate swaps?

Back 9

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

Front 10

What is the swap spread?

Back 10

the difference between the swap's fixed rate and the rate on a Treasury whose maturity matches the swap's maturity

Front 11

What factors influence swap spreads?

Back 11

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

Front 12

What are the 3 general types of transactions in the secondary market for swaps?

Back 12

1. a swap reversal
2. a swap sale (or assignment)
3. a swap buy-back (or close-out or cancellation)

Front 13

What is a swap reversal?

Back 13

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

Front 14

What is a swap sale or swap assignment?

Back 14

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

Front 15

What is a buy-back or close-out sale (or cancellation)?

Back 15

involves the sale of the swap to the originial counterparty

Front 16

What is a bullet swap?

Back 16

a generic plain vanilla or interest rate swap; notional principal amount does not vary over the life of the swap

Front 17

What is an amortizing swap?

Back 17

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)

Front 18

What is an accreting swap?

Back 18

the notional principal amount increases at a predetermined way over time

Front 19

What is a roller-coaster swap?

Back 19

the notional principal amount can rise or fall from period to period

Front 20

What is a basis rate swap?

Back 20

both parties exchange floating-rate payments based on a different money market reference rate

Front 21

What are swaptions?

Back 21

grant the option buyer the right to enter into an interest rate swap at a future date

Front 22

What is a payer swaption?

Back 22

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

Front 23

What is a reciever swaption?

Back 23

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

Front 24

What is a forward start swap?

Back 24

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

Front 25

What are interest rate/equity swaps?

Back 25

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

Front 26

What is the reference rate?

Back 26

benchmark rate used in a swap or interest rate agreement

Front 27

What is an interest rate cap or ceiling?

Back 27

when one party agrees pay the other if the reference rate exceeds a predetermined level

Front 28

What is an interest rate floor?

Back 28

when one party agrees to pay the other if the reference rate falls below a predetermined level

Front 29

What is the strike rate?

Back 29

the predetermined level of the reference interest rate

Front 30

What is an interest rate collar?

Back 30

done by buying an interest rate cap and selling an interest rate floor

Front 31

What are captions?

Back 31

options on caps

Front 32

What are flotions?

Back 32

options on floors

Front 33

What are the 3 types of credit risk?

Back 33

1. default risk
2. credit spread risk
3. downgrade risk

Front 34

What are the 3 types of credit derivatives?

Back 34

1. credit options
2. credit forwards
3. credit swaps

Front 35

What are credit options?

Back 35

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

Front 36

What are credit forward contracts?

Back 36

underlying is the credit spread; payoff depends on the credit spread at the settlement date of the contract

Front 37

What are credit swaps?

Back 37

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

Front 38

What are the two types of credit default swaps?

Back 38

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