Lecture11 - 11-1Swaps and Risk Dr QU BaozhiPhone(852 27887312Email:[email protected] P740711-2OverviewThe market for swaps has grown

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Unformatted text preview: 11-1Swaps and Risk ManagementInstructor: Dr. QU BaozhiPhone: (852) 27887312Email:[email protected]: P740711-2OverviewThe market for swaps has grown enormously and this has raised serious regulatory concerns regarding credit risk exposures. Such concerns motivated the BIS risk-based capital reforms. Generic swaps in order of quantitative importance: interest rate, currency, credit, commodity and equity swaps.11-3Interest Rate Swaps◆Interest rate swap as succession of forwards.•Swap buyer agrees to pay fixed-rate•Swap seller agrees to pay floating-rate.◆Purpose of swap•Allows FIs to economically convert variable-rate instruments into fixed-rate (or vice versa) in order to better match the duration of assets and liabilities.•Off-balance-sheet transaction.11-4Plain Vanilla Interest Rate Swap Example•Consider a money center bank that has raised $100 million by issuing 4-year notes with 10% fixed coupons. On asset side: C&I loans linked to LIBOR. Duration gap is negative.DA- kDL< 0•Second party is a savings bank with $100 million in fixed-rate mortgages of long duration funded with CDs having duration of 1 year.DA- kDL> 011-5Example (continued)•Savings bank can reduce duration gap by buying a swap (taking fixed-payment side).•Notional (dollar) value of the swap is $100 million.•Maturity is 4 years with 10% fixed-payments.•Suppose that LIBOR currently equals 8% and bank agrees to pay LIBOR + 2%.11-6Fixed-Floating Rate SwapShort-term assets(C&I indexed loans)Long-term liabilities(4-year, 10%)Long-term assets(Fixed-rate Mortgages)Short-term liabilities(1-year CDs)1%fixedLIBOR+2%Money Center BankSavings Bank11-7Financing Cost Resulting from SwapMoney Center BankSavings BankCash outflow from...
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This note was uploaded on 02/22/2009 for the course ECONOMICS 4313 taught by Professor Tsui during the Spring '09 term at HKU.

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Lecture11 - 11-1Swaps and Risk Dr QU BaozhiPhone(852 27887312Email:[email protected] P740711-2OverviewThe market for swaps has grown

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