Topic 8 Swaps - Nov2017.pptx - BAFI 1029 Risk Management...

Info icon This preview shows pages 1–8. Sign up to view the full content.

View Full Document Right Arrow Icon
BAFI 1029 Risk Management Topic 8: Swaps
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Derivatives “financial instruments or securities that derive their value from the value of some other instrument, commodity or asset” When the value of underlying asset changes, so will the value of the derivative. 01/01/2015 RMIT University©2015 Schoolof Economics, Finance and Marketing 2
Image of page 2
3 Swaps - definition An agreement between two parties to exchange a series of cash flows at pre- defined rates, at a series of pre-agreed dates Includes Interest Rate Swaps, Currency Swaps, Commodity Swaps, Debt/Equity Swaps and even Earthquake Swaps. 01/01/2015 RMIT University©2015 Schoolof Economics, Finance and Marketing
Image of page 3

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Topic 7 4 Rationale for IR Swaps A company with a high credit rating (say AAA), will pay less to raise funds under identical terms and conditions than a less creditworthy company (say BBB rating): Any incremental borrowing premium paid by the BBB company is described as a "credit quality spread” This is usually greater in fixed interest rate markets than it is in floating rate markets. Credit quality spread usually increases with term to maturity 01/01/2015 RMIT University©2015
Image of page 4
5 Rationale for Swaps Two companies with different credit ratings can exploit this credit quality spread. The high credit rating company borrows in the fixed rate market The low credit rating company borrows in the floating rate market The two companies “swap” interest rate payments, and effectively “reduce” their funding costs 01/01/2015 RMIT University©2015 Schoolof Economics, Finance and Marketing
Image of page 5

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Features of a swap Generate a lower cost funding; Hedge interest rate exposure; Gain higher yielding investment assets; To implement overall asset or liability management strategies; To create types of investment asset not otherwise obtainable; and To take speculative positions in relation to future movements in interest rates. 01/01/2015 RMIT University©2015 Schoolof Economics, Finance and Marketing 6
Image of page 6
Swaps vs futures and options 01/01/2015 RMIT University©2015 Schoolof Economics, Finance and Marketing 7 Swaps Futures and options Customised and negotiated as OTC Exchange traded Counter party risk present, although can be minimised by undertaking collateral default swaps (CDS) Clearing House acts a counter party to each side of the contract Counterparties contract with each other and are known Counterparties are not visible (anonymous to each other) Agreements are customised and tailored to each party Contracts are standardised and specifications are known
Image of page 7

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 8
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern