Derivatives09-10A - Swaps

Derivatives09-10A - Swaps - 1.1 Derivatives Session 6....

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Unformatted text preview: 1.1 Derivatives Session 6. Swaps 1.2 Where we are Last Session: Conclude FRAs and Interest Rate Futures (Chapters 5-6, OFOD) This Session: Swaps (Chapter 7, OFOD) Next Session: Wrap-up and volatility smile. 1.3 Plan for This Session Swaps Interest Rate Swap Structure and Uses The Swap Curve Valuation of IR Swap Bond Viewpoint & as PF of FRA Currency Swap Valuation of Currency Swap As bond & PF of Forward FX Contracts Other Swaps and Compounding Swaps 1.4 Nature of Swaps A swap is an agreement to exchange cash flows at specified future times according to certain specified rules 1.5 An Example of a Plain Vanilla Interest Rate Swap An agreement by Microsoft to receive 6-month LIBOR & pay a fixed rate of 5% per annum every 6 months for 3 years on a notional principal of $100 million Next slide illustrates cash flows 1.6---------Millions of Dollars--------- LIBOR FLOATING FIXED Net Date Rate Cash Flow Cash Flow Cash Flow Mar.5, 2004 4.2% Sept. 5, 2004 4.8% +2.10 2.50 0.40 Mar.5, 2005 5.3% +2.40 2.50 0.10 Sept. 5, 2005 5.5% +2.65 2.50 +0.15 Mar.5, 2006 5.6% +2.75 2.50 +0.25 Sept. 5, 2006 5.9% +2.80 2.50 +0.30 Mar.5, 2007 6.4% +2.95 2.50 +0.45 Cash Flows to Microsoft 1.7 Cash Flow Diagram of Swap: MS Pay Fixed at 5% Receive Floating at LIBOR Payment at t i , fixed at t i-1 Net Cash exchanged +- t 1 t 2 t 3 t 4 t 5 t 6 t +- 1.8 Swap Characteristics Cash Flows (Fixed and Floating) could be described (augmented) by showing notional amount exchanged at maturity Allows for the description of the Swap as Short a Fixed-Rate Bond, B FIX Long a Floating-Rate Bond, B FLT For a New Swap, by Definition, B FIX = B FLT Be Aware of Day Count Conventions, Fixed vs. Floating LIBOR: Act/360 Fixed: 30/360 or Act/360 or etc. 1.9 Typical Uses of an Interest Rate Swap Converting a liability from fixed rate to floating rate floating rate to fixed rate Converting an investment from fixed rate to floating rate floating rate to fixed rate 1.10 Intel and Microsoft (MS) Transform a Liability MS LIBOR 5% LIBOR+0.1% 5.2% Intel- Intel has issued a 3-year, $100mm note at a rate of 5.2%-- Net of the Swap, Intel has transformed this to a borrowing of LIBOR+20bps- Micro has borrowed $100mm for 3-years at LIBOR+10bps-- Net of the Swap, Micro has transformed this to a fixed, 3-year borrowing at 5.1% 1.11 Financial Institution is Involved- The Swap Dealer (AAA) F.I. LIBOR LIBOR LIBOR+0.1% 4.985% 5.015% 5.2% Intel MS Net of the Dealer:- Intel has LIBOR+21.5bps financing- MS has 5.015% fixed financing 1.12 Intel and Microsoft (MS) Transform an Asset Intel MS LIBOR 5% LIBOR-0.2% 4.7% Intel has an investment that pays LIBOR-20bps over the next 3-years- Net of the Swap, Intel has transformed this into an investment paying a fixed 4.80% Micro has an investment that pays a fixed rate of 4.7% over 3-years- Net of the Swap, MS has converted this into a floating rate deposit at LIBOR-30bps 1.131....
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This note was uploaded on 02/21/2010 for the course FINA 221 taught by Professor Na during the Spring '09 term at HKUST.

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Derivatives09-10A - Swaps - 1.1 Derivatives Session 6....

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