Chap_25_SLIDES_SPR09

Chap_25_SLIDES_SPR09 - Ch-25 SWAPS Overview 25-1 - The...

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-1 25-1 Ch-25 SWAPS Overview The market for swaps has grown enormously and this has raised serious regulatory concerns regarding credit risk exposures. At the same time, the growth in exotic swaps such as inverse floater have also generated controversy (e.g., Orange County, CA). Generic swaps in order of quantitative importance : interest rate, currency , credit, commodity and equity swaps.
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-2 25-2 Interest Rate Swaps Interest rate swap as series of forwards. Swap buyer agrees to pay fixed-rate Swap seller agrees to pay floating-rate. Purpose of interest rate 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.
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25-3 Plain Vanilla Interest Rate Swap Example Consider 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. Earns Floating Rate Duration gap is negative D A - kD L < 0 Second party is Savings bank with $100 million in fixed-rate mortgages of long duration funded with CDs having duration of 1 year.
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Chap_25_SLIDES_SPR09 - Ch-25 SWAPS Overview 25-1 - The...

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