Add the Financial Intermediary

Add the Financial Intermediary - 4 Exchange of Principal In...

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

View Full Document Right Arrow Icon
Add the Financial Intermediary Now add a financial institution who demands a spread of 4bps. Design a swap that makes AAA and BBB better off. 1
Background image of page 1

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

View Full DocumentRight Arrow Icon
Valuation of an Interest Rate Swap Interest rate swaps can be valued as the difference between the value of a fixed-rate bond and the value of a floating-rate bond. Alternatively, they can be valued as a portfolio of forward rate agreements (FRAs). We will use only the first approach. 2
Background image of page 2
Valuation in Terms of Bonds The fixed rate bond is valued in the usual way. To value the floating rate bond we don’t know all the future values of LIBOR so we don’t know the future payments. The trick is to remember that immediately after a payment, the value of a floating rate bond is its face value. 3
Background image of page 3

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

View Full DocumentRight Arrow Icon
An Example of a Currency Swap An agreement to pay 5% on a sterling principal of £10,000,000 & receive 6% on a US$ principal of $18,000,000 every year for 5 years
Background image of page 4
Background image of page 5

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

View Full DocumentRight Arrow Icon
Background image of page 6
Background image of page 7

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

View Full DocumentRight Arrow Icon
Background image of page 8
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 4 Exchange of Principal In an interest rate swap the principal is not exchanged In a currency swap the principal is exchanged at the beginning and the end of the swap 5 The Cash Flows (Table 7.5, page 176) Year Dollars Pounds $------millions------2010 18.00 +10.00 2011 +1.08 0.5 2012 +1.08 0.5 2013 +1.08 0.5 2014 +1.08 0.5 2015 +19.08 10.5 6 Valuation of Currency Swaps Like interest rate swaps, currency swaps can be valued either as the difference between 2 bonds or as a portfolio of forward contracts. We will value using bonds. 7 Credit Risk A swap is worth zero to a company initially. At a future time its value is liable to be either positive or negative. The company has credit risk exposure only when its value is positive. Credit risk arises because the counterparty may default. 8...
View Full Document

This note was uploaded on 01/19/2012 for the course FIN 4520 taught by Professor Lucyackert during the Spring '12 term at Kennesaw.

Page1 / 8

Add the Financial Intermediary - 4 Exchange of Principal In...

This preview shows document pages 1 - 8. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online