Interest Rate and Currency Swaps (The Research Foundation of by Keith Brown, Donald Smith

By Keith Brown, Donald Smith

Rate of interest and forex Swaps: an educational is a radical dialogue of 2 valuable and known different types of derivatives-interest expense and forex swaps. The authors supply step by step directions and real-life examples of ways to exploit the swaps. workouts (and strategies) after every one bankruptcy allow readers to profit via doing, and the publication incorporates a complete bibliography.

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Interest Rate and Currency Swaps (The Research Foundation of AIMR and Blackwell Series in Finance)

Rate of interest and foreign money Swaps: an academic is an intensive dialogue of 2 precious and accepted sorts of derivatives-interest expense and forex swaps. The authors supply step by step directions and real-life examples of ways to exploit the swaps. workouts (and options) after every one bankruptcy let readers to profit through doing, and the ebook features a finished bibliography.

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Extra resources for Interest Rate and Currency Swaps (The Research Foundation of AIMR and Blackwell Series in Finance)

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Solution: The key is to recognize that the combination of buying the cap and writing a floor at the same strike rate generates the same settlement cash flows as a pay-fured swap. The fixed rate on the swap would equal the strike rate on the cap and floor. Consider first the 8 percent cap-floor combination. The treasurer could buy the cap for 413 basis points (the market maker's offer) and sell the floor for 401 basis points (the market maker's bid). The net is an up-front outflow of 12 basis points (times the notional principal).

The last few swap payment dates will then have positive values compared with the on-market FRAs because the firm is paying a below-market fixed rate. This interpretation demonstrates that the credit risk inherent in a swap agreement results from its structural design of applying the same fixed rate to all settlement periods, as well as from the random nature of interest rates. Assume for a moment that LIBOR follows a path that is completely anticipated by the market and that those anticipations track the time path of the FRAs.

First, consider the capital market interpretation. An on-market swap is analogous to owning an FRN that pays LIBOR and issuing an equally valued, fixed-rate note that pays a fixed coupon rate of 6 percent. The off-market swap is interpreted as owning the same FRN at LIBOR but issuing a more highly valued fixed-rate note bearing the 8 percent coupon rate. 9. This capital market interpretation suggests that the up-front cash received could be accounted for in the same manner as the premium on a newly issued, high-coupon bond.

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