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1、Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall,29-1,Chapter 29 Interest-Rate Swaps, Caps, and Floors,Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall,29-2,Learning Objectives,After reading this chapter, you will understand what an interest-rate swap is the relat
2、ionship between an interest-rate swap and forward contracts how interest-rate swap terms are quoted in the market how the swap rate is calculated how the value of a swap is determined the primary determinants of the swap rate how a swap can be used by institutional investors for asset/liability mana
3、gement,Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall,29-3,Learning Objectives (continued),After reading this chapter, you will understand how a structured note is created using an interest-rate swap what a swaption is and how it can be used by institutional investors what a rate
4、 cap and floor are, and how these agreements can be used by institutional investors the relationship between a cap and floor and options how to value caps and floors how an interest-rate collar can be created,Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall,29-4,Interest-Rate Swaps
5、,In an interest-rate swap, two parties (called counterparties) agree to exchange periodic interest payments. The dollar amount of the interest payments exchanged is based on a predetermined dollar principal, which is called the notional principal amount. The dollar amount that each counterparty pays
6、 to the other is the agreed-upon periodic interest rate times the notional principal amount. The only dollars that are exchanged between the parties are the interest payments, not the notional principal amount. This party is referred to as the fixed-rate payer or the floating-rate receiver. The othe
7、r party, who agrees to make interest rate payments that float with some reference rate, is referred to as the floating-rate payer or fixed-rate receiver. The frequency with which the interest rate that the floating-rate payer must pay is called the reset frequency.,Copyright 2010 Pearson Education,
8、Inc. Publishing as Prentice Hall,29-5,Interest-Rate Swaps (continued),Entering into a Swap and Counterparty Risk Interest-rate swaps are over-the-counter instruments, which means that they are not traded on an exchange. An institutional investor wishing to enter into a swap transaction can do so thr
9、ough either a securities firm or a commercial bank that transacts in swaps. The risks that parties take on when they enter into a swap are that the other party will fail to fulfill its obligations as set forth in the swap agreement; that is, each party faces default risk. The default risk in a swap
10、agreement is called counterparty risk.,Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall,29-6,Interest-Rate Swaps (continued),Interpreting a Swap Position There are two ways that a swap position can be interpreted: as a package of forward/futures contracts as a package of cash flows
11、 from buying and selling cash market instruments Although an interest-rate swap may be nothing more than a package of forward contracts, it is not a redundant contract, for several reasons. Maturities for forward or futures contracts do not extend out as far as those of an interest-rate swap. An int
12、erest-rate swap is a more transactionally efficient instrument because in one transaction an entity can effectively establish a payoff equivalent to a package of forward contracts. Interest-rate swaps now provide more liquidity than forward contracts, particularly long-dated (i.e., long-term) forwar
13、d contracts.,Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall,29-7,Interest-Rate Swaps (continued),Interpreting a Swap Position To understand why a swap can also be interpreted as a package of cash market instruments, consider an investor who enters into the following transaction:
14、Buy $50 million par of a five-year floating-rate bond that pays six-month LIBOR every six months; finance the purchase by borrowing $50 million for five years at 10% annual interest rate paid every six months. The cash flows for this transaction are shown in Exhibit 29-1 (see Overhead 29-8). The sec
15、ond column shows the cash flow from purchasing the five-year floating-rate bond. There is a $50 million cash outlay and then 10 cash inflows. The amount of the cash inflows is uncertain because they depend on future LIBOR. The next column shows the cash flow from borrowing $50 million on a fixed-rat
16、e basis. The last column shows the net cash flow from the entire transaction. As the last column indicates, there is no initial cash flow (no cash inflow or cash outlay). In all 10 six-month periods, the net position results in a cash inflow of LIBOR and a cash outlay of $2.5 million. This net position, however, is identical to the position of a fixed-rate payer/floating-rate receiver.,Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall,29-8,Exhibit 29-1 Cas
