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Interest Rate Swaps and Other Derivatives

Interest Rate Swaps and Other Derivatives

Howard Corb
Copyright Date: 2012
Pages: 624
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  • Book Info
    Interest Rate Swaps and Other Derivatives
    Book Description:

    The first swap was executed over thirty years ago. Since then, the interest rate swaps and other derivative markets have grown and diversified in phenomenal directions. Derivatives are used today by a myriad of institutional investors for the purposes of risk management, expressing a view on the market, and pursuing market opportunities that are otherwise unavailable using more traditional financial instruments. In this volume, Howard Corb explores the concepts behind interest rate swaps and the many derivatives that evolved from them.

    Corb's book uniquely marries academic rigor and real-world trading experience in a compelling, readable style. While it is filled with sophisticated formulas and analysis, the volume is geared toward a wide range of readers searching for an in-depth understanding of these markets. It serves as both a textbook for students and a must-have reference book for practitioners. Corb helps readers develop an intuitive feel for these products and their use in the market, providing a detailed introduction to more complicated trades and structures. Through examples of financial structuring, readers will come away with an understanding of how derivatives products are created and how they can be deconstructed and analyzed effectively.

    eISBN: 978-0-231-53036-1
    Subjects: Business, Finance

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-xii)
  3. Preface
    (pp. xiii-xvi)
  4. Acknowledgments
    (pp. xvii-xviii)
  5. List of Abbreviations
    (pp. xix-xxii)
  6. Chapter 1 An Introduction to Swaps
    (pp. 1-39)

    The interest rate swaps market has experienced tremendous growth since what is commonly regarded as the first swap was executed in 1981. In that year Salomon Brothers intermediated a cross-currency swap between the World Bank and IBM in a transaction that at the time was unique and provided considerable advantage to both counterparties. The growth in the market since then manifests itself not only in the vast increase in the notional outstanding of interest rate swaps but also in the varied users and uses of swaps. The purpose of this chapter is to provide a broad overview of the swaps...

  7. Chapter 2 The Risk Characteristics and the Traditional Uses of Swaps
    (pp. 40-75)

    In this chapter we will consider two things: the risks inherent when one enters into a swap and the traditional ways in which investors use swaps. When an investor enters into a swap, there are several sources of risk that he faces. In particular, there are three primary sources of risk in a fixed-floating swap: interest rate risk, spread risk, and counterparty risk. Cross-currency swaps also have currency risk. We shall discuss each of these in this chapter.

    It would seem an unlikely pairing, then, to discuss some of the traditional ways in which investors have used swaps in this...

  8. Chapter 3 The Pricing of Swaps
    (pp. 76-134)

    We spent a considerable amount of time in Chapter 1 discussing the fundamentals of the swaps market. In Chapter 2 we focused on the risk characteristics of swaps. In this chapter we are going to be focused on the pricing of swaps.

    When we speak of pricing a fixed-floating swap when it is first executed, this amounts to determining the fixed coupon that makes the trade an NPV = 0 transaction. At other times we will be interested in valuing a fixed-floating swap that has been in existence for some time. In these cases, the pricing of a swap refers...

  9. Chapter 4 Caps and Floors
    (pp. 135-165)

    There are two main types of plain vanilla options traded in the swaps market: caps and floors, on the one hand, and (single European) swaptions, on the other. In this chapter we will look at caps and floors. We will discuss how they are used by investors and how they are priced using a variant of the Black-Scholes model known as Black’s formula.

    A cap is a call on rates. Caps can be written on a variety of floating rate indexes, the most common of which is 3-month LIBOR. For example, the payoff on a cap on 3-month LIBOR depends...

  10. Chapter 5 Swaptions
    (pp. 166-229)

    The second type of option frequently traded in the swaps market is swaptions. Swaptions are options on swaps, giving the holder the right, but not the obligation, to enter into a swap. We will discuss how swaptions are used by investors and how they are priced using Black’s formula. We will discuss some of the shortcomings of Black’s formula for the pricing of swaptions (and for the pricing of other interest rate options, for that matter) and introduce an alternative known as the normal model, which is now widely used throughout the industry. We will also discuss Bermudan swaptions.


  11. Chapter 6 Swaps with Embedded Options
    (pp. 230-291)

    In this chapter we will take a look at a variety of swaps that have one or more embedded options in them. Typically, buy-side investors receive fixed in such swaps and short the options that are being embedded into the trade. As we will see, this results in a trade in which the investor receives a higher fixed coupon than he would otherwise get in a plain vanilla swap.

    Oftentimes these trades are geared in such a way that they provide the highest fixed rate possible to the investor. In the swaps market, such trades are sometimes referred to as...

  12. Chapter 7 Structured Notes
    (pp. 292-352)

    In the early 1990s, the U.S. economy was in a deep recession, and the Fed had cut short-term interest rates significantly in an effort to stimulate the economy. Investors who had previously enjoyed a period of high interest rates and high returns from the fixed income markets were now faced with the prospect of historic low yields. At the same time, the sophistication of the derivative markets was on the rise, allowing dealers to price and hedge more complex, riskier trades. Such trades would often offer potentially high returns to investors but came at the expense of tremendous risks—risks...

  13. Chapter 8 Relative Value and Macro Trades
    (pp. 353-413)

    It’s impractical to completely categorize all the types of speculative trades that people put on in the swaps market—there are just too many of them. But what we will try to do in this chapter is give a sense of some of the major categories of trades that people often look at. Please bear in mind from the outset that this will be far from complete.

    Broadly speaking, we can classify speculative trades as being either relative value or macro in nature. By relative value, we refer generically to trades that involve “buying” one or more components (which are...

  14. Chapter 9 More Recent Product Innovations
    (pp. 414-462)

    The few years preceding the financial crisis were marked by a number of new, exotic trades in the swaps market following what had been considered by many to be a long period of relatively little innovation. Some of these trades were somewhat pathbreaking in nature, whereas others simply borrowed well-known concepts from other markets and recast them in the swaps market. Still others were a by-product of other products whose popularity was on the rise.

    The trades that we will look at in this chapter exhibit correlation risk—the feature that more than one underlying variable determines the value of...

  15. Appendix A Refresher in Option Pricing
    (pp. 463-518)
  16. Appendix B A Brief Review of Some Fixed Income Topics
    (pp. 519-522)
  17. Appendix C A Closer Look at Day Count and Payment Conventions in Swaps
    (pp. 523-528)
  18. Appendix D A Quick Look at Mortgages
    (pp. 529-536)
  19. Appendix E The Normal Model
    (pp. 537-544)
  20. Solutions to Selected Problems
    (pp. 545-584)
  21. Bibliography
    (pp. 585-588)
  22. Index
    (pp. 589-600)