Swap Contract

•A swap contract is an agreement to exchange

future cash flows stemming from interest payments.

•In most interest rate swaps, one cash flow is based on variable or
floating rate of interest and other on a fixed rate.
•Cash Flow are just payments ,and payments involves a price
(interest rate)
•When that price is specified and guaranteed upfront ,the loan is
known as fixed rate loan ,debt, or obligation.
•When that price is not specified and subject to changes the loan is
known as floating rate loan.
•A fixed-floating swap is an agreement to exchange cash flows based
on fixed rate of interest with cash flow based on floating rate of
interest.
• Basis Swap- in a basis swap instead of swapping a fixed –rate payment for
a floating rate payment, we swap a payment based on one rate index for
that on another index
For e.g.: Mr. A borrow money from Citibank at their prime rate but would
prefer to pay at LIBOR.
• Currency Swap/Cross currency swap-A cross currency interest rate swap or
“currency swap” is one in which two price are denominated in different
currencies,
For e.g.: we borrow Australian Dollars at floating rate and wish to pay a fixed
rate in U.S.Dollars.so we just need ASD –USD fixed –floating swap .
• In currency swap ,one need to take care of foreign exchange rate, as
exchange rate fluctuate over the life of the swap, one party or other is
going to pay price, as this change the value of the payment in terms of the
other currency
• By exchanging notional at both the ends of the trade ,we mitigate that
risk.
• Interest rate options,the basic interest rate derivative include :
1. The Cap-it is the guarantee that an interest rate will not rise
above certain level.
2. A floor- Guarantee a lower bound that an interest rate will
not go below a certain level.
3. A collar-Identifies a range in which rates are guaranteed to
fall.
4. A swaption –it grants the right, but not the obligation ,to
enter into a swap in the future.