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Introduction to Derivative Securities Lecture Note 1 FINA 6219 Professor Andrew Chen Outline

What are Derivative Securities (of Derivatives) and what are they used for? Types of Derivative Securities
o

Forward and Futures Contracts Specification Hedging Examples Options Basic Specification Speculation and Hedging Examples Other Types of Options Swaps Swap Mechanisms Terminology of Interest Rate Swaps Simple example of Interest Rate Swaps

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What are Derivatives?

A derivative security (or contingent claim) is a securit y whose value is wholly based on the pri ce of underlying or primitive asset s. Derivatives are useful and powerful tools for risk management. They are not dangerous. Derivatives do not kill companies, people do!

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Forward Contracts

A forward contract is an agreement between two parties to buy an underlying asset at a set time in the future at an agreed-upon price. o Long forward position. o Short forward position. Not traded on exchanges. Contract Specification o Amount and quality of the underlying asset to be delivered o Delivery price (K) o Time of delivery (T) and location o Forward contracts are zerosum games
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Example: Using Forward contracts to hedge exchange-rate risk

A U.S. company is exporting goods to Britain and in six months knows it will collect one million British pound (GBP). The company wants to hedge its exposure to USD/GBP exchange rate risk. Assume that the current spot and forward prices for USD/GBP are as follows:
Date Forward Price ($) Spot 1.8927 1-mth 1.8882 3-mth 1.8784 6-mth 1.8638
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Example (continued)

To hedge its foreign exchange risk, the comp any enters into a forward contract to sell one million British pounds in six months at a delivery price of $1.8638 per GBP.
o

The company will have fixed the U.S. dollars to be realized at $ 1,863,800 (1,000,000 GBP x $ 1.8638 per GBP).

The company commits to converting its GBP revenue in to dollars at the agreed-to rate. The company's profit/loss on the short forward position in the forward contract (which is equal to K ST ) will

offset its foreign-exchange loss/profit in the spot market.


AC: 16

Example (continued)

Suppose USD/GBP spot exchange rate in 6 months is ST = 1.8835. o The net dollar revenue to the company will be the payoff on the forward contract plus the foreign exchange transaction.
(1,000,000)(1.8638-1.8835) + (1,000,000)(1.8835) =$1,863,800

Hedge or dont hedge?

Spot in 6-mos

Un-hedged (Convert @ spot) Hedged with forward Net Gain (+)/Loss (-) with Hedge 1.8546 $1,854,600 $1,863,800 +$9,200 1.8638 1,863,800 1,863,800 +0 1.8765 1,876,500 1,863,800 -12,700
AC: 17

Example (continued)

Questions

Suppose the 6-month GBP forward price appreciates to $1.8645 per GBP soon after the company signs the forward contract. Has the company's short position on the forward contract made or lost money? Does the delivery price of the company's forwa rd contract change overtime as the mark et forward rate fluctuates? Determination of the market value of previou sly established forward contracts will be discussed later.

AC: 18

Another Example (Long Hedge)

Suppose another U.S. company knows that it will have to pay five million British pound s in three months for goods it has p urchased from a British supplier. o The company can hedge its foreign exchange risk by taking a long position in five million British pounds for a price of $1.8784 per GBP in three months. o This has the effect of fixing the price to be paid to the British exporter at $9,392,000.

Alternatively viewed, the gain/loss on the long forward contract (ST - K) offsets the loss/gain from having to buy British pounds in the spot market in three months.
AC: 19

Example (continued)

Suppose the British pound spot exchange rate in thr ee months is $1.8796. o The net dollar cost to the company will be the foreign exchange transaction minus the payoff on the forward contract.

(5,000,000)(1.8796) - (5,000,000) (1.8796 - 1.8784) = $9,392,000

Hedge or dont hedge?

Spot in 3-mos Un-hedged (Convert @ spot) Hedged with forward Net Gain (+)/Loss (-) with Hedge 1.8676 $9,338,000 $9,392,000 -$54,000 1.8784 9,392,000 9,392,000 +0 1.8954 9,477,000

9,392,000 +85,000
AC: 110

Payoff Diagram for Long and Short positions


Payoff 0 Long Position ST - K ST Short Position K - ST K
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Futures Contracts

Futures contracts are similar to forward contracts Major differences

o o o o

Exchanged traded and regulated Standardized Futures Traders Marked-to-market Margin requirements (performance bonds) are also a significant feature of futures contracts Taxation of Futures Transactions
AC: 112

Futures Contracts

Standardized Contracts o Amount and quality of the underlying asset to be delivered

For commodities there is usually a range of grades that can be delivered (by the short party), but

the price received is adjusted according to grade.

Contract size (Examples) o Soybeans - 5,000 bushels (bu) o Pork bellies - 40,000 pounds (lbs.) o Orange juice - 15,000 pounds (lbs.) o Gold - 100 ounces (oz) o Silver - 5,000 ounces (oz) o Japanese Yen - 12.5 million Yen
AC: 113

Futures Contracts

Delivery Arrangements Future price quotas (example) o Soybeans cents per bu

Pork bellies cents per lb. Daily Price Limits o The futures exchanges typically impose daily price limits on futures prices. Trading stops for the day when an up or down limit is reached. Position Limits o Maximum number of contracts held at any one time in an asset and by contract month.
o

AC: 114

Futures Traders

Classified by Trading Strategy o Hedgers Speculators

Spreaders Arbitrageurs
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Futures Traders

Classified by Trading Style o Scalpers

Day Traders

Position Traders

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Futures Traders

Daily Settlement
o

The clearinghouse uses margins and the daily settlement of the accounts to help ensure its survivals.

o o

Initial Margin

The amount that must be deposited on the day the transaction is opened.

o o

Maintenance Margin

The amount that must be maintained every day after the transaction.
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Marking to Market

By tradition, the forward or futures price is i nitially set so the current market value

of the contract is equal to zero. The terms of a futures contract, on the other hand, are revised every day to maintain a zero market value for the contract. o Suppose that you entered into 5 futures contracts to sell gold for $410 in 30 days. o The next day the futures price of identical contracts for sale in 29 days is being negotiated at a futures price of $405.
AC: 118

Marking to Market

As a futures contract, the futures price of yo ur contract would be revised to $405.

You would have added to your account the difference between the futures price yesterday and today, multiplied by the number of futures contracts you have outstanding o Your account would be credited by $2,500 [5x 100 x (410-405)]. o If your contract were a forward contract, it would take on a positive market value. Why? This everyday process is called marking to market.
AC: 119

Step by Step example

Suppose on Dec 1, 2008, an investor contacted a broker to buy (take a long position) thr ee (3) March 2009 silver futures co ntracts on the New York Commodity Ex change (COMEX). o At the time the order was executed, the futures price was 488.0 cents per ounce. The size of each contract is 5,000 ounces. The broker required the investor to post an initial margin of $1,250 per contract or $3,750 in total. The broker also informed the investor that the maintenance margin was $900 per contract or $2,700 in total.

AC: 120

Example (continued)

If the balance in the margin account falls belo w the maintenance margin, the invest or receives a margin call (or a house call) and is expected to add funds to the margin account to bring the balance back to the initial margin. The additional funds deposited in the margin a ccount are called variation margin, they usually are required to be deposited on the day you receive the margin call.
AC: 121

Example (continued)

In most cases, an investor earns interest on th e balance in a margin account. In addition , an investor may be able to meet th e initial margin by depositing secu rities instead of cash. At the end of each trading day (starting wi th the close of trading on the first tradi ng day) each contract is marked to market and the margin account is adjus ted to

reflect the investor's gain or los s.

By the end of trading on December 1, the M arch futures price for silver was 491. 0 cents per ounce. The investor's accou nt was credited $450 [3x 5,000 x (4.91 4.88)]. Why? The 15,000 ounce s of March silver, which the investor contra cted to buy at $4.88 per ounce, could b e sold for $4.91 per ounce.
AC: 122

Example (continued)

The investor can withdraw any balance in the ma rgin account in excess of the initial margin. T hus, by the end of December 1, the i nvestor could withdraw $450. The gain or loss on a futures position is det ermined by the settlement price, which is the average of the futures prices at which the contract traded immediately prior to the close of trading for the day. The settlement price for December 1 was 491.0 cents per ounce.

At the close of each subsequent day that th e investor maintained the long position in March silver, his margin account was marked to market.
AC: 123

Example (continued)

Consider the following example:


o

Initial margin - $3,750 Maintenance Margin - $2,700

*Margin call (or House call) **Closing out position

Date Futures Price Daily gain/loss Margin account balance 488.0 $3,750 Dec. 1 491.0 $450 $4,200 Dec. 2 485.0 -900 3,300 Dec. 3 480.0 -750 -1,200*

3,750 Dec. 4 481.0 150 3,900 Dec. 7 486.0 750 4,650 Dec. 8 486.0 0 -4,650** 0
AC: 124

Example (continued)

Gain/loss on futures position

Profit = 4,650 - (3,750 + 1,200) = - $300 Under the futures contract, the gain/loss is realized day by day because of the daily settlement procedures.

Gain/loss on forward contract o 15,000 x (4.86 - 4.88) = $300 o Under the forward contract, the whole gain/loss is realized at the end of the life of the contract.
AC: 125

Taxation on Futures Transactions

Investors' and traders' profits from most future

s contracts, as well as index options are co nsidered to be 60 percent capital gains a nd 40 percent ordinary income.

Capital gains are taxed at the ordinary incom e tax rate, but subject to a maximum of 15 percent. o Therefore, an investor in the 31 percent tax bracket would have futures profit taxed a blended rate of 60%(15%) + 40%(31%) = 21.4%
AC: 126

Taxation of Futures Transactions

In addition, all futures and index options profit s are subject to a market-tomarket rule in which accumulated profits are ta xable in the current year even if the cont ract has not been closed out. o For example, assume that you bought a futures contract on October 15 at a price of $1,000 and your account of course would be mark-to-market daily. o Suppose that at the end of the year, the accumulated profit of your futures position was $400 and the futures

price at the end of the year was $1,400. You would be required to pay the tax that year on $400 even though you had not closed out the contract. In other words, realized and unrealized profits are taxed and losses are recognized.
AC: 127

The Exchange Clearinghouse Broker Clearinghouse Broker Trading Pit

Seller Buyer
What is the significance of the Clearinghouse??
AC: 128

Options

Specifications o Call options o Put options Terminology:


o o

Option premium European versus American options

The purchaser of an option is not obligated to buy or sell the asset. The holde r will not exercise the option unle ss his or her payoff is positive.

It costs nothing to enter a forward or futures contract (except commissions and margin requirements). By contrast, an investor must pay an up-front fee or premium for an options contract.

AC: 129

Example of Speculating with Options

Bullish Outlook o On March 4, 2009, the common stock of TWX was trading at $17.28. o If your outlook for TWX is positive, you could buy TWX July 16 call options for $2.15 per option. Suppose you buy 10 contracts for a total cost (ignoring commissions) of $2,150 [10 x 100 x 2.15]. Note that

buying a TWX July 16 call option contract gives you the right to purchase 100 shares of TWX common stock at a cost of $16.00 per share at any time before the option expires in July in 2009. If the price of TWX stock climbs to $30 before your option expires and the value of one call option rises to $16.50, you have two choices if you want to dispose of your options:
AC: 130

Bullish Outlook example (continued)

Option 1

You can exercise your option and buy stock for $16.00 per share for a total cost of $16,000 [10 x 100 x 16.00], and simultaneously sell the shares on the stock market for $30,000 [10 x 100 x 30]. Your net profit (ignoring commissions) is $11,850 [30,000 - 16,000 - 2,150].
AC: 131

Bullish outlook example (continued)

Option 2 o You can close out your position by selling the 10 options contracts for $16,500, yielding a net profit of $14,350 [16,500 - 2,150].

In this case, you earn a return on investment of 667.44% [(14,350/2,150)], whereas the return on an outright stock purchase, given the same price movement, would be only 65.29% [(30,000-16,0002,150)/(16,000+ 2,150)].
AC: 132

Example of Speculating with Options

Bearish Outlook o On March 4, 2009, MAC closed at $38.93. o If your outlook MAC is negative, you could buy July 37.50 put options for $2.25 per option. Suppose you buy

5 contracts for a total cost (ignoring commissions) of $1,125 [5 x 100 x 2.25]. Note that buying the MAC July 37.50 put option contract gives you the right to sell 100 shares of its common stock at a price of $37.50 per share at any time before the option expires in July, 2009 If the price of MAC falls to $31.00 before your options expire in July and the price of one put option rises to $8.50, you have two choices if you want to dispose of your options:
AC: 133

Bearish outlook example (continued)

Option 1 o You can buy 500 shares of MAC stock at $31 per share and simultaneously exercise your put options to sell the stock at $37.50 per share. o Profits would be $2,125 [18,750 - 15,500 - 1,125], representing a rate of return for the investment of 12.78%.
AC: 134

Bearish outlook example (continued)

Option 2 o Sell the put option contracts, and collect the

difference between the price paid and the price received, Profits would be of $3,125 [4,250 1,125], representing a rate of return for investment of 177.78%.
AC: 135

Hedging with Options

Important differences with Forwards/Futures o It costs nothing to enter a forward/futures contract (except for margin requirements). By contrast, an investor must pay an upfront fee (the premium) for an options contract.

Forward/Futures contracts are designed to neutralize ris k by fixing the price that the hedger will pay or receive for the underlyin g asset. By contrast, put options provid e insurance. They offer a way for investors to p rotect themselves against adverse price movements in the future while allowing t hem to benefit from favorable price movements.
AC: 136

Hedging with options example

Protective put for portfolio insurance o Consider an investor who on March 4, 2009 owns 1,000 shares of JCP. The closing share price is $59.90 per share and the investor's portfolio position in JCP is worth $59,900. o The investor is concerned about downside risk and purchases 10 April 60 put contracts at a premium of $3.20 per option. o The cost of this portfolio insurance is $3,200 [10 x 100 x 3.20].
AC: 137

Hedging with options example (continued)

Therefore, the protective put (S + P) position preserves upside potential and limits down side risk to the put exercise price minus the premium, i.e., $56,800 [1,000 x (60.00 - 3.20)].
Stock Price on April 17 Portfolio Value Option Value

Portfolio + Option - Premium $30 $30,000

$30,000 $56,800 $40 $40,000 $20,000 $56,800 $50 $50,000 $10,000 $56,800 $60 $60,000 $0 $56,800 $70 $70,000 $0 $66,800

$80 $80,000 $0 $76,800


AC: 138

Real-Life Example

Enron Story o 25,000 shares ($85/share) valued at $2,125,000 o 10 months later, shares drop to $0.25/share, portfolio valued at $6,250. Had he used a protective put, he would have preserved his position o The Option Clearinghouse Corporation (OCC), an AAA insurance company, would

guarantee the performance of the put options.


AC: 139

One-Step Binomial OPM

Given the following binomial stock price trees, what are the values of a 3month call option with strike price = $50, and a 3month put option with strike price = $50? o Assume that the stock price may go up by 10% (u = 1.10) or down by 10% (d = 0.90), and the risk-free interest is 5% in 3-month.
AC: 140

One-Step Binomial OPM (continued)

Solution technique (Pricing a Call Option) o Find the risk-neutral probability

As Cu= max(Su K, 0) = 5, and Cd = max(Sd k, 0) = 0. Apply formula for the onestep binomial OPM for call: Thus, we have

C = [(0.5629)(5) + (1 0.5629)(0)]e-0.05(3/12) = 2.78


AC: 141

One-Step Binomial OPM (continued)

Solution technique: (Pricing a Put Option) o Find the derived probability p = 0.5629
o

Derive Pu=max(K Su,0) = 0, and Pd=max(K Sd, 0 ) = 5 Apply the formula for onestep binomial OPM for put: Thus, we have

P = [(0.5629)(0) + (1 0.5629)(5)]e-0.05(3/12) = 2.13


AC: 142

Multi-Step Binomial OPM

If we want to use a two timestep binomial OPM to evaluate a six-month Europ ean call option with a strike price of $50. Assume that the stock price starts at 50 and in e ach of two time steps may go up by 10% (u = 1.10) or down by 10 % (d = 0.90). Since each time-step is three months in length, t = 3/12 = 0.25, and the risk-free interest rate is 5% per year with continuous compounding (r = 0.05).

AC: 143

Multi-Step Binomial OPM (continued)

We know the riskneutral derived probability of an increase in the stock price in each time step is

The stock price tree is illustrated in the followin g slide.


AC: 144

Stock Price Tree


AC: 145

Solution Techniques

Method 1: Working backwards period by period


o o

At node 10.5 At node 0 At node 0 At node

D: Cuu = max(60.5 50, 0) = E: Cud = max (49.5 50, 0) = F: Cdd = max(40.5 50, 0) = B:

Cu =
o

At node C:

Cd =
o

At node A:

AC: 146

Solution Techniques

Method 2: Applying the 2 step binomial-tree OPM for call


o

If we know the following formula for two-step binomial OPM for call option,

we can directly use the formula to compute the call value as follows

where
o

Cuu = Max (Suu K, 0) = 10.5; Cud = Max (Sud K, 0) = 0;

Cdd = Max (Sdd K, 0) = 0


C=[(0.5629)2(10.5)+2(0.5629)(0.4371) (0)+(0.4371)2(0)]e-2(0.05)(0.25) = 3.2449.
AC: 147

Pricing of a European Put Option

Consider a new example of a six-month Europ ean put option with a strike price of 70 on a stock whose current price is also 70.

We suppose there are two time steps of three months ( t = 0.25) and in each time step the stock price either moves up by 15% (u = 1.15) or down by 20% (d = 0.80). We assume that the risk-free interest rate is 5% per year with continuous compounding (r = 0.05). For this case, the risk-neutral probability of an increase in the stock price is:
AC: 148

Solution Techniques

Method 1: Working Backwards period by period


AC: 149

Method 1 (continued)

As before, we work backward in the tree to co mpute the initial put option price of 6 .39317.
AC: 150

Solution Techniques

Method 2: Applying the twostep binomial-tree model for Eu ropean put option

The value of a two-timestep European put option is the present value of its expecte d terminal value based upon the riskneutral probabilities

and discounted at the risk-free r ate of interest. Notice again that the di scounting takes place two time-step in thi s case:
P=[(0.6074)2(0)+2(0.6074)(0.3926) (5.6)+(0.3926)2(25.2)]e-2(0.05)(0.25) = 6.39317.
AC: 151

From Theory to Practice

Coming up with u, d, and p.


AC: 152

Case Example

Defensive strategies following a stock merger for Car dinal Health, Inc.

On November 27, 1996 Owen Healthcare, Inc. (OWN) and Cardinal Health, Inc. (CAH) announced a definitive agreement to merge. The merger was to be accounted for as a pooling-of-interest and to be recognized as a tax-free reorganization for holders of OWN and CAH. The target date for closing was March 18, 1997. The following are hedging strategies for CAH shares.

AC: 153

Case Example

Protective Put Options o The investor owned CAH stock and was unable to sell the shares due to tax limitations. o Downside risk could be reduced by buying protective puts.

Given the market price of CAH stock was $61 per share at the time. Investors could purchase a two-year European-style, cash-settled protective put option with strike price of $55 from Morgan Stanley for $4.50 per share. The hedging outcomes with buying protective puts at option expiration are as follows:
AC: 154

Case Example

Protective Put Options


ST P55

Net Value of Portfolio 40 15 55 4.5 = 50.50 50 5 55 4.5 = 50.50 60 0 60 4.5 = 55.50 70 0 70 4.5 = 65.50 80 0 80 4.5 = 75.50 90 0

90 4.5 = 85.50 100 0 100 4.5 = 95.50


AC: 155

Case Example

Hedging with Protective Put


AC: 156

Case Example

Zero Cost Collar o Investors could use zerocost collar to reduce the downside risk without paying any option premium. o Essentially the investors purchase a two-year, European style, cash-settle put options with strike

price of $55.00 from Morgan Stanley and finance the put premium by selling a twoyear, European style, cashsettled call options with strike price of $77.00 from Morgan Stanley. The hedging outcomes with zero-cost collar are as follows:
AC: 157

Case Example

Zero Cost Collar


ST P55 -C77 Net Value of Portfolio

40 15 0 40 + 15 0 = 55 50 5 0 50 + 5 0 = 55 60 0 0 60 + 0 0 = 60 70 0 0 70 + 0 0 = 70 80 0

-3 80 + 0 3 = 77 90 0 -13 90 + 0 13 = 77 100 0 -23 100 + 0 23 = 77


AC: 158

Case Example

Hedging with Zero-cost Collar


AC: 159

Case Example

Advantages of zero-cost collar

Investors hedge equity position below the put strike while retaining ownership, voting rights and dividends. No net upfront out-of-pocket expense to the investors. Cash-settlement of options defers any sale of the underlying shares. Option strike prices and maturities may be customized to meet investors risk/reward parameters.

Disadvantages
o o

Investors relinquish upside above call strike price. Investors must post stock and put options as collateral against short call options. Investors are exposed to Morgan Stanley credit risk.

AC: 160

Case Example

Zero Cost Call Spread Collar

In the zero-cost collar hedging strategy, investors give away all future upside to fund the downside protection. Investors can have downside protection without giving away all future upside potential. Given the current market price of CAH stock at $61 per share, investors could enter into a call spread collar with Morgan Stanley by buying a two-year cashsettled put option with strike price of $52 and a two-year cash-settled call option with strike price of $75 per share with Morgan Stanley and finance the premiums by selling a twoyear cash-settled call option

with strike price of $61 per share. The hedging outcomes with zero-cost call spread collar are as follows
AC: 161

Case Example

Zero Cost Call Spread Collar


ST P52 -C61 C77 Net Value of Portfolio 40 12 0 0

40 + 12 0 + 0 = 52 50 2 0 0 50 + 2 0 + 0 = 52 60 0 0 0 60 + 0 0 + 0 = 60 70 0 -9 0 70 + 0 14 + 0 =61 75 0

-14 0 75 + 0 14 + 0 = 61 80 0 -19 5 80 + 0 19 + 5 = 66 90 0 -29 15 90 + 0 29 + 15 = 76 100 0 -39 25 100 + 0 39 + 25 = 86

AC: 162

Case Example

Hedging with Call Spread Collar


AC: 163

Other Types of Options

Stock Index Options


o o

Settled in cash Popular contracts such as options on S&P 500 are traded on CBOE Mostly traded on PHLX

Foreign Currency Options


o

Futures Options (i.e. Options on Futures)


o

When exercised, investor receives a futures contract plus cash difference between the futures price and the exercise price.

OTC Options
o

Exotic options such as calls on max, calls on min, chooser, compound options, etc.

Embedded Options

Options that are part of another security, such as convertible bonds, LYONs, PERCS, etc.

AC: 164

Swaps

According to the market survey of ISDA (the International Swaps and Derivatives Association), the sw ap markets are huge and growing:

Year-end outstandings for interest rate swaps

Year-end outstandings for currency swaps Year-end outstandings for interest rate options

Total IR and currency outstandings

Total credit Default swap outstandings

Total equity derivative outstandings 1987

$ $ $ $ $ $ 1988

682.80 182.80

865.60

1,010.20 316.80 327.30 1,654.30 1989 1,502.60 434.90 537.30 2,474.70 1990 2,311.54 577.53 561.30 3,450.30 1991 3,065.10

807.67 577.20 4,449.50 1992 3,850.81 860.39 634.50 5,345.70 1993 6,177.35 899.62 1,397.60 8,474.50 1994 8,815.56 914.85 1,572.80 11,303.20 1995 12,810.74 1,197.39 3,704.50 17,712.60

1996 19,170.91 1,059.64 4,722.60 25,453.10 1997 22,291.33 1,823.63 4,920.10 29,035.00 1998 50,997.00 1999 58,265.00 2000 63,009.00 2001 69,207.30 918.87 2002 101,318.49 2,191.57 2,455.29

2003 123,899.63 2,687.91 2,784.25 2004 164,491.72 5,441.86 3,778.15

AC: 165

Swaps

Terminology
o

Interest Rate Swap An arrangement to exchange interest-rate payments between two counterparties. Fixed-rate payer Pays fixed and receives variable rate of interest in the swap. It has a long position in the swap. Floating-rate payer Pays variable rate and receives fixed rate of interest in the swap. It has a short position in the swap.

Two counterparties
o

Plain vanilla (the fixed/floating interest rate swap):


o

Two counterparties exchange their interest payments on the notional principal for a specified length of time. The first party pays the fixed amount and receives a floating amount of interest in the swap; while the second party pays the floating amount and receives a fixed amount of interest in the swap.
AC: 166

Fixed/Floating Rate Swap

Example: Costs of Borrowing


Floating-rate Market Fixed-rate Market AAA T-Bill + 0.25% 8.8% BBB

T-Bill + 0.75% 10.0% Quality Spreads: 0.5% 1.2%


AC: 167

Fixed/Floating Rate Swap


AC: 168

Fixed/Floating Rate Swap


8.9% T-Bill T-Bill + 0.75% 8.8% (Floating Rate Market) (Fixed Rate Market)
AC: 169

Fixed/Floating Rate Swap

Effective Costs of Borrowing

With Swap Without Swap AAA T-Bill 0.1% T-Bill + 0.25% BBB 9.65% 10.0%
AC: 170