Topic 8 Forwards, Futures, Swaps and Management of Interest Rate Risk

TOPIC 8
FORWARDS, FUTURES,
SWAPS AND
MANAGEMENT OF
INTEREST RATE RISK
Topic highlights
Part I
1) OTC forward market vs. Organized futures market
2) Mechanics of Futures Trading
3) Why firms hedge?
4) Hedging concepts
5) Stock Market Hedge using Stock Index Futures
Part II
6) Forward Rate Agreements (FRAs)
7) Interest Rate Futures
8) Interest Rate Options: Cap, Floor, Collar
9) Interest Rate Swaps
Over-the-Counter (OTC) Forward Market
• customized
• private negotiation
• essentially unregulated
• higher credit risk
Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. Ch. 38: 3
© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Organized Futures Trading
• Contract Development
• Contract Terms and Conditions
– contract size
– quotation unit
– minimum price fluctuation
– trading hours
• Delivery Terms
– delivery date and time
– delivery or cash settlement by ‘close out’
Organized Futures Trading
• Daily Price Limits and Trading Halts
– limit moves (max and min price at which a contract can
trade during a day  prevent margin accounts from being
depleted so quickly that losses cannot be covered)
– circuit breakers (restrict trading after prices have moved by
specified amounts during the day  permit market to ‘cool
off’ and avoid panic trading, allow additional margins to be
collected through margin calls)
6
7
Mechanics of Futures Trading
• Placing an Order
– pit
– open outcry
– electronic systems
• The Role of the Clearinghouse
– margin deposits
– reduces credit risk
– https://qz.com/871648/cme-group-cme-is-closing-the-
last-of-new-yorks-commodity-trading-pits-on-dec-30/
9
10
11
12
Mechanics of Futures Trading
• Daily Settlement
– initial margin
– maintenance margin
– settlement price
– variation margin
– open interest: number of contracts outstanding
Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. Ch. 13

8: 13
Types of Futures Contracts
• Agricultural Commodities (e.g. palm oil futures)
• Natural Resources (e.g. oil futures)
• Foreign Currencies
• Eurodollars
• Treasury Notes and Bonds
• Interest Rate Futures (e.g. KLIBOR futures)
• Stock Index Futures (e.g. KLCI futures)
• Managed Funds
• Hedge Funds
• Options on Futures
• Weather Futures
Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. Ch. 14

8: 14
Why Hedge?
• Reasons to hedge
– Shareholders might be unaware of the firm’s risks.
– Shareholders might not be able to identify the correct
number of futures contracts necessary to hedge.
– Shareholders might have higher transaction costs of
hedging than the firm.
– There may be tax advantages to a firm hedging.
– Hedging reduces bankruptcy risk and costs.
– Managers may be reducing their own risk.
– Hedging may send a positive signal to creditors.
– Dealers hedge their market-making activities in
derivatives.
Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 15 15

Ch. 11:
Why Hedge?
• Reasons not to hedge
– Hedging can give a misleading impression of the
amount of risk reduced, a moral hazard problem
– Hedging eliminates the opportunity to take
advantage of favorable market conditions
– There is no such thing as a hedge. Any hedge is
an act of taking a position that an adverse market
movement will occur. This, itself, is a form of
speculation.

Ch. 11:
Hedging Concepts
• Short Hedge and Long Hedge
– Short hedge implies a short position in futures
contract. Short hedges can occur because the
hedger owns an asset and plans to sell it later.
– Long hedge implies a long position in futures
contract. Long hedges can occur because the
hedger plans to purchase an asset later.
– An anticipatory hedge is a hedge of a transaction
that is expected to occur in the future.

Ch. 11:
Hedging Concepts
• The Basis
 Basis = spot price – futures price
 Hedging and the Basis
 (short hedge) = ST – S0 (from spot market)
– (fT – f0) (from futures market)
(long hedge) = – (ST – S0) (from spot market)
+ (fT – f0) (from futures market)
If hedge is closed prior to expiration,
 (short hedge) = (St – S0) – (ft – f0)
 (long hedge) = –(St – S0) + (ft – f0)
If hedge is held to expiration, S t = ST = fT = ft.

Ch. 11:
Hedging Concepts
 Hedging and the Basis
• Example: Buy asset for $100, sell futures for $103.
Hold until expiration. Sell asset for $97, close
futures at $97. Or deliver asset and receive $103.
Make $3 for sure.

Ch. 11:
Hedging Concepts
 Example: On March 30. Spot gold $387.15 and
June futures $388.60. Buy spot, sell futures. Note:
b0 = 387.15 – 388.60 = –1.45. If held to expiration,
profit should be change in basis or 1.45.
• At expiration, let ST = $408.50. Sell gold in spot
for $408.50, a profit of 21.35. Buy back futures
at $408.50, a loss of 19.90.
• Net gain =1.45 or $145 on 100 oz. of gold.

Ch. 11:
Hedging Concepts
 Example: (continued)
• Instead, close out prior to expiration when St =
$377.52 and ft = $378.63. Loss on spot = 9.63.
Profit on futures = 9.97. Net gain = 0.34 or $34
on 100 oz.
• Note that change in basis was:
bt - b0 = -1.11 - (-1.45) = 0.34.
 In forward markets, the hedge is customized so
there is no basis risk.

Ch. 11:
Stock Market Hedge using
Stock Index Futures
• Stock Index Futures Hedging
– Appropriate hedge ratio is
• Nf = – (
( S/f) (S/f)
• where S is the beta from the CAPM
and f is the beta of the futures, often
assumed to be 1.

Ch. 11:
Stock Index Futures
• Stock Market Hedges
– We primarily shall use the S&P 500 futures (U.S.) or the
FTSE Bursa Malaysia KLCI futures (FKLI) (Malaysia).
Its price is determined by multiplying the quoted price
by $250 (S&P futures) or RM50 (FKLI). For example, if
the S&P 500 futures is at 1300, the price is 1300($250)
= $325,000
– Stock Portfolio Hedge
• Refer to Table 11.10 for example (short hedge).
– Anticipatory Hedge of a Takeover
• Refer to Table 11.11 for example (long hedge).

Ch. 11:
Stock Index Futures
Example (Table 11.10)
• On March 31, a portfolio manager is concerned about the
market over the next four months. The portfolio has
accumulated an impressive profits, which the manager wishes
to protect over the period ending July 27. The portfolio has
total current market value of $7,725,425 and weighted
average portfolio beta of 1.06.
• S&P 500 September futures (multiplier of $250) has a price of
1,305 on March 31 and 1,295.04 on July 27.
• If the portfolio’s total market value falls to $7,518,700, what is
the hedge efficiency ratio?
24
Stock Index Futures
Solution:
• Price of one futures contract on March 31 = $250(1,305) =
$326,250.
• Optimal number of index futures contracts to hedge portfolio’s
market risk Nf = – (
( S/f) (S/f) = – (1.06/1)
($7,725,425/$326,250) = – 25.10 contracts
• Decision: Short 25 S&P 500 index futures on March 31.
• Come July 27, the market value of stocks in the portfolio
declined by $7,725,425 – $7,518,700 = $206,725, or a loss of
2.68%.
25
Stock Index Futures
• Come July 27, buy 25 S&P 500 index futures contracts to
close out position.
Profit from futures contracts = (1,305 – 1,295.40)($250)(25)
= $60,000
• Hedge Efficiency ratio = $60,000 / $206,725 *100% = 29.02%
26
Ch. 11:
Interest Rate Risk
• This is the risk faced owing to adverse movement in
interest rates.
• Interest rate risk may be borne if firms or individuals borrow
funds with floating interest rate. Here the risk is that
changes in interest rates can change the cost of capital or
financing.
• On the other hand, interest rate risk may also be borne if
firms or individuals invest in interest-bearing assets, where
the rate of return depends on changes in interest rates.
• Derivatives as tools to manage interest rate risk: forward
rate agreements (FRAs), interest rate futures, interest rate
options, interest rate swap, swaptions.
28
Interest Rate Risk
• The payoff of a derivative on a bond is based on the
price of the bond relative to a fixed price.
• The payoff of a derivative on an interest rate is based
on the interest rate relative to a fixed interest rate.
• In some cases these can be shown to be the same,
particularly in the case of a discount instrument. In
most other cases, however, a derivative on an interest
rate is a different instrument than a derivative on a
bond.
29
Forward Rate Agreements
• Definition: A forward contract in which the underlying
is an interest rate
• A FRA can work better than a forward or futures on a
bond, because its payoff is tied directly to the source
of risk, i.e. the interest rate.
• FRA is an over-the-counter agreement between two
parties, to lock-in an interest rate for a short period of
time.
• FRAs offer companies the facility to fix future interest
rates today on either borrowing or lending/investing
for a specific future period.

Ch. 13:
• Decision Rule:
 Borrower  Long FRA to hedge
 Lender / Investor  Short FRA to hedge
• When actual interest rate at FRA expiration > agreed rate in
FRA, FRA seller compensates FRA buyer.
• When actual interest rate at FRA expiration < agreed rate in
FRA, FRA buyer compensates FRA seller.
• FRA can be settled either at the initiation of the borrowing or
lending transaction (‘settlement at initiation’) or at the maturity
of the borrowing or lending transaction (‘settlement in arrears’).
• Initiation of the borrowing or lending transaction is the
expiration date of FRA.
31
– The Structure and Use of a Typical FRA
• Underlying is usually LIBOR (a floating interest rate).
Equivalent in Malaysia is KLIBOR.
• Payoff is made at expiration of FRA and discounted.
For FRA on m-day LIBOR, settlement at initiation is
 (LIBOR - Agreed upon rate)(m/36 0) 
(Notional Principal)  
 1  LIBOR(m/36 0) 
• Example: Long an FRA on 90-day LIBOR expiring in
30 days. Notional principal of $20 million. Agreed
upon rate is 5 percent. Settlement will be
 (LIBOR - 0.05)(90/3 60) 
($20,000,0 00) 
 1  LIBOR(90/3 60) 

Ch. 13:
• Some possible payoffs. If LIBOR at expiration is 4
percent,
 (0.04 - 0.05)(90/3 60) 
($20,000,0 00)   $49,505
 1  0.04(90/360) 
So the FRA buyer has to pay $49,505 to FRA seller.
• If LIBOR at expiration is 6 percent, the payoff is
 (0.065 - 0.05)(90/3 60) 
($20,000,0 00)   $73,801
 1  0.065(90/360) 
So the FRA buyer receive $73,801 from FRA seller.
• Note the terminology of FRAs: A  B means FRA expires
in A months and underlying matures in B months.

Ch. 13:
Ch. 13:
If actual LIBOR rate turns out to be 8.00% on day 30 (higher than
agreed FRA rate of 5.00%)
• FRA settlement in arrears = $20,000,000 (0.08 – 0.05)(90/360)
= $150,000
The company receive compensation from FRA seller.
• FRA settlement at initiation = $150,000 / [1 + 0.08(90/360)
= $147,059
• The company borrow at LIBOR + 1.00% repayment amount due on
the loan = $20,000,000 [1 + (0.08 + 0.01)(90/360)]
= $20,450,000
• Total amount paid = $20,450,000 – $150,000 = $20,300,000
• Effective annual cost of borrowing with FRA hedge
= ($20,300,000 / $20,000,000)365/90 – 1 = 0.0622 = 6.22%
• Effective annual cost of borrowing without FRA hedge
= ($20,450,000 / $20,000,000)365/90 – 1 = 0.0944 = 9.44%
35
If actual LIBOR rate turns out to be 1.00% on day 30 (lower than
agreed FRA rate of 5.00%)
• FRA settlement in arrears = $20,000,000 (0.01 – 0.05)(90/360)
= -$200,000
The company pay compensation to FRA seller.
• FRA settlement at initiation = -$200,000 / [1 + 0.01(90/360)
= -$199,501
• The company borrow at LIBOR + 1.00% repayment amount due on
the loan = $20,000,000 [1 + (0.01 + 0.01)(90/360)]
= $20,100,000
• Total amount paid = $20,100,000 + $200,000 = $20,300,000
• Effective annual cost of borrowing with FRA hedge
= ($20,300,000 / $20,000,000)365/90 – 1 = 0.0622 = 6.22%
• Effective annual cost of borrowing without FRA hedge
= ($20,100,000 / $20,000,000)365/90 – 1 = 0.0204 = 2.04%
36
Ch. 13:
• The above example is a ‘1 x 3’ FRA.
• Hedging the interest rate risk with FRA has stabilize the net
total interest payment regardless of what the eventual LIBOR
interest rate turns out.
• Note: FRAs do not involve any actual lending or investment of

the principal (just a notional principal). FRA is a separate
contract from initial position in investment or borrowing.
38
Interest Rate Futures
• Definition: a standardized exchange traded contract on
interest rates. It is widely used due to the high liquidity of
interest rate futures markets, simplicity in use, and the
rather common interest rate exposure that companies
possess.
• Price of interest rate futures = 100 – interest rate
• Decision Rule:
 Borrower  Short interest rate futures to hedge
 Lender / Investor  Long interest rate futures to
hedge
39
• Summary:
Exposure Futures position Interest rates Futures price
Borrower Short futures today Increase Decrease (Gain)
Decrease Increase (Loss)
Investor Long futures today Increase Decrease (Loss)
Decrease Increase (Gain)
40
Example 1
Suppose a company has RM5,000,000 on short-term
deposit with 3-months’ rollover. The company is worried
that come next rollover in December, the interest rate
would have decreased. Current interest rate is 4% and
December interest rate futures priced at 96. Show how
the interest rate risk may be hedged using futures if
come December, interest rate is 2.5% and December
interest rate futures priced at 97.30. December interest
rate futures has a contract size of RM1,000,000 and 3-
month maturity.
41
Solution:
• Number of contracts = deposit amount / contract size
= RM5m / RM1m = 5 contracts
• Hedge by purchasing 5 December KLIBOR futures priced
at 96 today.
• Come December, deposit is rolled over at 2.5%.
Loss (less interest income)
= (4% – 2.5%) x RM5m x 3/12 = RM18,750
• Close-out the futures position by selling 5 December
futures at 97.30.
Profit per futures contract = 97.30 – 96 = 1.30%. This is
equivalent to 130 ticks. (KLIBOR futures 1 tick = RM25)
Profit from futures = 130 x 5 contracts x RM25
= RM16,250
• Hedge Efficiency ratio = 16,250 / 18,750 = 86.66%
42
Example 2
Suppose a company has RM10,000,000 short-term
borrowings on 6-months’ rollover. The company is
worried that come next rollover in December, the interest
rate would have increased. Current interest rate is 7%
and December interest rate futures priced at 93.25.
Show how interest rate risk may be hedged using futures
if come December, interest rate is 8% and December
futures priced at 92.50. December futures has a contract
size of $1,000,000 and 3-month maturity.
43
Solution:
• Number of contracts = loan amount / contract size
= RM10m / RM1m = 10 contracts
However, since the borrowing 6-months rollover whereas
KLIBOR futures has 3-month maturity cycle, number of contracts
needed for hedging = 10 x 6/3 = 20 contracts
• Hedge by selling 20 Dec KLIBOR futures priced at 93.25.
• Come December, borrowing is rolled over at 8%.
Loss (extra interest payment)
= (8% – 7%) x RM10m x 6/12 = RM50,000
• Close-out the futures position by purchasing 20 Dec futures at
92.50.
Profit per futures contract = 93.25 – 92.50 = 0.75%. This is
equivalent to 75 ticks. (KLIBOR futures 1 tick = RM25)
Profit from futures = 75 x 20 contracts x RM25
= RM37,500
• Hedge Efficiency ratio = 37,500 / 50,000 = 75%
44
Interest Rate Options
• Definition: an option in which the underlying is an
interest rate; it provides the rights to make a fixed
interest payment and receive a floating interest
payment or the rights to make a floating interest
payment and receive a fixed interest payment.
• The fixed rate is called the exercise rate.
• Most are European-style.

Ch. 13:
• The Structure and Use of a Typical Interest Rate
Option
• With an exercise rate of X, the payoff of an interest
rate call is
(Notional Principal)  Max(0, LIBOR  X)(m/360) 
• The payoff of an interest rate put is
(Notional Prinicpal)  Max(0, X - LIBOR)(m/3 60) 
• The payoff occurs m days after expiration.
• Example: notional principal of $20 million, expiration
in 30 days, underlying of 90-day LIBOR, exercise
rate of 5 percent.

Ch. 13:
• If LIBOR is 1 percent at expiration, payoff of a call is

($20,000,0 00)  Max(0,0.01  0 .05 )(90/360)   $ 0
• The payoff of a put is
($20,000,0 00)  Max(0,0.05  0 .01)(90/360)   $ 200 ,000
• If LIBOR is 9 percent at expiration, payoff of a call is
($20,000,0 00)  Max(0,0.09  0 .05 )(90/360)   $ 200 ,000
• The payoff of a put is
($20,000,0 00)  Max(0,0.05  0 . 09 )(90/360)   $ 0

Ch. 13:
• Interest Rate Option Strategies (Decision Rule):
 Borrower  long interest rate call to hedge
 Lender / Investor  long interest rate put to hedge
• Call option protect against an increase in interest
rates, but preserving the flexibility to benefit from a
decrease in interest rates.
• Put option protect against a decrease in interest rates,
but preserving the flexibility to benefit from an increase
in interest rates.

Ch. 13:
Ch. 13:
Ch. 13:
• Interest Rate Caps, Floors, and Collars
• A combination of interest rate calls used by a borrower
to hedge a floating-rate loan is called an interest rate
cap. The component calls are referred to as caplets.
• A combination of interest rate puts used by a lender to
hedge a floating-rate loan is called an interest rate
floor. The component puts are referred to as
floorlets.
• A combination of a long cap and short floor at different
exercise prices is called an interest rate collar.

Ch. 13:
• Interest Rate Cap
– Each component caplet pays off independently of
the others.
– Refer to Table 13.7 for an example of a borrower
using an interest rate cap.
– To price caps, price each component caplet
individually and add up the prices of the caplets.

Ch. 13:
Ch. 13:
•Interest Rate Floor
Each component floorlet pays off independently of
the others
Refer to Table 13.8 for an example of a lender using

an interest rate floor.
To price floors, price each component floorlet

individually and add up the prices of the floorlets.
54
Ch. 13:
• Interest Rate Collar
– A borrower using a long cap can combine it with a
short floor so that the floor premium offsets the cap
premium. If the floor premium precisely equals the
cap premium, there is no cash cost up front. This is
called a zero-cost collar.
– The exercise rate on the floor is set so that the
premium on the floor offsets the premium on the cap.
– By selling the floor, however, the borrower gives up
gains from falling interest rates below the floor
exercise rate.
– Refer to Table 13.9 for example.

Ch. 13:
Ch. 13:
Interest Rate Swaps
• Definition: Interest rate swap is an agreement between two
parties to exchange their respective series of cash flows. This
typically involves a fixed rate payment exchanged for a
floating rate payment (plain vanilla interest rate swap).
• Both parties are obligated by the swap’s conditions.
• Swaps permit a change to the effective nature of an asset or
liability without changing the underlying exposure.
• Swap contract is separate from the loan contract.
58
Interest Rate Swaps
• The Structure of a Typical Interest Rate Swap
• Example: On December 15 XYZ enters into $50
million NP swap with ABSwaps. Payments will be
on 15th of March, June, September, December for
one year, based on LIBOR. XYZ will pay 7.5%
fixed and ABSwaps will pay LIBOR. Interest based
on exact day count and 360 days (30 per month). In
general the cash flow to the fixed payer will be
 Days 
(Notional principal) (LIBOR - Fixed rate)  
 360 or 365 

Ch. 12:
Interest Rate Swaps
• The payments in this swap are
 Days 
($50,000,0 00)(LIBOR - 0.075) 
 360 
• Payments are netted.

• Refer to Figure 12.2 for payment pattern
• Refer to Table 12.1 for sample of payments after-
the-fact.

Ch. 12:
Ch. 12:
Ch. 12:
Why Interest Rate Swaps?
Reason 1: Hedge Interest Rate Risk
Converting Floating Interest Payments into Fixed Interest Payments

Ch. 12:
Why Interest Rate Swaps
Reason 2: Theory of Comparative Advantage
• Borrowers with weaker credit ratings may face larger credit
spread for fixed rate borrowing. Such companies may borrow at
relatively more attractive floating rates and swap for the desired
fixed rate payments without any change to the underlying debt.
The benefit (savings on interest payments) that accrues can
improve the bottom line for both swap parties.
• Example
Assume there are 2 firms and each wants to borrow $10m loan.
Fixed-rate market Floating-rate market
A 7.0% KLIBOR+1%
B 9.0% KLIBOR+1.5%
Firm A prefers to borrow floating rate debt while Firm B prefers to
borrow fixed rate debt. Illustrate how an interest swap helps each of the
firms to minimize interest payments and meet with their preferences.
Find the swap payments between the firms.
64
• Firm A has absolute advantage of 2% over Firm B in fixed-rate market and
0.5% in floating-rate market.
• Comparative advantage = 2% - 0.5% = 1.5%
• Based on comparative advantage, Firm A should initially borrow at fixed rate
while Firm B should borrow at floating rate. After that, the firms can go into a
swap in order to meet with their preferences.
• This 1.5% comparative advantage shows total cost savings of two firms and
fees to intermediary (if any).
• Assume no intermediary and the firms have equal bargaining power.
• Firm A:
Without swap, interest payment = KLIBOR+1%
With swap, net interest payment = (KLIBOR+1%) – 0.75%
= KLIBOR + 0.25%
• Firm B:
Without swap, interest payment = 9%
With swap, net interest payment = 9% - 0.75% = 8.25%
65
• Under the swap, Firm A should pay floating swap interest payment
to Firm B and receive fixed swap interest payment from Firm B.
Remember, Firm A had initially borrowed debt that pay fixed
interest payment.
• Let: fixed swap payment = x; floating swap payment = KLIBOR
Use Firm A net interest payment (with swap) to solve:
Interest payment on fixed rate debt = 7%
Pay floating swap payment to B = KLIBOR
Receive fixed swap payment from B =x
Net payment after swap = 7% + KLIBOR – x = KLIBOR + 0.25%
Solve: x = 6.75%
66
Interest Rate Swaps
Finding Swap Rate
Example
Suppose we are given the yields of zero-coupon bonds (strips) as
of today (time 0)
Maturity (months) Zero-coupon yield
6 5.50%
12 5.70%
18 5.90%
24 6.20%
30 6.50%
Assume that floating rate reset is every 6 months. What is the swap
rate on a 2-year generic interest rate swap?
67
S o lu t io n :
Firs t le g
At t = 0
We kn o w 6 -m o n t h s s p o t r a t e = 5 .5 0 %
At t = 6 m o n th s
Flo a t in g in t e r e s t w ill b e p a id a t 5 .5 0 %
S o , fo r a 6 -m o n th s b o n d , th e P V o f a $ 1 b o n d is
$1
=$ 0 .9 7 3 2
1  0.055
2
S e c o n d le g
Be tw e e n t = 6 a n d t = 1 2 m o n t h s
Le t a % b e t h e in t e r e s t r a t e b e tw e e n 6 a n d 1 2 m o n th s
We kn o w t h a t fo r 1 2 m o n t h s r a te to d a y, th e s p o t r a t e = 5 .7 0 %
He n c e , to m a in ta in e q u ilib r iu m , t h e in t e r e s t r a t e fo r th e s e c o n d
le g c a n b e c a lc u la t e d a s
2
 0.055  a%   0.057 
1  1    1  
 2  2   2 
S o lvin g fo r a %, w e g e t a = 0 .0 5 9 0 0 2 o r 5 .9 0 0 2 %
S o , fo r a 1 2 -m o n th s b o n d , t h e P V o f a $ 1 b o n d is

$1  1  0.055
2
 1

 1  0.059
2
 1
 $0.9453
We c a n w o r k o u t s im ila r ly fo r t h e 3 r d a n d 4 t h le g s .
68
This s umma rize s to b e
Time Forwa rd ra te s Ze ro p ric e s x×y
(%) (x) (y) ($)
6 5.5000 0.9732 0.0535
12 5.9002 0.9453 0.0558
18 6.3006 0.9165 0.0577
24 7.1026 0.8850 0.0629
Sub -tota l 3.7201 0.2299
The e ffe c tive s wa p ra te is found b y  xy  0.2299  0.061802 or
 y 3.7201
6.1802%.
69

Topic 8 Forwards, Futures, Swaps and Management of Interest Rate Risk

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Topic 8 Forwards, Futures, Swaps and Management of Interest Rate Risk

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TOPIC 8

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. Ch. 13

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. Ch. 14

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 15 15

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 16 16

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Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 18 18

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Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 21 21

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 22 22

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• Note: FRAs do not involve any actual lending or investment of

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 45 45

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 46 46

• If LIBOR is 1 percent at expiration, payoff of a call is

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 47 47

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 48 48

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 51 51

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 52 52

Refer to Table 13.8 for an example of a lender using

To price floors, price each component floorlet

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 56 56

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 59 59

• Payments are netted.

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 60 60

Chance/Brooks An Introduction to Derivatives and Risk Management, 8th ed. 63 63

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