| 
  • If you are citizen of an European Union member nation, you may not use this service unless you are at least 16 years old.

  • You already know Dokkio is an AI-powered assistant to organize & manage your digital files & messages. Very soon, Dokkio will support Outlook as well as One Drive. Check it out today!

View
 

swaps

Page history last edited by Brian D Butler 14 years, 3 months ago

for discussion on Currency Swaps, please see the GloboTrends page "foreign exchange swaps"

 

swaps covering interbank borrowing costs, credit risk and cross-currency transactions

 

Example:  Yen Swap Spreads:

 

premiums to swap London borrowing rates for those set in Tokyo.  In March 2009, "Japanese banks were asked to pay as much as 35 basis points this month on top of the yen London Interbank Offered Rate, or Libor, to receive the yen rate set in Tokyo. That was the largest gap since at least May 1999 and also exceeded levels following Japan’s banking crisis in the 1990s."

 

Backgroud to the Swaps market:

 

The market for interest rate derivatives, in general, and for swaps, in particular, has grown exponentially in the last decade. Recent estimates indicate that the notional outstanding volume of transactions of privately negotiated (over-the-counter) derivatives at the end of 1997 (old) amounted to over $29 trillion, of which interest rate swaps amounted to over $22.3 trillion. Given the importance of the yen in international trade and nance, it is not surprising that yen interest rate swaps form a substantial proportion of this volume (about 19.5%), second only to those denominated in dollars (about 27.3%)

 

Risks

In general, the credit risk of swaps is related to the default risk in fixed income markets.

 

The important characteristic of over-the-counter derivatives that distinguishes them from exchange-traded products is that they are not backed by the guarantee of a clearing corporation or exchange. Hence, each of the two counterparties to the transaction is exposed to the default risk of the other.  This default risk is particularly  important for long-dated instruments such as interest rate swaps.

 

Value

Swaps are typically negotiated as zero-value transactions when they are initiated, with the swap rate being dened as the xed rate to be exchanged for a floating rate such as LIBOR. However, their value changes over time as interest rates fluctuate. In the case of a fixed-for-floating interest rate swap, as long-term interest rates rise, the fixed rate payer benets from being locked into the lower interest rate. Consequently, the value of the fixed side moves \in-the-money." By the same token, the floating rate payer receives fkows that are lower than the changed interest rates would dictate, and hence, the value of the floating side moves \out-of-the-money." The opposite occurs when long-term interest rates decline. Default risk arises when the entity for which the swap is out-of-the-money is unable to meet its commitments to the counterparty for which the swap is in-the-money.

 

Swap Rates:

In an effcient market, one would expect market swap rates to incorporate the risk of default, if the counterparties rationally anticipate this possibility. Hence, one would expect the swap rates to be sensitive to the credit ratings of the counterparties. For instance, a swap dealer who pays a floating rate and receives fixed payments in exchange would require a BBB-rated counterparty to pay a higher fixed rate compared to a AAA-rated counterparty.  Conversely, the dealer would be willing to make lower fixed payments in exchange for floating rate payments to a BBB-rated counterparty than a AAA-rated counterparty. Hence, the

swap spread, dened as the difference between the swap rate and the yield on a par Treasury bond with the same maturity, should be greater for the BBB-rated counterparty than the AAA-rated counterparty, and so also should be the differences between the bid and the offer rates.

 

read more from the Source here:  http://www.stern.nyu.edu/fin/workpapers/wpa98069.pdf

 

 

 

Comments (0)

You don't have permission to comment on this page.