Interest rate swaps

Sun, Tong-sheng; Sundaresan, Suresh; Wang, Ching

doi:10.1016/0304-405x(93)90041-9

Cited by 95 publications

(1 citation statement)

References 11 publications

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“…In another strand of the literature we find an abundant body of scholarship that investigates change in swap spreads. See for instance Sun et al (1993), Brown et al (1994), Duffie and Huang (1996), Cossin and Pirotte (1997), Minton (1997), Lang et al (1998), Lekkos and Milas (2001), Fehle (2003) and Huang and Chen (2007). We identify three issues central to this body of swap spread analysis.…”

Section: Prior Researchmentioning

confidence: 99%

Effectively hedging the interest rate risk of wide floating-rate coupon spreads

Schröder,

Dunbar

2011

RMFI

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Bond issuers frequently immunise/hedge their interest rate exposure by means of interest rate swaps (IRS). The receiving leg matches all bond cash flows, while the pay leg requires floating rate coupon payments of form LIBOR plus a spread. The goal of hedging against interest rate risk is only achieved in full if the present value of this spread is zero. Using market data it is shown that under a traditional IRS hedging strategy an investor could still experience significant cash flow losses given a 1 per cent shift in the underlying benchmark yield curve. Consideration is given to the instantaneous interest rate risk of a bond portfolio that allows for general changes in interest rates. Two contributions are made. The paper analyses the size of hedging imperfections arising from the widening of the floating rate spread in a traditional swap contract and subsequently proposes two new practical, effective and analytically tractable swap structures: Structure 1: an improved parallel hedge swap, hedges against parallel shifts of the yield curve; and Structure 2: an improved non-parallel hedge swap, hedges against any movement of the swap curve. Analytical representations of these swaps are provided such that spreadsheet implementations are easily attainable.

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Section: Prior Researchmentioning

confidence: 99%

Effectively hedging the interest rate risk of wide floating-rate coupon spreads

Schröder,

Dunbar

2011

RMFI

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Interest Rate Swaps

Johnson¹

2010

Bond Evaluation, Selection, and Management

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Vanilla interest rate swaps may be viewed as simple interest rate derivatives, but the implication of entering into such contracts may not be so readily apparent. In particular, investment managers and asset/liability managers in the insurance industry are often presented with such contracts from investment banks as hedging solutions for insurance liabilities, such as fixed annuities. Within the context of hedging insurance liabilities, if used properly the risk of using interest rate swaps is not as great as if the swap were used for speculative purposes. However, it is important for the interest rate exposure, which is inherent in interest rate (IR) swaps and other interest sensitive financial products, to be analyzed and understood by all practitioners. Though participants in the interest rate swap market often measure their exposure to the default of their counterparty, default risk is not the only material risk. In particular, this article will illustrate that the potential P&L exposure due to unanticipated interest rate changes also warrants attention, though it may not always be fully investigated. To quote renowned hedge fund manager George Soros: "the risks involved (in IR swap deals) are not always fully understood, even by sophisticated investors, and I am one of them." In this article, we provide a framework for measuring the potential interest rate exposure of such swaps. This framework incorporates the use of short-rate models which have been well documented in the academic literature, and widely employed in industry. We will consider generic interest rate swap deals in several different yield curves environments, and under various volatility assumptions, and investigate the potential P&L exposure, and the potential counterparty exposure, under a market-consistent set of yield-curve scenarios. Further, it is our goal to not only present the current analysis but also provide practitioners with the background and tools necessary in order to perform similar analysis. In order to achieve this goal we first provide background on IR swaps, and the various stochastic interest rate models commonly used in industry, as well as several other relevant topics.

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Interest Rate Swaps

2017

Derivatives Markets and Analysis

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Interest rate swaps

Cited by 95 publications

References 11 publications

Effectively hedging the interest rate risk of wide floating-rate coupon spreads

Effectively hedging the interest rate risk of wide floating-rate coupon spreads

Interest Rate Swaps

Interest Rate Swaps

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