Interest Rate Swaps and Other Derivatives

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  • Format: Hardcover
  • Copyright: 8/30/2012
  • Publisher: Columbia Univ Pr
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Interest rate swaps allow counterparties to exchange fixed rate streams of payment for floating ones. The first swap was executed over thirty years ago, and since then, the interest rate swaps market and other related derivative markets have grown and diversified in phenomenal directions. Today interest rate swaps and other derivatives are used by myriad institutional investors for the purposes of risk management, expressing a view on the market, and exploiting market opportunities that are otherwise unavailable using more traditional financial instruments. In this volume, Howard M. Corb further explains the concepts behind interest rate swaps and the derivatives spawned from their success. While his book is filled with sophisticated formulas and analysis, it is geared toward the average reader in search of an in depth understanding of these markets. Corb helps readers develop an intuition about these products and their use in the market, and he follows their manipulation into more complicated trades and structures. Through examples from financial and reverse engineering, he demonstrates how such products are created and how they can be deconstructed and analyzed effectively.

Table of Contents

Prefacep. xiii
Acknowledgmentsp. xvii
List of Abbreviationsp. xix
An Introduction to Swapsp. 1
Overviewp. 1
Swapsp. 3
Fixed-Floating Swapsp. 4
Basis Swapsp. 28
Cross-Currency Swapsp. 34
The Risk Characteristics and the Traditional Uses of Swapsp. 40
Interest Rate Riskp. 40
PV01p. 43
Spread Riskp. 48
A Closer Look at Swap Spreadsp. 50
Currency Riskp. 57
Counterparty Riskp. 58
Traditional Uses of Swapsp. 63
New Issue Hedgingp. 63
Asset Swapsp. 68
Balance Sheet Managementp. 70
The Pricing of Swapsp. 76
Where Do Swap Rates Come From?p. 76
The Link Between Swap Rates and Eurodollar Futuresp. 79
The Futures Convexity Biasp. 84
Moving On: Bootstrapping the Curve and Creating a Swap Modelp. 86
A Stylized Examplep. 89
PV01s in Our Stylized Examplep. 102
Moving On: Pricing Up Nonstandard Swapsp. 102
Mark-to-Marketsp. 104
Unwindsp. 111
Assignmentsp. 112
Forward Starting Swapsp. 113
Caps and Floorsp. 135
An Introduction to Caps and Floorsp. 135
Cap-Floor Parityp. 137
Uses of Caps and Floorsp. 138
An Embedded Cap Tradep. 140
Valuing Caps and Floorsp. 142
Volp. 144
Valuing Caps and Floors in Our Stylized Modelp. 147
Variations of Standard Caps and Floorsp. 150
Swaptionsp. 166
An Introduction to Swaptionsp. 166
The Value of Swaptions at Expirationp. 168
Swaption Parityp. 169
Uses of Swaptionsp. 170
Valuing Swaptions Using Black's Formulap. 172
Swaption Volp. 174
Pricing Swaptions in Our Stylized Examplep. 175
The Link Between Caps/Floors and Swaptionsp. 178
Questioning Black's Model for Interest Rate Optionsp. 180
Are Interest Rates Lognormal?p. 181
Swaption Prices and Implied Volp. 184
Skewp. 184
The Normal Modelp. 193
Backgroundp. 193
The Modelp. 194
Pricing Under the Normal Modelp. 195
Relationship Between Normal Implied Vol and Lognormal Implied Vol for At-the-Money Swaptionsp. 198
Explaining Skew: The Relationship Between Normal Implied Vol and Lognormal Implied Vol for Off-the-Money Swaptionsp. 205
The Normal Model: The Industry Standardp. 206
Other Models Used to Price Interest Plate Optionsp. 208
Bermudan Swaptionsp. 209
Optimal Exercise of Bermudan Swaptionsp. 211
Valuation of Bermudan Swaptionsp. 217
Swaps with Embedded Optionsp. 230
An Underlying Conceptp. 230
Cancelable Swapsp. 232
Some Uses of Cancelable Swapsp. 234
Solving for the Fixed Rate in Cancelable Swapsp. 235
Bermudan Cancelablesp. 242
Index Amortizing Swapsp. 248
An Explanation of the Tradep. 250
Pricing Index Amortizing Swapsp. 252
Relationship Between Index Amortizing Swaps and Cancelable Swapsp. 253
Knockout Swapsp. 256
Swaps with Convexity Adjustmentsp. 262
LIBOR in Arrears Swapsp. 262
CMS Swapsp. 273
Structured Notesp. 292
The Rise of the Structured Note Marketp. 294
A Glossary of Structured Notesp. 295
Size of the Marketp. 299
What Are Structured Notes?p. 300
In the Beginning … Floating Rate Notesp. 305
A Prime Floating Rate Notep. 305
Capped Floatersp. 308
An Example: Pricing Up a Capped Floaterp. 309
Inverse Floatersp. 310
An Example: Pricing Up a Leveraged Inverse Floaterp. 315
Orange Countyp. 321
Range Notesp. 324
LEANsp. 324
Binary Accrual Notesp. 326
Regulatory Responsep. 331
Non-Inversion Notesp. 332
The Pricing of Non-Inversion Notesp. 333
Relative Value and Macro Tradesp. 353
Carry and Roll-Down Analysisp. 354
Curve Tradesp. 361
Yield Curve Trades for Longer Holding Periodsp. 367
Forward Yield Curve Tradesp. 373
Conditional Yield Curve Tradesp. 376
Trading Swap Spreadsp. 382
Spread Trades for Longer Holding Periodsp. 385
Spread of Spread Tradesp. 387
Conditional Spread Tradesp. 389
Asset Swaps Revisitedp. 394
Asset Swap Mathp. 398
Asset Swaps Todayp. 400
More Recent Product Innovationsp. 414
An Introduction to Correlation Trades: Caps Versus Payer Reduxp. 415
Forward Vol Tradesp. 416
Preliminaryp. 417
Description of Forward Volp. 419
Heuristic Pricing of Forward Vol Tradesp. 421
Will the Forward Price Be Higher or Lower Than the Spot Price?p. 424
Are Forward Vol Trades Truly a Pure View on Vol?p. 425
Bermudan Cancelable Swaps Revisitedp. 426
Curve Optionsp. 427
Why Did Curve Options Come About?p. 430
Implied Correlationp. 433
Implied Volatility Versus Realized Volatilityp. 434
Supply and Demand of Curve Optionsp. 436
The Pricing of Curve Optionsp. 437
A Couple of Tradesp. 442
Delta Hedging Curve Optionsp. 450
So Why Did 30-Year Swap Spreads Go Negative - and What Does That Have to Do with Curve Options?p. 453
Appendixesp. 463
Refresher in Option Pricingp. 463
The Basicsp. 463
Boundaries on Option Pricesp. 468
European Put-Call Parityp. 474
Binomial Pricingp. 475
Multiperiod Extensionsp. 481
The Black-Scholes Formulap. 483
Option Sensitivitiesp. 488
Deltap. 488
Gammap. 492
Vegap. 497
Thetap. 499
Binary Optionsp. 500
Delta of Binary Optionsp. 503
Vega of Binary Optionsp. 508
Packagesp. 510
A Brief Review of Some Fixed Income Topicsp. 519
Present Valuep. 519
Durationp. 520
Macaulay Durationp. 520
Modified Durationp. 521
Effective Durationp. 522
A Closer Look at Day Count and Payment Conventions in Swapsp. 523
A Quick Look at Mortgagesp. 529
The Normal Modelp. 537
The Relationship Between LN and N for Swaptions that Are Struck At-the-Money Forwardp. 539
The Relationship Between LN and LN for Off-the-Money Swaptionsp. 541
Option Sensitivities Under the Normal Modelp. 543
Solutions to Selected Problemsp. 545
Bibliographyp. 585
Indexp. 589
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