Thị trường tài chính và các định chế tài chính_ Chapter 15

Background cont’d  Amounts owed are typically netted out so that only the net payment is made  The market for swaps is facilitated by over-the-counter trading  Swaps are less standard

Chapter 15

Interest Rate Derivative Markets

Financial Markets and Institutions, 7e, Jeff Madura

Copyright ©2006 by South-Western, a division of Thomson Learning All rights reserved.

Chapter Outline

 Background

 Participation by financial institutions

 Types of interest rate swaps

 Risks of interest rate swaps

 Pricing interest rate swaps

 Factors affecting the performance of interest rate swaps

 Interest rate caps, floors, and collars

 Globalization of swap markets

party exchanges one set of interest payments for

another

 e.g., fixed-rate payments are exchanged for floating-rate

payments

 The notional principal

 The fixed interest rate

 The formula and type of index to determine the floating rate

 The frequency of payments

 The lifetime of the swap

Background (cont’d)

 Amounts owed are typically netted out so that only the net payment

is made

 The market for swaps is facilitated by over-the-counter trading

 Swaps are less standardized than other derivatives

 Swaps became popular in the early 1980s because of large

fluctuations in interest rates

 e.g., financial institutions traditionally had more interest rate-sensitive liabilities than assets and were adversely affected by rising interest rates

 e.g., some foreign financial institutions had access to long-term fixed rate funding but used funds primarily for floating rate loans

 By engaging in an interest rate swap, both institutions can reduce their exposure to interest rate risk (see next slide)

Background (cont’d)

payments to a European financial institution in exchange for floating-rate payments

 If interest rates rise, the U.S financial institution receives higher interest payments from the floating-rate portion, which helps to offset the rising cost of obtaining deposits

 If interest rates decline, the European institution provides lower interest payments in the swap, which helps to offset the lower interest payments received on its floating-rate loans

 The U.S institution forgoes the potential benefits from a decline

in interest rates

 The European institution forgoes the potential benefits from an increase in interest rates

Background (cont’d)

 A primary reason for the popularity of swaps is market imperfections

convenience encourages individual depositors to

place deposits locally

 Swaps are sometimes used for speculative

purposes

rising interest rates even if its operations are not

exposed to interest rate movements

Participation by Financial

Institutions

 Financial institutions that are exposed to interest rate movements commonly engage in swaps to reduce interest rate risk

 Some commercial banks and securities firms

serve as intermediaries by matching up firms

and facilitating the swap arrangements

 Some institutions act as dealers in swaps

position in order to serve a client

Participation by Financial

Institutions

Financial Institution Participation in Swap Market

Commercial banks  Engage in swaps to reduce interest rate risk

 Serve as an intermediary by matching up two parties in a swap

 Serve as a dealer by taking the counterparty position to accommodate a party the desires to engage in a swap

S&Ls and savings banks  Engage in swaps to reduce interest rate risk

Finance companies  Engage in swaps to reduce interest rate risk

Securities firms  Serve as an intermediary by matching up two parties in a swap

 Serve as a dealer by taking the counterparty position to accommodate a party that desires to engage in a swap Insurance companies  Engage in swaps to reduce interest rate risk

Pension funds  Engage in swaps to reduce interest rate risk

Types of Interest Rate Swaps

 Plain vanilla swaps

 In a plain vanilla swap (fixed-for-floating

swap), fixed-rate payments are periodically

exchanged for floating-rate payments

 Consider two scenarios:

Types of Interest Rate Swaps

(cont’d)

 Plain vanilla swaps (cont’d)

Rising Interest Rates Declining Interest Rates

Level of

Interest Payments

End of Year

Fixed Outflow Payments

Floating Inflow Payments

Fixed Outflow Payments

Floating Inflow Payments

Using A Plain Vanilla Swap

Bruny Bank has negotiated a plain vanilla swap in which it will exchange fixed payments of 8

percent for floating payments equal to LIBOR

plus 1 percent at the end of each of the next

four years Assume that the notional principal is

$100 million Fill in the table on the next slide

for the two scenarios of rising and falling

interest rates

.

12

Scenario 1 Year

Floating rate received 8.0% 8.5% 9.5% 10.5%

Floating rate received 7.5% 7.0% 6.0% 5.5%

Fixed rate paid 8.0% 8.0% 8.0% 8.0%

Net dollar amount received –$500K –$1M –$2M –$2.5M

Types of Interest Rate Swaps

(cont’d)

 Forward swaps

 A forward swap involves an exchange of

interest payments that does not begin until a specified future point in time

interest rate risk at a future point in time

the fixed rate on a swap beginning immediately

 Institutions may be able to negotiate a fixed rate today that is less than the expected fixed rate on a swap

negotiated in the future

Types of Interest Rate Swaps

(cont’d)

 A forward swap beginning in year 3:

Rising Interest Rates Declining Interest Rates

Level of

Interest Payments

End of Year

Fixed Outflow Payments

Floating Inflow Payments

Fixed Outflow Payments

Floating Inflow Payments

Types of Interest Rate Swaps

(cont’d)

 Callable swaps

 A callable swap provides the party making

the fixed payments with the right to terminate the swap prior to its maturity

future interest payments if it desires

 The fixed-rate payer pays a premium in the

form of a higher interest rate than without the call feature

 Callable swaps are an example of swaptions

Types of Interest Rate Swaps

(cont’d)

 A callable swap terminated in year 3:

Rising Interest Rates Declining Interest Rates

Level of

Interest Payments

End of Year

Fixed Outflow Payments

Floating Inflow Payments

Fixed Outflow Payments

Floating Inflow Payments

3

Types of Interest Rate Swaps

(cont’d)

 Putable Swaps

floating-rate payments with a right to terminate the

swap

 The floating-rate payer pays a premium in the form of a higher floating rate

 An extendable swap contains a feature that allows the

fixed-for-floating party to extend the swap period

 The terms of an extendable swap reflect a price paid for the extendability feature

Types of Interest Rate Swaps

(cont’d)

 A putable swap terminated in year 3:

Rising Interest Rates Declining Interest Rates

Level of

Interest Payments

End of Year

Fixed Outflow Payments

Floating Inflow Payments Fixed Outflow

Payments

Floating Inflow Payments

3

Types of Interest Rate Swaps

(cont’d)

 An extandable swap after year 8:

Rising Interest Rates Declining Interest Rates

Level of

Interest Payments

End of Year

Fixed Outflow Payments

Floating Inflow Payments Fixed Outflow

Payments

Floating Inflow Payments

8 Extend

8 Don’t Extend

Types of Interest Rate Swaps

would prefer to be the fixed-rate payer

would prefer to be the floating-rate payer

Floating Inflow Payments

Single Fixed Outflow Payment

Types of Interest Rate Swaps

(cont’d)

 A rate-capped swap involves the exchange of fixed-rate

payments for floating-rate payments that are capped

 The floating-rate payer pays an up-front fee for this feature

 The fixed-rate payer may allow the cap if it believes interest

rates will not exceed the cap and receives the up-front fee

 An equity swap involves the exchange of interest payments

linked to the degree of change in a stock index

 Appropriate for portfolio managers of insurance companies or pension funds that are managing stocks and bonds

Floating Inflow Payments Fixed Outflow

Payments

Floating Inflow Payments

Cap level

Types of Interest Rate Swaps

(cont’d)

 Other types of swaps

 Some swaps are combined with other transactions such as the issuance of bonds

 Corporate borrowers may be able to get a more attractive rate when using floating-rate debt

 Other corporate borrowers may prefer to borrow at a rate but find it advantageous to borrow at a fixed rate

floating- Financial intermediaries may match up participants and sometimes assume the default risk involved

Types of Interest Rate Swaps

(cont’d)

 Other types of swaps (cont’d)

 Tax advantage swaps

previous years can engage in a swap that calls for receipt of a large up-front payment with less

favorable terms over time

 Firms would realize an immediate gain and possible losses in future years

this year could engage in a swap requiring a large payment now and more favorable terms over time

Risks of Interest Rate Swaps

 Basis risk is the risk that the interest rate of the

index used for an interest rate swap will not

move perfectly in tandem with the floating-rate instruments of the parties involved in the swap

 Default risk is the risk that a firm involved in the swap will not meet its payment obligations

party will discontinue its payments

 Sovereign risk reflects potential adverse effects

resulting from a country’s political conditions

of the swap

Pricing Interest Rate Swaps

 Prevailing market interest rates

 The fixed rate in the swap is influenced by supply and demand

conditions for funds

 Generally, the interest rates of the swap reflect the prevailing interest rates at the time of the agreement

 Credit and sovereign risk

 e.g., a firm that desires a fixed-for-floating swap will require a lower fixed rate applied to its outflow payments if the credit risk or sovereign risk of the counterparty is high

Factors Affecting the Performance

of Interest Rate Swaps

movements

party’s swap position

 e.g., strong economic growth can increase rates, which is

beneficial for a party that is swapping fixed-rate payments for floating-rate payments but not for the counterparty

 Economic growth indicators

 Inflation indicators

 Indicators of government borrowing

Interest Rate Caps, Floors, and

Collars

 An interest rate cap offers payments in periods when a

specified interest rate index exceeds a specified ceiling (cap) interest rate

 Payments are based on the amount by which the interest rate exceeds the ceiling

 Typical purchasers are institutions that are adversely affected by rising interest rates

 The seller of an interest rate cap received an up-front fee and is obligated to provide period payments as needed

 Typical sellers are institutions that expect interest rates to

decline or remain stable

 Commercial banks and securities firms serve as dealers and/or brokers for interest rate caps

Using An Interest Rate Cap

Bungee Bank purchases a three-year cap for a fee of 3 percent of notional

principal valued at $50 million, with an interest rate ceiling of 10 percent

The agreement specified LIBOR to be used to represent the prevailing

market interest rate LIBOR is currently 8 percent and is expected to

increase by 1 percent in each of the next three years Fill in the table

Interest Rate Caps, Floors, and

Collars (cont’d)

 An interest rate floor offers payments when a specified interest

rate index falls below a specified floor rate

 Payments are based on the amount by which the interest rate falls below the floors rate

 Interest rate floors can be used to hedge against lower interest rates

 Sellers of interest rate floors receive an up-front fee and are

obligated to provide periodic payments as needed

 Commercial banks and securities firms serve as dealers and/or brokers for interest rate caps

Using An Interest Rate Floor

Purage Bank purchases a three-year floor for a fee of 3 percent of notional

principal valued at $50 million, with an interest rate floor of 8 percent The

agreement specified LIBOR to be used to represent the prevailing market

interest rate LIBOR is currently 6 percent and is expected to increase by

1 percent in each of the next three years Fill in the table below

.

End of Year

Using An Interest Rate Floor

(cont’d)

End of Year

Interest Rate Caps, Floors, and

Collars (cont’d)

 Interest rate collars

interest rate cap and the simultaneous sale of an

interest rate floor

 The fee received from selling the floor can be used to pay the fee for purchasing the cap

rates purchase collars

 If interest rates rise as expected and remain above the floor, the institution will not have to make payments

Globalization of Swap Markets

corporations from various counties that are exposed to interest rate risk engage in interest rate swaps

denominated in many different currencies

 Dollar-denominated swaps account for about half the value of all swaps outstanding

have a globalized network of subsidiaries

information about participants based in other countries

Globalization of Swap Markets

(cont’d)

 Currency swaps

currencies are exchanged at specified exchange rates and at specified intervals

 A combination of currency futures contracts

hedge their exposure to exchange rate fluctuations

 Currency swaps can be used in conjunction with bond issues

to hedge foreign cash flows

Globalization of Swap Markets

(cont’d)

 Risks of currency swaps

currency swap on the currency it is exposed to and uses a related currency instead

may default on its obligation

may restrict the convertibility of a particular currency