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

1
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.
2
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
3
Background

An interest rate swap is an arrangement whereby one
party exchanges one set of interest payments for another


e.g., fixed-rate payments are exchanged for floating-rate
payments

The provisions of a swap include:

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
4
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)
5
Background (cont’d)

A U.S. financial institutions could send fixed-rate
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
6
Background (cont’d)


A primary reason for the popularity of swaps is
market imperfections

A lack of information about foreign institutions and
convenience encourages individual depositors to place
deposits locally

Swaps are sometimes used for speculative
purposes

e.g., a firm could engage in a swap to benefit from
rising interest rates even if its operations are not
exposed to interest rate movements
7
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

Charge fees and may provide credit guarantees

Some institutions act as dealers in swaps

The financial institution takes the counterparty position

in order to serve a client
8
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
9
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:

A consistent rise in market interest rates

A consistent decline in market interest rates
10
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
11
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
 
1 2 3 4
LIBOR 7.0% 7.5% 8.5% 9.5%
Floating rate received
       
Fixed rate paid
       
Swap differential
       
Net dollar amount received
       
Scenario 2 Year
  1 2 3 4
LIBOR 6.5% 6.0% 5.0% 4.5%
Floating rate received
       

Fixed rate paid
       
Swap differential
       
Net dollar amount received
       
13
Scenario 1 Year
 
1 2 3 4
LIBOR 7.0% 7.5% 8.5% 9.5%
Floating rate received 8.0% 8.5% 9.5% 10.5%
Fixed rate paid 8.0% 8.0% 8.0% 8.0%
Swap differential 0.0% 0.5% 1.5% 2.5%
Net dollar amount received $0 $500K $1.5M $2.5M
Scenario 2 Year
 
1 2 3 4
LIBOR 6.5% 6.0% 5.0% 4.5%
Floating rate received 7.5% 7.0% 6.0% 5.5%
Fixed rate paid 8.0% 8.0% 8.0% 8.0%
Swap differential –0.5% –1.0% –2.0% –2.5%
Net dollar amount received –$500K –$1M –$2M –$2.5M
14
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

Useful for institutions that expect to be exposed to
interest rate risk at a future point in time

The fixed rate on a forward swap may differ from
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
15
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
0 3 0 3