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Interest-rate swaps (Fixed-for-floating swaps (users of swaps (Companies…
Interest-rate swaps
Fixed-for-floating swaps
main swap instrument (plain vanilla swap) arranged by swap dealers on OTC basis, no secondary market.
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Swap payments
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Swap establishes additional set of payment obligations that hs the effect of changing interest rate exposure of both parties. Payments - swap rate (fixed rate) & BBSW (floating interest rate)
Swap rate
Swap dealers
Swaps are mainly arranged by swap dealers whoa re counterparts to each borrowers swap contract - reduces search costs.to avoid an open position a dealer tries to balance the aggregate amounts of paying & receiving swap counterparts
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Default risk
swap party that is due to receive the swap payment faces the paying party's default risk. Dealer may require swap party to post collateral against future expected swap payments
Comparative advantage
Swaps enable borrowers to have comparative advantages - exit when spread between 2 borrowers interest rates differs in fixed & floating rate markets.
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Swap rate
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PV of fixed rate payments = PV of expected floating rate payments. Swap rate must equalise these payments.
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