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SWAPS - Coggle Diagram

- - - - A fixed interest rate, also known as a fixed-rate, is an interest rate that remains constant throughout the specified period of a financial transaction or investment. In other words, it does not change over time, regardless of market interest rate fluctuations. Fixed interest rates are commonly used in various financial products, such as loans, bonds, and certain types of investments.
      - • A fixed interest rate is set at the beginning of a financial arrangement and remains the same for the entire duration of that arrangement. • This means that the borrower or investor knows exactly how much interest they will pay or earn over the life of the transaction, providing predictability and stability in cash flows.
    - - A floating rate, also known as a variable rate or adjustable rate, is an interest rate that can change periodically based on a reference benchmark or index. Floating rate adjusts to reflect current market conditions. Floating rates are commonly used in various financial products, such as adjustable-rate mortgages, floating-rate bonds, and certain types of loans.
      - Explanation: • A floating interest rate is not fixed but rather fluctuates in response to changes in a specified benchmark interest rate or index. • The rate adjustment typically occurs at predetermined intervals, such as monthly, quarterly, or annually. • Borrowers or investors with floating-rate products are exposed to changes in market interest rates, which can result in varying interest payments or returns.
    - - 1) A Basis Swap is a financial derivative contract in which two parties exchange cash flows based on different floating interest rates or benchmarks. It allows counterparties to capture the spread, or basis, between these two rates. In a Basis Swap: 1. One party pays a floating interest rate based on one benchmark rate (Floating Rate Leg 1). 2. The other party pays a floating interest rate based on a different benchmark rate, adjusted by a specified basis, often expressed in basis points (Floating Rate Leg 2).
      - Involves the exchange of a floating interest payment vs. a floating interest payment.
      - 2) The primary purpose of a Basis Swap is to manage or speculate on changes in the spread between two floating interest rates. It is a versatile financial instrument used for hedging interest rate risk, optimizing funding costs, taking advantage of market movements, and addressing specific financial objectives related to interest rate differentials.
  - - - Profit when Interest Rates Fall
      - Loss when Interest Rates Rise
    - - Loss when Interest Rates Rise
      - Loss when Interest Rates Fall
- - - - Credit Rating Downgrade: A credit rating downgrade event is triggered when a recognized credit rating agency (e.g., Moody's, S&P, Fitch) downgrades the credit rating of the reference obligation to a level specified in the CDS contract. The downgrade must typically meet certain criteria, such as a minimum rating threshold.
      - Restructuring: Restructuring events involve changes to the terms of the reference obligation that are adverse to the bondholders. This can include changes to the maturity, interest rate, or principal amount of the debt. Restructuring events can be complex and are typically defined in detail within the CDS contract.
      - Acceleration: Acceleration events occur when the terms of the reference obligation are altered in a way that accelerates the maturity of the debt. This often happens when a default or bankruptcy occurs, and bondholders demand full repayment.
      - Moratorium: A moratorium event is declared when the issuer of the reference obligation imposes a temporary halt or delay on payments to bondholders, typically during a financial crisis or when seeking to negotiate new terms.
      - Repudiation/Moratorium of Obligations: This event occurs when the issuer explicitly refuses to acknowledge or honor its debt obligations, even if payment has not yet been due.
      - Cessation of Payments: This event is triggered when the issuer stops making payments on its debt obligations, which may or may not be associated with a formal default.
      - Failure to Pay: This event occurs when the issuer fails to make a scheduled payment of principal or interest on the reference obligation, regardless of whether a formal default or bankruptcy has occurred. It is a broader event than default, encompassing situations where payment obligations are not met.
      - Default: Default is one of the most common credit events in CDS contracts. It occurs when the issuer of the reference obligation fails to make a scheduled interest or principal payment on the debt, violating the terms of the bond or loan agreement.
      - Bankruptcy: Bankruptcy is another significant credit event. It happens when the issuer files for bankruptcy protection, indicating its inability to meet its financial obligations. Bankruptcy can result in a significant loss for bondholders.
  - - - It considers the debt obligations of more than one company as its reference obligation.
    - - When the buyer of the protection does not hold the debt obligation. Typically he bets on a reference obligation, which he does not owns.
    - - It considers the debt obligation of only one company as its reference obligation.
- - - - The TRS specifies the reference asset or basket of assets whose total return is being exchanged. This asset can be a single stock, a bond, an equity index, a portfolio of securities, or other financial instruments.
    - - TRS is often used for risk transfer and management purposes. The receiver may want to gain exposure to an asset's performance or hedge against the risks associated with the asset, while the payer may seek to generate income from the asset without selling it.
    - - The payer (seller) in the TRS agrees to make regular payments to the receiver (buyer), which are typically calculated based on the total return of the referenced asset. The payment frequency can vary, such as monthly, quarterly, or annually.
    - - TRS contracts can be highly customized to meet the specific needs of the parties involved. They can specify factors such as the reference asset, notional amount, payment frequency, and any additional terms
    - - Like other swap contracts, TRS involves a notional principal amount that serves as the reference point for calculating cash flows and is not exchanged between the parties.
    - - As with all derivative contracts, TRS involves counterparty risk. If one party defaults on its payment obligations, it can lead to financial losses for the other party.
    - - The receiver of the TRS is entitled to the total return on the asset, which comprises capital gains or losses, interest income, dividend income, and any other economic benefits generated by the asset. This makes TRS different from traditional equity swaps, which may only involve capital gains or losses.
    - - The TRS agreement includes a termination date or maturity date, at which point the contract concludes, and any remaining obligations are settled.
    - - TRS allows one party (the "receiver" or "buyer") to gain exposure to the performance of a particular asset, typically without owning it. The other party (the "payer" or "seller") retains ownership of the asset.