Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
25.1
Chapter 25
Swaps Revisited
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
25.2
Valuation of Swaps
? The standard approach is to assume
that forward rates will be realized
? This works for plain vanilla interest rate
and plain vanilla currency swaps,but
does not necessarily work for non-
standard swaps
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
25.3
Variations on Vanilla Interest
Rate Swaps
? Principal different on two sides
? Payment frequency different on two sides
? Can be floating for floating instead of floating
for fixed
? It is still correct to assume that forward rates
are realized
? How should a swap exchanging the 3-month
LIBOR for 3-month T-Bill rate be valued?
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
25.4
Compounding Swaps
? Interest is compounded instead of being paid
? Example,the fixed side is 6% compounded
forward at 6.3% while the floating side is
LIBOR plus 20 bps compounded forward at
LIBOR plus 10 bps.
? This type of compounding swap can be
valued using the,assume forward rates are
realized” rule,This is because we can enter
into a series of forward contracts that have
the effect of exchanging cash flows for their
values when forward rates are realized.
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
25.5
Currency Swaps
? Standard currency swaps can be valued
using the,assume forward LIBOR rate
are realized” rule.
? Sometimes banks make a small
adjustment because LIBOR in currency
A is exchanged for LIBOR plus a spread
in currency B
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
25.6
More Complex Swaps
– LIBOR-in-arrears swaps
– CMS and CMT swaps
– Differential swaps
To value these we assume that the
realized rate is the forward rate plus a
convexity adjustment
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
25.7
Equity Swaps
? Total return on an equity index is
exchanged periodically for a fixed or
floating return
? When the return on an equity index is
exchanged for LIBOR the value of the
swap is always zero immediately after a
payment,This can be used to value the
swap at other times.
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
25.8
Swaps with Embedded
Options
? Accrual swaps
? Cancelable swaps
? Cancelable compounding swaps
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
25.9
Other Swaps
? Indexed principal swap
? Commodity swap
? Volatility swap
? Bizzarre deals,for example the P&G
5/30 swap