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Learn about the following:

How asset swaps work. Why investors use asset swaps. Par/par structures. The risks asset swaps produce.

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Course Summary

Asset Swaps 

  • How asset swaps work
  • Why investors use asset swaps
  • Par/par structures
  • The risks asset swaps produce 

35 minutes

8 question multiple choice test 

1. The asset swap structure

  • Combination of fixed rate bond and interest rate swap
  • Why investors do this
  • Minimising interest rate risk
  • Benefits, interest rate hedging, matching funding costs
  • Libor margin
  • Bond yield relative to swap rate 

2. Par/par structures

  • What they are
  • Why investors like this
  • Bonds at a premium and bonds at a discount to par
  • Up-front payments
  • Credit exposures 

3. Strengths & weaknesses

  • Enhanced returns
  • Credit risk on the asset
  • Liquidity of the asset
  • Liquidity of the swap
  • Structural complexity
  • Basis swaps
  • Counterparty credit exposure on swap 

4. Summary

5. Test

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20th September 2009

When two parties agree to enter an interest rate swap (IRS) one party pays a fixed rate of interest and the other a variable rate. The variable rate is often referenced to Libor or Euribor. The interest payments are based on a notional amount, (with IRS no principal amount changes hands). In the market there are conventions for calculating the interest payments. For example USD IRS use an annual actual 360 interest rate calculation for the fixed payment and a quarterly or semi annual actual 360 calculation for the floating payment. Maturities are normally between 2 and 20 years but it is possible to trade swaps that have maturities exceeding 50 years. Customers using swaps to hedge can expect a dealer to quote a dealing spread. The dealer will want to receive a higher fixed rate than the one they pay. It's one way the dealer makes money from trading. Dealers will insist before trading that the appropriate documentation is signed. For swaps standard documentation is provided by the International Swaps and Derivatives Association (ISDA). This document is called a master agreement. It covers all swaps between the two parties. Individual transactions are then agreed by confirmation which refers to the master agreement.