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elearning > Interest rate swaps

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Learn about the following:

What interest rate swaps are and how they work. How dealers make (and lose) money with swaps. How swaps can be used to manage risk. The key risks with swaps. How these risks can be controlled.

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Course Summary

IRS menuIRS cash flowsIRS Value

IRS useIRS hedging useIRS risk

  • 45 minutes
  • 11 question multiple choice
  • What interest rate swaps are & how they work
  • How dealers make (and lose) money with swaps
  • How swaps can be used to manage risk
  • The key risks with swaps
  • How these risks can be controlled

Interest Rate Swaps

1. How interest rate swaps work

  • What dealers agree
  • Fixed and floating payments, example
  • Interest conventions
  • The swap rate, bid and offer, dealer’s screen
  • How much profit on a swap?
  • What affects the profit
  • How swap rates change
  • Making and losing money on swaps

2. Practical uses for swaps

  • Hedging a loan, advantages, disadvantages
  • Amortising swaps
  • Hedging a bond issue
  • All-in-cost, balance sheet management, advantages
  • Mortgage hedging, amortisation, pre-payments

3. Swaps and risk

  • Credit exposures, mark-to-market values
  • What affects the credit exposure, practical implication
  • Mitigation using collateral

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.


Payment RequiredMarket Guides > Gap reports-what they are 69% relevant

14th October 2009

Gap reports are frequently used in firms to show the extent of the interest rate risk that is being run. They are sometimes referred to as interest rate repricing reports. If you look at the assets (investments) and the liabilities (funding) in a bank or building society balance sheet it is most unlikely that they will all be on the same interest basis. Some assets and liabilities are floating or variable rate. This means they are linked to Libor or Base rate. Some assets and liabilities are fixed rate. As a result the balance sheet will have a mixture of fixed rate and floating rate interest payments and receipts. When this happens the firm is exposed to a type of market risk called interest rate risk. When interest rates change the value of the balance sheet can alter. It may work in your favour it may work against you. The main difficulty is the uncertainty you face and that's something you need to manage. A gap report measures this risk. Let's see how.