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For the Thoroughbred horse racing champion, see: Swaps (horse).

Financial markets

Bond market Fixed income Corporate bond Government bond Municipal bond Bond valuation High-yield debt Swaps (March 1, 1952 - November, 1972) was a California bred American thoroughbred racehorse. ... This article does not cite any references or sources. ... Download high resolution version (480x640, 110 KB)Blockade in front of NYSE. Picture taken in April 2004. ... The bond market, also known as the debit, credit, or fixed income market, is a financial market where participants buy and sell debt securities usually in the form of bonds. ... This article does not cite any references or sources. ... A corporate bond is a bond issued by a corporation. ... A government bond is a bond issued by a national government denominated in the countrys own currency. ... In the United States, a municipal bond (or muni) is a bond issued by a state, city or other local government, or their agencies. ... Bond valuation is the process of determining the fair price of a bond. ... In finance, a high yield bond (non-investment grade bond, speculative grade bond or junk bond) is a bond that is rated below investment grade at the time of purchase. ...

Stock market Stock Preferred stock Common stock Registered share Voting share Stock exchange A stock market or (equity market) is a private or public market for the trading of company stock and derivatives of company stock at an agreed price; both of these are securities listed on a stock exchange as well as those only traded privately. ... For other uses, see Stock (disambiguation). ... Preferred stock, also called preferred shares or preference shares, is typically a higher ranking stock than voting shares, and its terms are negotiated between the corporation and the investor. ... Common stock, also referred to as common shares, are, as the name implies, the most usual and commonly held form of stock in a corporation. ...

Foreign exchange market The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. ...

Derivatives market Credit derivative Hybrid security Options Futures Forwards Swaps The derivatives markets are the financial markets for derivatives. ... // A credit derivative is a financial instrument or derivative (finance) whose price and value derives from the creditworthiness of the obligations of a third party, which is isolated and traded. ... Definition A hybrid security, as the name implies, is a security that combines two or more different financial instruments. ... This article is about options traded in financial markets. ... In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. ... A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. ...

Other Markets Commodity market Money market OTC market Real estate market Spot market Chicago Board of Trade Futures market Commodity markets are markets where raw or primary products are exchanged. ... This article is about short-term financing. ... Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. ... Real estate is a legal term that encompasses land along with anything permanently affixed to the land, such as buildings. ... Template:The Spot Market The Spot Market or Cash Marketis a commodities or securities market in which goods are sold for cash and delivered immediately. ...

Finance series Financial market Financial market participants Corporate finance Personal finance Public finance Banks and Banking Financial regulation The field of finance refers to the concepts of time, money and risk and how they are interelated. ... This article does not cite any references or sources. ... There are two basic financial market participant catagories, Investor vs. ... Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... -1... This article does not cite any references or sources. ... For other uses, see Bank (disambiguation). ... Financial supervision is government supervision of financial institutions by regulators. ...

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In finance, a swap is a derivative in which two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. Derivatives traders at the Chicago Board of Trade. ... A counterparty is a legal and financial term. ...

The cash flows are calculated over a notional principal amount, which is usually not exchanged between counterparties. Consequently, swaps can be used to create unfunded exposures to an underlying asset, since counterparties can earn the profit or loss from movements in price without having to post the notional amount in cash or collateral. In the context of an interest rate swap, the notional principal amount is the specified amount on which the exchanged interest payments are based; this may be in US dollars, or pounds sterling, or whatever currency the swap is based on. ...

Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on changes in the underlying prices. In finance, a hedge is an investment that is taken out specifically to reduce or cancel out the risk in another investment. ... Interest rate risk is the risk that the relative value of an interest-bearing asset, such as a loan or a bond, will worsen due to an interest rate increase. ... Speculation involves the buying, holding, and selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. ...

Structure

A swap is an agreement between two parties to exchange future cash flows according to a prearranged formula. They can be regarded as portfolios of forward contracts. The streams of cash flows are called “legs” of the swap. Usually at the time when contract is initiated at least one of these series of cash flows is determined by a random or uncertain variable such as interest rate, foreign exchange rate, equity price or commodity price.

Most swaps are traded Over The Counter (OTC), "tailor-made" for the counterparties. Some types of swaps are also exchanged on futures markets, for instance Chicago Mercantile Exchange Holdings Inc., the largest U.S. futures market, the Chicago Board Options Exchange and Frankfurt-based Eurex AG. David Swensen, a Yale Ph.D. at Salomon Brothers, engineered the first swap transaction according to "When Genius Failed: The Rise and Fall of Long-Term Capital Management" by Roger Lowenstein. Derivatives traders at the Chicago Board of Trade. ...

The five generic types of swaps, in order of their quantitative importance, are: interest rate swaps, currency swaps, credit swaps, commodity swaps and equity swaps.

The Bank for International Settlements (BIS) publishes statistics on the notional amounts outstanding in the OTC Derivatives market. At the end of 2006, this was USD 415.2 trillion, more than 8.5 times the 2006 gross world product. However, since the cash flow generated by a swap is equal to an interest rate times that notional amount, the cash flow generated from swaps is a substantial fraction of but much less than the gross world product -- which is also a cash-flow measure. The majority of this (USD 292.0 trillion) was due to interest rate swaps. These split by currency as: Tax rates around the world Tax revenue as % of GDP Economic policy Monetary policy Central bank   Money supply Gold standard Fiscal policy Spending   Deficit   Debt Policy-mix Trade policy Tariff   Trade agreement Finance Financial market Financial market participants Corporate   Personal Public   Regulation Banking Fractional-reserve Full-reserve   Free banking Islamic... Nominal or notional amounts outstanding are defined as the gross nominal or notional value of all deals concluded and not yet settled on the reporting date. ... The derivatives markets are the financial markets for derivatives. ... You may be looking for: list of countries by GDP (nominal) - list based on current currency market exchange rates list of countries by GDP (PPP) - list based on purchasing power parity This is a disambiguation page — a navigational aid which lists other pages that might otherwise share the same title. ... This article does not cite any references or sources. ... An interest rate swap is a derivative in which one party exchanges a stream of interest payments for another partys stream of cash flows. ...

Source: "The Global OTC Derivatives Market at end-December 2004", BIS, [1], "OTC Derivatives Market Activity in the Second Half of 2006", BIS, [2]

Usually, at least one of the legs has a rate that is variable. It can depend on a reference rate, the total return of a swap, an economic statistic, etc. The most important criterion is that it comes from an independent third party, to avoid any conflict of interest. For instance, LIBOR is published by the British Bankers Association, an independent trade body. For other uses, see Euro (disambiguation). ... USD redirects here. ... Japanese 10 yen coin (obverse) showing Phoenix Hall of Byodoin Yen is the currency used in Japan. ... GBP redirects here. ... ISO 4217 Code CHF User(s) Switzerland, Liechtenstein, Campione dItalia Inflation 1. ... A conflict of interest is a situation in which someone in a position of trust, such as a lawyer, a politician, or an executive or director of a corporation, has competing professional or personal interests. ... LIBOR stands for the London Interbank Offered Rate and is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale (or interbank) money market. ... The British Bankers Association (BBA) is a trade association, which represents banks and other financial services firms, either British or foreign owned, that operate in the United Kingdom. ...

Example

Take the case of a plain vanilla fixed-to-floating interest rate swap. Here party A makes periodic interest payments to party B based on a variable interest rate of LIBOR +50 basis points. An interest rate swap is a derivative in which one party exchanges a stream of interest payments for another partys stream of cash flows. ... LIBOR stands for the London Interbank Offered Rate and is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale (or interbank) money market. ... A basis point (often denoted as bp, bps or ; rarely, permyriad) is a unit that is equal to 1/100th of 1%. It is commonly used to denote the change in a financial instrument, or the difference (spread) between two interest rates; although it may be used in any case...

Party B in turn makes periodic interest payments based on a fixed rate of 3%. The payments are calculated over the notional amount. The first rate is called variable, because it is reset at the beginning of each interest calculation period to the then current reference rate, such as LIBOR. A reference rate is any publicly available quoted number or value that is used by the parties to a financial contract. ... LIBOR stands for the London Interbank Offered Rate and is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale (or interbank) money market. ...

Total return swap

Main article: total return swap

A total return swap is a swap in which party A pays the total return of an asset, and party B makes periodic interest payments. The total return is the capital gain or loss, plus any interest or dividend payments. Note that if the total return is negative, then party A receives this amount from party B. The parties have exposure to the return of the underlying stock or index, without having to hold the underlying assets. The profit or loss of party B is the same for him as actually owning the underlying asset. Total return swap, or TRS (especially in Europe), or total rate of return swap, or TRORS, is a contract in which one party receives interest payments on a reference asset, plus any capital gains and losses over the payment period, while the other receives a specified fixed or floating cash... This article is about the business definition. ... In finance, an underlying is an investment from which a derivative security is derived. ...

Total return swap (also known as total rate of return swap, or TRORS) is a contract in which one party receives interest payments on a reference asset plus any capital gains and losses over the payment period, while the other receives a specified fixed or floating cash flow unrelated to the credit worthiness of the reference asset, especially where the payments are based on the same notional amount. The reference asset may be any asset, index, or basket of assets.

The TRORS, then, allows one party to derive the economic benefit of owning an asset without putting that asset on its balance sheet, and allows the other (which does retain that asset on its balance sheet) to buy protection against a potential decline in its value.

The essential difference between a TRORS and a credit default swap is that the latter provides protection not against loss in asset value but against specific credit events. In a sense, a TRORS isn’t a credit derivative at all, in the sense that a credit default swap is. A TRORS is funding-cost arbitrage. A credit default swap (CDS) is a bilateral contract under which two counterparties agree to isolate and separately trade the credit risk of at least one third-party reference entity. ...

Equity Swap

Main article: equity swap

An equity swap is a special type of total return swap, where the underlying asset is a stock, a basket of stocks, or a stock index. Compared to actually owning the stock, in this case you do not have to pay anything up front, but you do not have any voting or other rights that stock holders do have. An equity swap, a branch of derivative security, is a swap in which at least one party pays the return on a stock or stock index. ...

Valuation

The value of a swap is the net present value (NPV) of all future cash flows. Initially, the terms of a swap contract are such that the NPV of all future cash flows is equal to zero. It has been suggested that this article or section be merged with Discounted cash flow. ... This article does not cite any references or sources. ...

For example, consider a plain vanilla fixed-to-floating interest rate swap where Party A pays a fixed rate, and Party B pays a floating rate. In such an agreement the fixed rate would be such that the present value of future fixed rate payments by Party A are equal to the present value of the expected future floating rate payments (i.e. the NPV is zero). Where this is not the case, an Arbitrageur, C, could: In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ...

1. assume the position with the lower present value of payments, and borrow funds equal to this present value
2. meet the cash flow obligations on the position by using the borrowed funds, and receive the corresponding payments - which have a higher present value
3. use the received payments to repay the debt on the borrowed funds
4. pocket the difference - where the difference between the present value of the loan and the present value of the inflows is the arbitrage profit.

See: Rational pricing; Arbitrage Rational pricing is the assumption in financial economics that asset prices (and hence asset pricing models) will reflect the arbitrage-free price of the asset as any deviation from this price will be arbitraged away. This assumption is useful in pricing fixed income securities, particularly bonds, and is fundamental to... In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ...

Variations

Variations of swaps include cross currency swaps, amortizing swaps and so on. A currency swap is a foreign exchange agreement between two parties to exchange a given amount of one currency for another and, after a specified period of time, to give back the original amounts swapped. ...

Interest Rate Swaps

The most common type of swaps is a “plain Vanilla” interest rate swap. It is the exchange of a fixed rate loan to a floating rate loan. The life of the swap can range from 2 years to over 15 years. The reason for this exchange is to take benefit from comparative advantage. Some companies may have comparative advantage in fixed rate markets while other companies have a comparative advantage in floating rate markets. When companies wanted to borrow they look for cheap borrowing i.e. from the market where they have comparative advantage. However this may lead to a company borrowing fixed when it wants floating or borrowing floating when it wants fixed. This is where a swap comes in. A swap has the effect of transforming a fixed rate loan into a floating rate loan or vice versa.

London Inter Bank Offer Rate (LIBOR)

LIBOR is the rate of interest offered by banks on deposit from other banks in euro currency market. One month LIBOR is the rate offered for 1-month deposits, 3-month LIBOR for three months deposits, etc. LIBOR rates are determined by trading between banks and change continuously as economic conditions change. Just prime rate of interest quoted in the domestic market, LIBOR is a reference rate of interest in the International Market.

Currency Swaps

The Currency Swap involves exchanging principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest payments on an equal loan in another currency. Just like interest rate swaps, the currency swaps also are motivated by comparative advantage.

Options

An option on a swap is called a swaption. To meet Wikipedias quality standards, this article or section may require cleanup. ...

References

• Financial Institutions Management, Saunders A. & Cornett M., McGraw-Hill Irwin 2006

See also

• Credit default swap
• Cross currency swap
• Equity swap
• Foreign exchange swap
• Constant maturity swap
• Yield curve
• Inter-Bank Swaps Brokers
• Variance swap
• Interest rate swap
• Total return swap

A credit default swap (CDS) is a bilateral contract under which two counterparties agree to isolate and separately trade the credit risk of at least one third-party reference entity. ... A currency swap is a foreign exchange agreement between two parties to exchange a given amount of one currency for another and, after a specified period of time, to give back the original amounts swapped. ... An equity swap, a branch of derivative security, is a swap in which at least one party pays the return on a stock or stock index. ... Forex swap is an over the counter short term interest rate derivative instrument. ... Constant Maturity Swaps are used in the financial markets to have a reference yield curve. ... The US dollar yield curve as of 9 February 2005. ... A variance swap is a financial derivative whose payoff is the realised volatility squared of the underlier based on a prespecified set of sampling points. ... An interest rate swap is a derivative in which one party exchanges a stream of interest payments for another partys stream of cash flows. ... Total return swap, or TRS (especially in Europe), or total rate of return swap, or TRORS, is a contract in which one party receives interest payments on a reference asset, plus any capital gains and losses over the payment period, while the other receives a specified fixed or floating cash...

External links

• swaps index, quantnotes.com
• swaps-rates.com, Interest swap rates statistics online
• Bank for International Settlements