# Tag Info

40

Garabedian, Typically, the "swap curve" refers to an x-y chart of par swap rates plotted against their time to maturity. This is typically called the "par swap curve." Your second question, "how it relates to the zero curve," is very complex in the post-crisis world. I think it's helpful to start the discussion with a government bond yield curve to ...

16

There are two parts to your question and I'd like to answer them separately. Curve Construction On a daily basis, you can observe prices on a large variety of instruments, whose prices are driven by news and trading flows. Based on market prices of these instruments, there are a number of ways to create discount curves/forward curves. At a very high level (...

16

I guess it depends on what they're referring to... The traditional swap curve (LIBOR-based) is certainly not risk free, as evidenced by the experience of the financial crisis and the resulting migration to OIS discounting. The OIS curve (which is a kind of swap curve...) is now the standard risk-free curve. The Treasury yield curve is not favored, because ...

12

I think your question can be split into two parts: (i) how to value a swap mathematically and (ii) how swaps actually work as a traded product. Part (i): As noob2 pointed out, "theoretically", a swap is valued with the help of two curves: one "forward" curve and one "discounting" curve. Say you want to "value" a 10-...

11

The reason why you can price a swap without a model is because you can replicate the payoff using only zero-coupon bonds. For the fixed leg this is trivial. For the floating leg, at $T_0$ invest $1$ at Libor, at $T_1$ you get $1/B(T_0,T_1) = 1 + \tau L(T_0,T_1)$, you pay the floating coupon $\tau L(T_0,T_1)$ reinvest $1$ at Libor etc... at $T_{n}$,...

11

A Basis swap is a broad category of swaps where you exchange one floating rate against another floating rate. Without knowing the specific rates involved it is difficult to say more. An OIS Swap is an Overnight Index Swap, where you exchange a fixed rate against an average of the overnight rates for the tenor of the swap. For example, if the ON rate is ...

10

The piece you are missing is an approximation via the Taylor formula of the logarithm: $$\ln(1+x) \approx x-\frac{x^2}{2} \; .$$ Apply this to the first term in the final formula of the technical paper: $$\frac{2}{T}\ln\frac{F_{0}}{S^{*}} = \frac{2}{T}\ln\left(1+\left(\frac{F_{0}}{S^{*}}-1\right)\right) \approx \frac{2}{T}\left(\left(\frac{F_{0}}{S^{*}}-1\... 9 Why does USD based security valuation have to give a thing about what London Banks think? Your question is based on false premises: the USD Libor is not determined by polling London based banks as you seem to believe, but banks on the London money market. The difference is important, as there are—of course—banks which are not based in London and active on ... 8 Firstly, understand that the 1y Libor is not useful here; the swap is 2 6-month periods, which will each fix on 6m Libor. These days, the *ibor fixings at different tenors are essentially separate, and 0x6 & 6x12 do not compound up to 0x12. So we have 6m fixing at 0.63006%, and a 1y swap at 0.645% mid. To do this properly, we would need a discounting ... 8 If you take Quantuple's stuff a little further, you can really see whether you're long skew. You can pretty easily see the dependence on convexity too (though it should be obvious that you're long convexity). So first off, we need some smile parametrisation that lets us easily control convexity and skew. I just went with a made up one;$$\mathrm{convexity} ...

8

An FX Swap can be described as "borrowing in one currency and lending in another". When put this way it is clear that it has something to do with interest rates in the two currencies. You will be very happy if the i.r. in the currency borrowed rises and the i.r. in the currency lent falls the day after you do the deal, because you will have locked in more ...

8

Let’s say the settlement period is T+2, and you made a deal on the 8/10/2018. The spot date would be 10/10/2018 (assuming no holidays!), that’s when the physical exchange would happen. Now if you don’t want physical delivery, then tomorrow (9/10/18) you can use T/N (tommorow/next) swap to delay the physical delivery by one day, T/N is essentially swap ...

7

The problem here is that your market is not arbitrage-free: JPY OIS = 10% per day, flat USD OIS = 0% per day, flat USDJPY spot = 100 USDJPY Forward for tomorrow = 100 A quick sense check is that, if you have an interest rate differential, you cannot have the FX forward equal to the spot FX. I would take advantage of the arbitrage as follows: I ...

7

A constant maturity swap (CMS) rate for a given tenor is referenced as a point on the Swap curve. A swap curve itself is a term structure wherein every point on the curve is the effective par swap rate for that tenor. This is analogous to a 3m LIBOR curve represents 3m forward rates for a given tenor. A swap rate can be considered as a weighted-average of ...

7

As I've mentioned in a comment, it would be wrong to think that entering a variance swap specifically amounts to being "long skew". What you can say however is that, in the absence of jumps (i.e. in a pure diffusion framework, see here and here for further info), the fair variance strike $K_{var}$ at which a variance swap with notional $N$ and payoff $$N ... 7 If I look at the market I think this is mainly driven by the very nature of the long end investors of the swap curve. Compared to govi curves the swap curves provides a much better liquidity in longer tenors. Although we have seen a trend of bringing longer dated bonds to the market by government, too. Austria and Belgium are just two examples of these and ... 7 I downvoted because I think the FED is very detailed in their documentation. The definition of a forward is a very basic financial question that a bit of google search can answer and not a quant question. Nonetheless, since your question is upvoted, others think differently. As the links you provided state: Breakeven is: 5-Year Treasury Constant Maturity ... 6 There are several ways to understand how to price a swap. One way is to see it as a sum of Forward Rate Agreements that you can price individually. This is more or less what Probilitator explained. A simpler way imho is this: if you are receiver of floatting leg the value of the swap at t\leq T_0$$ Swap_t = Leg_{Float,t} - Leg_{Fixed,t} $$I think ... 6 It is incorrect to use 1m euribor or O/N euribor in a 6m Euribor forward curve. You should only use instruments based on 6M euribor, such as 1x7 FRA, 6x12 FRA or swaps v 6m Euribor, as you have done in your second example. The actual 6m euribor fixing itself can be thought of as a 0x6 FRA out of spot. Before the financial crisis basis between different ... 6 There is no contradiction. If the strike of the floor and cap are both equal to the swap rate, and all accrual/payment frequencies, etc. are the same, then put-call partiy implies$$C_{t}-F_{t}=S_{t}, where $C_{t},F_{t},S_{t}$ are the values of the cap, floor and swap instruments at time $t$. Since the (theoretical Black-Scholes) volatility is ...

6

fixedLegBPS is the basis-point sensitivity of the fixed leg, that is, how much its NPV changes when the fixed rate changes by one basis point: it's calculated as the NPV corresponding to a fixed rate of 1 bps. Since the NPV of the fixed leg is linearly proportional to the fixed rate, you can write the equation targetNPV : fixedRate = BPS : 1 basis point ...

6

In simple terms: An ordinary swap might be a 10 year swap of Libor vs a fixed rate; this fixed rate is determined in the marketplace every day and is published by Reuters, Bloomberg etc. as the '10 year swap rate'. Once you enter into the swap this rate remains fixed for you, of course, that is why it is called a fixed rate. But every day Reuters publishes a ...

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At most banks, swaption traders have models that allow non atm volatilities to be controlled by two parameters. Specifically , a parameter to control the smile (richness of out of the money options) and the skew (whether implied vol is upward or downward sloping as a function of strike ). Look up papers on the SABR model. In practice, one would ...

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Better yet, don't use LIBOR for discounting at all. Since LIBOR involves credit spread over the risk free rate, using LIBOR for discounting would adjust the deal's market value to reflect some amount of credit risk. Hull and White argue it's not generally the best idea, since it would mean double-counting, as one also normally computes the CVA to handle ...

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The key inputs to this calculation are two yield curves obtained from market data: $\{v_i\}$ the discounting factors (value today of \$1 received at time i) and$\{r_i\}\$ the forecasting curve (forward semiannual rates for period i to i+1). The calculation itself proceeds as follows. There are two legs to a fixed/floating interest rate swap. The fixed leg,...

6

In Argentina (and a few other emerging markets), a cross-currency swap is somewhat liquid (much less so than in was before the most recent sovereign default). You can find someone to trade 2 year fixed ARS for floating USD (LIBOR; will probably be SOFR soon). 2 years ago you could easily find someone for 5 year fixed ARS for floating USD (LIBOR). The ARS ...

5

The importance here is that it actually does not matter in what time zone or market the libor rates are set. Key is that it is supposed (!!!) to be a gauge at what rate contributing banks could borrow funds at in the inter-bank market. Like you can go to any African country and borrow or lend US dollar, so can any Japanese, European, or American bank borrow ...

5

To explain it I will need some preliminaries. A forward starting payer swap (or receiver swap of the floating leg) is an instrument where the holder pays fixed and receives floating at some predetermined points in time in the future. (The payment/exhange dates of fixed and floating could differ - e.g. the fixed leg is paid annualy and the floating is paid ...

5

I have traded those convexity adjustments for many years. Any decent model of these adjustments allows the user to vary the correlation as they please, rather than assuming something. If it is of interest, the implied correlations usually trade significantly under 1, especially in periods when the curve is volatile. ie when forward rates might be going in ...

5

Swaps are used for hedging purposes against directional rates movements (insurance companies hold loads of fixed income instruments and are thus hugely exposed to overall rate levels, depending on holding period and portfolio turnover) and to insure against inflation (insurance firms receive fixed premium payments), to target portfolio duration This is ...

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