Swap

Summaries

1. Price vs. Value

Price is just like the forward price in the forward contract (FR)

Value is V(t) as in the forward contract (So it can be +ve, value to long side, or –ve, value to short side)

(At the beginning, the value is zero to both parties)

 For example, in a swap in which one party pays fixed rate and receives floating rate, the fixed rate will be determined so that the present value is equal to the floating rate (pricing the contract). This fixed rate is called the swap rate. The value of the swap is zero to both parties.

2. Swap is just a series of off-market interest rate forward rate agreements (FRAs), which the expiration dates of the FRAs the same as the payment dates of the SWAP. Off market means they are not initialized to zero value at the beginning. But the overall series of FRAs does have a zero value initially.

Or

Swap is also a series of combined call/puts. For example, for a fix payer swap (you pay fixed rate), it is equivalent to long call and short put. The exercise price is the fixed rate.

3.

Interest Rate Swap (fixed rate payer: get paid with floating rate increases) – equivalent to selling fixed rate bond and invest in floating rate bond – To price the swap, find a fixed rate to equate the PV of the floating rate.

Equity Swap (fixed rate payer: get paid when equity appreciates): Borrow at fixed rate and invest in equity

Currency Swap (fixed rate payer: get paid when foreign currency appreciates): equivalent to issuing bonds at currency A (e.g. domestic), exchange to currency B at spot rate, and buy bonds at currency B with the same maturity and payments