An option can be created for a forward contract. Recall that at contract initiation a forward will have a value of zero. European options on forwards will have the same price as European options on futures contracts; but American options on forwards will have a different price from American options on futures. The payoff values […]

# Derivatives Part 2

## Introduction to Swaps

Swaps are private over the counter agreements that are largely unregulated; swaps can be highly customized to meet the needs of the counterparties. A swap is a mutually agreed exchange of cash flows. A swap has an initial value of zero; with the passage of time and change of market conditions, the swap may have […]

## Plain Vanilla Interest Rate Swap

In an interest rate swap, two parties will agree to: term, fixed rate, floating rate benchmark (commonly LIBOR), notional principal, and payment frequency. The notional principal is not exchanged; rather it is used to calculate coupon payments. “Plain vanilla interest rate swap” specifically refers to a fixed-floating agreement; the term “interest rate swap” may refer […]

## Equity Swaps

An equity swap is a derivative contract in which two counterparties agree to exchange a set of their future cash flows on preset dates in the future. Structurally, equity swaps are very similar to plain vanilla interest rate swaps: there is a single notional principal and the structure is pay fixed/receive floating. One party’s payments […]

## Currency Swaps

Currency swaps have some key differences from interest rate swaps: There are two notional principal amounts; Each notional is in a different currency; The notionals are exchanged at the beginning of the swap and then again at the end of the swap. Periodic cash flow payments are made in different currencies. Currency Swap Steps: Initial […]

## Swap Pricing vs. Swap Valuing

Pricing: The determination of initial swap terms at the start of the swap’s life Interest Rate Swap Price = interest rate paid by fixed rate payer Valuing: Calculating the market value of a swap at any point in its life. A swap’s value at initiation is set to zero. Key Swap Valuation Concepts Analysts must […]

## Pricing and Valuing a Plain Vanilla Interest Rate Swap

The price of a plain vanilla interest rate swap is quoted as the fixed rate side; never forget that the value of a swap is not the same as the price. In order to find the appropriate fixed rate for the interest rate swap’s price, the swap can be viewed as a combination of bonds. […]

## Pricing and Valuing Currency Swaps

Four types of currency swaps exist: Pay one currency at a fixed rate, receive another currency fixed rate. Pay one currency at a fixed rate, receive another currency at a floating rate. Pay one currency at a floating rate, receive another currency at a fixed rate. Pay one currency at a floating rate, receive another […]

## Pricing and Valuing Equity Swaps

Three common types of equity swaps are: Pay Fixed Interest Rate, Receive Return on Equity Pay Floating Interest Rate, Receive Return on Equity Pay Return on One Equity, Receive Return on a Different Equity Pricing Equity Swaps The same formula used to find the fixed interest rate when pricing a plain vanilla interest rate swap […]

## Swaps as Theoretical Equivalents of Other Derivatives

Interest Rate Swaps as a Series of Forward Rate Agreements An interest rate swap can be recreated by a series of forward rate agreements (FRAs). A difference between an interest rate swap and a series of FRAs is that the swap will have a single fixed rate, but the forward contracts will be priced at […]