Interest rate swaps and other derivatives

Preface

Acknowledgments

List of Abbreviations

1. An Introduction to Swaps

1.1. Overview

1.2. Swaps

1.2.1. Fixed-Floating Swaps

1.2.2. Basis Swaps

1.2.3. Cross-Currency Swaps

2. The Risk Characteristics and the Traditional Uses of Swaps

2.1. Interest Rate Risk

2.1.1. PV01

2.2. Spread Risk

2.2.1. A Closer Look at Swap Spreads

2.3. Currency Risk

2.4. Counterparty Risk

2.5. Traditional Uses of Swaps

2.5.1. New Issue Hedging

2.5.2. Asset Swaps

2.5.3. Balance Sheet Management

3. The Pricing of Swaps

3.1. Where Do Swap Rates Come From?

3.1.1. The Link Between Swap Rates and Eurodollar Futures

3.1.2. The Futures Convexity Bias

3.2. Moving On: Bootstrapping the Curve and Creating a Swap Model

3.2.1. A Stylized Example

3.2.2. PV01s in Our Stylized Example

3.3. Moving On: Pricing Up Nonstandard Swaps

3.3.1. Mark-to-Markets

3.3.2. Unwinds

3.3.3. Assignments

3.3.4. Forward Starting Swaps

4. Caps and Floors

4.1. An Introduction to Caps and Floors

4.1.1. Cap-Floor Parity

4.1.2. Uses of Caps and Floors

4.1.3. An Embedded Cap Trade

4.1.4. Valuing Caps and Floors

4.1.5. Vol

4.1.6. Valuing Caps and Floors in Our Stylized Model

4.1.7. Variations of Standard Caps and Floors

5. Swaptions

5.1. An Introduction to Swaptions

5.1.1. The Value of Swaptions at Expiration

5.1.2. Swaption Parity

5.1.3. Uses of Swaptions

5.1.4. Valuing Swaptions Using Black's Formula

5.1.5. Swaption Vol

5.1.6. Pricing Swaptions in Our Stylized Example

5.2. The Link Between Caps/Floors and Swaptions

5.3. Questioning Black's Model for Interest Rate Options

5.3.1. Are Interest Rates Lognormal?

5.3.2. Swaption Prices and Implied Vol

5.3.3. Skew

5.4. The Normal Model

5.4.1. Background

5.4.2. The Model

5.4.3. Pricing Under the Normal Model

5.4.4. Relationship Between Normal Implied Vol and Lognormal Implied Vol for At-the-Money Swaptions

5.4.5. Explaining Skew: The Relationship Between Normal Implied Vol and Lognormal Implied Vol for Off-the-Money Swaptions

5.4.6. The Normal Model: The Industry Standard

5.5. Other Models Used to Price Interest Plate Options

5.6. Bermudan Swaptions

5.6.1. Optimal Exercise of Bermudan Swaptions

5.6.2. Valuation of Bermudan Swaptions

6. Swaps with Embedded Options

6.1. An Underlying Concept

6.2. Cancelable Swaps

6.2.1. Some Uses of Cancelable Swaps

6.2.2. Solving for the Fixed Rate in Cancelable Swaps

6.2.3. Bermudan Cancelables

6.3. Index Amortizing Swaps

6.3.1. An Explanation of the Trade

6.3.2. Pricing Index Amortizing Swaps

6.3.3. Relationship Between Index Amortizing Swaps and Cancelable Swaps

6.4. Knockout Swaps

6.5. Swaps with Convexity Adjustments

6.5.1. LIBOR in Arrears Swaps

6.5.2. CMS Swaps

7. Structured Notes

7.1. The Rise of the Structured Note Market

7.2. A Glossary of Structured Notes

7.3. Size of the Market

7.4. What Are Structured Notes?

7.5. In the Beginning … Floating Rate Notes

7.5.1. A Prime Floating Rate Note

7.6. Capped Floaters

7.6.1. An Example: Pricing Up a Capped Floater

7.7. Inverse Floaters

7.7.1. An Example: Pricing Up a Leveraged Inverse Floater

7.7.2. Orange County

7.8. Range Notes

7.8.1. LEANs

7.8.2. Binary Accrual Notes

7.9. Regulatory Response

7.10. Non-Inversion Notes

7.10.1. The Pricing of Non-Inversion Notes

8. Relative Value and Macro Trades

8.1. Carry and Roll-Down Analysis

8.2. Curve Trades

8.2.1. Yield Curve Trades for Longer Holding Periods

8.2.2. Forward Yield Curve Trades

8.2.3. Conditional Yield Curve Trades

8.3. Trading Swap Spreads

8.3.1. Spread Trades for Longer Holding Periods

8.3.2. Spread of Spread Trades

8.3.3. Conditional Spread Trades

8.4. Asset Swaps Revisited

8.4.1. Asset Swap Math

8.4.2. Asset Swaps Today

9. More Recent Product Innovations

9.1. An Introduction to Correlation Trades: Caps Versus Payer Redux

9.2. Forward Vol Trades

9.2.1. Preliminary

9.2.2. Description of Forward Vol

9.2.3. Heuristic Pricing of Forward Vol Trades

9.2.4. Will the Forward Price Be Higher or Lower Than the Spot Price?

9.2.5. Are Forward Vol Trades Truly a Pure View on Vol?

9.2.6. Bermudan Cancelable Swaps Revisited

9.3. Curve Options

9.3.1. Why Did Curve Options Come About?

9.3.2. Implied Correlation

9.3.3. Implied Volatility Versus Realized Volatility

9.3.4. Supply and Demand of Curve Options

9.3.5. The Pricing of Curve Options

9.3.6. A Couple of Trades

9.3.7. Delta Hedging Curve Options

9.3.8. So Why Did 30-Year Swap Spreads Go Negative and What Does That Have to Do with Curve Options?

Appendixes

A. Refresher in Option Pricing

A.1. The Basics

A.2. Boundaries on Option Prices

A.3. European Put-Call Parity

A.4. Binomial Pricing

A.4.1. Multiperiod Extensions

A.5. The Black-Scholes Formula

A.6. Option Sensitivities

A.6.1. Delta

A.6.2. Gamma

A.6.3. Vega

A.6.4. Theta

A.7. Binary Options

A.7.1. Delta of Binary Options

A.7.2. Vega of Binary Options

A.8. Packages

B. A Brief Review of Some Fixed Income Topics

B.1. Present Value

B.2. Duration

B.2.1. Macaulay Duration

B.2.2. Modified Duration

B.2.3. Effective Duration

C. A Closer Look at Day Count and Payment Conventions in Swaps

D. A Quick Look at Mortgages

E. The Normal Model

E.1. The Relationship Between σ_LN and σ_N for Swaptions that Are Struck At-the-Money Forward

E.2. The Relationship Between σ_LN and σ_LN for Off-the-Money Swaptions

E.3. Option Sensitivities Under the Normal Model

Solutions to Selected Problems

Bibliography

Index.