Derivatives Chapter 5

Question 1

Caps

Floors

Collars

Answer 1

Caps:

• OTC call option on an interest rate (calls profit as prices rise)
• Borrowers hedge using caps (use as hedge against a loan)

Floors:

• OTC put option on an interest rate (put profits as prices fall)
• Lenders hedge using floors

Collars:

• cap and floor combined

Question 2

Interest Rate Swaps:

Features

Plain Vanialla Swap(on exam)/Coupon Swap

Swaption

Basis Swap/Index Swap

Answer 2

Question 3

Asset Swap

Answer 3

package of an asset and a swap together

Example:

investor buys an FRN and transacts a swap to recieve a fixed rate and pay LIBOR (to create a synthetic fixed rate investment)

Question 4

Total Return Swap

Answer 4

creates exposure to the appreciation (or fall) in value, and the investment return from a specified asset/market

Question 5

Amortising

Accreting

Roller Coaster Swaps

Answer 5

Amortising: notional principal decreases over the life of the swap (e.g. matched against a loan paid back by instalments)

Accreting: notional principal increases (e.g. with increased borrowing requirements)

Roller Coaser: notional interest rises and falls (e.g. in line with seasonal borrowing requirements)

Question 6

Inflation Swaps

Answer 6

cash flows calculated by reference to an inflation index

Question 7

Constant Maturity Swaps (CMS) `

Answer 7

Interest rate swap where the rate is reset by reference to a swap market rate (rather than to LIBOR)

Question 8

Arrears Swaps

Answer 8

Interest rate swap where the floating rate is observed and paid at the end of the period

Question 9

Forward Start Swaps

Answer 9

Swap agreement transacted today, with an agreed future start date

Question 10

Overnight Index Swaps (OISs)

Answer 10

a fiexed/floating swap where the floating index is an overnight interest rate

Question 11

Market-to-Market Swap

Answer 11

settlements calculated by revaluing the swap

effect: same as closing out the existing swap and putting a new swap in place

Question 12

Commodity Swap

Answer 12

swaps a fixed (pre-agreed) commodity price for a floating (market) price

Question 13

Equity (volatility) Swap

Answer 13

payments on one or both sides linked to the performance of equities or an equity index

Question 14

Credit Default Swaps

Answer 14

provide protection against/compensation for ‘credit events’

credit events:

• default
• bankrupcy
• signiicant fall in an asset’s value
• debt restructuring

Question 15

Master Agreements

features

Answer 15

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Features:

• negotiated between trading parties based on a standard printed contract
• legally binding once signed
• important issues covered: termination events, default events, netting

Question 16

Collateral Management

Answer 16

• banks may ask for collateral as security against credit risk
• ‘margining’ keeps the amoung of collateral in excess of perceived credit risk
• margin calls may be made daily, weekly, or monthly

Question 17

MarkitSERV

Answer 17

• Combines MarketWire and the DTCC’s trade confirmation platform to provide a single gateway for OTC derivative trade processing.
• connects market participants and execution venues to downstream processing platforms
• owned by DTCC

Question 18

The Depositary Trust & Clearing Corporation (DTCC)

Answer 18

• provides a matching service (‘Deriv/SERV’) for OTC derivatives, used in post trade processing

Question 19

SWIFTNet FpML

Answer 19

• a financial industry co-operative payment sustem
• allows users to send secure messages, PTC trade confirmations and advice

Question 20

Financiel Products Markup Language (FpML)

Answer 20

• industry standard protocol developed for dealing and processing OTC derivatives communications
• provides standard data content and structure

Question 21

NEX TriOptima

Answer 21

• software product that helps clients redice capital, credit and operational costs associated with OTC derivatives portfolios

Question 22

SwapClear

Answer 22

• provides clearing for basic interest rate swaps

Question 23

EurexOTC Clear

Answer 23

• Transaction management service for OTC swaps, facilitation capital managment and clearing

Question 24

ICE Link

Answer 24

• Credit derivatives trade matching and processing service