interest rate swap

The Global Money Markets
by Frank J. Fabozzi , Steven V. Mann and Moorad Choudhry
Published 14 Jul 2002

Consequently, interest rate swaps can be viewed as a package of more basic interest rate derivative instruments—forwards. The pricing of an interest rate swap will then depend on the price of a package of forward contracts with the same settlement dates in which the underlying for the forward contract is the same reference rate. While an interest rate swap may be nothing more than a package of forward contracts, it is not a redundant contract for several reasons. First, maturities for forward or futures contracts do not extend out as far as those of an interest rate swap; an interest rate swap with a term of 15 years or longer can be obtained.

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Namely, both swaps and caps/floors are combinations of more basic derivative instruments. A swap is a portfolio of forward contracts; caps/floors are portfolios of options on interest rates. The most prevalent swap contract is an interest rate swap. An interest rate swap contract provides a vehicle for market participants to transform the nature of cash flows and the interest rate exposure of a portfolio or balance sheet. In this chapter, we explain how to analyze interest rate swaps. We will describe a generic interest rate swap, the parties to a swap, the risk and return of a swap, and the economic interpretation of a swap. Then we look at how to compute the floating-rate payments and calculate the present value of these payments.

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First, maturities for forward or futures contracts do not extend out as far as those of an interest rate swap; an interest rate swap with a term of 15 years or longer can be obtained. Second, an interest rate swap is a more transactionally efficient instrument. By this we mean that in one transaction an entity can effectively establish a payoff equivalent to a package of forward contracts. The forward contracts would each have to be negotiated separately. Third, the interest rate swap market has grown in liquidity since its establishment in 1981; interest rate swaps now provide more liquidity than forward contracts, particularly long-dated (i.e., long-term) forward contracts. Package of Cash Market Instruments To understand why a swap can also be interpreted as a package of cash market instruments, consider an investor who enters into the transaction below: ■ buy $50 million par value of a 5-year floating-rate bond that pays 6- month LIBOR every six months ■ finance the purchase by borrowing $50 million for five years at a 10% annual interest rate paid every six months.

Stigum's Money Market, 4E
by Marcia Stigum and Anthony Crescenzi
Published 9 Feb 2007

Many use the swap rate curve as a benchmark, in part because of the transparency of swap rates. Another reason is the dual nature of the risks associated with interest-rate swaps.13 We note below the “riskless” nature of interest-rate swaps given the strong credit quality of the counterparties and netting practices, and because there is no principal to default on. Standing in contrast, another key characteristic of interest-rate swaps is that they are tied to a rate not considered risk-free—LIBOR. Having dual elements of safety and hedging capability gives the interest-rate swaps market appeal. Moreover, with swaps tied closely to LIBOR, they have additional appeal, since the Financial Accounting Standards Board has given LIBOR status as an acceptable benchmark. 13 Joseph G.

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We did this very much on a matched-book basis, turning medium-term, fixed-rate liabilities into medium-term, floating-rate liabilities. From there, we developed into an outright trader of interest-rate swaps. The next step was that we began to use interest-rate swaps in much the same way that a traditional asset-liability manager would use Treasuries. When we were constructive on the market, convinced that rates would come down, we would not only buy Treasuries, but start doing swaps in which we were receivers of fixed. “That is where we started, and certainly the majority of the top 100 banks in the world are at that level of sophistication now. They use interest-rate swaps not only to match up assets and liabilities, but as a tool for gapping: instead of putting medium-term Treasuries on the balance sheet, they now use swaps as an off–balance sheet way to acquire a fixed-rate, term asset.”

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There are varying reasons for the rate disparities, but researchers find that studies showing a differentiation between Eurodollar and fed funds rates sometimes fail to isolate other factors that affect the spread. CHAPTER 19 Interest-Rate Swaps Copyright © 2007, 1990, 1983, 1978 by The McGraw-Hill Companies, Inc. Click here for terms of use. An interest-rate swap is a contract between two parties to pay and receive, with a set frequency, interest payments determined by applying the differential between two interest rates—for example, 5-year fixed and 6-month LIBOR—to an agreed-upon notional principal. Put more intuitively, an interest-rate swap is a trade that produces, over time, the same cash flows that would be produced if party A were to say to party B, “You and I have different liabilities with the same maturity—let’s swap,” and the swap were done.

Derivatives Markets
by David Goldenberg
Published 2 Mar 2016

Futures Contracts 7.5.8 Cross-Hedging, Adjusting the Hedge for non S&P 500 Portfolios 7.6 The Spot Eurodollar Market 7.6.1 Spot 3-month Eurodollar Time Deposits 7.6.2 Spot Eurodollar Market Trading Terminology 7.6.3 LIBOR3, LIBID3, and Fed Funds 7.6.4 How Eurodollar Time Deposits are Created 7.7 Eurodollar Futures 7.7.1 Contract Specifications 7.7.2 The Quote Mechanism, Eurodollar Futures 7.7.3 Forced Convergence and Cash Settlement 7.7.4 How Profits and Losses are Calculated on Open ED Futures Positions PART 2 Trading Structures Based on Forward Contracts CHAPTER 8 STRUCTURED PRODUCTS, INTEREST-RATE SWAPS 8.1 Swaps as Strips of Forward Contracts 8.1.1 Commodity Forward Contracts as Single Period Swaps 8.1.2 Strips of Forward Contracts 8.2 Basic Terminology for Interest-Rate Swaps: Paying Fixed and Receiving Floating 8.2.1 Paying Fixed in an IRD (Making Fixed Payments) 8.2.2 Receiving Variable in an IRD (Receiving Floating Payments) 8.2.3 Eurodollar Futures Strips 8.3 Non-Dealer Intermediated Plain Vanilla Interest-Rate Swaps 8.4 Dealer Intermediated Plain Vanilla Interest-Rate Swaps 8.4.1 An Example 8.4.2 Plain Vanilla Interest-Rate Swaps as Hedge Vehicles 8.4.3 Arbitraging the Swaps Market 8.5 Swaps: More Terminology and Examples 8.6 The Dealer’s Problem: Finding the Other Side to the Swap 8.7 Are Swaps a Zero Sum Game?

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PART 2 Trading Structures Based on Forward Contracts CHAPTER 8 STRUCTURED PRODUCTS, INTEREST-RATE SWAPS 8.1 Swaps as Strips of Forward Contracts 8.1.1 Commodity Forward Contracts as Single Period Swaps 8.1.2 Strips of Forward Contracts 8.2 Basic Terminology for Interest-Rate Swaps: Paying Fixed and Receiving Floating 8.2.1 Paying Fixed in an IRD (Making Fixed Payments) 8.2.2 Receiving Variable in an IRD (Receiving Floating Payments) 8.2.3 Eurodollar Futures Strips 8.3 Non-Dealer Intermediated Plain Vanilla Interest-Rate Swaps 8.4 Dealer Intermediated Plain Vanilla Interest-Rate Swaps 8.4.1 An Example 8.4.2 Plain Vanilla Interest-Rate Swaps as Hedge Vehicles 8.4.3 Arbitraging the Swaps Market 8.5 Swaps: More Terminology and Examples 8.6 The Dealer’s Problem: Finding the Other Side to the Swap 8.7 Are Swaps a Zero Sum Game?

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224; bank borrowing in spot Eurodollar (ED) market 250; ‘buying’ and ‘selling’ Eurodollar (ED) futures 256; calculation of adjusted hedge ratios 245; solution to 269; calculation of optimal (risk-minimizing) hedge ratio 240; cash settlement and effective price on S&P 500 spot index units 234; solution to 269; exchange rate risk, currency positions and 218; solution to 268; foreign exchange (FX) risk and jet fuel market 219; solution to 268–9; underlying spot 3-month Eurodollar (ED) time deposit 261; solution to 270; contract month listings 214, 215, 228; contract offerings 227–8; contract size 214, 215, 227, 228; contracts offered 257–8; currency forward positions vs. currency futures positions 220; currency futures 213–17; contract specifications 213–15; pricing vs. currency forward pricing 225; quote mechanism, future price quotes 216–17; risk management strategies using 217–24; daily price limits 228, 229; daily settlements 216, 260; diversifiable risk 225; dividend-adjusted geometric mean (for S&P 500) 227; dollar equivalency 227, 234, 239–40; economy-wide factors, risk and 225–6; effective payoff 220, 233; EFP eligibility 214; Eurodollar (ED) deposit creation 253; Eurodollar (ED) futures 220–1, 245, 246, 249, 250, 252–64; cash settlement, forced convergence and 258–61; contract specifications 254–5; forced convergence, cash settlement and 258–61; open positions, calculation of profits and losses on 262–4; quote mechanism 256–8; exchange rate risks and currency futures positions 217–20; Lufthansa example 217–20; exchange rule 214, 228; exchange-traded funds (ETFs) 226; exercises for learning development 266–8; Fed Funds Rate (FFR) 251; Federal Funds (FF) 249–50, 251, 252; Federal Reserve system (US) 249; financial futures contracts, selection of 213; FLIBOR (Futures LIBOR) 256, 257, 262, 263, 264, 267–8; forced conversion of Eurodollar (ED) futures 260; foreign exchange (FX) reserves, currency composition of 247–8; forward price change, present value of 242; hedging 224–5; hedging a cross hedge 244; issues in 224–5; quantity uncertainty 224–5; holding period rate of return 237; idiosyncratic risk 225; index points 226; interest rate derivatives (IRDs) 254; International Monetary Fund (IMF) 246; JPY/USD futures 213–15; key concepts 265–6; last trade date/time view calendar 214, 228; lending (offering) Eurodollars (EDs) 249–50; liabilities, Eurodollars (EDs) and 246; LIBID (London Interbank Bid Rate) 249–50, 252; LIBOR (London Interbank Offered Rate) 249, 250–4, 262, 263–4; Federal Funds (FF) vs. 251–2; liquidity and 220, 222, 231, 237, 252, 258; lock-in characteristics 220, 233; market risk 225–6; minimum price increment 214, 215; naive hedge ratio (NHR) 234, 240–1, 243; open interest 258; placing Eurodollars (EDs) 248–9; position accountability 214, 215, 228, 229; raw price change, present value of 243; realized daily cash flows, creation of 243; risk management strategies using currency futures 217–24; risk management using stock index futures 231–45; cross-hedging 243–5; monetizing S&P 500 Spot Index 231–4; naive hedge ratio, adjustment for risk-minimizing hedge ratio 239–41; non S&P 500 portfolios, adjustment of hedge for 243–5; pricing and hedging preliminaries 231; profits from traditional hedge 235–6; risk, return analysis of traditional hedge 236–8; risk minimizing hedge using forward vs. futures contracts 241–3; risk-minimizing hedging 238–9; rolling hedge strategy: efficient market hypothesis (EMH) 223; interpretations of profits from rolling hedge 221–3; Metallgesellschaft example 223; numerical example of 223–4; rule book chapter 228; settlement procedure 214, 228, 229, 258–9; S&P 500 Fact Sheet 226; S&P 500 Futures 228; spot commodities, S&P 500 futures contracts as 233–4; spot Eurodollar market 245–54; Eurodollar time deposits, creation of 252–4; spot 3-month Eurodollar time deposits 246–8; spot trading terminology 248–50; Stigum’s Money Market (Stigum, M.) 252; stock index futures 225–30; commentary 230; S&P 500 futures quotes, quote mechanism for 230; S&P 500 Spot Index 225–7; S&P 500 Spot Index, effective payoff on monetization of 233; S&P 500 Spot Index, monetization of 231–4; S&P 500 Stock Index Futures Contract Specifications 227–9; tailing the hedge 241–2; taking Eurodollars (EDs) 249; ticker symbol 214, 215, 228, 229, 261; timing in Eurodollar (ED) futures 257; tick size 228, 229; trading hours 214, 228; traditional hedge, risk and return analysis on 236–8; basis risk 238; holding period rate 237; intermediate execution, basis risk and 237–8; liquidity advantage in execution 237; unallocated foreign exchange (FX) reserves 248 financial innovation using European Put-Call Parity 401–5; American Put-Call Parity (no dividends) 403–5; generalized forward contracts 401–3 financial institutions and use of swaps 299–301 finite-maturity financial instruments, options as 20, 354 fixed leg in interest-rate swaps 293 fixed payments in interest-rate swaps 278–9 fixed-rate mortgages 7 FLIBOR (Futures LIBOR): financial futures contracts 256, 257, 262, 263, 264, 267–8; interest-rate swaps 278, 287 floating leg in interest-rate swaps 293 floating payments in interest-rate swaps 279–80 floating-rate bond implicit in swap 306 floating-rate payments as expected cash flows 306 floor-brokers 140 floor-traders 140 foreign currencies: forward prices on 24–5; futures prices on 25–6; see also currency futures foreign economy (FE) 103–4 foreign exchange (FX) forward contracts: example of pricing 107–9; pricing using no-arbitrage 106–7 foreign exchange (FX) markets, price quotes in 103–5 foreign exchange (FX) rates (New York, March 11, 2014) 30–1 foreign exchange (FX) reserves, currency composition of 247–8 foreign exchange (FX) risk 3–5 forward contracts: differences between futures contracts and 122; on dividend-paying stocks, pricing with no-arbitrage 100–3; hedging with 37, 43–5; on stocks with dividend yield, pricing with net interest model 99–100; swaps as strips of 274–8; valuation of (assets without dividend yield): default on 76; interpretation via synthetic contracts 78–82; leverage and 80–2; no up-front payments on 75; payment on maturity, expectation of 81; price vs. value for 73; valuing at expiration 74–5; valuing at initiation 75–8 forward market contracting: buying forward 7–8; Clearing House intermediation 14–15; concept checks: controlling for counterparty risk 12–13; exploration of forward rates in long-term mortgage market 9–10; exploration of spot rates in long-term mortgage market 11; solution 29; intermediation by Clearing House 15–16; solution 29–30; spot markets, dealing with price quotes in 6–7; counterparty risk 11; default 11–12; exit mechanism 15–16; features of 8; fixed-rate mortgages 7; forward agreement, terms of 8; forward contracts, differences between futures contracts and 122; forward market 8; forward prices 9, 24–5; forward transactions 8; historical data, checking on 9–10; interest-rate risk management 9–10; intermediation 13–14, 14–15; liquidity, enablement of 16; locked-in prices 12; market levels 11; market organization, importance of 13, 14; obligations, transfer of 16; offsetting trades 15–16; overnight averages 11; price quotes in forward markets 9–11; problems with forward markets 11–13; ‘reversing’ of trades 15–16; short positions 7; SouthWest Airlines, case example 12–13; spot, forward, and futures contracting 7–13; standardization 14; transfer of obligations 16; see also hedging with forward contracts; valuation of forward contracts forward prices 9, 24–5; change in, present value of 242; no-arbitrage, forward pricing with 102–3 front stub period 294 fundamental theorem of asset pricing number one (FTAP1): equivalent martingale measures (EMMs) 509, 511–12, 517, 528–9, 530, 532, 533; model-based option pricing (MBOP) 450, 451, 452; option pricing in continuous time 540; risk-neutral valuation 596–7, 601–2, 605, 606, 624, 631 fundamental theorem of asset pricing number two (FTAP2): binomial option pricing model (BOPM) 490; model-based option pricing (MBOP) 452; option pricing in continuous time 540; risk-neutral valuation 596–7, 601–2, 605, 606, 624, 631; risk-neutral valuation and another version of 606 future value (FV) 69–70, 382, 386, 390, 395 Futures Commission Merchant (FCM) 122, 123, 124, 125, 137, 140 futures contracts: futures market contracting 17; market organization for: ‘buying’ and ‘selling’ of 126–7; daily value of 146; differences between forward contracts and 122; futures price and 127; market participants 122–5 futures market contracting 17–26; concept check, price quotes in futures markets 19; contract size 19; contract specifications 17, 18–19; delivery dates 19; fancy forward prices 19, 25; futures contract 17; futures market 17; futures prices 17, 25–6; futures transaction 17; key definition, futures contract 17; mapping out spot, forward, and futures prices 20–6; ‘Open Outcry Futures’ 19; price quotes in futures markets 17–19; seller’s options 17; as solution to forward market problems 13–16; volatility (uncertainty) 22; see also hedging with futures contracts; market organization for futures contracts futures trading: hedging with forward contracts 35; market organization for futures contracts: cash flow implications of 144; daily settlement, perspectives on 144; delivery obligations 142; offsetting trades 142–4; phases of 125–6 gap management problem, solutions for 300–1 Gaussian distributions 543, 546, 548, 557, 565, 577 general equilibrium (GE) 453; models of, risk-neutral valuation and 615 generalized forward price 402 geometric Brownian motion (GBM) 553–61; continuous version 559–61; discrete version 553–9 Girsanov’s theorem 605 Globex and Globex LOB 134–6 Globex trades, rule for recording of 135 Gold pricing on London Bullion Market 20–3 guaranteeing futures obligations 139–41 hedge ratio: dollar bond position and 478; model-based option pricing (MBOP) and 455 hedging: financial futures contracts 224–5; hedging a cross hedge 244; issues in 224–5; quantity uncertainty 224–5; hedged position profits, graphical method for finding 55; hedgers 37; hedging definitions 168; minimum variance hedging 185–8; estimation of risk minimization hedge ratio 187–8; OLS regression 187–8; risk minimization hedge ratio, derivation of 186–7; motivation for hedging with forward contracts 33–7; objective of 167–8; as portfolio theory 165–8; reverse hedge 618, 620, 621; riskless hedge 607, 616, 620, 628, 632; rolling hedge strategy: efficient market hypothesis (EMH) 223; interpretations of profits from rolling hedge 221–3; Metallgesellschaft example 223; numerical example of 223–4; short hedge 168; synthesis of negative correlation, hedging as 165–7 hedging a European call option in BOPM (N=2) 477–85; complete hedging program (for BOPM, N=2) 484–5; concept check, value confirmation 485; hedge ratio and dollar bond position, definition of (step 2) 478; parameterization (step 1) 477–8; replicating portfolio, construction of (step 3) 478–84; concept check: interpretation of hedge ratio 482; down state, replication in 481; hedge ratio, interpretation of 482–3; replication over period 2 (under scenario 1) 479–82; replication under scenario 2 (over period 2) 484; scenarios 478–9; solving equations for ?

Risk Management in Trading
by Davis Edwards
Published 10 Jul 2014

(See Figure 3.18, Interest Rate Interpolation.) 92 RISK MANAGEMENT IN TRADING T Rate Source 0.0028 0.0833 0.25 0.50 1 2 3 4 5 7 10 30 0.06% 0.22% 0.28% 0.42% 0.32% 0.47% 0.79% 1.18% 1.57% 2.19% 2.79% 3.67% Fed Funds Eurodollar Deposit Eurodollar Deposit Eurodollar Deposit Libor (Interest Rate Swap) Libor (Interest Rate Swap) Libor (Interest Rate Swap) Libor (Interest Rate Swap) Libor (Interest Rate Swap) Libor (Interest Rate Swap) Libor (Interest Rate Swap) Libor (Interest Rate Swap) Interest Rate Interest Rate Interpolation 4.00% 3.00% 2.00% 1.00% 0.00% 0 5 10 15 20 25 30 35 Tenor (years) Observations FIGURE 3.18 Interpolated Interest Rates TEST YOUR KNOWLEDGE 1.

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* Terms can be customized * Limited ability to customize terms * Liquidating the trade can be difficult * Liquidating the trade is relatively easy * Each party is exposed to risk the counterparty won’ t meet their obligations. * Counterparty risk is largely eliminated because exchange is high credit quality counterparty. FIGURE 2.6 Forwards versus Futures INTEREST RATE SWAPS An interest rate swap is a financial derivative that allows traders to exchange a series of fixed and floating rate cash flows. In the most common type of interest rate swap, one trader will pay the other a fixed cash flow, while the KEY CONCEPT: FUTURES, FORWARDS, AND COMMODITY SWAPS Futures, forwards, and commodity swaps are the most common ways for traders to access the commodity markets.

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This will help it match its income (from the mortgages) to its expenditures (payments to savings accounts). If it can find a counterparty that is interested in receiving a fixed rate on its investments, they can agree to exchange cash flows. Interest rate swaps are traded directly between two traders (bilaterally) or facilitated by a bank (over the counter). Trades can be individually negotiated and, as a result, there can be a wide variety of interest rate swaps. Some common variations of interest rates swaps allow fixed/float payments to be denominated in two separate currencies, two floating rates to be exchanged, or fixed rates in two different currencies to be exchanged.

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett
by Jack (edited By) Guinan
Published 27 Jul 2009

As the lending time increases, though, the disparity between the two types of interest calculations grows. Related Terms: • Bond • Interest Rate Swap • Premium • Coupon • Money Market Account Interest Rate Swap What Does Interest Rate Swap Mean? An agreement between two parties (known as counterparties) in which one stream of future interest payments is exchanged for another stream, based on a specified principal amount. Interest rate swaps often involve exchanging a fixed payment for a floating payment, which is linked to an interest rate (most often the LIBOR). The Investopedia Guide to Wall Speak 143 A company typically uses interest rate swaps to limit or manage its exposure to fluctuations in interest rates or to obtain a marginally lower interest rate than it would have been able to get without the swap.

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Traditionally, the exchange of one security for another for the purpose of changing the maturity (bonds), the quality of issues (stocks or bonds), or one’s investment objectives. Swaps include currency swaps and interest rate swaps. Investopedia explains Swap If companies in different countries have regional advantages on interest rates, a swap will benefit both firms. For example, one firm may have a lower fixed interest rate while another has access to a lower floating interest rate. To take advantage of this situation, the companies would do an interest rate swap. Related Terms: • Arbitrage • Credit Default Swap • Interest Rate Swap • Commodity • Currency Swap Swing Trading What Does Swing Trading Mean? A style of trading that is used to capture quick gains in a stock over a one- to four-day trading period.

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The Investopedia Guide to Wall Speak 143 A company typically uses interest rate swaps to limit or manage its exposure to fluctuations in interest rates or to obtain a marginally lower interest rate than it would have been able to get without the swap. Investopedia explains Interest Rate Swap Interest rate swaps are the exchange of one set of cash flows (based on interest rate specifications) for another. Because they trade over the counter (OTC), they are really contracts set up between two or more parties and thus can be customized in a number of ways. Generally, swaps are sought by firms that desire a type of interest rate structure that another firm can provide less expensively. For example, let’s say Cory’s Tequila Company (CTC) is seeking to lend funds at a fixed interest rate, but Tom’s Sports Inc.

Barometer of Fear: An Insider's Account of Rogue Trading and the Greatest Banking Scandal in History
by Alexis Stenfors
Published 14 May 2017

The STIRT desks at the banks had not been particularly glamorous before 2007. We traded a range of instruments that were important, but not interesting and complex enough to represent the forefront of financial innovation. The turnover in OISs, FRAs, IRSs (interest rate swaps), CRSs (cross-currency basis swaps) and FX swaps, among others, was enormous. However, options, long-end interest rate swaps and structured products enjoyed considerably more prestige. The crisis turned everything upside down. Suddenly, the spotlight fell on us. Options traders needed to know the direction of LIBOR in order to price customer deals and value their books correctly.

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Interbank money market: The market where banks borrow from and lend to each other. Interdealer broker: A brokerage firm that acts as an intermediary between major dealers (typically banks) to facilitate trades. Interest rate swap (IRS): A derivative where two counterparties agree to exchange periodic interest payments based on a specified notional amount. Typically, interest rate swaps involve the exchange a fixed interest rate for a floating rate (e.g. LIBOR), or vice versa. Layering: Submitting a series of manipulative buy (or sell) orders with the intention of selling rather than buying (or buying rather than selling).

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ABBREVIATIONS ACI Association Cambiste Internationale BBA British Bankers’ Association BBAIRS BBA Interest Rate Settlement BIS Bank for International Settlements CDO collateralised debt obligation CDOR Canadian Dollar Offered Rate CDS credit default swap CEO chief executive officer CIA Central Intelligence Agency CIBOR Copenhagen Interbank Offered Rate CME Chicago Mercantile Exchange CPI Consumer Price Index CRS cross-currency basis swap ECB European Central Bank ERM Exchange Rate Mechanism EU European Union EURIBOR Euro Interbank Offered Rate FBI Federal Bureau of Investigation FCA Financial Conduct Authority FIBOR Frankfurt Interbank Offered Rate FRA forward rate agreement FSA Financial Services Authority FX foreign exchange GDP gross domestic product HELIBOR Helsinki Interbank Offered Rate ICMA International Capital Market Association IMM International Monetary Market IRS interest rate swap ISDA International Swaps and Derivatives Association KLIBOR Kuala Lumpur Interbank Offered Rate LIBOR London Interbank Offered Rate LIFFE London International Financial Futures and Options Exchange NIBOR Norwegian Interbank Offered Rate OIS overnight index swap OPEC Organization of the Petroleum Exporting Countries OTC over the counter PIBOR Paris Interbank Offered Rate PRA Prudential Regulation Authority SEC Securities and Exchange Commission SFO Serious Fraud Office SIMEX Singapore International Monetary Exchange STIBOR Stockholm Interbank Offered Rate STIRT Short-term Interest Rate Trading TAF Term Auction Facility TIBOR Tokyo Interbank Offered Rate TIFFE Tokyo International Financial Futures Exchange INTRODUCTION ‘It’s a misunderstanding’ ‘How can the FSA be sure you will not do this again?’

Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives
by Satyajit Das
Published 15 Nov 2006

DM/CHF payments IBM World Bank $ payments DM/CHF payments DM/CHF bondholders $ payments $ bondholders Figure 1.2 N 1981 World Bank – IBM currency swap DAS_C02.QXP 8/7/06 4:22 PM Page 37 1 N Financial WMDs – derivatives demagoguery 37 The currency swap evolved into the interest rate swap, shown in Figure 1.3. Floating rate swap payments Borrower B Borrower A Fixed rate swap payments Floating rate interest payments Floating rate lender Fixed rate interest payments Fixed rate lender Figure 1.3 N Interest rate swap The currency swap and the interest rate swap are still the mainstay of the derivatives markets. Nobody knew it then, but there was going to be a whole lotta swapping going on. The golden age/LIBOR minus 50 I came across my first swap in the early 1980s.

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It is tricky to have negative interest rates: I wondered what that actually meant. I guessed the investor paid the borrower. It was definitely weird. The trick was figuring out how the deal was put together. The investor basically purchased a bond with an embedded interest rate swap. It looked like Figure 1.4. Investment in bond Investment/repayment of principal Bond Investor 8.50% pa Interest rate swap 8.75% pa Dealer Investor LIBOR Purchase by investor of cap on LIBOR (strike rate = 17.25% pa) 17.25% pa Inverse FRN Investor LIBOR Figure 1.4 N Inverse floater The only extra bit is that the investor also bought an interest rate cap, that is, a series of options designed to protect the investor if interest rates went DAS_C02.QXP 8/7/06 4:22 PM Page 47 1 N Financial WMDs – derivatives demagoguery 47 up above 17.25% pa.

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Nero stood back and scrutinized his handiwork. Nero was right. If the investor wanted we could engineer in as much leverage as he liked. ‘Sir would like more leverage on the side? Coming right up.’ We would add a few more interest rate swaps to the deal, as DAS_C02.QXP 8/7/06 4:22 PM Page 50 Tr a d e r s , G u n s & M o n e y 50 US$100 million investment in bond Investment/repayment of principal Bond Investor 8.50% pa US$400 million interest rate swap 8.75% pa × 4 = 35.00% pa Dealer Investor 4 × LIBOR Purchase by investor of cap on LIBOR (strike rate = 10.875% pa) 43.50% pa Inverse FRN Investor 4 × LIBOR Figure 1.5 N Leveraged inverse floater shown in Figure 1.5.

The Fix: How Bankers Lied, Cheated and Colluded to Rig the World's Most Important Number (Bloomberg)
by Liam Vaughan and Gavin Finch
Published 22 Nov 2016

One or two old contacts from London and some particularly persistent brokers dragged Hayes out for a pint now and then amid the neon lights of Tokyo, where a wealthy young expat could have some serious fun, but Hayes was irritatingly distracted company. He had developed a more rarefied addiction. Interest-rate swaps, forward rate agreements, basis swaps, overnight indexed swaps—the menu of complex financial instruments Hayes bought and sold came in a thousand varieties, but they shared one thing in common: Their value rose and fell with reference to benchmark interest rates, and, in particular, to Libor.

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As London’s financial markets took off, they became increasingly complex. Within a few years, Libor had morphed from being a tool to price individual loans and bonds to being a benchmark for derivatives deals worth hundreds of billions of dollars. Chief among these new 16 THE FIX derivatives was the interest-rate swap, which allowed companies to mitigate the risk of fluctuating interest rates. The swap was invented during a period of extreme volatility in global rates in the 1970s and early 1980s.5 The concept is simple: Two parties agree to exchange interest payments on a set amount for a fixed period. In its most basic and common form, one pays a fixed rate, in the belief that interest rates will rise, while the other pays a floating rate, betting they will fall.

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What authorities around the world failed to recognize was that even lenders that made submissions too high or too low to be included in the final calculation could still influence where Libor was set because they pushed a previously excluded rate back into the pack.9 Traders with vast derivatives positions only needed to move the rate by a few hundredths of a percentage point to make huge profits, and their influence was small enough to evade detection. On a $100 billion portfolio of interest-rate swaps, a bank could gain millions of dollars from a 1 basis point move. Where Libor is set not only affects how much money banks and other sophisticated investors make on their derivatives bets, it also dictates how much interest U.S. homeowners pay on their mortgages each month.And poorer people with bad credit profiles are disproportionately affected.

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown
by Simon Johnson and James Kwak
Published 29 Mar 2010

The modern derivatives revolution began with the invention of the interest rate swap (by Salomon Brothers) in 1981. In this transaction, Company A pays interest at a fixed rate to Company B and Company B pays interest at a floating rate (which can go up or down as economic conditions change) to Company A. Interest rate swaps allow companies to exchange fixed rate payments for floating rate payments, or vice versa—“swapping” interest rate risks between the two parties.‡ Similarly, currency swaps allow companies to swap currency risks by exchanging different currencies (or combinations of currencies). Interest rate swaps can also be combined with currency swaps.

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(Because the evolution of derivatives has run ahead of regulatory and accounting rules, derivatives can also serve other purposes, such as helping companies smooth their earnings over multiple periods or reduce their tax bills by deferring earnings into the future.) By the middle of 2008, the market for over-the-counter (customized) interest rate swaps had grown to over $350 trillion in face value (the amount on which interest is calculated) and over $8 trillion in gross market value.*73 The derivatives dealers—both investment banks and large commercial banks—were taking a piece of every interest rate swap in fees. Even better, the dealers would typically hedge their exposures; ideally, for every swap with one client, they would conduct an opposite swap with another client, so the two trades canceled out—leaving nothing but fees from both clients.

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There were also two representatives of industry organizations at the meeting.4 * Because the accounting treatment of derivatives was unclear, the amount of capital that banks had to set aside for their derivatives positions was generally disproportionately low compared to the amount of risk they were taking on. Because they could generate higher profits with less capital, their “return on equity” was higher. † Derivatives are essentially zero-sum transactions. The face value, or notional value, of a derivative is the basis on which the value of the transaction is calculated. For example, in an interest rate swap, the payments made by the two parties are calculated as interest rates (percentages) on the notional value; the amount of money that changes hands is much lower than the notional value. The market value of a derivative contract is calculated by the Bank for International Settlements as the current value of the contract to the party that is “in the money”—in other words, the amount of money that would change hands in order to close out the contract at this moment. 1 THOMAS JEFFERSON AND THE FINANCIAL ARISTOCRACY Great corporations exist only because they are created and safeguarded by our institutions; and it is therefore our right and our duty to see that they work in harmony with these institutions.

The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . And Are Ready to Do It Again
by Nicholas Dunbar
Published 11 Jul 2011

With about €2 billion of debt, there was a routine reason for the treasury of Poste Italiane—the Italian post office—to be using interest rate swaps. The derivatives would transform its cost of borrowing into a lower, shorter-term benchmark rate that closely tracked European Central Bank rates. Although interest rate swaps are not standardized instruments that trade on an exchange, they are heavily traded by banks, hedge funds, and corporate end users in a highly competitive market. In such markets, bid-offer spreads are tight. For a standardized, vanilla interest rate swap, the spread was as low as one basis point (a hundredth of a percentage point) of the underlying debt transformed with the derivative.

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Or they could use longer-term loans that tracked the interest rates paid by governments on their bonds, perhaps getting locked into a disadvantageous rate. Imagine that once you had committed yourself to one of these two financing routes, an invisible toggle switch allowed you to change your mind, canceling out the interest payments you didn’t want to make in return for making the payments that you did. Thus was the interest rate swap, the world’s most popular derivative, born. Swaps first proved their value in the 1980s, when the U.S. Federal Reserve jacked up short-term interest rates to fight inflation. With swaps, you could transform this short-term risk into something less volatile by paying a longer-term rate. Swaps again proved useful in 1997, when Asian central banks used high short-term interest rates to fight currency crises.

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Swaps again proved useful in 1997, when Asian central banks used high short-term interest rates to fight currency crises. Just how heavily traded these contracts became can be gauged from the total “notional” amount of debt that was supposed to be transformed by the swaps (which is not the same as their value): by June 2008, a staggering $356 trillion of interest rate swaps had been written, according to the Bank for International Settlements.2 As with forward contracts on currencies and commodities, the rates quoted on these swaps are considered to be a more informative way of comparing different borrowing timescales (the so-called yield curve) than the underlying government bonds or deposit rates themselves.

The Spider Network: The Wild Story of a Math Genius, a Gang of Backstabbing Bankers, and One of the Greatest Scams in Financial History
by David Enrich
Published 21 Mar 2017

The loan had a floating interest rate tethered to the Federal Reserve’s base rate,* which currently stood at 2 percent. That carried risks. If the Fed subsequently hiked rates, ABC Corp. would see its interest payments shoot higher. So investment banks concocted a derivative product, known as an interest-rate swap, that would help protect ABC Corp. from the possibility of being burned. ABC Corp. and Giantbank would enter into a derivative contract that simulated a pair of similar $100 loan transactions. First, ABC Corp. would agree to borrow $100 from Giantbank with a fixed 2 percent rate. Then Giantbank would agree to borrow $100 from ABC Corp. with a floating rate tied to the Fed’s base rate or another metric.

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Under this construction, ABC Corp. would stand to make money on the swap if the floating rates jumped above 2 percent, which would make up for the higher interest rates it would owe First National on the original loan. If floating rates declined, ABC Corp. would owe money to Giantbank, but that would be offset by its savings from the declining rates on the First National loan. In other words, the derivative neutralized the interest-rate risks ABC Corp. faced in its original loan. (Got it?) Providing interest-rate swaps was a valuable service, involving not only complex calculations but also the assumption of large risks, and banks charged their clients handsomely. If that setup sounds terrifyingly complicated, keep in mind that like so many instruments in the hall of mirrors that is modern finance, there might not even be an “ABC Corp.”

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That meant a particular interest rate—and this is where Libor would eventually come into the equation—could have massive effects when it came to a bank’s bottom line: If it moved in an advantageous direction, a particular swap could become extremely lucrative. By 2010, some $1.28 trillion of these interest-rate swaps would change hands on a daily basis, up from $63 billion fifteen years earlier. As always, the advantage went to the trader who found an edge—whether that edge was a gullible client, a superior product, a more sophisticated computer model, whatever. Sometimes the edge was simply pushing the envelope just a little bit further than anyone else.

The Big Short: Inside the Doomsday Machine
by Michael Lewis
Published 1 Nov 2009

* ISDA had been created back in 1986, by my bosses at Salomon Brothers, to deal with the immediate problem of an innovation called an interest rate swap. What seemed like a simple trade to the people doing it--I pay you a fixed rate of interest in exchange for your paying me a floating rate--wound up needing a blizzard of rules to govern it. Beneath the rules was the simple fear that the party on the other side of a Wall Street firm's interest rate swap might go bust and fail to pay off its bets. The interest rate swap, like the credit default swap, exposed Wall Street firms to other people's credit, and other people to the credit of Wall Street firms, in new ways

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AIG Financial Products was created in 1987 by refugees from Michael Milken's bond department at Drexel Burnham, led by a trader named Howard Sosin, who claimed to have a better model to trade and value interest rate swaps. Nineteen eighties financial innovation had all sorts of consequences, but one of them was a boom in the number of deals between big financial firms that required them to take each other's credit risks. Interest rate swaps--in which one party swaps a floating rate of interest for another party's fixed rate of interest--was one such innovation. Once upon a time, Chrysler issued a bond through Morgan Stanley, and the only people who wound up with credit risk were the investors who bought the Chrysler bond.

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Once upon a time, Chrysler issued a bond through Morgan Stanley, and the only people who wound up with credit risk were the investors who bought the Chrysler bond. Chrysler might sell its bonds and simultaneously enter into a ten-year interest rate swap transaction with Morgan Stanley--and just like that, Chrysler and Morgan Stanley were exposed to each other. If Chrysler went bankrupt, its bondholders obviously lost; depending on the nature of the swap, and the movement of interest rates, Morgan Stanley might lose, too. If Morgan Stanley went bust, Chrysler, along with anyone else who had done interest rate swaps with Morgan Stanley, stood to suffer. Financial risk had been created out of thin air, and it begged to be either honestly accounted for or disguised.

Mathematics of the Financial Markets: Financial Instruments and Derivatives Modelling, Valuation and Risk Issues
by Alain Ruttiens
Published 24 Apr 2013

collars collateralized debt obligations (CDOs) color sensitivity commodities commodity futures backwardation contango market price non-financial producers/users trading calculations conditional swaps Conditional VaR (C-VaR) confidence levels constant maturity swaps (CMSs) contango continuous interest compounding continuous interest rates continuous time continuous variables contracts contracts for difference (CFD) contribution, performance convenience yield conversion factors (CFs) convertible bonds (CBs) bond floor CB premium conversion ratio Hard Call protection outcome of operation pricing graph risk premium stock price parity convexity adjustments see also bond convexity copper prices copulas correlation basket options credit derivatives implied Portfolio Theory Spearman’s coefficient VaR calculations volatility counterparty risk futures see also credit risk counter-value currency (c/v) Courtadon model covered period, FRAs Cox, Ingersoll and Ross model Cox–Ross–Rubenstein (CRR) model credit default swaps (CDSs) on basket cash settlement with defined recovery rate market operations variants credit derivatives CDSs credit risk main features valuation application example basket derivatives binomial model CDO pricing correlation measures credit risk models useful measures Merton model “credit events” credit exposure credit risk behind the underlying components data use dangers default rates Merton model models in practice quantification recovery rates credit VaR crossing CRR see Cox–Ross–Rubenstein model CRSs see currency rate swaps crude oil market CTD see cheapest to deliver cubic splines method currencies futures options performance attribution spot instruments currency rate swaps (CRSs) c/v see counter-value currency C-VaR see Conditional VaR D see discount factors DCF see discounted cash flows method decision-making deep ITM (DITM) deep OTM (DOTM) default rates default risk see credit risk delta delta-gamma neutral management delta-normal method, VaR derivatives credit valuation problems volatility Derman see Black, Derman, Toy process deterministic phenomena diff swaps diffusion processes Dirac functions dirty prices discounted cash flows (DCF) method discount factors (D) duration D forward rates IRSs risk-free yield curve spot rates yield curve interpolations discrete interest compounding discrete time discrete variables DITM see deep ITM DOTM see deep OTM drift duration of bonds see bond duration duration D dVega/dTime dynamic replication see delta-Gamma neutral management dZ Black–Scholes formula fractional Brownian motion geometric Wiener process martingales properties of dZ(t) standard Wiener process economic capital ED see exposure at default effective duration, bonds efficient frontier efficient markets EGARCH see exponential GARCH process EONIA see Euro Over-Night Index Average swaps equities forwards futures Portfolio Theory stock indexes stocks valuation EUR see Euros EURIBOR rates CMSs EONIA/OIS swaps FRAs futures in-arrear swaps IRSs quanto/diff swaps short-term rates Euro Over-Night Index Average (EONIA) swaps European options basket options bond options caplets CRR pricing model exchange options exotic options floorlets Monte Carlo simulations option pricing rho Euros (EUR) CRSs forward foreign exchange futures spot market swap rate markets volatility Euro Stoxx EWMA see exponentially weighted moving average process Excel functions MA process Monte Carlo simulations excess return exchange options exotic options basket options Bermudan options binomial pricing model Black–Scholes formula currency options exchange options interest rates Monte Carlo simulations options on bonds options on non-financial underlyings PFCs pricing methods see also second generation options exotic swaps see also second generation swaps expected credit loss expected return exponential GARCH (EGARCH) process exponentially weighted moving average (EWMA) process exposure at default (ED) fair price/value “fat tails” problem financial models ARCH process ARIMA process ARMA process AR process GARCH process MA process MIDAS process finite difference pricing methods fixed leg of swap fixed rate, swaps floating rate notes/bonds (FRNs) floating rates floorlets floors forecasting ARIMA ARMA process AR process MA process foreign exchange (FX) see currencies; forex swaps; forward foreign exchange forex (FX) swaps forward foreign exchange 1 year calculations forex swaps forward forex swaps forward-forward transactions forward spreads NDF market operations forward rate agreements (FRAs) forwards Black–Scholes formula bonds CFDs CRSs equities foreign exchange FRAs futures vs forwards prices options PFCs rates swaps volatility forward zero-coupon rate 4-moments CAPM fractional Brownian motion FRAs see forward rate agreements FRNs see floating rate notes/bonds futures bonds commodities currencies equities forwards vs futures prices IRR margining system market price option pricing pricing settlement at maturity short-term interest rates stock indexes theoretical price future value (FV) bond duration short-term rates spot rates zero-coupon swaps FX see foreign exchange; forex swaps gain-loss ratio (Bernardo Ledoit) gamma gamma processes GARCH see generalized ARCH process Garman–Klass volatility Gaussian copulas Gaussian distribution Gaussian hypothesis generalized ARCH (GARCH) process EWMA process I/E/MGARCH processes non-linear models regime-switching models variants volatility general Wiener process application fractional Brownian motion gamma processes geometric Wiener process Itô Lemma Itô process jump processes volatility modeling see also standard Wiener process geometric average geometric Wiener process German Bund see Bund (German T-Bond) global VaR Gordon–Shapiro method government bonds Greece Greeks see sensitivities Hard Call protection Heath, Jarrow and Morton (HJM) model Heaviside function hedging bond futures delta-gamma neutral management futures 129–30 immunization vs hedging money market rate futures stock index futures heteroskedasticity hidden layers, NNs high frequency trading “high” prices historical method, VaR historical volatility HJM see Heath, Jarrow and Morton model Ho and Lee model Hull and White model Hurst coefficient IGARCH see integrated GARCH process immunization implied correlation implied repo rate (IRR) implied volatility definition historical volatility surface volatility curves volatility smiles in-arrear swaps indexes basket options capitalization-weighted price/value-weighted see also stock indexes inflation-linked bonds inflation swaps Information Ratio (IR) initial margin in the money (ITM) caps convertible bonds deep ITM options innovation term, AR instantaneous returns integrated GARCH (IGARCH) process interbank rates see EURIBOR rates; LIBOR rates interest rate options BDT process Black and Karasinski model caps collars floors forward rates HJM model LMM model single rate processes swaptions yield curve modeling interest rates day counting discount factors futures FV/PV interest compounding IRSs options short-term spot rates term structure see also yield interest rate swaps (IRSs) bond duration and CRSs fixed/floating rates pricing methods prior to swap pricing method revaluation vanilla swaps yield curve see also constant maturity swaps intermediate period, FRAs International Swaps and Derivatives Association (ISDA) intraday margining settlements intraday volatility investor decision-making IR see Information Ratio IRR see implied repo rate IRSs see interest rate swaps ISDA see International Swaps and Derivatives Association ITM see in the money Itô process Itô’s Lemma Japanese yen (JPY) Jarrow, Robert A.

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Exchanged cash flows can be assets cash flows originating from assets payments, in this case one talk about asset swaps, or cash flows originating from debts interest payments, hence the naming of liability swaps. If the whole set of exchanged cash flows involves a common single currency, the swap is called an interest rate swap (IRS). If the exchange of cash flows involves two currencies, one talks of currency rate swap (CRS) or cross currency rate swap (CCRS).2 A swap is an unconditional product: the exchange of cash flows cannot depend from any kind of condition. A contrario, credit default swaps and similar derivatives on a default risk are not swaps, strictly speaking, because there are conditional.

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Indeed, in a vanilla swap, floating rates interest cash flows are paid at the expiry dates, so that only the first LIBOR is known at swap inception but not the following ones (noted in italics). Note also that in such a swap, the only cash flows exchanged are interest cash flows (the principal amount is not involved at all), hence the name interest rate swap. 6.1.2 An example of CRS liability swap (data from February 2002) A supranational institution, here called SNL, has issued a 6-year bond of Norwegian krone (NOK) 750 million @ 61/2% p.a. (ACT/ACT), immediately swapped into its own EUR currency, that is, EUR 85 227 272.73, at the current EUR/NOK spot rate of 8.8000 (the rationale of this swapped issue will appear later).

The Trade Lifecycle: Behind the Scenes of the Trading Process (The Wiley Finance Series)
by Robert P. Baker
Published 4 Oct 2015

The CCP matches every trade so if A wants to trade an interest rate swap with B, A trades with the CCP and the CCP trades the exact opposite of the trade with B. The CCP guarantees the obligations of the contract but has no market risk. It does however carry the risk that one of the counterparties defaults. This risk is managed in many ways, including by taking margin (or collateral) from each of its counterparties. Clearing trades centrally means that CCPs themselves become crucial nodes in the financial network. It is estimated, for example, that almost half of all outstanding interest rate swap transactions are centrally cleared.

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Figure 3.6 shows a deposit with repayment interest at regular intervals and the final receipt for the principal plus the last instalment of interest. 3.5 SWAP The term swap is very general, giving rise to many meanings (e.g. commodity swap, FX swap, credit default swap etc). However, when otherwise unqualified, it is taken as being an interest rate (IR) swap. The simplest form of interest rate swap is a trade with several pre-defined settlement dates and a nominal notional amount of money that is never exchanged. One side (by convention the buyer) pays a fixed amount on each settlement and the other side pays a floating amount determined by some reference index (such as LIBOR). This is known as a fixed for floating swap (see Figure 3.7).

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For example, we pay fixed 3% of 25 Understanding Traded Products – Follow the Money a dollar notional and receive a floating rate in euros based on LIBOR EUR, which is then converted to dollars at the prevailing foreign exchange rate on fixing day to determine the direction and size of settlement. Although there is always a notional amount in any interest rate swap, this is never actually exchanged. It is only used for determination of amount to be paid or received. 3.6 FOREIGN EXCHANGE SWAP Not to be confused with currency swaps, a foreign exchange swap is the exchange of one currency for another now (after a short time for settlement) and the reverse exchange at some point in the future.

How the City Really Works: The Definitive Guide to Money and Investing in London's Square Mile
by Alexander Davidson
Published 1 Apr 2008

The UK has a 42 per cent turnover in foreign equities, down from 43 per cent in 2005, and compared with 33 per cent in the United States. The UK is the market leader in international bonds (2006), with 70 per cent of the secondary market, unchanged since 1992. In over-the-counter (OTC) derivatives, the UK has a 43 per cent market share (April 2004), of which about three-quarters are interest rate swaps and similar products, which makes it the global leader, according to IFSL statistics. The United States has 24 per cent. In marine insurance net premium income, the UK has a 20 per cent market share (2005), while the United States has 11 per cent. London’s share of world hedge fund assets reached 21 per cent in June 2006, which represents a steady gain since 2003, when it was 14 per cent, but it has a long way to catch up with the United States at 66 per cent.

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Issuers of bonds usually offer a fixed rate of return, which is what investors prefer. But if the bonds fall in value, investors may feel they have lost out. This is why investors use the swaps market, which enables them to swap fixed for floating rates. The majority of the swaps market consists of interest rate swaps (see Chapters 8 and 11). Mergers and acquisitions Mergers and acquisitions (M&A) is the area where investment banks are often compared and judged. They will advise a company planning a takeover or that is a likely bid target, and may help it to raise capital for the purpose. The prospective buyer of a quoted company can be another company, from Europe, the United States or elsewhere.

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More complex terminology may be used, depending on which of the asset classes are involved. The asset classes are credit fixed income, financials, interest rate market, equity and commodities. Credit fixed income includes credit derivatives, bonds, commercial paper and loans; financials include foreign exchange and forwards; interest rate markets include interest rate swaps and options, and deposits, as well as forward rate agreements and overnight index swaps. Of the rest, equity covers the stock market; commodities include soft commodities such as food, feedstuffs and beverages, including grains, pork _________________________________ INTRODUCTION TO DERIVATIVES 61  bellies, shrimp, wines, wheat and corn, as well as hard commodities, which are industrial raw materials such as oil, gas, electricity, nuclear fuel and metals.

Expected Returns: An Investor's Guide to Harvesting Market Rewards
by Antti Ilmanen
Published 4 Apr 2011

Swap–Treasury spread positions I start with interest rate swaps because swap–Treasury spreads may be viewed as a common element in various non-government vs. government spreads. Non-government assets tend to have more stable spreads over the swap curve than over Treasuries. Although swap–government spreads are often classified as credit spreads, it has long been recognized that the credit risk component in swap spreads is negligible. I first explain why counterparty credit risk hardly impacts swaps and then review the link between swap spreads and LIBOR–repo spreads:• Interest rate swap contracts have minimal default exposure because the principal is not at risk—just one side of profits/losses.

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Summary statistics of U.S. money market rate spreads, 1980–2009 Assets not covered in this chapter include many interesting cases with too short histories or poor data quality. Candidates range from the obvious to esoteric: emerging market debt, inflation-linked bonds, convertible bonds, interest rate swaps, credit derivatives, various structured products, exchange-traded funds, catastrophe bonds, distressed debt, and carbon trading. 3.5 REAL RETURN HISTORIES The results above focused on nominal returns, as does most of this book. To compensate for what some readers might find to be insufficient emphasis on real returns, Table 3.6 presents the compound average real returns for many assets, decade by decade for the 110 years, and also for the 19th century (actually the 98-year period from 1802 to 1899) where possible.

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The fewer chances a fiscally stretched government has to inflate, or devalue its debt through a depreciating currency, the greater is its temptation to default. In most countries, government bonds still have the lowest yields, but it is no longer unthinkable to see government yields rising above high-quality corporate yields. Indeed, even in developed markets, long-dated interest rate swaps are increasingly trading below government yields, and sovereign credit default swap spreads have dramatically increased since 2008. The time horizon also matters. Long-dated Treasuries are arguably a more natural riskless asset for long-horizon investors, given the uncertain reinvestment rate for short-dated bills.

Wall Street: How It Works And for Whom
by Doug Henwood
Published 30 Aug 1998

But where much of the rise in exchange-traded instruments was simply a matter of Europe and Japan catching up with U.S. financial futures markets, OTC growth was mainly the proliferation of new instruments worldwide. In 1986, notional principal in interest rate swaps was $400 billion, with another $100 billion in currency swaps outstanding; at the end of 1990, the figures were $2.3 trillion and $578 billion, respectively, to which had been added another $56l billion in caps, floors, collars, and swaptions; in 1997, notional principal on interest rate swaps totaled $22.1 trillion, and currency swaps, $1.5 trillion (Bank for International Settlements 1998). The biggest users of currency swaps once were nonfinancial corporations — the multinationals that dominate world trade, who borrow and do business in scores of currencies around the world.

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But financial institutions have been steadily increasing their use, with 40% of notional principal outstanding, a bit ahead of nonfinancial firms, with governments a distant third. Financial institutions dominate the market for interest rate swaps; after all, interest-bearing paper is the basic commodity they deal in. Corporations accounted for just 23% and governments, 6%. The U.S. share of swap markets is surprisingly small — less than a third of interest INSTRUMENTS rate swaps and quarter of the currency kind — and the dollar's share has been shrinking steadily, from 79% of interest rate swaps in 1987 to 30% in 1996, with the yen and the European currencies rising dramatically. No doubt European and Asian economic integration is at work here, though the merger of Continental countries into the euro will change everything.

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Details of custom derivatives may be more than many readers want to know, but they do involve the full richness of financial imagination. Swaps were pioneered in the late 1970s, but the first deal to attract wide attention was a currency swap between IBM and the World Bank in 1981, and the first interest rate swap was one involving the Student Loan Marketing Association (Sallie Mae), a U.S.-government-sponsored vendor of student loans (Abken 1991).^^ Unlike exchange-traded derivatives, swaps don't really involve a claim on an underlying asset; in most cases, the partners in the swap, called counterparties, swap two sets of cash flows, cash flows that are usually thrown off by positions in other securities (bond interest, stock dividends, etc.).

Electronic and Algorithmic Trading Technology: The Complete Guide
by Kendall Kim
Published 31 May 2007

Treasuries x x x x x MBS x x Agency x x x x Corporate Bonds x x x x Munis European Issues x x x x x x Products supported. Source: Aite Group. Derivatives x x x Electronic and Algorithmic Trading for Different Asset Classes 119 Firms eSpeed Products Interest Rate Swaps ICAP Interest Rate Swaps Q3 2004 Europe Credit Derivatives Q4 2004 Europe and U.S. MarketAxess Thomson TradeWeb Exhibit 11.7 Launch Date 2003 Credit Derivatives Q3 2005 Q1 2005 for Interest Rate Swaps Euro Q3 2005 for U.S. Q3 2005 for Credit Derivatives U.S. Market Focus Europe and U.S. Europe and U.S. Europe and U.S. Europe and U.S. Expansion into derivatives. Source: Firms. brokers or dealers.

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Electronic access to stocks has been more prevalent than for futures and options, but these asset classes are catching up particularly in foreign exchange. A growing number of trading platforms now support trading in over-the-counter (OTC) derivatives. According to the Bond Market Association in 2004, 25 platforms now allow users to execute transactions in 111 112 Electronic and Algorithmic Trading Technology interest rate swaps, credit default swaps, options, futures, and other derivative products. This is nearly double the number of platforms that supported derivatives trading in 2003. The equities markets will execute trades using some sort of algorithmic model, but the same will most likely be true for other products such as futures, options, and foreign exchange.

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By 2008, electronic trading will account for over 60% of total U.S. fixed-income trading volume (see Exhibits 11.2 and 11.3), as leading platforms continue to expand into less liquid products, according to the Aite Group. Competition is expanding into less liquid Fixed-income instruments, which include European markets, algorithmic trading, and OTC derivative products such as interest rate swaps and credit derivatives. The marketplace has also witnessed contraction in the number of trading platforms from its peak in 2000, when over 70 electronic fixed-income trading platforms existed, to fewer than 30 platforms remaining at the end of 2004. Realistically, only a handful of those remaining platforms can be considered legitimate.

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined
by Lasse Heje Pedersen
Published 12 Apr 2015

—Saying among traders The global fixed-income markets are vast in terms of the value of outstanding bonds, the turnover of these bonds, and the size of the related derivatives markets. The most important fixed-income market is the government bond market, followed by the markets for corporate bonds and mortgage bonds. The key derivatives markets include bond futures, interest-rate swaps, credit default swaps, options, and swaptions, which give the option to enter into an interest-rate swap. Almost all bond prices depend heavily on the risk-free interest rate, so there is significant co-movement among bond yields and bond returns. Therefore, fixed-income arbitrage traders often trade on the relative value among fixed-income securities to exploit price differences among closely related securities.

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For example, a 10-year Japanese government bond has a high carry if the Japanese yield curve is steep. Some macro investors trade on bond carry across countries, buying bonds in countries with high carry while shorting bonds in countries with low carry. Such trades can be implemented with cash bonds (financed in repo), bond futures, or interest-rate swaps. • Yield-curve carry trade: Macro investors also trade bonds of different maturities within the same country. This is called a yield-curve trade. Chapter 14 provides more sophisticated measures of bond carry (that include a so-called roll-down effect) and discusses in more detail how to implement bond and yield-curve trades

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Panel B shows, at four selected dates, the entire yield curve where the (off-the-run) bonds originally issued as 30-year bonds are represented as diamonds and all other securities are plotted as solid circles. The disconnect between on- and off-the-run 10-year bonds during the global financial crisis is evident. Sources: Panel A: Using data from AQR Capital Management. Panel B: Gürkaynak and Wright (2012). 14.6. SWAPS AND SWAP SPREADS An interest-rate swap is a derivative that exchanges the cash flows of a fixed-rate loan to those of a floating-rate loan. The counterparty paying the fixed rate is called the “payer,” and the counterparty receiving the fixed rate is called the “receiver.” We will take the viewpoint of the receiver (who faces an interest-rate risk similar to that of an investor who is long on a bond).

Sabotage: The Financial System's Nasty Business
by Anastasia Nesvetailova and Ronen Palan
Published 28 Jan 2020

The overall aim of these exercises, a UK Parliamentary Committee would discover, was to pass on to customers as much of RBS’s bad debts as possible, while at the same time to extract ‘value’ from small- and medium-size business customers to buffer the bank’s profits. There hardly appears to be any aspect of business at RBS that was not sabotage. Following the onset of the financial-market contagion from the subprime debt crisis, the bank sought to offload some of its ill-judged long-term interest rate swaps. Many of those deals, known as interest rate swaps, had been signed during the good times with the intention of protecting the bank against interest rate rises. Now that interest rates were tumbling, those swaps arrangements threatened to cost RBS billions upon billions of dollars. Managers at RBS (though, admittedly, not only at the RBS) hit on the ingenious idea that their own customers were their best bet of resolving this problem.

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To help with the deal, RBS would often loan their customers the funds necessary to buy the costly hedges, at fixed interest rates of 7 or 8 per cent – at a time when interest rates were heading towards 0 per cent, thus making extra profits. The scheme worked so smoothly (for RBS, not the clients) that thereafter, and separately, RBS required all members of the RBS Group to make all new commercial loans over £500k subject to the purchase of interest rate swaps. ‘Every deal which we have seen sold to an RBS customer,’ concluded the UK Parliamentary Committee, was a ‘heads we win, tails you lose’ trade: the customer was always the loser.3 A variety of schemes was used to incentivize staff. RBS business managers were given ‘ovation’ vouchers, tax free and acceptable as a payment method by major stores.

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A special ‘reward’ was given for introducing business customers to employees in the RBS Markets team, where such customers were subsequently sold those expensive hedging products. An RBS corporate manager could double his year’s basic salary with additional bonuses by helping to sell only a few interest rate swaps to his customers. Some single sales alone could be worth 20–30 per cent of an annual target.4 A whole division within RBS was dedicated to helping customers in difficulties: the Global Restructuring Group (GRG), so renamed in 2009 to oversee some 16,500 small and medium enterprises (SMEs) in distress with assets worth £65bn that had been placed in special measures.5 GRG’s mission was described by the law firm Clifford Chance, RBS’s lawyers, as ‘to return customers to financial health and to protect the bank’s position by minimising losses and maximising recoveries’.6 It was the latter and not the former that proved to be the case.

The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal
by Ludwig B. Chincarini
Published 29 Jul 2012

The Long-Dated Swap Imbalance Lehman was in the intermediary business.4 To illustrate the damage that Lehman’s bankruptcy did to the financial system, assume that all of Lehman’s exposure was from market making, giving the firm only counterparty risks from its large OTC book. Then consider one part of Lehman’s book: 30-year interest-rate swaps (IRS). An interest-rate swap is an agreement between two parties to exchange a series of cash flows over a defined number of years. In a typical IRS, one party pays a fixed interest rate for the entire period and the other party pays a floating rate, which depends on prevailing interest rates at the time of payment.

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See also Greed and housing bubble blame for circle of greed causing Federal Reserve and financial crisis of 2008 and overview of Huang, Chi-Fu HUD (Housing and Urban Development), affordable-housing goal of Hufschmid, Hans Hunsader, Eric Scott Hybrid ARM ICD (Investment Corporation of Dubai) IG (investment grade) index III Fund LP Illiquid securities Implied volatility Income distribution Index art Indices: ABX index average returns of CDX index CMBX index IG index IndyMac Insurance, basics of Interest-rate risk Interest rates Interest-rate swap (IRS) International Swaps and Derivatives Association Internet stock bubble of 2000 Investment banks. See also specific banks capital markets client services conflicts of interest corporate and risk management demise of equities exposure to residential real estate fixed income foreign exchange global distribution leverage of Main Street and mortgage market and overview of profits research stock prices structure technology Investment Corporation of Dubai (ICD) Investment grade (IG) index Investors, interconnected IRS (interest-rate swap) Isaacs, Jeremy M.

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(A liquid security is one that can easily be bought and sold near its last traded price, such as a Treasury bond. An illiquid security is one that might be hard to buy or sell; its purchase price may move significantly from the last quoted price.) The Short U.S. Swap Trade LTCM traders made many swap trades during the firm’s lifetime. A plain vanilla interest-rate swap is a basic transaction in which one party agrees to pay a floating interest rate to another party over a specific time period, and the other party agrees to pay a fixed interest rate over the same specific time period. Of course, LTCM traders didn’t use the vanilla version. They made money on the swap spread: the difference between a swap interest yield that represents the cost of borrowing between banks, and the government bond yield, which is the government’s cost of borrowing.

Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America
by Matt Taibbi
Published 15 Feb 2010

The financial services industry was faced with yet another potential catastrophe in early 2010 when some of the interest rate swaps Goldman had created for the nation of Greece blew up. The Greece scandal was a variation on a predatory scam that banks like Goldman and JPMorgan had been using to fleece municipalities in the United States for years; the swaps essentially allowed cities, counties, and countries to refinance their debt in a scheme that was very similar to the mortgage-refi schemes used by predatory lenders in the mid-2000s. The idea behind an interest rate swap, which is yet another type of unregulated derivative instrument, goes like this: a debtor who is paying variable-rate interest pays a bank like Goldman a fee in exchange for the security of fixed interest.

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In this case the Nostradamus was McArdle, who a half year before Greece blew up was reaming me for being too general in my description of Goldman’s aggressive forays into the unregulated derivatives market. “At any rate,” she wrote, “none of these derivatives have much to do with CDOs or CDSs; you might as well conflate stocks and bonds because they’re both ‘securities.’ No one, as far as I know, is now proposing that we need to curtail the use of interest rate swaps [emphasis mine].” An earlier example of an interest rate swap disaster had been Jefferson County, Alabama, which in 2008 had been virtually bankrupted by a series of swap deals it entered into with JPMorgan, deals that forced the county to institute mass layoffs and unpaid leave and left its residents facing a generation of massively inflated sewer bills.

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Common sense sounds great, but if you’re too lazy to penetrate the mysteries of carbon dioxide—if you haven’t mastered the whole concept of breathing by the time you’re old enough to serve in the U.S. Congress—you’re not going to get the credit default swap, the synthetic collateralized debt obligation, the interest rate swap. And understanding these instruments and how they were used (or misused) is the difference between perceiving how Wall Street made its money in the last decades as normal capitalist business and seeing the truth of what it often was instead, which was simple fraud and crime. It’s not an accident that Bachmann emerged in the summer of 2010 (right as she was forming the House Tea Party Caucus) as one of the fiercest opponents of financial regulatory reform; her primary complaint with the deeply flawed reform bill sponsored by Senator Chris Dodd and Congressman Barney Frank was that it would “end free checking accounts.”

Dark Towers: Deutsche Bank, Donald Trump, and an Epic Trail of Destruction
by David Enrich
Published 18 Feb 2020

Bill and Edson expanded the menu. Bill started dreaming up new types of a popular derivative known as swaps that were designed to help institutions protect themselves from changes in things like interest rates. He combined different types of swaps into mutant instruments with names like callable interest rate swaps and yield curve swaps and swaptions. This was good news for clients and great news for Merrill. Each time Merrill sold a swap to a client, it pocketed a fee. What’s more, Broeksmit devised clever new ways for Merrill to protect itself by using derivatives when it bought assets from customers.

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John Breit, a particle physicist hired to rein in some of the traders, many years later would credit Bill with having saved his job from an angry Edson on multiple occasions. By the early 1990s, Merrill’s board of directors was getting nervous about the bank’s expanding portfolio of derivatives. The imprudent use of derivatives had caused violent explosions inside some proud American companies, such as Procter & Gamble, which lost $157 million on a batch of interest-rate swaps it had purchased with borrowed money. (“Derivatives such as these are dangerous,” P&G’s chairman lamented.) Such blowups had damaged the reputations of the banks that had sold the soon-to-be-toxic instruments. Merrill’s board wanted to avoid their bank stumbling into a similar trap. One source of the bank’s anxiety was that by the early 1990s, swaps and other derivatives had changed dramatically—and, more important, were being used very differently.

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It was thanks to Merrill that Robert Citron, the treasurer of Orange County in Southern California, ended up using taxpayers’ money to dabble in derivatives. The bank’s salesmen in California had spent years wooing this quirky man (Citron liked to wear turquoise jewelry and loud ties and he regularly consulted astrology charts) because they could tell he was a “pigeon”—an easy mark. Sure enough, Citron soon started gorging on the tasty new interest-rate swaps that Merrill was cooking up. Orange County placed an astronomical wager that interest rates in the United States and in Switzerland would move in different directions. Citron’s municipality even agreed to buy the derivatives with money it borrowed from Merrill, fattening the bank’s profits.

Why Aren't They Shouting?: A Banker’s Tale of Change, Computers and Perpetual Crisis
by Kevin Rodgers
Published 13 Jul 2016

But primarily, the risk comes from the fact you might not pay back the loan. This is ‘credit risk’. Away from the aeons-old business of lending money at interest, many large banks run various trading businesses, most of which use the principal model. Merrill Lynch was no exception. Merrill’s bankers traded bonds; they traded interest rate swaps; they traded loans; they traded short-dated deposits. Loic would take me around the cavernous trading floor during quieter moments and point out where all these businesses were located, their staff hunched over tightly packed rows of desks. These tours were useful, but the most vital part of the education I got from Loic in those first few weeks was about how our department, FX, functioned.

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In essence, because the share forward can be ‘manufactured’ using other components (the ‘share now’ combined with borrowing or lending) – its price must be the same as the sum of the components. ‘Pricing derivatives: just find the way they can be made from other things,’ I scribbled down hurriedly as the lecture ended. It was a useful lesson and under our professor’s steely gaze we learned to apply it to a large number of different markets: currency forwards, interest rate swaps, commodity futures and so on. But all the derivatives in these examples have one thing in common – they have a linear payout, which is to say the profit or loss from holding them is a straight line depending on the price of the underlying asset. In our simple share example, if the correct price of £110 was shown to a customer who agreed to buy the share for delivery in one year’s time, then, if the current price of the share went up 5 per cent, so too would the value of the customer’s deal since the share forward would now not be worth £110 but £115.50 – this is simply the new, correct forward price with a current share price of £105 and 10 per cent interest rates for a year.

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Computer power then started to play a part. First, via the familiar route of allowing the product to be priced and risk-managed. At its simplest, pricing a CDS is an easy matter which relies on the same kind of arbitrage logic as my finance professor’s ‘share forward’ example because you can replicate a CDS with a bond, an interest rate swap and a loan.fn1 But any departure from this simplest case – a CDS which doesn’t match the bond maturity, for example, or one which is linked to multiple bonds because it references a borrower, not a bond – requires analytic firepower to be brought to bear. The use of DBAnalytics in Deutsche Bank and its equivalent in other rival firms directly led to the expansion of the market.

Extreme Money: Masters of the Universe and the Cult of Risk
by Satyajit Das
Published 14 Oct 2011

To limit losses, Harvard borrowed money to terminate the swaps, paying $498 million to banks during 2009 to cancel $1.1 billion of interest rate swaps. It agreed to pay $425 million over 30–40 years to offset an additional $764 million in swaps. Harvard implemented austerity measures—freezing salaries, reducing staff, and cutting capital spending, including the planned expansion. Harvard’s swaps had created a liquidity crisis of their own, which no one, least of all Summers, had imagined. Along with Robert Rubin and Alan Greenspan, Summers was instrumental in defeating the U.S. Commodity Futures Trading Commission’s attempt in 1998 to regulate over-the-counter derivatives, including interest rate swaps. In 2009 Summers, now director of President Obama’s National Economic Council, sought to regulate the derivatives market “to protect the American people.”

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Indiana Finance Authority’s consultant came up with 50 percent lower traffic forecasts, valuing the toll road at half the $3.8 billion purchase price. A third consultant concluded that Maunsell’s forecasts exceeded the highway capacity after 2020. Macquarie used derivatives, known as accreting interest rate swaps, to lower early payments by increasing later payments. Complex securities, such as TICKETs (tradeable interest bearing convertible to equity trust securities), with low early interest rates that increased over time, were used. The arrangements were identical to those used in subprime mortgages.

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As part of a settlement, the County agreed to build a sewer system collecting overflows and cleaning the water. The original $3.2 billion cost ultimately doubled. Between 1997 and 2002, Jefferson County issued $2.9 billion in sewer bonds. In 2002, bankers advised refinancing the debt using adjustable rate bonds and interest rate swaps, saving millions of dollars in interest cost. In an adjustable rate bond, the interest rate is reset periodically by reference to market rates. Between 2002 and 2004, Jefferson County issued more than $3 billion of adjustable rate bonds, predominantly auction rate securities (ARSs), bonds with a long maturity where the rate is regularly reset through a Dutch auction6 typically held every 7, 28, or 35 days.

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better
by Andrew Palmer
Published 13 Apr 2015

Because the value of a bond rises and falls in an inverse relationship to the trajectory of interest rates, investors who have bought a bond can protect themselves from an interest-rate rise by selling a future: as they lose money on one, they gain on the other. The first futures were for a type of mortgage-­backed security; they paved the way for much more actively traded contracts in Treasury-bond futures. Other types of derivatives followed. The first interest-rate swap, in which a borrower paying a floating-rate loan agrees to swap payments with a borrower who has taken out a fixed-rate loan, was agreed to in 1981. Equity-derivatives contracts based on the S&P 500 index were introduced in 1982. Credit-default swaps, which act as a kind of insurance policy against default by a corporate borrower, were invented in the 1990s.

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The role of the US government in promoting the securitization markets is well known. Ginnie Mae, a government-owned corporation, was the first to sell securities backed by a portfolio of mortgage loans in 1970; the first collateralized mortgage obligation was issued by Fannie Mae in 1983. The first currency and interest-rate swap was written in London between the World Bank and IBM, in an agreement that saw the World Bank exchange its surplus dollars for the computing firm’s stock of unwanted Swiss francs and deutsche marks. The first credit-default swap transaction, in 1994, saw the European Bank for Reconstruction and Development, a multilateral organization ostensibly dedicated to funding the transition economies of Eastern Europe, insure JP Morgan against the risk of Exxon defaulting.12 Political goals are also important in driving financial markets forward.

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They are then sliced into different tranches: the most senior tranches of CDOs of mortgage-backed securities were given high ratings during the most recent US housing boom because the performance of all the different mortgages in the pool was thought to be diversified. Counterparty risk: The risk that the other party to a contract will not live up to its obligations. The counterparty risk in an interest-rate swap is that one of the parties to the swap will not pay up. Credit-default swap: A credit-default swap is a form of insurance against default by a bond issuer. Credit ratings: An evaluation by a credit-rating agency of the creditworthiness of a debtor. Ratings are widely used by investors and are embedded in international rules, including those on how much equity banks have to use to fund themselves.

Principles of Corporate Finance
by Richard A. Brealey , Stewart C. Myers and Franklin Allen
Published 15 Feb 2014

Swaps allow them to change their risk in these ways. The market for swaps is huge. In 2011 the total notional amount of interest rate and currency swaps outstanding was over $460 trillion. By far the major part of this figure consisted of interest rate swaps.21 We therefore show first how interest rate swaps work, and then describe a currency swap. We conclude with a brief look at total return swaps. Interest Rate Swaps Friendly Bancorp has made a five-year, $50 million loan to fund part of the construction cost of a large cogeneration project. The loan carries a fixed interest rate of 8%. Annual interest payments are therefore $4 million.

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Convenience yield After a record harvest, grain silos are full to the brim. Are storage costs likely to be high or low? What does this imply for the net convenience yield? 9. Interest rate swaps A year ago a bank entered into a $50 million five-year interest rate swap. It agreed to pay company A each year a fixed rate of 6% and to receive in return LIBOR. When the bank entered into this swap, LIBOR was 5%, but now interest rates have risen, so on a four-year interest rate swap the bank could expect to pay 6½% and receive LIBOR. a. Is the swap showing a profit or loss to the bank? b. Suppose that at this point company A approaches the bank and asks to terminate the swap.

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Let’s see what happens. TABLE 26.3 The top panel shows the cash flows in millions of dollars to a homemade fixed-to-floating interest rate swap. The bottom panel shows the cash flows to a standard swap transaction. Friendly Bancorp calls a swap dealer, which is typically a large commercial or investment bank, and agrees to swap the payments on a $66.67 million fixed-rate loan for the payments on an equivalent floating-rate loan. The swap is known as a fixed-to-floating interest rate swap and the $66.67 million is termed the notional principal amount of the swap. Friendly Bancorp and the dealer are the counterparties to the swap.

The Enigma of Capital: And the Crises of Capitalism
by David Harvey
Published 1 Jan 2010

Then, towards the end of the 1980s, to offset the volatility, the practice of hedging (placing two-way bets on currency futures) became more common. An ‘over the counter’ market arose outside of the regulatory framework and the rules of the exchanges. This was the kind of private initiative that led to an avalanche of new financial products in the 1990s – credit default swaps, currency derivatives, interest rate swaps, and all the rest of it – which constituted a totally unregulated shadow banking system in which many corporations became intense players. If this shadow system could operate in New York, then why not also in London, Frankfurt, Zurich and Singapore? And why confine the activity to banks? Enron was supposed to be about making and distributing energy but it increasingly merely traded in energy futures and when it went bankrupt in 2002 it was shown to be nothing but a derivatives trading company that had been caught out in high-risk markets.

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Bail-outs worldwide of institutions that invested in CDOs, hedge funds, etc., followed by recession, unemployment and collapses in foreign trade met by various Keynesian-style stimulus packages and liquidity injections by central banks Appendix 2: Financial Innovations and the Rise of Derivative Markets in the US, 1973–2009 1970 Mortgage-backed securities introduced 1972 Chicago Currency Futures Market opens 1973 Chicago Board Options Exchange; trading in equity futures begins 1975 Trading in Treasury Bill and mortgage-backed bonds futures 1977 Trading in Treasury bond futures 1979 Over-the-counter and unregulated trading, particularly in currency futures, becomes commonplace. The ‘shadow banking system’ emerges 1980 Currency swaps 1981 Portfolio insurance introduced; interest rate swaps; futures markets in Eurodollars, in Certificates of Deposit and in Treasury instruments 1983 Options markets on currency, equity values and Treasury instruments; collateralised mortgage obligation introduced 1985 Deepening and widening of options and futures markets; computerised trading and modelling of markets begins in earnest; statistical arbitrage strategies introduced 1986 Big Bang unification of global stock, options and currency trading markets 1987–8 Collateralised Debt Obligations (CDOs) introduced along with Collateralised Bond Obligations (CBOs) and Collateralised Mortgage Obligations (CMOs) 1989 Futures on interest rate swaps 1990 Credit default swaps introduced along with equity index swaps 1991 ‘Off balance sheet’ vehicles known as special purpose entities or special investment vehicles sanctioned 1992–2009 Rapid evolution in volume of trading across all of these instruments.

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The ‘shadow banking system’ emerges 1980 Currency swaps 1981 Portfolio insurance introduced; interest rate swaps; futures markets in Eurodollars, in Certificates of Deposit and in Treasury instruments 1983 Options markets on currency, equity values and Treasury instruments; collateralised mortgage obligation introduced 1985 Deepening and widening of options and futures markets; computerised trading and modelling of markets begins in earnest; statistical arbitrage strategies introduced 1986 Big Bang unification of global stock, options and currency trading markets 1987–8 Collateralised Debt Obligations (CDOs) introduced along with Collateralised Bond Obligations (CBOs) and Collateralised Mortgage Obligations (CMOs) 1989 Futures on interest rate swaps 1990 Credit default swaps introduced along with equity index swaps 1991 ‘Off balance sheet’ vehicles known as special purpose entities or special investment vehicles sanctioned 1992–2009 Rapid evolution in volume of trading across all of these instruments. Volume of trading, insignificant in 1990, rose to more then $600 trillion annually by 2008 Sources and Further reading I relied on news reports for much of the detailed information I cite throughout the text.

Layered Money: From Gold and Dollars to Bitcoin and Central Bank Digital Currencies
by Nik Bhatia
Published 18 Jan 2021

He confessed that the system might have collapsed had it not been for a measly $3.6 billion bailout. Why? The answer lies in derivatives. Derivatives are financial contracts not considered securities. (Securities describe stocks and bonds for example, and derivatives describe stock options, futures contracts, and interest rate swaps.) Derivatives blossomed in the 1990s as a way to synthetically expose a portfolio to an array of outcomes, most commonly the fluctuation of interest rates. They were bank liabilities in a new form, one that was difficult for financial regulators or even the banking system as a whole to fully comprehend.

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An enormous margin call from the investment bank and major LTCM counterparty Bear Stearns in September 1998 triggered a collective realization that derivatives held by the hedge fund had the power to bring down the entire house of flimsy interbank risk. At the time of the LTCM bailout, the total market value of all the world’s derivatives including interest rate swaps, credit default swaps, and foreign exchange currency swaps was $3 trillion. To compare, the total supply of U.S. Treasuries was also about $3 trillion. By 2007, the total supply of U.S. Treasuries increased to $4 trillion but the market value of derivatives outstanding increased to $11 trillion.

Frequently Asked Questions in Quantitative Finance
by Paul Wilmott
Published 3 Jan 2007

The mark-to-market value of the CDS depends on changes in credit spreads. Therefore they can be used to get exposure to or hedge against changes in credit spreads. To price these contracts one needs a model for risk of default. However, commonly, one backs out an implied risk of default from the prices of traded CDSs. Diff(erential) swap is an interest rate swap of floating for fixed or floating, where one of the floating legs is a foreign interest rate. The exchange of payments are defined in terms of a domestic notional. Thus there is a quanto aspect to this instrument. One must model interest rates and the exchange rate, and as with quantos generally, the correlation is important.

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On later payment dates this principal can then be amortized again, starting from its current level at the previous payment date and not based on its original level. This makes this contract very path dependent. The contract can be priced in either a partial differential equation framework based on a one- or two-factor spot-rate based model, or using Monte Carlo simulations and a Libor market-type model. Interest rate swap is a contract between two parties to exchange interest on a specified principal. The exchange may be fixed for floating or floating of one tenor for floating of another tenor. Fixed for floating is a particularly common form of swap. These instruments are used to convert a fixed-rate loan to floating, or vice versa.

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Inverse floater is a floating-rate interest-rate contract where coupons go down as interest rates go up. The relationship is linear (up to any cap or floor) and not an inverse one. Knock-in/out option are types of barrier option for which the payoff is contingent on a barrier level being hit/missed before expiration. LIBOR-in-arrears swap is an interest rate swap but one for which the floating leg is paid at the same time as it is set, rather than at the tenor later. This small difference means that there is no exact relationship between the swap and bond prices and so a dynamic model is needed. This amounts to pricing the subtle convexity in this product.

How to Speak Money: What the Money People Say--And What It Really Means
by John Lanchester
Published 5 Oct 2014

Third, and finally, one of the most brilliant things the financial services industry ever did was to take the word “debt,” which people were brought up to consider a bad thing that you want to avoid, and to rename it as “credit,” which sounds like a good thing that you want more of. This is a major example of reversification at work. credit default swap (CDS) A financial instrument arising from interest rate swaps. The simplest way of looking at a CDS is as a form of insurance. If you are receiving interest from someone to whom you’ve lent money, you may start to wonder what happens if she starts to have trouble paying you. If you get worried, you might want to insure the interest you’re getting, so that in the event of a default by your borrower, you still get your money.

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Also, 11. inflation will fall—remember, inflation means that money is worth less, whereas a rise in interest rates means that money is more expensive. There’s more, too, but these eleven things provide a starting point for all the things that are completely taken for granted by people who speak money when they hear “interest rates.” interest rate swaps Financial techniques in which two parties do what it says on the tin: they swap interest rates. The most common example is when A has a floating interest rate and B has a fixed rate, and they both, for their differing reasons, would prefer to be on the other kind of deal. So they enter into a contract where A pays B’s interest rate, and B pays A’s.

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Unfortunately some of these swaps were mis-sold by banks, with the effect of severely damaging small businesses that didn’t know what they were getting into and thought they were reducing their risks. Instead they were locking themselves into unfavorable deals that were ruinously expensive to undo. The UK interest rate swap scandal has attracted less attention and opprobrium than the PPI scandal, perhaps because the victims tended to be small businesses rather than individuals, but in its essential detail—banks knowingly selling customers an unsuitable product—it was the same. inventory The amount of stuff a business has in stock.

Makers and Takers: The Rise of Finance and the Fall of American Business
by Rana Foroohar
Published 16 May 2016

But by the 1990s, and much more so after 2000, derivatives began to explode and expand in a way that made it clear that at least some of what was being traded had nothing to do with protecting people or companies in the real economy, but was more about speculation—one could call it gambling—with an increasingly complex array of financial instruments, on things like interest rate swaps, credit default swaps, and even bets on what the weather would be like from day to day. Derivatives are best known to most people as the “financial weapons of mass destruction” that Warren Buffett has warned us about, the complex securities that blew up our financial system in 2008. These financial instruments—be they interest rate swaps, foreign exchange bets, or grain futures—have very real, very tangible impacts. Yet to the banks, hedge funds, and the other institutions that trade them, they are simply another part of the economy that can be arbitraged for profit.

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Gensler remembers going out to LTCM’s headquarters in Greenwich, Connecticut, on a Sunday to investigate. “It quickly became clear to me that we had no idea what the ramifications would be in our financial system, and where, because these trades were booked in the Cayman Islands,” he says. “It was a terrible feeling.”24 Derivatives—be they interest rate swaps, foreign exchange bets, or energy futures—have real-world impacts, as we’ve already seen. Yet to the banks, hedge funds, and the other institutions that trade them, they are simply another moneymaking vehicle, something to be bought and sold. What’s more, most of us play a part in the cycle that drives up commodity prices and disproportionately enriches the financial sector, via our retirement savings.

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That Wall Street debt was “the biggest contributing factor to the increase in Detroit’s legacy expenses,” explains Turbeville, who wrote an influential report in 2013 outlining the role that finance had played in Detroit’s demise.35 The long and short of it was that the people negotiating the debt settlement on behalf of the city were completely outsmarted and outflanked by financiers, who cut deals for millions of dollars of extremely long-term interest rate swaps that were subject to immediate termination if the city’s credit deteriorated, which of course it quickly did. The termination of the contracts required immediate payment of all projected profits that would be earned by the banks had the contract not been terminated. That meant that Detroit was suddenly on the hook for a huge lump-sum payment that made its cash flow position completely untenable.

Commodity Trading Advisors: Risk, Performance Analysis, and Selection
by Greg N. Gregoriou , Vassilios Karavas , François-Serge Lhabitant and Fabrice Douglas Rouah
Published 23 Sep 2004

Among the large set of potential candidates, we have selected: the return on the Goldman Sachs Commodity Index (GSCI), previously used by Capocci and Hübner (2004); the return on Moody’s Commodity Index (MCOM); the U.S. Moody’s Baa Corporate Bond Yield to proxy for the default risk premium (DEF) as well as the monthly change on this yield (∆DEF); the U.S. 10-year/6-month Interest Rate Swap Rate to proxy for the maturity risk premium (MAT) as well as its monthly change (∆MAT); and finally the monthly change in the U.S. dollar/Swiss franc exchange rate to proxy for the currency risk premium (FX). These data series were extracted from the JCFQuant database. The Performance of CTAs in Changing Market Conditions 119 Finally, we use the option strategy factor proposed by Agarwal and Naik (2002) and Liang (2003) to capture the optionality component of CTA returns.

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The values are significant at the 5 percent level. 0.154 0.163 0.194 0.173 CTA Index Systematic Fin/Metal Diversified R2adj 0.335 0.371 0.333 0.358 (continued) CTA Index Systematic Fin/Metal Diversified TABLE 6.6 — — — — — — — — Bear −0.001 −0.001 −0.001 −0.002 — — — — RUS3 Strong Bull RUS2 — — — — — — — — UMD — — — — — — — — HDMZD −0.153 −0.202* −0.180 −0.199 0.289* 0.376** 0.274** 0.417* ∆MAT — — — — 0.522* 0.591* −0.263 0.781* ∆DEF 122 TABLE 6.7 PERFORMANCE Tailor-Made Model Results for Currency Index R2adj Entire Period Weak Bull Moderate Bull Strong Bull Bear Alpha ATMC DEF MAT 0.099 −3.188 −0.485** 2.364* — 0.332 — 0.090 — 0.372 −0.757* — 3.923 — — 0.273 — FX UMD HDMZD RUS2 0.099 0.083* 0.122** — 0.409* 0.569** 0.030 — — — — — — — — — — −3.172 — — — — — — — — — — ATMC = series of returns on the one-month ATM call written on the Russell 3000 index. DEF = U.S. Moody’s Baa corporate bond yield. MAT = U.S. 10-year/6-month Interest Rate Swap Rate. FX = monthly change in the U.S. dollar/Swiss franc exchange rate. UMD (Up Minus Down) = average return on the two high prior return portfolios minus the average return on the two low prior return portfolios. HDMZD (High Dividend Minus Zero Dividend) = average return of the highestdividend-paying stocks versus the stocks that do not dispense dividends.

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UMD (Up Minus Down) = average return on the two high prior return portfolios minus the average return on the two low prior return portfolios. HDMZD (High Dividend Minus Zero Dividend) = average return of the highest-dividend-paying stocks versus the stocks that do not dispense dividends. ∆MAT = change in the U.S. 10-year/6-month Interest Rate Swap Rate. GSCI = return on the Goldman Sachs Commodity Index. RUS2 = square of the excess returns on the Russell 3000. RUS3 = cube of the excess returns on the Russell 3000. MCOM = return on Moody’s Commodity Index. ** The values are significant at the 10 percent level. ** The values are significant at the 5 percent level.

A First-Class Catastrophe: The Road to Black Monday, the Worst Day in Wall Street History
by Diana B. Henriques
Published 18 Sep 2017

Increasingly, they also competed with banks in the rapidly growing private market for over-the-counter “swaps,” a new type of derivative contract that the futures exchanges wanted the CFTC to regulate in the face of resistance from both banks and brokerage firms. At the time, most members of oversight panels such as the Wirth subcommittee seemed to have no idea what swaps were or how they worked. Swaps are simply contracts by which two parties agree to exchange two future streams of cash that each is entitled to receive. In the case of interest rate swaps, the fastest-growing category in the mid-1980s, the streams of cash being “swapped” are the future interest payments on loans. Say Bank A is due to get fixed interest payments on a $100 million loan over the next ten years. On an identical loan, Bank B is due to collect variable interest payments, which will fluctuate with the market.

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As private contracts, they created invisible obligations between all kinds of financial institutions, debts that could suddenly go sour and leave one party to the contract exposed to enormous losses. Corrigan had shared his concerns at a meeting of the Federal Open Market Committee in May 1984, just as the Chicago crisis was unfolding. These gimmicks, “interest-rate swaps and other things,” were piling up in the shadows of the banking system, Corrigan told Paul Volcker and his colleagues on the committee. And they involved risks that “may not be totally understood, even by those who are playing in the markets.” He added, “And worse than that, they may not even be fully understood by us.

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But that was a landscape that would contain a daunting array of risks, including systemic risk, which he called “the ever-present snowball effect.” With large banks and other financial firms tightly but invisibly linked to one another and to counterparts overseas, systemic risk was a growing concern. “I have in mind such things as futures, options, options on futures, interest rate swaps,” and a host of other contingent liabilities, he said. These derivatives were often structured through Wall Street brokerage firms, and they were being used heavily by giant insurance companies. And because most of them were invisible to auditors and regulators, it was impossible to gauge how many Wall Street firms and insurance companies would be in danger if a major firm on one side of a derivatives deal failed.

Liar's Poker
by Michael Lewis
Published 1 Jan 1989

The Salomon salesmen, having schmoozed their client, move in to finish him off. They recommend that the thrift managers buy a billion dollars' worth of interest rate swaps. The thrift managers clearly don't know what an interest rate swap is; they look at each other and shrug. One of the Salomon salesmen tries to explain. The thrift men don't want to hear; they want to play golf. But the Salomon salesmen have them by the short hairs and won't let go. "Just give us a billion of them interest rate swaps, so we can be off," the thrift managers finally say. End of skit. *In the interest of variety, thrift will be used interchangeably with savings and loans throughout the text, as it is on Wall Street.

The Bond King: How One Man Made a Market, Built an Empire, and Lost It All
by Mary Childs
Published 15 Mar 2022

An inverted curve is a strong recession indicator, and it freaks people out every time. But as the crisis burned off, Pimco could see that things would revert to normal. Traders would again demand more yield for longer-term Treasuries. So Pimco put on a curve “steepener,” buying the very short-term Treasuries and selling longer-dated ones, and it expressed it through interest rate swaps. Just as it predicted, as markets calmed, the curve recurved. Pimco raked in its profits. Elsewhere, another pocket was humming along: Pimco Advisory, where Dick Weil was running the firm’s consulting for public and private institutions, along with Sabrina Callin, a partner who’d helmed the Commercial Paper Funding Facility program.

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Investors benchmark Total Return’s performance against an index, which always has a substantial slug of Treasuries. Any marginal deviation from the index weightings was a call, which clients tracked carefully. Total Return was disregarding an entire category, the most foundational one. Gross ramped up his bet in April, adding positions in derivatives like interest rate swaps betting against Treasuries. Now he wasn’t just at 0 percent Treasuries—these bets gave him essentially negative ownership of Treasuries. If Treasury prices fell, he would make even more money. He was in battle mode, and this was just another big contrarian call—the kind he was accustomed to getting right.

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No one would know the final numbers until someone won. How could he know the price before it was priced? This was by no means the first time Gross had encountered an auction. Why was this confusing to him? The explanations weren’t good enough for Gross, king of the secondary market, of liquid Treasuries and interest rate swaps, where things were priced in an instant. Finally, others including Ivascyn did interject, trying to slow Gross’s growing aggression at the team. These aren’t for you, they tried to say. You’re being unfair. Which just turned his attention toward them. On to Ivascyn. “So, you’re buying stuff you don’t know how to value?”

Corporate Finance: Theory and Practice
by Pierre Vernimmen , Pascal Quiry , Maurizio Dallocchio , Yann le Fur and Antonio Salvi
Published 16 Oct 2017

Such financial flows can be: currency swaps without principal; interest rate swaps (IRS); currency swaps with principal. Unlike financial assets, financial flows are traded over the counter with no impact on the balance sheet, and allow the parties to modify the exchange or interest rate terms (or both simultaneously) on current or future assets or liabilities. Interest rate swaps are a long-term portfolio of FRAs (from one to 15 years). As with FRAs, the principle is to compare a floating rate and a guaranteed rate and to make up the difference without an exchange of principal. Interest rate swaps are especially suited for managing a company’s long-term currency exposure.

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Lastly, the issuer can deduct the coupon payments from its corporate income tax, thus reducing the actual cost of the loan. 1. Spreads The spread is the difference between the rate of return on a bond and that on a benchmark used by the market. In the euro area, the benchmark for long-term debt is most often the interest rate swap (IRS) rate; sometimes the spread to government bond yields is also mentioned. For floating-rate bonds and bank loans (which are most often with floating rates), the spread is measured to a short-term rate, the three- or six-month Euribor in the eurozone. The easyJet bond was issued with a spread of 147 basis points (1.47%) to mid swap rate, meaning that easyJet had to pay 1.47% more per year than the risk-free rate to raise funds.

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. −0.331% (3 months) LIBOR (London Interbank Offered Rate) Money-market rate observed in London corresponding to the arithmetic mean of offered rates on the London banking market for a given maturity (between 1 and 12 months) and a given currency (euro, sterling, dollar, etc.). −0.376% (euro 3 months) IRS The IRS rate indicates the fixed interest rate that will equate the present value of the fixed-rate payments with the present value of the floating-rate payments in an interest rate swap contract. The convention in the market is for the swap market makers to set the floating leg – normally at Euribor – and then quote the fixed rate that is payable for that maturity. Section 20.4 Socially responsible bonds Green bonds are, from a purely financial point of view, standard bonds.

Trading at the Speed of Light: How Ultrafast Algorithms Are Transforming Financial Markets
by Donald MacKenzie
Published 24 May 2021

Trying to understand and explain those differences then became one of the goals of the research. In this book, I focus on four classes of instrument—futures, shares, governments’ sovereign bonds, and foreign exchange—that are all comparable in that they are simple and highly liquid. (The research also encompassed options and interest-rate swaps, but the greater complexity of these instruments makes them less directly comparable. Apart from chapter 6, in which the options market offers an extreme case of what is being discussed, I have not considered these markets, again to avoid overcomplicating the book.)36 Understanding and explaining how trading is organized requires taking a historical perspective, because its organization is “path dependent”: how trading was organized in the past affects how it is organized today.

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Differences in market structure among the main classes of highly liquid financial instrument US Europe Futures Dominated by anonymous order books and HFT Dominated by anonymous order books and HFT Shares Largely dominated by anonymous order books and HFT Largely dominated by anonymous order books and HFT Sovereign bonds Dealer-client market, but with anonymous order books and HFT in interdealer trading Much electronic trading, but almost intact dealer-client market, with virtually no HFT Foreign exchange Dealer-client market; partially colonized by anonymous order books and HFT Dealer-client market; partially colonized by anonymous order books and HFT Listed options Anonymous order books but only limited amounts of “classic” HFT; some face-to-face trading (suspended in coronavirus crisis) Some anonymous order-book trading but much dealer intermediation Interest-rate swaps Much electronic trading, but largely intact dealer-client market; only limited HFT Almost intact dealer-client market; little HFT Source: Author’s interviews. As indicated by tables 4.1 and 4.2, however, the anonymous order book/HFT market structure is far from universal, and in some markets dealers still play central roles.

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The near-catastrophic 2008 banking crisis prompted another phase of intense congressional involvement in reform efforts, but those efforts have not played a major part in the events described in this book, because their greatest effects were on one of the markets that I researched but (to prevent this book from becoming overcomplicated) I have not discussed: interest-rate swaps, in which efforts to practice HFT have to date largely been unsuccessful.16 The legal crackdown on spoofing, touched on above, was, however, largely made possible by this post-2008 congressional reform effort. On the face of it, this is puzzling, since spoofing played no discernible role in the crisis, but widespread involvement of Congress in reform can create political opportunities for regulators to move on unrelated matters.

Where Does Money Come From?: A Guide to the UK Monetary & Banking System
by Josh Ryan-Collins , Tony Greenham , Richard Werner and Andrew Jackson
Published 14 Apr 2012

Currency swaps: Currency swaps allow for the exchange of two currencies on a specific date at a set exchange rate, and then a reversal of the swap on a future date, usually at a different exchange rate. Commonly, this is a combination of a spot trade with a forward trade of opposite direction (e.g. sell CHF 100,000 and buy EUR spot; buy CHF 100,000 and sell EUR 30 days forward). On average, currency swaps accounted for $1,765 billion a day in 2010. Foreign interest rate swaps: Interest swaps allow counterparties to exchange streams of interest payments for a period of time, with the exchange of principle at a pre agreed exchange rate at maturity. On average, interest swaps accounted for $43 billion a day in 2010. Options: Currency options give the holders the right (which they do not have to exercise) to acquire or sell foreign currency at a specified price for a certain period of time.

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INDEX A | B | C | D | E | F G | H | I | K | L | M N | O | P | Q | R | S T | U | V | W allocation, credit 105, 106, 109, 111, 141 anti-Bullionist school 43 Article 101 EC 118 Asset Purchase Facility see Quantitative Easing Babylon 34 bank accounts balances 15, 16 customers’ ownership of money in 11-12 government 153 importance of 138 Bank Charter Act 1833 43 Bank Charter Act 1844 43-5 bank deposits 15, 17, 20-1 Bank of England bank deposits, quotes about 17 bank reserves, control of 19 commercial bank money, little control over 21-2 creation of 41, 42 credit creation for public spending 143-4 demand-driven interest rates 150-1 effecting the market rate of interest 77 electronic money creation 14 foreign exchange reserves 160 Lender of Last Resort 24, 97, 103, 138 LIBOR and 70-1, 83n, 102 money supply 6, 20 Moral Suasion 47 regulation of credit 24 regulation of wider range of financial institutions 49 repurchasing agreements (repos) 78-9, 101 standing facilities 79-80 supply-driven interest rates 150-1 see also cash; central bank money; central bank reserves; liquidity Bank of International Settlements 61 Bank of Japan 80-1, 104, 112 banking central see Bank of England commercial see commercial banks confusion around 11 crises 42-3, 45 earliest systems 34-5 lending 7 liability 11-12, 16, 62, 63, 85, 106 misconceptions of 7 modern, origins of 37-42 online 52-3 perceptions of 11-14 reform, questions to consider 141-2 see also clearing system Banking school 43 banknotes liquidity of 60 sale of 72-4 bartering 29, 30, 32, 32n base money see central bank money Basel Committee on Banking Supervision (BCBS) 52, 93-4, 95 Bernanke, Ben 81n bilateral netting 165 bilateral settlement 64 Bills of Exchange 37, 38n, 137 bonds government 41, 78, 118, 120, 122, 124-5 issuance of 37, 40-2 liquidity of 60 purchase operations 81 Bradbury bills 45-6 Bretton Woods agreement 46, 50 broad money 48, 51, 60-1 building societies 16 Bullionist school 42-3, 44 capital equity 84-5, 87-8, 94 forms of 84 minimum levels required of banks 93-5 own 84, 85, 93-4 retained earnings 93-4 capital adequacy effect on bank credit creation 95 levels 100, 140 leverage ratios 96-7, 97n rules 93-5 capital flows, international 50, 52, 127-33 capitalism 32, 61, 137-8 cash decline in use of 52-3 definition 6, 14 on demand 71, 72 sale of banknotes 72-4 central bank see Bank of England central bank money banks’ liquidity requirements 74-5 comparison with commercial bank money 75-7 definition 6, 14, 60 ratio to commercial bank money 22, 75 central bank reserves definition 6, 14-15 economic growth, little impact on 22 intangibility 67 interbank payments 64-71, 102 lending to commercial banks 21 liquidity for clearing system 65 liquidity of 60 Chartalism 35, 36 Chinese economic reforms 111-12 classical economics 30-1 clearing system Bank of England 64-5 clearing banks 48-9 early banking systems and 34-5 electronic payments 16, 64 goldsmiths 38 interbank 68-9 ratio of reserves held 7 Cobbett, William 44 coinage exchange rates 45 holders and exchangers of 37 silver 37 value of 36 commercial bank money comparison with central bank money 75-7 definition 6, 15 liquidity of 60 modern, creation of 40 ratio of money in circulation 52-3 ratio to base money 22 supply, no limits to 23-4 commercial banks bank accounts with Bank of England 64-5 business loans 106, 107-8 confidence of 23-4, 140 corridor system of reserve targets 83n, 99, 150-1 credit controls 47 credit creation 6, 62-4 credit lending criteria 7-8 credit rationing 105-10 definition 13 deposits 6 determining quantity of central bank reserves 7, 21 fear of insolvency 23-4, 24 financial intermediaries 12-14, 19 IOUs see liability lending criteria 7-8 LIBOR and 70-1, 83n, 102 money creation see money creation mortgages 107 profits 87, 94 regional 42, 43-4 shadow banking 101-2 ‘special profit’ from interest on credit 74 see also capital; credit; liquidity; money creation commodity theory of money 30-3 Competition and Credit Control (CCC) 49-50, 98 compulsory cash-reserve requirements 21 compulsory reserve ratios 98 computer money 14 Consolidated Fund 153-4 Consolidated Fund Extra Receipts (CFERs) 153n Continuous Linked Settlement (CLS) Bank 165-6, 168 corridor system 83n, 99, 150-1 country banks 42, 43-4 crawling pegs 130 credit credit creation see credit creation deregulation of controls on 48-52 direct regulation of 24, 96, 110-12 lending criteria 7-8 leverage ratios 96-7, 97n rationing 105-10 see also Competition and Credit Control (CCC); goldsmiths credit creation allocation 105, 106, 109, 111, 141 bank lending 6 booms 49-50, 51 capital adequacy rules 93-5 fiscal policy links 126-7 liquidity regulation 97-100 money as 34 money created by banks 62-4 quantity theory of 109-10 window guidance 111-12 see also money creation; productive credit creation; unproductive credit creation credit theory of money 33-4 credit unions 16 crowding out 124-6 currency bands 130 Currency school 42-3 currency swaps 162 Davies, Glynn 34, 46, 50 Debt Management Account (DMA) 154-7 Debt Management Office (DMO) 122, 124, 154, 155n, 156 debts 34-5 declining marginal utility 106 deductive reasoning 33n Defoe, Daniel 10 deposits bank 15, 17, 20-1 commercial banks creation of 7 demand 15, 43-4, 64, 65, 138 facilities 79 insurance 76-7 rates 150 receipts 34, 37, 38, 39, 40 deregulation 48-52 digital money 52-3 Discount Window Facility 84 double-entry bookkeeping 63 East Asian Economic Miracle 111-12 electronic money 14, 52-3, 67 endogenous money 103-4, 106, 109 equation of exchange 31n equity capital 84-5, 87-8, 94 eurodollars 50 European Central Bank (ECB) 52, 120-1 European Union (EU) 118-21 eurozone economies 120-1, 132-3 Exchange Equalisation Account (EEA) 158-60 exchange rates foreign 127-33, 158-60, 161, 162-8 government intervention 130-2 regimes 45-53, 129-30 Exchequer Pyramid 153, 154, 156 exogenous money 103-4, 109 Federal Reserve Bank of Chicago 44 Ferguson, Niall 28, 36 financial crisis eurozone 120-1 key questions raised 5-6 North Atlantic 29 originate and distribute model of banking 100-1 as a solvency and liquidity crisis 102-3 subprime mortgages 101, 138 Financial Services Authority (FSA) 99 Financial Services Compensation Scheme (FSCS) 16, 76 fiscal policy see Government Fisher, L. 31n floating currency regimes 130 floor system 152 foreign exchange eurozone 132-3 government intervention 130-2 markets 127-9 payment system 162-8 regimes 129-30 reserves 158-60 trade and speculation 161 transactions 162 foreign interest rate swaps 162 forex transactions 162-8 forwards (forex transaction) 161, 162 fractional reserve banking 7, 37, 38-40, 44 Galbraith, Professor J.K. 58, 146 GDP transactions 24, 51-2, 83, 96, 109-10, 125-6 see also productive credit creation general equilibrium 32 Gilt Edged Market Makers (GEMMs) 122-3, 156 gilts 41, 82, 155-6 gold standard 45-7 Gold Standard Act 1925 46 Golden Period 45 goldsmiths 37, 38-9, 40 Goodhart’s law 61, 138 Government bank accounts 153-60 bonds 41, 78, 118, 120, 122, 124-5 borrowing 122-3, 124-6 intervention to manage exchange rates 130-2 linking fiscal policy to credit creation 126-7 monetary policy 42-5, 47, 49-50, 120-1, 141-2 money creation, bypassing restrictions 119-20 money creation, EU restrictions on 117-19 money-financed fiscal expenditure 144-5 money supply, effect of borrowing on 124-6 productive investment 125-6 spending 123-4 taxation 35-6, 41, 121, 139, 140 Government Banking Service 156 gross non-payment versus payment settlement method 163-4 hedging 161 Herstatt risk 164 high-powered money see central bank money hire purchase houses 48 ICP/Cobden Centre poll 11, 12 imperfect information 7, 105, 107, 140 see also perfect information Impossible Trinity 131-2 Independent Commission on Banking 13 Ingham, Geoffrey 119 Innes, Mitchell 35 insolvency explanation of 86, 87 protection against 93-7 see also solvency interest compound 39 debt, interest-bearing 144-5 legalisation of 41 savings accounts 12 interest rates crowding out 124-6 foreign rate swaps 162 government debt 119 interbank rate 102, 150, 152 LIBOR 70-1, 83n, 102 margin 12 market rate 50, 77 monetary policy and 80-1 negative 80 policy rate 50, 79, 150 intra-day clearing 68 investment banking 13 investors bonds 40-1 government 126 private 125 IOUs see liability Keynes, John Maynard 4, 33, 71 lending cycles of 18-19 facilities 79-80 fractional reserve banking 7, 37, 38-40, 44 rates 150 leverage ratios 96-7, 97n liability 11-12, 16, 62, 63, 85, 106 LIBOR 70-1, 83n, 102 liquidity Bank of England influence on 78 crisis 86-7 Discount Window Facility 84 expectations, centrality to 138-9 financial crisis and 102-3 regulation of 97-100 solvency and 84-7 loans Bank of England influence on 77 business 106, 107-8 central bank 65-6, 78-9 central bank reserves 78-9 commercial banks 6 confidence in borrower to repay 20-1, 140 credit unions 16 in economic downturn 71 goldsmiths 38 maturity transformation 12 risk rating 94 secured 106-7 securitisation 100-1 M0 see central bank money M1, broad money 60 M2, broad money 61 M3, broad money 61 M4, broad money 15, 61 Maastricht Treaty 118-19 margin 12 marginal utility 31-2 market-makers 155 Marx, Karl 32, 39 maturity transformation 12 McKenna, Reginald 4 medium of exchange 29, 35, 38, 52, 139 Mill, John Stuart 30 Minimum Lending Rate (MLR) 50 Minsky, Hyman 33 Modern Monetary Theory (MMT) 121n monetary policy early 42-5 government reforms 49-50 politics of 120-1 reform, questions to consider 141-2 review of 47 Monetary Policy Committee (MPC) 79, 150 money acceptability of 139-40 commodity theory of 30-3 credit theory of 33-4 definition 6, 138-9 efficiency of exchange 30 emergence of modern money 137-8 endogenous 103-4, 106, 109 exogenous 103-4, 109 functions of 29 as information 67 local currency 145-6 marginal utility 31-2 money creation see money creation neutrality of 30-2 role of state in defining 35-7 as social relationship 33-4, 139-40 see also cash; money creation money creation allocation of 105, 106, 109, 111, 141 capital adequacy ratios 95 commercial banks and 6, 61, 64, 139-40 confidence of banks 23-4 creation of, misunderstanding 5 endogenous and exogenous money 103-4, 106, 109 implications for economic prosperity and financial stability 7-8 link to central reserves 7 multiplier model 18-21 securitisation 100-1 shadow banking 101-2 see also credit; Quantitative Easing money supply Bank of England measures of 60-1 control of 20, 48 definition 15 effects on 71 expansion by governments 145 money creation creation see credit; money creation overview 6 money tax 74 Mosler, Warren 36 multiplier model 18-21 national currency 6 National Loans Fund (NLF) 154, 158 National Savings and Investments (NS&I) 154, 158 neoclassical economics 31-4, 51 new money see money creation non-GDP transactions 24, 109 non-PVP method 163-4 Northern Rock 103 Open Market Operations (OMOs) 78, 79, 151 Operational Lending Facility 79-80 options (hedging) 161, 162 orthodox economics 31-4 Outright Monetary Transactions (OMTs) 121 own capital 84, 85, 93-4 payment versus payment (PVP) systems 165-6, 167, 168 pegged exchange rate regimes 130 perfect information 31, 32, 77, 105 see also imperfect information policy rate 50, 79, 150 productive credit creation 24, 111, 142 see also GDP transactions promissory notes 37, 38 Promissory Notes Act 1704 40, 42 PVP systems 165-6, 167, 168 Quantitative Easing (QE) Bank of England 81 bond purchases 81 definition 80-1 effect on economy 82-3 financial assets, purchase of 152 lending, impact on 22, 23 Quantity Theory of Credit 24n, 51, 109-10, 141 real time gross settlement (RTGS) 76, 79 repurchasing agreements (repos) 78-9, 101 reserve accounts 64-5 reserve ratios 19, 20, 21, 49, 51, 98 reserve targeting 150-1 residential mortgage-backed securities (RMBSs) 100-1 retail banking 13 risk management systems 94 safe-deposit boxes 11 savings, investment of 12-13 savings accounts 60 Schumpeter, Joseph 10, 30-1 secondary banking crisis 1974 50 securities 40-1 securitisation 100-1 seigniorage 74 settlement 29, 59, 64, 76, 128n, 162-3, 167-8 shadow banking system 101-2 Simmel, Georg 28 solvency financial crisis and 102-3 regulation of 84-7 see also insolvency; liquidity speculators 161 spots (forex transaction) 162 sterling stock liquidity regime (SLR) 98-100 store of value 29, 33 subordinated debt 85 subprime mortgages 101, 138 supply and demand 31 T-accounts 63 tally sticks 34-5, 41 taxation 35-6, 41, 121, 139, 140 textbook model 18-21 traditional correspondent banking 163-4 Treaty of Maastricht 118-19 Tucker, Paul 21, 106 unit of account 29, 35, 36, 139 unproductive credit creation 24, 111 see also GDP transactions; productive credit creation On Us, with and without settlement risk 167 USA, gold standard 46-7 usury see interest value, measurement of 35 Walras, Leon 31 Ways and Means Advances 117n Wergeld 35 Werner, Richard 44, 81n, 109-10 wholesale banking 13 wholesale money markets 50 window guidance 111-12 WIR credit-clearing circle 145 * ‘Central bank money in the UK economy takes two forms: banknotes and banks’ balances with the Bank of England (reserves).

The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival
by Charles Goodhart and Manoj Pradhan
Published 8 Aug 2020

The benefits of equity finance are obvious, but worth reiterating. First, unlike debt, equity has no maturity and hence no looming deadline for redemption. Second, dividends are both discretionary and can be shaped to revenues or earnings in a way that fixed coupon payments cannot. Some debt instruments, like interest rate swaps and inflation indexed bonds, do show payments that are variable in nature, but the bulk of the debt universe is comprised of fixed coupon paying bonds. Missed coupon payments count as a default in a way that not paying dividends doesn’t. Finally, during periods of stress around debt, an income stream of fixed payments that is supposed to protect creditors turns out to be a dubious asset at best.

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Immigrants, taking up unskilled jobs Immigration Immigration, and productivity Immigration, causes political tension Immigration, impact on public finance Immigration, opposition to Immigration, public opposition to Immigration, targeted for care workers Immigration control Impossible trinity Incentives, of managers, misaligned Income inequality Income percentile Income share, of top percentiles Income taxation, progressive Index tracking, by asset managers India India, abundant supply of labour India, administration and reform India, administrative capital, weak India, airports India, facing decline in world labour supply India, growth decline in 2018/19 India, have the ability to replicate China’s ascent India, inflection of dependency ratio distant India, massive population, an attractive market India, new bankruptcy code (IBC) India, population of India’s growth India’s growth, private sector drives Indirect taxes Indonesia Industrialization Industrial Revolution Inequality Inequality, between countries Inequality, declining Inequality, falling Inequality, global Inequality, within countries Inequality, within economies Inequality of income Inequality of wealth Inflation Inflation, a monetary phenomenon Inflation, consequence of wars Inflation, low in Japan Inflation, reviving Inflation, stronger pressures for Inflation, surge of Inflation target, political pressure to modify Inflation, targets Inflation, unexpected Inflation accelerated Inflation and age-structure of population, linked Inflationary bias, major Inflation expectations, well anchored Inflation indexed bonds Inflation targeting Inflexion Inflexion point Informal care costs Information and communication technology Infrastructure Innovation Insiders Insiders, in Japan Insiders in Japan, having primary loyalty to company Insiders, in labour force Insolvency risks Institute for Fiscal Studies Institutional shareholders, when large can gain information and influence management Intangible investment Intellectual property rights Interest, paid on commercial bank reserves at central bank Interest rates Interest rates, exceptionally low Interest rates, extraordinarily low Interest rates, falling Interest rates, falling to historical lows Interest rates, trending down Interest rate swaps ‘Internal Labour Markets’ in Japan Internal migration International Monetary Fund (IMF) Inter-war period Inventories Inventory accumulation Investment Investment cycle, US Investment, ex ante (expected) Investment, in Japan, collapsing Investment, offshored to Asia Investment, reduced by shift of production via globalization Inward investment, into Japan Ipsos MORI Iran Iraq Ireland Islamic finance Italy J Jackson Hole Jackson Hole Conference Japan Japan, affected by China’s growth Japan, blueprint for ageing societies Japan, collapse of investment growth Japan, conventional analysis flawed Japan, corporate sector, delevering Japan, distinction between output per capita and output per worker Japan, dividend exemption policy Japan, experience of Japan, impressive record of productivity Japan, labour supply decline Japan, lessons of Japan, lost decade Japan, ‘miracle’ decades Japan, no sign of inflationary pressures Japan, owes debt to households Japan, revisionist history Japan, unit labour costs Japan, wage growth Japan, wage inflation in Japan corporate sector Japanese business, offshored production to China Japanese corporates, investing abroad rather than at home Japanese evolution, conventional interpretation Japanese labour market, particular features of Japan’s domestic investment Japan Spillover Report Japan’s Productivity Surge Jetsupphasuk, M.

The Asian Financial Crisis 1995–98: Birth of the Age of Debt
by Russell Napier
Published 19 Jul 2021

Remember that the key way of bypassing such Basle Accord rules is via off-balance sheet derivatives. The BIS estimated that at the end of last year there was US$30,000bn in credit market exposure outstanding in interest rate swap agreements. That’s 24× the core capital of the developed world banking system, and that’s assuming that Japanese banks have all the core capital which they are reporting. Of course interest rate swaps are only one form of off balance sheet derivative. We had all better hope that the rocket scientists put the right equations into those laptops and that that practice represents a genuine improvement in our understanding of risk rather than just another mystified form of extrapolation.

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Among the binarist cognoscenti (definition: those who believe that 0 and 1 have all the answers for forecasting), LTCM are the star players. If they can get it wrong then there must be a prospect that the lesser binarists might be having problems with their equations. This is terrible news. According to the BIS there is US$30trn outstanding in interest rate swaps alone. If the big binary guns could get the equations wrong then how big could the mispricing in the global derivatives business be? Of course the reply will be that such mispricing will come out in the wash in our new hedged world and thus there is not a problem. However, the wealth swings away from one bank and to another due to mispricing could threaten the stability of that bank.

Trading and Exchanges: Market Microstructure for Practitioners
by Larry Harris
Published 2 Jan 2003

Financial managers call this problem the duration mismatch problem. The duration of the bank’s assets is greater than the duration of its liabilities. To manage this risk, Wilshire Savings and Loan needs to hedge its uncertain cash flows. Hedging with Swaps Wilshire can hedge its interest rate risk by entering an interest rate swap. An interest rate swap is an agreement between two parties to swap a fixed-rate cash flow for a variable-rate cash flow. The swap contract specifies both cash flows. A typical swap contract involves a five-year swap of semiannual payments. The variable-rate cash flow depends on some short-term interest rate index, like the London InterBank Offered Rate (LIBOR).

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Simultaneously, the Clearing House pays Brad 250 dollars in variation margin. If the price of silver is the same when the contract expires, Brad will pay 4.55 an ounce for the silver, and Sharon will receive 4.55 an ounce. ◀ * * * Swaps are contracts for the exchange of two future cash flows. A cash flow is a series of payments. An interest rate swap provides for the exchange of a future series of fixed-rate interest payments for a future series of variable floating-rate interest payments. When they enter the contract, the traders negotiate the fixed-rate payments and agree upon a formula for computing the future variable-rate payments.

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A currency swap provides for the exchange of a future series of fixed payments in one currency for a future series of payments in another currency. Since the values of these contracts depend on the values of the cash flows that the traders swap, swaps are derivative contracts. * * * ▶ The Third Order Derivative of LIFFE The London International Financial Futures and Options Exchange (LIFFE) trades a euro interest rate swap futures contract called the Swapnote. This is a cash-settled futures contract that prices the expiration day value of a standard bond-pricing formula for a hypothetical fixed-rate bond. The hypothetical bond consists of a series of notional fixed 6 percent interest payments followed by the return of the notional principal at the maturity of the hypothetical bond.

All the Devils Are Here
by Bethany McLean
Published 19 Oct 2010

The earliest derivatives attempted to mitigate interest rate risk and currency risk. In the volatile economic environment of the 1980s, when interest rates and currency values could swing suddenly and unpredictably, big companies were desperate for ways to protect themselves; derivatives became the way. An interest rate swap allowed a company to lock in an interest rate and pay a fee to another entity—a counterparty, as they were called on Wall Street—willing to take the risk that rates would suddenly jump. (If rates dropped instead, the counterparty would make a nice profit.) The counterparty, in turn, would often want to hedge, or reduce, its own risks by entering into an offsetting trade with another entity.

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See Derivatives Cribiore, Alberto Cuomo Andrew Currency swaps Dallas, Bill Dallavecchia, Enrico Daurio, Jon Davis Square III Defaults, on subprimes Depository Institutions Deregulation and Monetary Control Act (1980) D’Erchia, Peter Derivatives of AIG Financial Products CDOs CDOs, multisector CDOs, synthetic credit default swaps currency swaps danger and warning about futures classification defeat high ratings, reasons for interest rate swaps of J.P. Morgan LTCM collapse netting out quants’ development of regulatory efforts structured investment vehicles (SIVs) tranches of See also specific instruments Deutsche Bank, ABS index Dimon, Jamie Dodge, Patti Donilon, Tom Dooley, Bill Drexel Burnham Lambert Dubrish, Robert Dugan, John Dunne, Jimmy Dynamic hedging Dyron, Dick Edper Edwards, Jeff Eichel, Scott Eisman, Steve Empiris LLC Enron European Bank for Reconstruction and Development (EBRD) Evans, Gay Everquest Exception pricing system Exxon Valdez Fakahany, Ahmass Falcon, Armando, Jr.

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“Hank,” AIG FP, control of biographical information earnings management by on FM Watch leaves AIG risk-management system of and Sosin style/personality of See also AIG Financial Products; American International Group (AIG) Greenberger, Michael Greenlining Institute Greenspan, Alan antiregulatory position on capital reserves “Committee to Save the World,” as derivatives supporter interest rate cuts on LTCM collapse subprimes, neglect of issue Gregory, Joe Guardian Savings & Loan Guldimann, Till, Value at Risk (VaR) developed by Gutierrez, Michael Habayeb, Elias Hagler, Grayland Scott, Reverend Hard-money lenders leading companies legislation and expansion of operation of second-lien mortgages by subprime MBS, first Harris, Patricia Hawke, John Hedge funds, at Bear Stearns, collapse of Hedging, dynamic hedging Hibbert, Eric High loan-to-value lending (HLTV) Holder, Steve Holding companies Home equity loans Homeownership and baby boomers Bush initiatives Clinton initiatives increase for credit risks and interest rates loan defaults, rise in Mozilo support of Home Ownership and Equity Protection Act (HOEPA) Home values drop in homes abandoned by owners increase in (2001-2006) Household Finance Howard, Tim HSBC Hudson Mezzanine Hunter, Allan Oakley Hybrid CDOs Icahn, Carl IKB IMARC Implicit government guarantee, Fannie Mae Incentive compensation Independent Swaps and Derivatives Association (ISDA) IndyMac Interest rates cuts and home buying increases Interest rate swaps Investment firms. See Wall Street; specific firms ISDA swap contract J. Aron Jedinak, Russell and Rebecca Johnson, Jim biographical information Fannie expansion under on Maxwell style/personality of J.P. Morgan Bear Stearns acquired by BISTRO CEOs. See Weatherstone, Sir Dennis credit default swaps derivatives lobbying by quants/quantitative analysis risk management special purpose entity (SPE) synthetics trading business entry Value at Risk (VaR) measure Jungman, Michael Junk bonds Kamilla, Rajiv Kapnick, Scott Karaoglan, Alain Kemp, Jack Kendall, Leon Kennedy, Judy Killian, Debbie Killinger, Kerry Kim, Dow Kindleberger, Charles Koch, Richard Kolchinsky, Eric Komansky, David Kronthal, Jeff firing of and Fleming Merrill CDOs returns to Merrill Kudlow, Larry Kurland, Stanford as Countrywide president leaves Countrywide style/personality of Kushman, Todd LaFalsce, John Lattanzio, Dale firing of and Merrill CDOs Lay, Ken Lazio, Rick Leach, Jim Lee, Wayne Lehman, David Lehman, Phil Lehman Brothers collapse of fraudulent activities losses (2007) Paulson during collapse Letters of credit Levine, Howard Levitt, Arthur Levy, Gus Lewis, Bob Lewis, Ken Lewis, Michael Lippman, Greg Lipton, Andrew Litton, Larry Litton Loan Servicing Lobbying derivatives supporters by Fannie Mae Lockhart, Jim Loeb, David Long Beach Mortgage establishment of federal investigations of Long Beach Savings & Loan establishment of Goldman deals loans, selling to Wall St.

The Curse of Cash
by Kenneth S Rogoff
Published 29 Aug 2016

On top of that, the Internal Revenue Service exercises considerable discretion over the timing of the refund; it is hardly a fully liquid asset. There are many solutions to the tax prepayment problem, and it is just not a serious obstacle. We discussed in chapter 10 the logistical complications that negative rates could create for bond issuers, and how they might be resolved. Relatedly, interest rate swap markets have become a key element of the financial ecosystem, allowing firms to conveniently hedge interest rate risk. A world of negative rates might require a restructuring of some of the institutions and legal frameworks surrounding these markets, but again, early experience in Europe suggests that this issue may not be nearly as problematic as some feared.

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Dennis (congressman), 71 Hawala transfer system, 68 helicopter money, 155–56, 249n16 Hellwig, Martin, 242n12 Henderson, Dale, 245n14, 254n4 Henry VIII (king of England), 20, 184 Hicks, John R., 234n6 history of currency, 15–17; birth of paper currency in China, 21–25; early coinage, 17–20; Franklin and paper currency in the colonial United States, 26–28; from gold-backed to pure fiat paper currency, 28–30; origin of coinage, 21; private notes in Europe, 25–26 hoarding, problem of, 87–88, 97, 115, 175, 233n8 Hong Kong: currency/GDP ratio, 2015, 36; currency per capita, 37, 40; foreign demand for paper currency of, 34; foreign holdings of currency, 41, 236n13 Hong Kong Monetary Authority, 138 horizontal equity, 59 human trafficking, 73–74 Ice Cube (musician, actor), 233n5 illegal drug market, estimated size of, 69 illegal immigration, 2, 74–76 Incas, 16–17 India, 73, 204, 215 inflation: Bitcoin and, 213; cumulative change in a currency’s value versus the dollar, examples of, 184; of early Chinese paper currencies, 23–25; fiscally engineered, 157; governmental default on debt and, 184–86; government intentions regarding, the negative interest rate and, 183–84; higher, drawbacks to, 149–50; historical examples of high, 183–84; optimal choice of inflation target, effect of proposal on, 105–6; quantitative easing and, 136–37; rates of and wages/unemployment, 247n1; 4% target for, 121, 125–26, 133, 147–50, 152–53; target inflation rates, the zero bound constraint and, 147–51; targeting, relaxing rigidity of the framework for, 152–54, 231–32; tightening policies of Volcker and Thatcher in response to, 119–20; in the United States, periods of, 27–28; war financing and, 27–28; the zero bound problem and collapse of, 120 inflation-targeting evangelism, 120, 232 inflation tax, 80, 82 interest-paying anonymous bearer bonds, 233n6 interest rates: central bank cuts in response to recent crises, 131–32; financial stability and, 177; monetary cost seigniorage and, 87; negative (see negative interest rates); New York Federal Reserve discount rates, 1929–1939, 128–29; nominal and real, 121, 243n1; nominal policy for the United States, Eurozone, and United Kingdom, 2000–2015, 130; opportunity cost seigniorage and, 82–83; on paper currency, Gesell’s proposal for, 163–67; quantitative easing and, 137–38 (see also quantitative easing); United Kingdom, 1930–present, 128; United Kingdom and United States short-term market, 1929–1939, 129; zero bound, at or near the, 130–32 interest rate swap markets, 180 Internal Revenue Service (IRS), 60 international dimensions to phasing out paper currency, 199; coordinated action, benefits of, 202–4; emerging markets, 204–5; foreign notes as substitutes for domestic ones, 199–201; forgone profits from supplying the world underground with currency, 202–4 international monetary policy coordination, 205–6 Irons, Jeremy (actor, Moonlighting), 74 ISIS (Islamic State of Iraq and Syria), 77 Israel, 131 Issing, Otmar, 7 Italy: cash used for different kinds of purchases, percentage of, 55–56; currency/GDP ratio, 1995, 46; restrictions on the use of cash, 64; seigniorage revenues from currency, 85; underground economy, estimated size of, 62–63 Itami, Juzo, 236n8 Itskhoki, Oleg, 250n18 Jackson, Andrew (US president), 192 Japan: cash circulating, amount of, 35–36, 235n6; currency/GDP ratio, 1953–2015, 35; currency per capita, 37, 40; double-digit inflation, 183; interest rates near the zero bound, 131; large-denomination notes, 31; loss of seigniorage as nonissue, 203; negative interest rates by the central bank, 123; negative interest rates in, 5; paper currency phaseout, costs and benefits of, 89–90; underground economy, 35; zero bound, continued struggle with, 122.

Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe
by Gillian Tett
Published 11 May 2009

He agreed that it was highly unlikely Exxon would default, and he was impressed by the steady stream of income from the fees. It was much higher than anything else he could earn on a highly rated bond or loan. “It seemed like a win-win situation,” Donaldson later recalled. Just as Salomon Brothers’ early interest-rate swaps deal between IBM and the World Bank had met two sets of needs, the Exxon deal was brilliantly transferring risk in a way that suited both parties. For several weeks, Masters made endless phone calls to London from New York as she and Donaldson—together with a phalanx of lawyers—worked out legal terms for the deal.

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Chase Manhattan had always had a formidable sales force, covering numerous corners of the financial world that J.P. Morgan had never managed to reach. It also had its own pool of creative financiers, including some in the CDO world. And, of course, the combined bank now had the advantage of vast size. The combined bank was estimated to control about half of the market for interest-rate swaps, a potentially formidable platform. Indeed, in early 2001, a few months after the merger was completed, the bank was named “Derivatives House of the Year.” Yet, as the J.P. Morgan swaps alums tried to adjust to the Chase influence, it was impossible to recapture the thrill of their early achievements.

The City
by Tony Norfield

The banks’ sale of mortgage securities played a major role in the expansion of mortgage debt to more and more borrowers, including in the end to those who were in no position to pay that debt back. Banks also create other kinds of security, known as derivatives, for hedging and speculative purposes. These include interest rate swaps, and futures and options on interest rates and currency values. They appear on a bank’s balance sheet as an asset or a liability, and the banks also earn dealing margins and other fees when they buy or sell derivatives. While derivatives are part of a bank’s business dealings, they are not capital invested in a bank’s or any other company’s operations.

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Table 8.4 shows London’s even stronger dominance in the ‘over-the-counter’ (OTC) interest rate derivatives market – where trading is done directly between banks and their customers, not on a financial exchange. This global business, of which London has nearly half, began only in the 1980s, but it forms the biggest part of the derivatives market, principally made up from the trading of interest rate swaps. In these transactions, companies and dealers exchange with their counterparties one form of interest payment for another, usually an interest rate that is fixed over a number of years for a rate set according to market conditions every six months. Other trading of derivatives takes place on exchanges, and the US is home to the biggest of these, mainly based in Chicago.

Austerity: The History of a Dangerous Idea
by Mark Blyth
Published 24 Apr 2013

Equities will decline in value, commodities too, as global demand weakens, and housing, outside a few markets, is not going to be increasing in value at 7 to 10 percent a year anytime soon. But deprived of fuel for the asset cycle, all those wonderful paper assets that can be based off these booms—commodity ETFs, interest rate swaps, CDOs and CDSs—to name but a few—will cease to be the great money machine that they have been to date. Having pumped and dumped every asset class on the planet, finance may have exhausted its own growth model. The banks’ business model for the past twenty-five years may be dying. If so, saving it in the bust is merely, and most expensively, prolonging the agony.

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(with Keynes), 123, 124–125 Henry, James, 244 Hirschman, Albert, 39, 100, 108, 109 Holland, 4 Hoover, Herbert, 119, 187 Hubbard, Glenn, 243 Hume, David, 17, 100–101, 167 on government debt, 107, 108–109 “On Money”, 107 producing austerity, 114–115 relationship between and market and the state, 115–122, 123 Hungary and austerity, 221 hyperinflation in the 1920s, 56 Hutchinson, Martin, 207, 209 Iceland bailout in, 231 economic strategies in, 235–240 Stock Exchange, 237 inflation, 240, 241 ING, 83 Inoue, Junnosuke, 198, 200 Inside Job, (documentary), 21 interest rate swaps, 234 international capital-flow cycle, 11 International Monetary Fund, 3, 17, 45, 55 and austerity, 122, 206, 213, 221 and bailouts, 71–73, 221 and loans to Ireland, 235 and the Bretton Woods institutions, 162–163 and the consolidation in Denmark, 207 and the hidden “Treasury View”, 163–165 and the situation in Iceland, 238–239 and the success of the REBLL states, 216 and “the Washington consensus”, 102, 161–163, 164 Polak model, 163–165 World Economic Outlook, 212, 215 See also Kahn, Dominique Strauss Ireland, 3, 4, 5, 205, 222 austerity in, 17, 169–170, 179, 205, 206 expansion, 207–208, 209 bailout in, 221, 231 capital-flow cycle in, 11 economic strategies in, 235–240 Eurozone current account imbalances, 78 fig. 3.1 Eurozone Ten-Year Government Bond Yields, 80 fig. 3.2 fiscal adjustment in, 173 government debt 2006–2012, 46, 47, 53, 62, 65, 66 real estate in rise in prices, 27, 64–68 Italy, 1, 3, 4, 5, 222 Eurozone Current Account Imbalances, 78 fig. 3.1 Eurozone Ten-Year Government Bond Yields, 80 fig. 3.2 fiscal adjustment in, 173 government debt 2006–2012, 47, 53, 62 slow growth crisis, 68–71 slow-growth problem, 69 sovereign debt of, 108 Janeway, Bill, 125 Jayadev, Arjun, 212, 213 Japan and Keynesianism, 225 and the London Naval Treaty, 199, d austerity in, 17, 178–180, 197–200, 204 Bank of Japan, 197 Seiyukai party, 199 Showa Depression, 198 See also Hamaguchi, Prime Minister; Korekiyo, Takahashi Johnson, Simon, 11, 72 Kahn, Dominique Strauss, 222 Kahn, R.

High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems
by Irene Aldridge
Published 1 Dec 2009

Spot trading in both interest rate products and bonds implies instantaneous or “on-the-spot” delivery and transfer of possession of the traded security. Futures trading denotes delivery and transfer of possession at a prespecified date. Swap trading is a contractual transfer of cash flows between two parties. Interest rate swaps may specify swapping of a fixed rate for a floating rate; bond swaps refer mostly to a trading strategy whereby the investor sells one bond and buys another at a comparable price, but with different characteristics. In fixed-income markets, many investors are focused on the product payouts rather than on the prices of the investments themselves.

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Instead of pricing default risk into the rate explicitly, exchanges trading interest rate futures require borrowers to post collateral accounts that reflect the creditworthiness of the borrower. Swap products are the most populous interest rate category, yet most still trade OTC. Selected swap products have made inroads into electronic trading. CME Group, for example, has created electronic programs for 30day Fed Funds futures and CBOT 5-year, 10-year, and 30-year interest rate swap futures; 30-day Fed Funds options; 2-year, 5-year and 10-year Treasury note options; and Treasury bond options. As Table 4.2 shows, however, electronic trading volumes of interest rate products remain limited. Bond Markets Bonds are publicly issued debt obligations. Bonds can be issued by a virtual continuum of organizations ranging from federal governments through local governments to publicly held corporations.

Planet Ponzi
by Mitch Feierstein
Published 2 Feb 2012

So, for example, if you are paying a floating interest rate on some debt, and you’d prefer to pay a fixed interest rate instead, you and I could arrange a deal whereby we enter into a interest rate swap agreement. I’ll pay you a floating rate‌—‌for example, three-month Libor. In exchange, you pay me an agreed fixed rate‌—‌for example, 4%. In effect, you’ve swapped your floating rate obligation for a fixed rate obligation. That achieves your objective. Now, if you borrowed $100 million in the first place, and if our interest rate swap was for that full $100 million, then the notional principal outstanding is $100 million. That doesn’t, however, mean that anything like that amount of cash is at stake.

Market Risk Analysis, Quantitative Methods in Finance
by Carol Alexander
Published 2 Jan 2007

Financial firms, of course, should be the experts at managing market risks; it is their métier. Indeed, over the last generation, there has been a marked increase in the size of market risks handled by banks in comparison to a reduction in the size of their credit risks. Since the 1980s, banks have provided products (e.g. interest rate swaps, currency protection, index linked loans, capital guaranteed investments) to facilitate the risk management of their customers. They have also built up arbitrage and proprietary trading books to profit from perceived market anomalies and take advantage of their market views. More recently, banks have started to manage credit risks actively by transferring them to the capital markets instead of warehousing them.

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The first and second derivatives of an investor’s utility function tell us whether the investor is risk averse, risk loving or risk neutral. 2 Quantitative Methods in Finance context refers to a financial instrument that is a contract on a contract, such as a futures contract on an interest rate, or an option on an interest rate swap.3 We shall employ numerous sensitivities throughout these volumes. For instance, the first order yield sensitivity of a bond is called the modified duration. This is the first partial derivative of the bond price with respect to the yield, expressed as a percentage of the price; and the second order yield sensitivity of a bond is called the convexity.

The Ascent of Money: A Financial History of the World
by Niall Ferguson
Published 13 Nov 2007

An explosion of ‘securitization’, whereby individual debts like mortgages are ‘tranched’ then bundled together and repackaged for sale, pushed the total annual issuance of mortgage backed securities, asset-backed securities and collateralized debt obligations above $3 trillion. The volume of derivatives - contracts derived from securities, such as interest rate swaps or credit default swaps (CDS) - has grown even faster, so that by the end of 2007 the notional value of all ‘over-the-counter’ derivatives (excluding those traded on public exchanges) was just under $600 trillion. Before the 1980s, such things were virtually unknown. New institutions, too, have proliferated.

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A put option is just the opposite: the buyer has the right, but not the obligation, to sell an agreed quantity of something to the seller of the option. A third kind of derivative is the swap, which is effectively a bet between two parties on, for example, the future path of interest rates. A pure interest rate swap allows two parties already receiving interest payments literally to swap them, allowing someone receiving a variable rate of interest to exchange it for a fixed rate, in case interest rates decline. A credit default swap, meanwhile, offers protection against a company’s defaulting on its bonds.

Panderer to Power
by Frederick Sheehan
Published 21 Oct 2009

Banks have counterparty risk to their borrowers: the borrower may not repay a loan. That was a concern when the value of LTCM’s collateral fell below the amount of money it had borrowed. There is also counterparty risk in a derivative contract. A hypothetical example: when Citigroup and J. P. Morgan enter an interest-rate swap, Citigroup will receive floating-rate interest payments every six months, and J. P. Morgan will receive fixed-rate interest payments at the same time.5 The interest-rate payments are computed based on a principal amount upon which the interest is earned: $100 million, for instance. The “counterparty” risk is that one of the participants fails and cannot pay back the $100 million of principal.

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A staffer offered more bad news: “The off-balance-sheet leverage was 100 to 1 or 200 to 1—I don’t know how to calculate it.”17 The staffer wasn’t alone. 14 Ibid., p. 118. 15 Ibid., pp. 110–111. 16 Ibid., p. 108. 17 Ibid., p. 108. Greenspan’s “first line of regulatory defense” didn’t know whether LTCM was trading interest-rate swaps or stolen cars. Greenspan expressed his exasperation several times during the meeting: “It is one thing for one bank to have failed to appreciate what was happening to [LTCM], but this list of institutions is just mind boggling.”18 So boggled was the man that Greenspan (and his successor Ben Bernanke) allowed the commercial banking system to leverage as never before, writing over $100 trillion worth of derivatives contracts between then and 2008—without so much as a dollar bill of reserves for these off-balance-sheet structures.

The Man Who Knew: The Life and Times of Alan Greenspan
by Sebastian Mallaby
Published 10 Oct 2016

According to the ISDA market surveys, the notional value of outstanding currency and interest-rate swaps rose from $11.3 trillion in H2 1994 to $37 trillion in H1 1998. “Market Surveys Data, 1987–2010” (International Swaps and Derivatives Association, Inc., June 30, 2010). 8. Robert Rubin and Jacob Weisberg, In an Uncertain World: Tough Choices from Wall Street to Washington (New York: Random House, 2003), 287–88. 9. It is sometimes pointed out that Born’s concerns related mainly to interest-rate swaps, not to the credit-default swaps that proved dangerous when the insurer AIG failed in 2008.

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Firms such as Morgan Stanley assembled teams of scientists to apply ideas like chaos theory to markets, and hedge funds such as Long-Term Capital Management began to bet not on the direction of a market’s move but rather on how far it would move in either direction. The sheer speed with which derivatives proliferated was remarkable. As of the end of 1987, the face value of privately negotiated derivatives—mostly interest-rate swaps—amounted to under $1 trillion. Seven years later, the number had soared more than tenfold, reaching $11 trillion.1 In the wake of the disasters at Orange County, Procter & Gamble, and Gibson Greeting Cards, Fortune’s Carol Loomis did her best to understand what was happening. Loomis was the doyenne of financial journalists, the writer who had exposed the workings of the first ever “hedged fund”—she was not easily bamboozled.

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It is sometimes pointed out that Born’s concerns related mainly to interest-rate swaps, not to the credit-default swaps that proved dangerous when the insurer AIG failed in 2008. But if Born’s instincts on central clearing and margin requirements had been adopted for interest-rate swaps, the same principles would presumably have been applied to credit-default swaps as that market developed in the next decade. Further, it is true that Born did not present a fully fleshed-out proposal; rather, the CFTC issued a “concept release,” consisting of a laundry list of discussion points, and Timothy Geithner, then at the Treasury, recalls her ideas as “mostly impenetrable.” But the implication of the release was that the over-the-counter market would benefit from safer foundations.

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead
by Alan S. Blinder
Published 24 Jan 2013

While their ancestry dates back centuries, modern financial derivatives really came into their own in the late 1980s and early 1990s. The International Swaps and Derivatives Association (ISDA), the industry’s trade association, estimates that the notional value of outstanding privately negotiated derivatives—mostly interest-rate swaps—amounted to under $1 trillion at the end of 1987. But they grew like kudzu, to $11 trillion by the end of 1992 and a staggering $69 trillion by 2001. WHAT IS A DERIVATIVE? “Derivative” is a generic term for any security or contract whose value is derived from that of some underlying natural security, such as a stock or a bond.

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See Interest-rate spreads time value of money, 29 unconventional tactics by Fed. See Unconventional monetary policy (UMP) Interest-rate spreads, 237–43 and bond-related risk, 41–42 and European crisis, 410 in normal economy, 239, 241 quantitative easing (QE) to reduce, 248–56 reducing, methods of, 242–43 widening and crisis, 237–40 Interest-rate swaps, 60 International Swaps and Derivatives Association (ISDA), 60 Internet bubble, 35, 38 Investment banks Bulge Bracket firms. See Bear Stearns; Goldman Sachs; Lehman Brothers; Merrill Lynch; Morgan Stanley credit-ratings, manipulation of, 80–81 as derivative broker-dealers, 61 executive compensation, 81–84 federal bailouts for.

The Gone Fishin' Portfolio: Get Wise, Get Wealthy...and Get on With Your Life
by Alexander Green
Published 15 Sep 2008

The fund’s non-inflation-indexed holdings may include the following:• Corporate debt obligations • U.S. government and agency bonds • Cash investments • Futures, options, and other derivatives • Restricted or illiquid securities • Mortgage dollar rolls The fund may invest up to 20% of its total assets in bond futures contracts, options, credit swaps, interest rate swaps, and other types of derivatives. These contracts may be used to keep cash on hand to meet shareholder redemptions or other needs while simulating full investment in bonds, to reduce transaction costs, for hedging purposes, or to add value when these instruments are favorably priced. Losses (or gains) involving futures can be substantial—in part because a relatively small price movement in a futures contract may result in an immediate and substantial loss (or gain) for the fund.

Damsel in Distressed: My Life in the Golden Age of Hedge Funds
by Dominique Mielle
Published 6 Sep 2021

Lehman was the liquidity provider for many funds and countless companies, a critical piece of the Wall Street maze in which all the players were hopelessly intertwined. Canyon, like every hedge fund, used Lehman as a counterparty, or a trading partner. We had not been only sitting on pending trades where we had sold them stocks, bonds and loans, but also ongoing contracts, credit and interest rate swaps, warehousing lines, you name it. So when Lehman’s stock started falling, from $65 per share at the beginning of 2008 to $12 in July, and rumors of a potential insolvency could be validated by an even cursory analysis of the cash balance, it became clear that left to its own fate, Lehman would unravel.

Digital Accounting: The Effects of the Internet and Erp on Accounting
by Ashutosh Deshmukh
Published 13 Dec 2005

XML-based languages and accounting cycles Accounting Cycle Transaction Type Revenue Cycle • • • • • Sales order Credit approval Shipping Billing Payment Expenditure Cycle • • • • • Review of inventory Choosing a supplier Purchase order Receipt of goods Receipt and payment of the bill Conversion Cycle • Product design • Production planning and control • Manufacturing • Inventory control • Source journals • General ledger • Financial reporting • Derivatives, interest rate swaps • Capital markets • Transfer of financial data Financial Reporting Finance XML Application ebXML BASDA e-Business XML BizCodes cXML ECML IOPT VISA XML Specification XML Voucher BIPS cXML eCX XML XML-EDI ECML IOPT VISA XML Specification XML Voucher BIPS XML UPS Tracking PDML PDX XBRL fpML FinXML FIXML RIXML MDML IFX OFX can be directly exchanged between different accounting applications.

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Financial Management, Strategic Management and Digital Accounting 295 Corporate Treasury Functions Corporate treasury functions include cash management, investment and debt management, financial risk management and investor relations. This is a catchall description, not an authoritative definition, and there is considerable overlap in these classifications. Treasury functions also deal with complex financial areas, such as foreign exchange rates, derivatives and interest rate swaps, among other things. Treasury functions also might differ between, say, a manufacturing firm and a bank. These treasury functions have changed due to Web-based tools and technologies. The pace of change is uneven; several years ago e-treasury or virtual treasury was projected to be a fait accompli for corporations.

Freedom Without Borders
by Hoyt L. Barber
Published 23 Feb 2012

Licensing also includes an excellent correspondent bank relationship. 30 Freedom Without Borders The bank has full power and authority to conduct all banking business that banks in Europe and North America can do (e.g., it can offer CDs and bank paper of all kinds, trade currencies, do interest rate swaps, and offer mortgages). It can conduct banking business with any client in any part of the world, except for the jurisdiction where it’s chartered and licensed. A Class 1 banking license has no requirements or limits on lending, with the exception that the bank may not lend out any loans or advances to directors or shareholders in excess of 1 percent of paid- in capital.

I.O.U.: Why Everyone Owes Everyone and No One Can Pay
by John Lanchester
Published 14 Dec 2009

The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Bill Clinton and George W. Bush administrations. Several other factors helped fuel the financial industry’s ascent. Paul Volcker’s monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made bond trading much more lucrative. The invention of securitization, interest rate swaps, and credit default swaps greatly increased the volume of transactions that bankers could make money on. And the aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services.

The Handbook of Personal Wealth Management
by Reuvid, Jonathan.
Published 30 Oct 2011

Specialists can help evaluate an aircraft’s integrity and history of maintenance and damage, as ____________________________________________________ ADVISORY SERVICES 49 ឣ well as the fairness of the seller’s asking price. It is important to go through these steps so undisclosed damage can be uncovered. Buyers will need to choose from an extensive choice of credit structures, including fixed and variable-rate loans, flexible lines of credit and innovative interest-rate swaps. Lending terms and payment schedules can be designed to accommodate the client’s specific requirements, including issues pertaining to tax efficiency, cash-flow management and other financial goals. In addition, refinancing can be a valuable way to free up some of the equity in an aircraft that is owned outright.

Getting a Job in Hedge Funds: An Inside Look at How Funds Hire
by Adam Zoia and Aaron Finkel
Published 8 Feb 2008

Positions are designed to generate profits from the fixed income security as well as the short sale of stock, while protecting principal from market moves. Fixed Income Arbitrage A fund that follows this strategy aims to profit from price anomalies between related interest rate securities. Most managers trade globally with a goal of generating steady returns with low volatility. This category includes interest rate swap arbitrage, U.S. and non-U.S. government bond arbitrage, forward yield curve arbitrage, and mortgage-backed securities (MBS) arbitrage. The mortgage-backed market is primarily U.S.-based, over-the-counter (OTC), and particularly complex. Note: Fixed income arbitrage is a generic description of a variety of strategies involving investments in fixed income instruments, and weighted in an attempt to eliminate or reduce exposure to changes in the yield curve.

Empirical Market Microstructure: The Institutions, Economics and Econometrics of Securities Trading
by Joel Hasbrouck
Published 4 Jan 2007

Many of the same financial institutions that rely heavily on electronic access to markets have also gone to great lengths and expense to maintain the trading operations for their diverse markets together on large, contiguous trading floors. This facilitates coordination when a deal involves multiple markets. The pricing and offering of a corporate bond, for example, might well involve the government bond, interest-rate swap, credit swap, and/or the interest rate futures desks. Thus, while no longer necessary to realize (in a single market) economies of scale, personal proximity may promote (across multiple markets) economies of scope. 2.3 Dealers 2.3.1 Dealer Markets A dealer is simply an intermediary who is willing to act as a counterparty for the trades of his customers.

The Money Machine: How the City Works
by Philip Coggan
Published 1 Jul 2009

Its extra costs are £2,500, the cost of the premium, but its borrowing costs are £5,000 less than it might have expected at the time when it bought the option. SWAPS Swaps were once seen as exclusive products which were tailor-made to suit the few sophisticated borrowers who could understand them. Nowadays they are a huge global market, with many simple, standardized products. The basic concept behind the interest-rate swap is that two borrowers raise money separately and then agree to service each other’s interest payments. However, many swap deals are much more complicated and can involve several currencies and half a dozen borrowers, with only the bank in the middle aware of all the details. Why should two borrowers want to pay each other’s interest?

The Great Tax Robbery: How Britain Became a Tax Haven for Fat Cats and Big Business
by Richard Brooks
Published 2 Jan 2014

The foreign currency debt legally remains, but the ‘currency swap’ removes exposure to the currency and money markets. All pretty standard, but not yet ‘tax enhanced’. Under the tax laws brought in by the mid-nineties’ Tory government, currency swaps would be taxed under two sets of rules, one covering foreign exchange, another ‘financial instruments’ such as interest rate swaps. Although the laws were complex, the principle was simple: the tax outcome should follow the economic result, so that if a hedge produced an overall profit it would be taxed and if it made a loss this could be deducted from a company’s other taxable profits. But intricate, overlapping tax laws make perfect playthings for a tax consultant, and the Ernst & Young advisers had certainly had their fun before their visit to the Pru.

Running Money
by Andy Kessler
Published 4 Jun 2007

You needed advanced calcu- 16 Running Money lus to figure out the value of those. But Nash wasn’t thinking about puts and calls. Here was an old-fashioned trader looking to get in the flow. He was clearly a guy who couldn’t let go. I’m used to the “roving eye” at meetings. One guy in Denver was trading interest rate swaps for his own account while we talked. He checked the quote screen in his office so often, I thought his eyeballs would pop out. But even he was an amateur compared to this. Fred finished up and there was a long silence. I jumped in. “Thanks again for taking the time to meet with us. We would be honored to have you involved in our fund.”

High-Frequency Trading
by David Easley , Marcos López de Prado and Maureen O'Hara
Published 28 Sep 2013

Equity  Description BR Brazilian Bovespa futures CF CAC 40 index futures DA Dax futures DJ DJIA Futures EN Nikkei 225 Futures ES S&P 500 E-mini FT FTSE 100 index HI Hang-Seng index futures IB IBEX 35 II FTSE MIB KM KOSPI 200 MD S&P 400 MidCap MG MSCI EAFE Mini MI ND NE NK NQ NZ PT RL RM SP SW TP TW VH XP XX YM Interest rates   Volume Description 5,582 AX Australian 10 yr bond 56,521 AY Australian 3 yr bond 97,337 BL Euro-bobl 5 yr 596 BN Euro-bund 10 yr 26,729 BZ Euro-schatz 2 yr 478,029 CB Canadian 10 yr 54,259 ED Eurodollar 55,812 FV T-Note 5 yr 16,791 GL Long gilt 16,775 JB Japanese 10 yr bond 46,121 KE Korean 3 yr 42 ST Sterling 3 months 2,022 TS 10-year interest rate swap 28,266 TU T-Note 2 yr S&P 400 MidCap E-mini Nasdaq 100 788 Nikkei 225 Futures 8,519 Nikkei 225 Futures 6,048 Nasdaq 100 173,211 New Zealand Dollar 3,809 S&P Canada 60 11,374 Russell 2000 91 Russell 1000 Mini 418 S&P 500 6,142 Swiss Market Index 18,880 TOPIX 8,416 MSCI Taiwan 24,533 STOXX Europe 50 196 ASX SPI 200 16,716 EURO STOXX 50 80,299 Dow Jones E-mini 110,122 TY UB UR US T-Note 10 yr Ultra T-Bond Euribor 3 months T-Bond 30 yr  Volume 3,889 3,159 27,228 53,292 16,136 8,276 11,864 59,830 16,353 5,401 3,707 1,765 41 24,912 95,793 9,341 3,747 57,588 The volume of trades over a 67-month period is given in thousands.

Underwater: How Our American Dream of Homeownership Became a Nightmare
by Ryan Dezember
Published 13 Jul 2020

The bank and its consultants had told the New York private-equity firm that bought American Roads as well as debt investors and a bond insurance company to expect 10 million cars to cross the bridge in 2012. Really, though, just 2.3 million trips were recorded. Worse yet for American Roads, interest rate swaps attached to the debt financing backfired. The swaps were meant to protect against rising interest rates. When rates were cut in response to the housing crash, a bill came due from the bank with which Macquarie had wagered. The wrong-way bet added $334 million to American Roads’ debt. In 2012, the toll road company faced debt payments of $35 million against $14.2 million in pretax earnings.

The Pay Off: How Changing the Way We Pay Changes Everything
by Gottfried Leibbrandt and Natasha de Teran
Published 14 Jul 2021

It may look like that from some angles, but the global large-value transfer system is an integral part of the engine that enables us to pay and borrow and that oils the wheels of commerce and trade. No one has yet found a better way to do that. Without foreign exchange markets, there would be fewer, slower and more expensive cross-border payments and therefore less trade. Without interest rate swaps there would be no defined-benefit pensions, no mortgages or loans – or at least far fewer – because the banks and other providers would be able to offer them only when they found investors ready to take the opposing risk. And without banks and capital markets for stocks and bonds, businesses would have much less access to funding.

Aiming High: Masayoshi Son, SoftBank, and Disrupting Silicon Valley
by Atsuo Inoue
Published 18 Nov 2021

Born in 1962 to an upper-middle-class Indian family, Rajeev Misra won a scholarship to Pennsylvania University and then worked as a computer programmer before taking an MBA at Massachusetts Institute of Technology. When he graduated from MIT it was the start of the credit boom and for the next 20-odd years – initially at Merrill-Lynch, later at Deutsche Bank – he would ride the crest of that wave, conducting derivative and interest-rate swaps and dealing in foreign exchange and credit derivatives, eventually being named Global Head of Credit at Deutsche Bank and leading a team of 3,000 around the world. When Son asked him how he had managed such an impeccable track record, Misra replied that ‘performance is absolutely crucial in finance but it’s not just about making money – you had to be entrepreneurial: build businesses, hire and manage well, develop strong relationships with clients.’

Mathematics for Finance: An Introduction to Financial Engineering
by Marek Capinski and Tomasz Zastawniak
Published 6 Jul 2003

Glossary of Symbols A B β c C C CA CE CE Cov delta div div0 D D DA E E∗ f F gamma Φ k K i m fixed income (risk free) security price; money market account bond price beta factor covariance call price; coupon value covariance matrix American call price European call price discounted European call price covariance Greek parameter delta dividend present value of dividends derivative security price; duration discounted derivative security price price of an American type derivative security expectation risk-neutral expectation futures price; payoff of an option; forward rate forward price; future value; face value Greek parameter gamma cumulative binomial distribution logarithmic return return coupon rate compounding frequency; expected logarithmic return 305 306 Mathematics for Finance M m µ  N N k ω Ω p p∗ P PA PE PE PA r rdiv re rF rho ρ S S σ t T τ theta u V Var VaR vega w w W x X y z market portfolio expected returns as a row matrix expected return cumulative normal distribution the number of k-element combinations out of N elements scenario probability space branching probability in a binomial tree risk-neutral probability put price; principal American put price European put price discounted European put price present value factor of an annuity interest rate dividend yield effective rate risk-free return Greek parameter rho correlation risky security (stock) price discounted risky security (stock) price standard deviation; risk; volatility current time maturity time; expiry time; exercise time; delivery time time step Greek parameter theta row matrix with all entries 1 portfolio value; forward contract value, futures contract value variance value at risk Greek parameter vega symmetric random walk; weights in a portfolio weights in a portfolio as a row matrix Wiener process, Brownian motion position in a risky security strike price position in a fixed income (risk free) security; yield of a bond position in a derivative security Index admissible – portfolio 5 – strategy 79, 88 American – call option 147 – derivative security – put option 147 amortised loan 30 annuity 29 arbitrage 7 at the money 169 attainable – portfolio 107 – set 107 183 basis – of a forward contract 128 – of a futures contract 140 basis point 218 bear spread 208 beta factor 121 binomial – distribution 57, 180 – tree model 7, 55, 81, 174, 238 Black–Derman–Toy model 260 Black–Scholes – equation 198 – formula 188 bond – at par 42, 249 – callable 255 – face value 39 – fixed-coupon 255 – floating-coupon 255 – maturity date 39 – stripped 230 – unit 39 – with coupons 41 – zero-coupon 39 Brownian motion 69 bull spread 208 butterfly 208 – reversed 209 call option 13, 181 – American 147 – European 147, 188 callable bond 255 cap 258 Capital Asset Pricing Model 118 capital market line 118 caplet 258 CAPM 118 Central Limit Theorem 70 characteristic line 120 compounding – continuous 32 – discrete 25 – equivalent 36 – periodic 25 – preferable 36 conditional expectation 62 contingent claim 18, 85, 148 – American 183 – European 173 continuous compounding 32 continuous time limit 66 correlation coefficient 99 coupon bond 41 coupon rate 249 307 308 covariance matrix 107 Cox–Ingersoll–Ross model 260 Cox–Ross–Rubinstein formula 181 cum-dividend price 292 delta 174, 192, 193, 197 delta hedging 192 delta neutral portfolio 192 delta-gamma hedging 199 delta-gamma neutral portfolio 198 delta-vega hedging 200 delta-vega neutral portfolio 198 derivative security 18, 85, 253 – American 183 – European 173 discount factor 24, 27, 33 discounted stock price 63 discounted value 24, 27 discrete compounding 25 distribution – binomial 57, 180 – log normal 71, 186 – normal 70, 186 diversifiable risk 122 dividend yield 131 divisibility 4, 74, 76, 87 duration 222 dynamic hedging 226 effective rate 36 efficient – frontier 115 – portfolio 115 equivalent compounding 36 European – call option 147, 181, 188 – derivative security 173 – put option 147, 181, 189 ex-coupon price 248 ex-dividend price 292 exercise – price 13, 147 – time 13, 147 expected return 10, 53, 97, 108 expiry time 147 face value 39 fixed interest 255 fixed-coupon bond 255 flat term structure 229 floating interest 255 floating-coupon bond 255 floor 259 floorlet 259 Mathematics for Finance forward – contract 11, 125 – price 11, 125 – rate 233 fundamental theorem of asset pricing 83, 88 future value 22, 25 futures – contract 134 – price 134 gamma 197 Girsanov theorem 187 Greek parameters 197 growth factor 22, 25, 32 Heath–Jarrow–Morton model hedging – delta 192 – delta-gamma 199 – delta-vega 200 – dynamic 226 in the money 169 initial – forward rate 232 – margin 135 – term structure 229 instantaneous forward rate interest – compounded 25, 32 – fixed 255 – floating 255 – simple 22 – variable 255 interest rate 22 interest rate option 254 interest rate swap 255 261 233 LIBID 232 LIBOR 232 line of best fit 120 liquidity 4, 74, 77, 87 log normal distribution 71, 186 logarithmic return 34, 52 long forward position 11, 125 maintenance margin 135 margin call 135 market portfolio 119 market price of risk 212 marking to market 134 Markowitz bullet 113 martingale 63, 83 Index 309 martingale probability 63, 250 maturity date 39 minimum variance – line 109 – portfolio 108 money market 43, 235 no-arbitrage principle 7, 79, 88 normal distribution 70, 186 option – American 183 – at the money 169 – call 13, 147, 181, 188 – European 173, 181 – in the money 169 – interest rate 254 – intrinsic value 169 – out of the money 169 – payoff 173 – put 18, 147, 181, 189 – time value 170 out of the money 169 par, bond trading at 42, 249 payoff 148, 173 periodic compounding 25 perpetuity 24, 30 portfolio 76, 87 – admissible 5 – attainable 107 – delta neutral 192 – delta-gamma neutral 198 – delta-vega neutral 198 – expected return 108 – market 119 – variance 108 – vega neutral 197 positive part 148 predictable strategy 77, 88 preferable compounding 36 present value 24, 27 principal 22 put option 18, 181 – American 147 – European 147, 189 put-call parity 150 – estimates 153 random interest rates random walk 67 rate – coupon 249 – effective 36 237 – forward 233 – – initial 232 – – instantaneous 233 – of interest 22 – of return 1, 49 – spot 229 regression line 120 residual random variable 121 residual variance 122 return 1, 49 – expected 53 – including dividends 50 – logarithmic 34, 52 reversed butterfly 209 rho 197 risk 10, 91 – diversifiable 122 – market price of 212 – systematic 122 – undiversifiable 122 risk premium 119, 123 risk-neutral – expectation 60, 83 – market 60 – probability 60, 83, 250 scenario 47 security market line 123 self-financing strategy 76, 88 short forward position 11, 125 short rate 235 short selling 5, 74, 77, 87 simple interest 22 spot rate 229 Standard and Poor Index 141 state 238 stochastic calculus 71, 185 stochastic differential equation 71 stock index 141 stock price 47 strategy 76, 87 – admissible 79, 88 – predictable 77, 88 – self-financing 76, 88 – value of 76, 87 strike price 13, 147 stripped bond 230 swap 256 swaption 258 systematic risk 122 term structure 229 theta 197 time value of money 21 310 trinomial tree model Mathematics for Finance 64 underlying 85, 147 undiversifiable risk 122 unit bond 39 value at risk 202 value of a portfolio 2 value of a strategy 76, 87 VaR 202 variable interest 255 Vasiček model 260 vega 197 vega neutral portfolio volatility 71 weights in a portfolio Wiener process 69 yield 216 yield to maturity 229 zero-coupon bond 39 197 94 

Everything Is Obvious: *Once You Know the Answer
by Duncan J. Watts
Published 28 Mar 2011

So although stretching out the vesting period diminishes the role of luck in determining outcomes, it certainly doesn’t eliminate it. In addition to averaging performance over an extended period, therefore, another way to try to differentiate individual talent from luck is to index performance relative to a peer group, meaning that a trader working in a particular asset class—say, interest rate swaps—should receive a bonus only for outperforming an index of all traders in that asset class. Put another way, if everybody in a particular market or industry makes money at the same time—as all the major investment banks did in the first quarter of 2010—we ought to suspect that performance is being driven by a secular trend, not individual talent.

The New Science of Asset Allocation: Risk Management in a Multi-Asset World
by Thomas Schneeweis , Garry B. Crowder and Hossein Kazemi
Published 8 Mar 2010

Extrapolating these conventions provides an aid in understanding the return and risk properties as well as trading patterns inherent in establishing an accepted asset class. Beyond taking different approaches, there are also different conventions. Some investors view currencies as a separate asset class while fully understanding that currencies may also be viewed as simple short-term interest rate swap between countries. Some investors refuse to pay managers for cash held in a multi-asset portfolio on the grounds that they should only pay when and where their monies are invested in specific assets and that cash is a placeholder. As we find our way through new terrain, there is a range of issues in determining the taxonomy for asset class determination; however, degree of difficulty must not be the stopping point of establishing a process by which we address asset allocation issues.7 The approach must be the creation of a map.

Tools for Computational Finance
by Rüdiger Seydel
Published 2 Jan 2002

After the Chicago Board of Options Exchange (CBOE) opened in 1973, the volume of the trading with options has grown dramatically. Options are discussed in more detail in Section 1.1. Swaps are contracts regulating an exchange of cash flows at different future times. A common type of swap is the interest-rate swap, in which two parties exchange interest payments periodically, typically fixed-rate payments for floating-rate payments. Counterparty A agrees to pay to counterparty B a fixed interest rate on some notional principal, and in return party B agrees to pay party A interest at a floating rate on the same notional principal.

Systematic Trading: A Unique New Method for Designing Trading and Investing Systems
by Robert Carver
Published 13 Sep 2015

This method is fine for semi-automatic traders who will probably be staring at charts anyway, but I don’t recommend it for others. The second method is to calculate the precise standard deviation of price changes over a moving window of time – the volatility look-back period. You can use a 110. There are even more complicated cases such as options, interest rate swaps and credit derivatives but I do not cover these here. 155 Systematic Trading short window like ten business days (around two weeks), or a longer one such as 100 days. As the upper panel of figure 23 shows, shorter windows mean your volatility estimate is noisy, which as you’ll see in chapter twelve will mean higher trading costs, but reacts very quickly to changes.

Hate Inc.: Why Today’s Media Makes Us Despise One Another
by Matt Taibbi
Published 7 Oct 2019

The world has just grown so complex that the majority of serious issues are beyond the understanding of non-specialists. Take “the economy.” The average citizen has basic ideas about money. We shouldn’t spend more than we have. People should pay their debts. And so on. But how many people know what a derivative is? An interest rate swap? An auction rate security? Just the process for issuing the public bond used to pay for the skating rink where your kids play is a morass so complex it took federal prosecutors nearly a decade to train themselves in the language of it, when they tried (and failed) to bust bankers who rigged that game to steal money.

Fault Lines: How Hidden Fractures Still Threaten the World Economy
by Raghuram Rajan
Published 24 May 2010

A competitive system is also likely to produce the financial innovation necessary to broaden access and spread risk. Financial innovation nowadays seems to be synonymous with credit-default swaps and collateralized debt obligations, derivative securities that few outside Wall Street now think should have been invented. But innovation also gave us the money-market account, the credit card, interest-rate swaps, indexed funds, and exchange-traded funds, all of which have proved very useful. So, as with many things, financial innovations span the range from the good to the positively dangerous. Some have proposed a total ban on offering a financial product unless it has been vetted, much as the Food and Drug Administration vets new drugs.

The Road to Ruin: The Global Elites' Secret Plan for the Next Financial Crisis
by James Rickards
Published 15 Nov 2016

Between June 30, 2001, and June 30, 2007, the gross notional value of all over-the-counter derivatives held by major banks as reported in a BIS survey grew from less than $100 trillion to more than $508 trillion. Over the same period, the Herfindahl index, a market concentration measure for U.S. dollar–denominated interest rate swaps, rose from 529 to 686, strong evidence that more swaps were concentrated in fewer large banks. In a lecture series from 2003 to 2005 at Northwestern University’s Kellogg School, I warned audiences a new financial catastrophe was coming, and that it would be more costly than the 1998 LTCM crisis.

The Clash of the Cultures
by John C. Bogle
Published 30 Jun 2012

The reality of transaction costs, however, suggests that we should pay more attention to total trading volume—including both purchases and sales—an incredible $5.4 trillion in total transactions, not far from one-and-a-half times the $3.8 trillion of equity fund assets of the group. However high the levels of mutual fund trading in stocks have soared relative to traditional norms, they pale by comparison to the trading volumes of hedge funds, to say nothing of the levels of trading in exotic securities such as interest rate swaps, collateralized debt obligations, derivatives such as futures on commodities, stock indexes, stocks, and even bets on whether a given company will go into bankruptcy (credit default swaps). The aggregate nominal value of these instruments, as I noted in Chapter 1, now exceeds $700 trillion.

Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street
by William Poundstone
Published 18 Sep 2006

They told investors that they had risk under control through their financial engineering. LTCM used a sophisticated form of the industry standard risk reporting system, VaR or “Value at Risk.” After the Black Monday crash of 1987, investment bank J. P. Morgan became concerned with getting a handle on risk. Derivatives, interest rate swaps, and repurchase agreements had changed the financial landscape so much that it was no longer a simple thing for a bank executive (much less a client) to understand what risks the people in the firm were taking. Morgan’s management wanted an executive summary. It would be a number or numbers (just not too many numbers) that executives could look at every morning.

A Pelican Introduction Economics: A User's Guide
by Ha-Joon Chang
Published 26 May 2014

For example, it allows you to replace a series of variable future payments or earnings with a series of fixed payments or earnings, like contracts for your mobile phone or fixed-price electricity deals over a period, according to Scott’s instructive analogy.5 The variation in payments or earnings could be due to variations in all sorts of things, so there are many different types of swaps; interest rates (interest rate swaps), exchange rates (currency swaps), commodity prices (commodity swaps), share prices (equity swaps), or even default risk of particular financial products (CDSs). At this point, your head may be spinning at the complexity of things, but that is in a way the point. The complexity of these new financial products is exactly what made them so dangerous, as I shall explain later.

Greed and Glory on Wall Street: The Fall of the House of Lehman
by Ken Auletta
Published 28 Sep 2015

Investment bankers commonly perform as the economy’s magicians, as wise intermediaries who match ideas and wealth, users and savers of capital; they provide lifelines for embryonic companies; they devise creative products that pump desperately needed capital into, say, starved housing, as they have done with Fannie Mae’s and mortgage interest-rate swaps. But, increasingly, many investment bankers justify everything they do. “All this frenzy may be good for investment bankers now,” banker Felix Rohatyn has said, “but it’s not good for the country or investment bankers in the long run. We seem to be living in a 1920’s jazz age atmosphere.” At Lehman, as on much of Wall Street, the operating ethic is fees—fees to cover expanding overheads, fees to boost profits and stock value and bonuses.

Flying Blind: The 737 MAX Tragedy and the Fall of Boeing
by Peter Robison
Published 29 Nov 2021

The four violations cited by the SEC: “Beginning in January 2003, an improper application of the accounting standards to GE’s commercial paper funding program to avoid unfavorable disclosures and an estimated approximately $200 million pre-tax charge to earnings; a 2003 failure to correct a misapplication of financial accounting standards to certain GE interest-rate swaps; in 2002 and 2003, reported end-of-year sales of locomotives that had not yet occurred in order to accelerate more than $370 million in revenue; and in 2002, an improper change to GE’s accounting for sales of commercial aircraft engines’ spare parts that increased GE’s 2002 net earnings by $585 million.”

file:///C:/Documents%20and%...
by vpavan

Rather than speed up and improve the standard-setting process, I believed this cabal was looking to place it in the corporate equivalent of leg irons. Waiting in the wings in Norwalk was consideration of a new accounting standard that, if adopted, would require companies to reveal the current market value of derivatives on their balance sheets. Derivatives are options, interest rate swaps, and other financial products whose values are determined by other securities. A currency swap is an example of a derivative. These swaps help companies protect profits against the risk that the value of a foreign currency they hold in large quantities will move against them. In 1994, several prominent companies suffered large losses because of derivative blowups.

Our Lives in Their Portfolios: Why Asset Managers Own the World
by Brett Chistophers
Published 25 Apr 2023

Philip Ashton and colleagues have noted, for example, that the consortium that purchased both the Chicago Skyway and Indiana Toll Road concessions in 2005 and 2006, respectively – namely, a partnership between Macquarie’s American infrastructure fund and the Spanish transportation-infrastructure developer Cintra – used interest rate swaps to this end.43 Similarly, while it was under the ownership and control of Blackstone funds, Invitation Homes used securitisation techniques to lower the cost of the debt that it raised to finance its single-family-housing acquisition spree. Specifically, it issued bonds backed by future flows of rental income from those homes.

Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism
by Kevin Phillips
Published 31 Mar 2008

Garraty, The Great Depression (New York: Harcourt Brace, 1986), pp. 52-57. 64 “Brazil October Inflation Rate Rises to 3-year High,” Bloomberg News, November 7, 2008. 65 “Mexico Inflation Soars to 7-year High in October,” Reuters, November 7, 2008. 66 “China’s October Inflation Matches Decade High of 6.5 Percent,” Bloomberg News, November 13, 2008. 67 “Singapore Inflation Hits 16-year High on Food, Energy,” Reuters India, November 23, 2008. 68 “Inflation in Pakistan at Near-30-year High,” United Press International, November 11, 2008. 69 “Asian Interest-Rate Swaps Signal More Rate Cuts Are Coming,” Bloomberg News, November 5, 2008. 70 “Indonesia’s October Inflation,” Reuters, November 3, 2008. 71 “Philippine Inflation Eases to 11.2 Percent in October,” Agence France-Press, November 5, 2008. 72 “Russia’s Inflation at 0.9 Percent in October,” RIA Novosti, November 5, 2008. 73 “Turkey: October Inflation Reflects Bad News for Consumers,” Turkish Statistics Institute, see europe.net, November 4, 2008. 74 “Inflation Sees a Slight Drop to 20 Pct.,” Egypt Daily News, November 10, 2008. 75 “Saudi Inflation Falls to 10.9 Percent,” Saudi Arabian Monetary Agency, October 12, 2008. 76 “Nigeria Oct.

Hard Times: The Divisive Toll of the Economic Slump
by Tom Clark and Anthony Heath
Published 23 Jun 2014

This was the big one, or so they said – the ‘once in a century’ event, as Alan Greenspan put it in 2008.3 But the financial elite is interested in financial phenomena – share-price swings and overnight interbank rates – that are only of direct concern to itself. If we're talking people instead of percentages – and talking particularly about the majority of people who do not dabble in stocks or in interest-rate swaps – then is a purely financial crisis really such a big deal? Is there any serious reason to think that disruptive events in the alien world of Wall Street or the City of London would leave us all living in a world turned upside down? The economic case for saying that they would do so starts with the historical observation that slumps which follow financial crises are invariably more significant.

Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America
by Danielle Dimartino Booth
Published 14 Feb 2017

The sudden turmoil stemmed from AIG Financial Products (AIGFP), the 377-person division based in London, where Yale professor Gary Gorton had worked. AIGFP had written about $500 billion worth of insurance on every conceivable type of derivative. Started in 1987 by Joseph J. Cassano, a former Drexel Burnham Lambert executive, AIGFP first waded into the derivatives market with interest rate swaps, “plain vanilla” products. But ten years later, as derivatives evolved, Cassano’s division was approached by JPMC with the idea to write insurance on CDOs and similar securities. Because the securities had AAA ratings, Cassano assumed they would rarely pay any claims. AIG’s high credit rating meant it didn’t have to post collateral on the insurance it issued.

Trading Risk: Enhanced Profitability Through Risk Control
by Kenneth L. Grant
Published 1 Sep 2004

The macroeconomic benefits of these market mechanisms have exploded in the past couple of decades and represent no small contribution to the economic prosperity we have enjoyed over this time period. In particular, with the advent of equity- and fixed-income derivatives such as index futures and interest-rate swaps, the rewards of a trading economy extend to the core capital markets. Companies can now use these products to accompany the issuance of new equity and debt, thereby eliminating the fear that their financial costs will increase dramatically by the time the funds are needed. As a result, the economy produces new goods, services, and jobs at a pace unimaginable one short generation ago. 242 TRADING RISK All of these benefits accrue to an economy because traders are there, willing to assume the risks that are inherent in essential economic processes such as capital formation but that, if not transferred to speculators, represent onerous contingent liabilities to the creators of new products and processes.

Financial Statement Analysis: A Practitioner's Guide
by Martin S. Fridson and Fernando Alvarez
Published 31 May 2011

Companies can limit this risk by using financial derivatives. One approach is to cap the borrower's interest rate, that is, set a maximum rate that will prevail, no matter how high the market rate against which it is pegged may rise. Alternatively, the borrower can convert the floating-rate debt to fixed-rate debt through a derivative known as an interest-rate swap. (The forces of supply and demand may make it more economical for the company to issue floating-rate debt and incur the cost of the swap than to take the more direct route to the same net effect, that is, to issue fixed-rate debt.) Public financial statements typically provide only general information about the extent to which the issuer has limited its exposure to interest rate fluctuations through derivatives.

Making It Happen: Fred Goodwin, RBS and the Men Who Blew Up the British Economy
by Iain Martin
Published 11 Sep 2013

Only someone who has been living in solitary confinement since 2008 could possibly be shocked. Hourican, once deemed a possible successor to Hester, was removed, in the end probably needlessly. Libor was not a one-off though. The revelations about the conduct of the banks came in waves. There was the scandal of interest rates swaps, in which businesses were sold products that they very often did not need or understand.8 Customers were encouraged, sometimes compelled if they wanted a loan, to take out cover that would protect them in the event of interest rates rising. The reverse happened. Rates, since the crisis, have plummeted.

Other People's Money: Masters of the Universe or Servants of the People?
by John Kay
Published 2 Sep 2015

Under US GAAP, if one derivative contract shows a loss and another derivative contract with the same counterparty shows a profit, then you need record only the net profit or loss in trading with that counterparty. This opportunity to ‘net’ one contract against another applies even if one derivative is an interest rate swap and the other a forward foreign exchange contract. 12. Vickers, J.S., 2011, Independent Commission on Banking Final Report: Recommendations, London, HMSO. 13. Liikanen, E. (chair), 2012, Report of the European Commission’s High-Level Expert Group on Bank Structural Reform, EU Commission, October. 14.

Naked Economics: Undressing the Dismal Science (Fully Revised and Updated)
by Charles Wheelan
Published 18 Apr 2010

Any investment strategy must obey the basic laws of economics, just as any diet is constrained by the realities of chemistry, biology, and physics. To borrow the title of Wally Lamb’s best-selling novel: I know this much is true. At first glance, the financial markets are remarkably complex. Stocks and bonds are complicated enough, but then there are options, futures, options on futures, interest rate swaps, government “strips,” and the now infamous credit default swaps. At the Chicago Mercantile Exchange, it is now possible to buy or sell a futures contract based on the average temperature in Los Angeles. At the Chicago Board of Trade, one can buy and sell the right to emit SO2. Yes, it’s actually possible to make (or lose) money by trading smog.

Capital Ideas: The Improbable Origins of Modern Wall Street
by Peter L. Bernstein
Published 19 Jun 2005

As investors, borrowers, and lenders increased their understanding of these basic concepts, the flow of applications grew from a trickle to a flood. Options were incorporated into the entirely new and complex debt instruments that blossomed during the 1980s. They are responsible for the mushrooming of the market for government-guaranteed home mortgages. Their hedging features made possible the development of the so-called interest rate swaps between major financial institutions, the explosion in daily trading in the foreign exchange markets, the ability of banks to shield themselves from the vagaries of the money markets, and the willingness of major investment banking firms to provide many millions of dollars of instant liquidity to their institutional customers.

The Black Box Society: The Secret Algorithms That Control Money and Information
by Frank Pasquale
Published 17 Nov 2014

Shahien Nasiripour, “Goldman Sachs Values Assets Low, Sells High to Customers as Senate Panel Alleges Double Dealing,” Huffington Post, April 14, 2011, http://www.huffi ngtonpost.com /2011/04 /14 /goldman-sachs-values-asse _n _849398.html. 99. Kayla Tausche, “Wall Street into Snapchat, and Regulators Are on Alert,” CNBC, July 30, 2013, http://www.cnbc.com /id /100924846. 100. For example, since a “simple fi xed/floating interest-rate swap contract . . . has zero value at the start,” it “is considered neither an asset nor a liability, but is an ‘off-balance-sheet’ item.” Carol J. Loomis, “Derivatives: The Risk That Still Won’t Go Away (Fortune 2009),” CNN Money, May 20, 2012, http://features .blogs .fortune .cnn .com /2012/05 /20 /derivatives -the -risk-that -still-wont-go-away-fortune-2009/. 101.

The Missing Billionaires: A Guide to Better Financial Decisions
by Victor Haghani and James White
Published 27 Aug 2023

The houses that were succeeding in those days of rapid change mixed street smarts with geeky smarts and that was definitely on display as I looked around the circle. To my left was Pete, a younger, and better looking version of Jack Nicholson, with a wicked sense of humor. He loved to bluff and tended to get away with it. Next was Wilkie, a slow talking, fast thinking former Otis elevator repairman from Alabama who became the firm's top interest rate swap trader. Then there was Moz, a US national math champion and on everyone's shortlist for the smartest guy at the firm. He knew a lot about game theory but was a bit mechanical in his LP play. And then there was Eric, a former Harvard Business School professor and excellent poker player. He knew the odds but, better than that, seemed able to read the rest of us like an open book.

Billionaires' Row: Tycoons, High Rollers, and the Epic Race to Build the World's Most Exclusive Skyscrapers
by Katherine Clarke
Published 13 Jun 2023

PART II Turbulence CHAPTER 10 “Too Much Money” David Juracich knew he had “too much money.” He had so much money that he didn’t know how to spend it. The Melbourne native had made a small fortune working for nearly two decades in the financial industry as a broker trading interest rate swaps, financial instruments designed to help major corporations protect against and profit from future swings in rates. It was one of the most profitable and controversial fields in finance. Tall, affable, and boyishly handsome, with a full head of wavy sandy-colored hair, Juracich had once been a state champion Aussie rower.

Money and Power: How Goldman Sachs Came to Rule the World
by William D. Cohan
Published 11 Apr 2011

Winkelman rode his masterful management and turn-around skills to a seat on the Management Committee and as co-head of fixed-income with a successful trader named Jon Corzine. J. Aron had become a big part of Goldman’s profit story. After years of acting only as an agent in the buying and selling of interest-rate swaps, Goldman had started acting as a principal in that business, too. “We were in the chicken camp on that,” Friedman said, before Goldman found courage. Goldman had also started a $783.5 million distressed investing fund, the Water Street Corporation Recovery Fund—named after a street that runs perpendicular to Broad Street in downtown Manhattan—with $100 million of its partners’ money to invest in the discounted debt securities of companies as a way to control them after a restructuring process.

…

If this kind of thing could be done outside the ken of often onerous state regulations that blanket the insurance industry, even better. To that end, in 1987, Greenberg created AIG Financial Products, known as AIGFP, by hiring a group of traders from the investment bank Drexel Burnham Lambert, led by Howard Sosin, who supposedly had a “better model” for trading and valuing interest-rate swaps and for generally taking and managing the risk that other financial firms wanted to sell. The market for derivatives was in its infancy, but growing, and Greenberg determined that AIG could be at its forefront. According to Greenberg, the overriding strategy at AIGFP was for the business to lay off most of the risks it was taking on behalf of its clients so that AIG was not exposed financially in the event of huge market-moving events that could not be modeled or anticipated.

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money
by Steven Drobny
Published 18 Mar 2010

Otherwise, what saved us was being long interest rates in peripheral economies that had very steep yield curves. Regardless, I learned a lot in 2008, and you can put both a positive and negative spin on it. Figure 7.4 LIBOR-OIS Basis, 2008 SOURCE: Bloomberg. OIS An overnight indexed swap (OIS) is an interest rate swap where the periodic floating rate of the swap is equal to the geometric average of an overnight index (e.g., a published interest rate) during the course of the payment period. OIS rates are an indication of market expectations of the effective federal funds rate over the term of the swap. The spread between OIS rates and LIBOR rates reflects credit risk and the expectation of future overnight rates.

Blockchain Revolution: How the Technology Behind Bitcoin Is Changing Money, Business, and the World
by Don Tapscott and Alex Tapscott
Published 9 May 2016

Prediction markets could complement and ultimately transform many aspects of the financial system. Consider prediction markets on the outcomes of corporate actions—earnings reports, mergers, acquisitions, and changes in management. Prediction markets would inform the insurance of value and the hedging of risk, potentially even displacing esoteric financial instruments like options, interest rate swaps and credit default swaps. Of course, not everything needs a prediction market. Enough people need to care to make it liquid enough to attract attention. Still, the potential is vast, the opportunity significant, and access available to all. ROAD MAP FOR THE GOLDEN EIGHT Blockchain technologies will impact every form and function of the financial services industry—from retail banking and capital markets to accounting and regulation.

Last Man Standing: The Ascent of Jamie Dimon and JPMorgan Chase
by Duff McDonald
Published 5 Oct 2009

They also told Dimon that if either of them appeared to be trying to stab the other in the back, he should fire them both. One area that needed no rebuilding whatsoever was the company’s derivatives business. JPMorgan Chase had long held a dominant position in all manner of derivatives—in 2004, the company was the top player in interest rate options, interest rate swaps, and credit and equity derivatives—and at the time of the merger it held $37 trillion in notional derivatives contracts, more than half the derivatives held by U.S. banks and trust companies. A lot has been made of this fact, but Dimon had by that point come around to the argument that derivatives were a good business for the firm, provided the risks and exposures were monitored rigorously.

How I Became a Quant: Insights From 25 of Wall Street's Elite
by Richard R. Lindsey and Barry Schachter
Published 30 Jun 2007

During my second year at Harvard, I did a specially directed studies course under Michael Porter and worked on some fascinating strategic vision projects regarding data, technology, and competitive practices. But the lure of Wall Street was very strong. My time at First Boston now was largely taken up by a project to study interest rate swaps. Swaps were a new product, traded by appointment, with the business being done “upstairs” in the investment bank, not on the trading floor. When I finished my MBA, First Boston asked me to join full time to put together swaps deals in the Corporate Finance group. I agreed, and there ended my pursuit of a PhD in mathematics. 

A Man for All Markets
by Edward O. Thorp
Published 15 Nov 2016

several billion dollars Market Neutral Strategies, Bruce I. Jacobs and Kenneth N. Levy editors, Wiley, New Jersey, 2005. when it opened Hours for the N.Y.S.E. were from 10 A.M. to 4 P.M. Monday through Friday, from October 1, 1974, until September 30, 1985, when the opening time changed to 9:30 A.M. of which we pioneered Among them were the interest rate swap (the object here was to hedge away interest rate risk in our positions), the bond cash and carry, the commodity cash and carry, capturing a profit when closed-end funds could be purchased below their liquidation value, and special deals. historical stock price data I learned only recently, while reading the interview of Harry Markowitz in Masters of Finance, IMCA, Greenwood Village, CO, 2014, page 109, that Markowitz and Usmen got the same answer for daily S&P 500 Index price changes as we did for a much larger data set of two hundred individual stocks.

Super Continent: The Logic of Eurasian Integration
by Kent E. Calder
Published 28 Apr 2019

Such pressures have led to a rash of credit scandals, sometimes involving favoritism to host governments to undertake economically dubious projects, as recently revealed in Malaysia, Sri Lanka, Pakistan, and elsewhere. Quiet Revolution in China 107 Western and Japanese banks do seem to have continuing interest in the BRI, despite the obvious risk that some projects may present. Foreign banks focus on providing foreign exchange, trade finance, interest-rate swaps, and cash management to multinational firms working on BRI projects. Citigroup, for example, had led large bond issues for the Bank of China and Beijing Gas to finance their BRI plans. It has also landed cash management and foreignexchange hedging contracts for several Fortune 500 companies operating on BRI projects.

The Controlled Demolition of the American Empire
by Jeff Berwick and Charlie Robinson
Published 14 Apr 2020

As an example, the interest rate quoted to a borrower looking to buy a house might be calculated by the mortgage company as LIBOR + 3%, meaning that if the rate the banks loan money to each other is 2.5%, then the interest a mortgage company charges to the home buyer would be 2.5% + 3%, or 5.5%. The major banks decided that if they put their heads together, they could rig this market and move the interest rates in the direction they desired, so they set about to discreetly corrupt the system. Their manipulation of the interest rates majorly impacted the interest rate swaps that corporations and governments use to manage their debt. The fraud that these banks were engaged in went on for many years and made them untold billions of dollars at the expense of governments around the world, corporations, and of course, the people of the world. When their criminal enterprise was finally discovered, the big banks do what they always do when they get caught red-handed committing felonies: they paid a small fine and nobody was prosecuted

Crisis Economics: A Crash Course in the Future of Finance
by Nouriel Roubini and Stephen Mihm
Published 10 May 2010

As with everything else in this mess, that’s easier said than done; there is no panacea. But some sensible steps should be taken immediately. First we must correct the problem of transparency. True, some derivatives have long been traded over the counter without problems—like plain-vanilla interest-rate swaps and currency swaps—and could reasonably remain that way. But CDSs are another story altogether. These must be brought into the light of day and subjected to rigorous regulation by the SEC and the CFTC. The Obama administration has already taken steps along these lines, and several proposals to make this regulation a reality are already on the table.

Investing Amid Low Expected Returns: Making the Most When Markets Offer the Least
by Antti Ilmanen
Published 24 Feb 2022

Similar analysis would show that trend following was profitable every decade for the composite and almost without exception for each asset class. Trend following has also worked well in markets with less liquidity and capacity. Babu et al. (2018) shows positive rewards when trend following has been applied to emerging market equities and currencies, interest rate swaps, credit default swap indices, exotic commodity futures, volatility futures, and equity long/short factors (“factor momentum”). Gupta-Kelly (2018) and Ehsani-Linnainmaa (2019) report evidence of time-series and cross-sectional factor momentum among stock selection factors. Private asset returns exhibit even stronger positive autocorrelation, due to artificially smooth returns, but such apparent return persistence is hardly exploitable in practice.

The Tyranny of Nostalgia: Half a Century of British Economic Decline
by Russell Jones
Published 15 Jan 2023

Lehman’s European operations were taken on by the Japanese brokerage house Nomura. 12 The amount of central bank liquidity swaps peaked at more than $600 billion around the turn of the year. 13 LIBOR, or the London inter-bank offered rate, is the average interest rate that banks charge each other for short-term, unsecured loans. It reflects in part the credit risk of the banking sector. The OIS, or overnight indexed swap, meanwhile, represents a country’s central bank rate over a certain period. Because the parties in a basic interest rate swap exchange not principal but the difference of the two interest streams, credit risk is not a major factor in determining the OIS rate. The LIBOR–OIS spread represents the difference between an interest rate with some credit risk built in and one that is virtually free of such hazards. When the gap widens, it is indicative of a financial sector that is under duress. 14 A bank, or any business, is solvent when the value of its total assets covers its total liabilities.

Chaos Monkeys: Obscene Fortune and Random Failure in Silicon Valley
by Antonio Garcia Martinez
Published 27 Jun 2016

Alan Brazil, the managing director for mortgage strategies at Goldman Sachs, was rationing out small, paperbound grease pucks, like a World War I commanding officer handing out munitions to his troops before an assault. It was, of course, the White Castle burger-eating contest. All trading turned from interest-rate swaps (minimum notional size: $50 million) to wagering on which young Goldman acolyte would down the most White Castle burgers in an hour. The betting structure was a typical Vegas-style over/under bet on how many burgers would be eaten without puking. The surrounding crowd turned into a howling, gesticulating mass of electrified greed, with the serious traders signaling to each other and actually writing down trades in notebooks, as they would million-dollar positions.

Investment: A History
by Norton Reamer and Jesse Downing
Published 19 Feb 2016

Two other traders suggested it should be lower, so the first trader replied, “OK, I will move the curve down 1 basis point, maybe more if I can.”123 Of course, the other reason the LIBOR scandal is so important is because so much money is tied to LIBOR. Indeed, as MIT professor Andrew Lo has pointed out, LIBOR was never intended to serve as the basis of such a large volume of financial contracts.124 Among the contracts it affects are mortgages, interest rate swaps—where one party agrees to exchange a fixed interest rate for a variable rate that is a certain number of percentage points higher than LIBOR—student loans, and other debt arrangements. In all, some $300 trillion worth of contracts is tied to LIBOR, and, as such, a tiny manipulation of a single basis point translates into enormous transfers of wealth.125 The LIBOR scandal demonstrates another important feature of typical market manipulation today: in highly liquid markets, some form of collusion is typically required.

Connectography: Mapping the Future of Global Civilization
by Parag Khanna
Published 18 Apr 2016

One other crucial difference between the two cities is that unlike Detroit Dongguan was not fleeced by the financial markets. China’s municipal debts are exorbitant and its state-owned enterprises badly need restructuring, but both are backed by the $4 trillion of the People’s Bank of China. Meanwhile, days before its bankruptcy, Detroit paid out $250 million to UBS and Bank of America on debts inflated due to interest rate swap agreements, leaving it with pennies to cover almost $20 billion in pension and health-care obligations. Does China have a better model for managing central government relations with cities than America? China has embarked on economic liberalization far more quickly than political democratization, but what is proving to be equally important for its long-term stability is how it manages devolution.

Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society
by Will Hutton
Published 30 Sep 2010

The latter had the same effect as the former, but it was harder to do: you needed a willing counter-party, which in the early days could take weeks to find. Nevertheless, both hedging and swapping fostered a deepening of the interbank market, with one deal prompting a sequence of others and all generating liquidity. Since the first big interest-rate swap deal in 1981 – between the World Bank and IBM – the market had grown to be worth trillions of dollars as banks sought to rearrange their portfolio of liabilities and assets according to whatever risk profile regarding interest rates and currencies they and their clients preferred. Banking was changing from nurturing long-term trust relationships with customers and borrowers to trying to manage and grow a balance sheet based on risk probabilities.

Mastering Blockchain, Second Edition
by Imran Bashir
Published 28 Mar 2018

Corda can be cloned locally from GitHub using the following command: $ git clone https://github.com/corda/corda.git When the cloning is successful, you should see output similar to the following: Cloning into 'corda'... remote: Counting objects: 74695, done. remote: Compressing objects: 100% (67/67), done. remote: Total 74695 (delta 17), reused 0 (delta 0), pack-reused 74591 Receiving objects: 100% (74695/74695), 51.27 MiB | 1.72 MiB/s, done. Resolving deltas: 100% (42863/42863), done. Checking connectivity... done. Once the repository is cloned, it can be opened in IntelliJ for further development. There are multiple samples available in the repository, such as a bank of Corda, interest rate swaps, demo, and traders demo. Readers can find them under the /samples directory under corda and they can be explored using IntelliJ IDEA IDE. Summary In this chapter, we have gone through an introduction to the Hyperledger project. Firstly, the core ideas behind the Hyperledger project were discussed, and a brief introduction to all projects under Hyperledger was provided.

In Pursuit of the Perfect Portfolio: The Stories, Voices, and Key Insights of the Pioneers Who Shaped the Way We Invest
by Andrew W. Lo and Stephen R. Foerster
Published 16 Aug 2021

The main strategy behind LTCM was to look for discrepancies in prices between two similar assets, buying the underpriced one and selling short the overpriced one, thereby making money when the asset prices converged. These were known as convergence trades.57 For example, based on quantitative models related to option pricing, traders might detect a discrepancy between the price of long-term Treasury bonds and the price of a related type of derivative security known as an interest rate swap, buying the former and selling the latter. Another was known as a relative value strategy and worked in a similar manner. Here, however, while convergence in prices was expected, it wasn’t guaranteed except perhaps over a long period of time. Besides these two main strategies, LTCM initially included a smaller number of directional trades, but such unhedged positions were much riskier.

The Relentless Revolution: A History of Capitalism
by Joyce Appleby
Published 22 Dec 2009

The American Dialect Society voted “subprime” the word of 2007.7 During the euphoria over rising housing prices, the lexicon of global finance migrated out of Wall Street into daily newspapers, where you could find references to option adjustable interest rate mortgages, collateralized debt obligations, interest rate swaps, swaptions, and special purpose vehicles! Hedge funds grew fivefold in the first decade of the twenty-first century, attracting managers of pension money, university endowments, and municipal investments, all now suffering with the retraction. Those people who ran hedge funds, established derivatives, and created option adjustable rate mortgages had built a house of cards with mortgage paper.

Oil: Money, Politics, and Power in the 21st Century
by Tom Bower
Published 1 Jan 2009

In 1996 the deregulatory atmosphere had encouraged one trader employed by the Japanese bank Sumitomo to mount a fraud trading copper futures on the London Metal Exchange and OTC copper “swaps,” while in America, Bankers Trust had caused the multinational corporation Procter & Gamble to suffer huge losses through the sale of interest rate “swaps,” and Orange County in California had become insolvent as a result of speculating on OTCs. By 1998, oil had become intrinsic to the OTC explosion. Many transactions were finalized by telephone conversations, with little committed to paper or e-mails. Vitol, Glencore and other traders spent millions of dollars gathering intelligence, but finding evidence even of normal trading was hard.

New Market Wizards: Conversations With America's Top Traders
by Jack D. Schwager
Published 28 Jan 1994

Therefore, you could buy the bond and sell the sterling forward at a huge premium, which over the life of the bond would converge to the spot rate. What was the term of the bond? The bond matured in four tranches: five, seven, nine, and twelve years. I don’t understand. Is it possible to hedge a currency that far forward? Of course it is. Even if you can’t do the hedge in the forward market, you can create the position through an interest rate swap. However, in the case of sterling/dollar, which has a very liquid term forward market, there was certainly a market for at least ten years out. How big was the issue? There were two tranches: the first for $100 millions and the second for $50 million. What happened when you pointed out that the issue was grossly mispriced?

The Brussels Effect: How the European Union Rules the World
by Anu Bradford
Published 14 Sep 2020

According to a study by Yesha Yadov and Dermot Turing, traders of credit derivative contracts (credit default swaps) conduct business four times more often with counterparties outside their own jurisdiction than they do with counterparties in their home jurisdiction.159 The authors illustrate this flexibility with the following example: [A] Swiss bank […] enters into a fixed-floating interest rate swap on a notional principal amount expressed in British Pounds, where its counterparty is the New York branch of a Japanese bank. Such a transaction may be documented under New York law and supported by collateral that includes German Government bonds held in Euroclear (which is located in Belgium and operates under Belgian law).160 The absence of a requisite geographical link between a particular clearinghouse and the parties to the transaction means that the parties have a choice as to where to conduct their clearing activities.161 This high degree of elasticity suggests that regulators like the EU’s ESMA—the European Securities and Markets Authority—face a serious threat of regulatory arbitrage.

The Social Life of Money
by Nigel Dodd
Published 14 May 2014

Aglietta, M. and L. Scialom (2003). “The Challenge of European Integration for Prudential Policy.” LSE Financial Markets Group Special Paper. London, London School of Economics, 152. Agnes, P. (2000). “The ‘End of Geography’ in Financial Services? Local Embeddedness and Territorialization in the Interest Rate Swaps Industry.” Economic Geography 76 (4): 347–66. Ahamed, L. (2009). Lords of Finance: 1929, The Great Depression, and the Bankers Who Broke the World, London, Windmill Books. Akin, D. and J. Robbins (1999). Money and Modernity: State and Local Currencies in Melanesia, Pittsburgh, Pittsburgh University Press.

The Making of Global Capitalism
by Leo Panitch and Sam Gindin
Published 8 Oct 2012

China’s low domestic consumption left it with a profound dependence on American consumer markets, sustained by the policy of keeping the renminbi low relative to the dollar despite China’s ever larger trade surpluses and capital inflows. Although a managed floating exchange band was implemented in 2005, supported by the introduction of an over-the-counter derivatives market, and of foreign-exchange and interest-rate swaps, the renminbi’s relative appreciation was small in real terms. This was only possible because extensive capital controls were maintained, even as China’s securities and bond markets were opened up to foreigners in line with the WTO accession agreement. But while US institutional investors and investment banks became key players in Chinese financial markets (they were especially involved in major merger and acquisitions activity, and in purchasing the lion’s share of stock offered for sale by SOEs107), China’s capital markets, while growing fast, remained “among the smallest in the world relative to the size of the domestic economy.”108 Despite China’s having consented under the WTO agreement to open its domestic banking sector to foreigners by 2007, the financial system remained dominated by five large state-owned commercial banks primarily engaged in lending to SOEs, while interest rates were administered by the central bank with the primary goal of avoiding upward pressures on the exchange rate.

The Concepts and Practice of Mathematical Finance
by Mark S. Joshi
Published 24 Dec 2003

Putting money on deposit for six months at an annualized rate of 5% and then rolling it into another six-month deposit at the same rate is not the same as putting money on deposit for one year at an annual rate of 5%. 13.2.3 Swaps Whilst the forward-rate agreement involves a principal, its close relative, the interest rate swap, does not. Rather than agreeing with a counterparty to put some money on deposit for a fixed period of time in the future at a fixed rate, we instead enter into a contract to pay him the floating rate of interest on a notional, whilst he pays us a rate fixed in advance. As the interest payments go both ways, there is no need to exchange principals.

The Narrow Corridor: States, Societies, and the Fate of Liberty
by Daron Acemoglu and James A. Robinson
Published 23 Sep 2019

In this regulated environment, the bureaucratized and comfortable jobs in banking came to be described by the “3-6-3 rule”—take deposits at 3 percent interest rate, lend them at 6 percent interest rate, and hit the golf course by 3 p.m. This started to change in the 1970s, particularly after Regulation Q was abolished in 1986, paving the way to a significant rise in concentration in banking. Together with greater concentration came a huge shift toward riskier activities, such as financial derivatives including interest rate swaps (where one party to the financial contract makes payments to the other depending on whether a benchmark interest rate is below or above a threshold) or credit default swaps (where payments are made depending on whether a debtor defaults). Even though the financial sector was branching into riskier activities, the rising political power of banks blocked any new regulations and in fact pushed for further deregulation.

Crashed: How a Decade of Financial Crises Changed the World
by Adam Tooze
Published 31 Jul 2018

A postmortem revealed that the stress tests had failed to account adequately for losses resulting from a restructuring of Greek debt. Furthermore, they had ignored altogether the issue of liquidity. In 2008 it had been collateral calls that triggered the disaster at Lehman and AIG. In 2011 they did the same to Dexia.34 The bank had contracted a huge portfolio of interest rate swaps on which it now faced demands for tens of billions of euros in collateral. The Belgian and French governments were forced into an expensive bailout at the worst possible moment. Given the potential impact on French public debt, the governor of the Banque de France, Christian Noyer, was forced to deny claims that France’s credit rating might be in jeopardy.35 Meanwhile, from the other side of the Atlantic came news of trouble at the high-profile brokerage firm MF Global.

The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance
by Ron Chernow
Published 1 Jan 1990

It dealt in Treasury bonds, underwrote municipal bonds, advised cities, provided stock research and brokerage, and traded in gold bullion, silver, and foreign exchange. It continued to have the fanciest private banking operation, wooing rich customers with ads that promised to relieve their anxiety about possessing $50-million portfolios. Abroad, Morgans stepped up capital market activity, specializing in interest-rate swaps, currency swaps, and other financial esoterica. It had merchant banks in Japan, Hong Kong, Belgium, and Germany. In London, the headquarters of its global capital markets operation, it spent $500 million to outfit two historic buildings near the Thames—the vacant Guildhall School of Music and Drama and the City of London School for Girls—with vast trading floors.

The Last Tycoons: The Secret History of Lazard Frères & Co.
by William D. Cohan
Published 25 Dec 2015

To comply with the inspector general's request, on May 27, 1993, Ferber--now at First Albany--wrote a one-paragraph letter to the MWRA, his client, revealing the existence of a contract between Lazard and Merrill Lynch, the MWRA's lead underwriter, under which they split more than $6 million in fees and commissions in exchange for Ferber and Lazard recommending that state agencies in Massachusetts use Merrill for financing and interest-rate swaps, a way for municipalities to reduce their interest costs. Merrill also paid Lazard $2.8 million in "consulting fees," and in return Ferber "was expected to help introduce Merrill Lynch to his contacts in government agencies" with the expectation that these agencies would choose Merrill Lynch as an underwriter of bonds and other financial transactions.

The Snowball: Warren Buffett and the Business of Life
by Alice Schroeder
Published 1 Sep 2008

Dangling off the side of the balance sheet on any given day were tens more billions, perhaps as many as $50 billion a day, of uncleared trades—transactions executed, but not yet settled. These would stall midair. Salomon also had many hundreds of billions of derivative obligations not recorded anywhere on its balance sheet—interest-rate swaps, foreign-exchange swaps, futures contracts—a massive and intricate daisy chain of obligations with counterparties all over the world, many of whom in turn had other interrelated contracts outstanding, all part of a vast entangled global financial web. If the funding disappeared, Salomon’s assets had to be sold—but while the funding could disappear in a few days, the assets would take time to liquidate.