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Interest Rate Swaps January 2015.

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Presentation on theme: "Interest Rate Swaps January 2015."— Presentation transcript:

1 Interest Rate Swaps January 2015

2 Types of Interest Rate Swaps Held
Plain Vanilla Interest Rate Swaps (CCP & OTC) Cross Currency Swaps BRL Interest Rate Swaps Inflation Indexed Swaps Basis Swaps Zero Coupon Swaps 2

3 What is an Interest Rate Swap (IRS)?
Agreement between two parties to exchange one stream of interest payments for another over a set period of time Notional principal is not actually exchanged, but used to determine interest payments Most common and liquid swaps are “Vanilla” IRS Each counterparty enters into one side of the swap Receive floating rate (ex. LIBOR) and pay fixed rate (swap rate) Receive fixed rate and pay floating rate Interest Rate Swaps can be traded as OTC or centrally cleared (a.k.a. - exchange cleared/CCP) OTC market allows for swaps to be highly customizable between counterparties Centrally clearing provides regulation that reduces counterparty risk by marking to market daily 3

4 How Do Vanilla Interest Rate Swaps Work?
Vanilla IRS is like two bonds exchanged between parties One with fixed interest payments and one with floating interest payments Counterparties agree on swap terms at initiation At specified payment dates, the party that owes a larger interest payment delivers a net payment to the counterparty Notional Effective Date Maturity Date Payment Frequency Rate Reset Frequency Fixed Rate Day Count Method 4

5 Why are Vanilla Interest Rate Swaps Used?
Vanilla IRS are used to hedge, speculate, and manage risk Generally, a firm will enter into an IRS contract to limit or manage exposure to fluctuations in interest rates Allows firm to manage floating-rate investments by paying float and receiving fixed or vice-versa for fixed rate investments Allows investors to create a desired interest rate structure inexpensively Synthetic bond positions can be created using a combination of swaps Since IRS reflect market expectations and require minimal up-front capital, swaps are also attractive to speculators Speculative Interest Rate Swap positions: RECEIVE FIXED/PAY FLOAT – Shorting interest rates (expect rates to go lower) RECEIVE FLOAT/PAY FIXED – Long interest rates (expect rates to go higher) 5

6 Why are Vanilla Interest Rate Swaps Used?
PIMCO View:  As QE comes to an end, long-term US Treasury rates will eventually rise and the Treasury yield curve will steepen Action Taken: Enter into PAY FIXED / RECEIVE FLOAT interest rate swap benchmarked to specific part of the yield curve.  If interest rates rise, the swap will increase in value Why not use futures?  Standardized futures contracts only exist for certain parts of the yield curve PIMCO View: Rates in Brazil will fall as their government continues to loosen monetary policy, but the market there is still pretty illiquid Action Taken: Enter into a RECEIVE FIXED / PAY FLOAT interest rate swap benchmarked to the Brazilian yield curve If Brazilian interest rates fall, the swap will increase in value 6

7 Valuation of Vanilla Interest Rate Swap
Valuation Process Determine present value of cash flows for each leg (fixed and float) Sum discounted cash flows for each leg Net the PV of fixed and float legs Net PV divided by notional is % of par price Credit risk is minimal, therefore the main driver of valuation is movement of floating rates Price sensitivity: Shorter the term of swap, less sensitive the valuation is to interest rate movements Longer the term of swap, more sensitive the valuation is to interest rate movements 7

8 Valuation of Vanilla Interest Rate Swap
Receiver Swap = Receive Fixed/Pay Float Value of Receiver Swap = PV of fixed leg – PV of float leg Payer Swap = Pay Fixed/Receive Float Value of Payer Swap = PV of float leg – PV of fixed leg Price is generally quoted as bond-like price (% of par) Bond-like price * notional / 100 = market value of swap Negative or positive determines if net interest is paid or received 8

9 SunGard IRS Setup Interpretation
RECEIVE LEG  Rate Qualifier in Security Number = BLANK PAY LEG  Rate Qualifier in Security Number = 00001 BOSB FIXED LEG  Accrual Method <> E or F FLOAT LEG  Accrual Method = E or F CCP IRS R or P at end of security number denominates position R = RECEIVER (Receive Leg is Fixed/Pay Leg is Float) P = PAYER (Pay Leg is Fixed/Receive Leg is Float) 9

10 Example – SunGard Setup
Terms are provided on trade ticket: Swap Type: Receive Fixed / Pay Float Notional: USD 1,000,000 Effective date: 12/31/2014 Maturity date: 12/31/2015 Fixed Payment Frequency: Quarterly Float Payment Frequency: Quarterly Reset Frequency: Quarterly Floating index: US0003M (ICE 3 Month LIBOR) Fixed Day Count: 30/360 Float Day Count: 30/360 Fixed Rate: % (annualized)* Floating Rate at initiation: % (annualized) *Fixed rate is calculated based on floating rate curve at swap initiation to make NPV equal 0.00 10

11 SunGard Setup – Receive Leg
11

12 SunGard Setup- Receive Leg
12

13 SunGard Setup – Receive Leg (CCP IRS)
13

14 SunGard Setup – Pay Leg 14

15 SunGard Setup – Pay Leg 15

16 SunGard Setup – Pay Leg (CCP IRS)
16

17 Markit/Reuters Holdings Upload/Download Process
ODT/FA setup swap in SunGard based on trade file/trade ticket information Setup data is reviewed by several groups JPC: Extracts required valuation data points from SunGard setup Converts data to format required by each vendor and creates holdings files Customized holdings files are sent to Markit and Reuters for valuation Download Markit and Reuters valuation files are delivered separately via FTP JPC obtains FTP valuation files and pushes prices to SunGard based on Pricing Number SunGard EMS review is used to confirm price movements 17

18 Markit Valuation File Valuation Information Displayed:
Trade ID (Security Number) - Pricing Number in SunGard PVLocal - Dirty PV market value of swap leg in local currency PresentValue – Dirty PV market value of swap leg in domestic currency Accrued - Accrued interest on swap leg PV01 (DV01) - MV movement in domestic currency per 1 basis point move in floating swap rates CleanPVLocal – Clean PV market value of swap leg in local currency CleanPV – Clean PV market value of swap leg in domestic currency DirtyPrice – Bond-like dirty price of swap leg CleanPrice – Bond-like clean price of swap leg PV01Local - MV movement in local currency per 1 basis point move in floating swap rates Swap PX – Net bond-like price of entire swap position (Price that is pushed into SG) 18

19 Bloomberg Swap Valuations Model (SWPM)
19

20 Bloomberg Swap Valuations Model (SWPM)
20

21 Bloomberg Swap Valuations Model (SWPM)
21

22 Example – Valuation Terms are provided on trade ticket:
Swap Type: Receive Fixed / Pay Float Notional: USD 30,000,000 Effective date: 12/31/2014 Maturity date: 12/31/2015 Fixed Payment Frequency: Quarterly Float Payment Frequency: Quarterly Reset Frequency: Quarterly Floating index: 3 Month LIBOR Fixed Day Count: 30/360 Float Day Count: 30/360 Fixed Rate: % (annualized)* Floating Rate at Initiation: 5.500% (annualized) *Fixed rate is calculated based on floating rate curve at swap initiation to make NPV equal 0.00 22

23 Example – Valuation 90-Day Spot Rate: 5.50% (annualized)
Annualized LIBOR Spot Curve on 12/31/2014 (swap initiation): 90-Day Spot Rate: 5.50% (annualized) 180-Day Spot Rate: 6.00% (annualized) 270-Day Spot Rate: 6.50% (annualized) 360-Day Spot Rate: 7.00% (annualized) This curve is used to calculate the swap rate a.k.a. the fixed rate that makes the swap value 0.00 at initiation The 90-Day Spot Rate at swap initiation is used to calculate the first payment for the floating leg 23

24 Example – Fixed Leg **Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Calculate present value of FIXED LEG: Determine fixed leg payments per $1.00 notional over life of swap The last payment will also include the par value of the swap leg ($1.00) Discount each payment back to valuation date of 1/30/2015 (60 days prior to 1st payment date, 150 days prior to 2nd payment date, etc.) Sum present value of all cash flows Result is the 1/30/2015 value of the FIXED LEG per $1 of notional 24

25 Example – Fixed Leg 90 180 270 360 Effective Date 12/31/2014
**Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Receive $ Receive $ Receive $ Receive $ $1.00 = $ Quarterly payments per $ of notional principal : Fixed Rate : 6.052% annually Fixed Rate : * 90/360 = per quarter Quarterly Payment per $ of notional = $1 * = $ per quarter Receive four coupon payments of $ in 60, 150, 240, and 330 days The last payment in 330 days will also include hypothetical par value of swap leg of $1.00 25

26 Example – Fixed Leg **Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Receive $ Receive $ Receive $ Receive $ $1.00 = $ Annualized LIBOR Spot Curve on 1/30/2015 (valuation date): 60-Day Spot Rate: 6.00% (annualized) 150-Day Spot Rate: 6.50% (annualized) 240-Day Spot Rate: 7.00% (annualized) 330-Day Spot Rate: 7.50% (annualized) 26

27 Example- Fixed Leg 90 180 270 360 ___________1______________
**Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Receive $ Receive $ Receive $ Receive $ $1.00 = $ ___________1______________ PV Factor Calculation: # of Days Discounting 360 [1 + (Rateannualized * ] Annualized LIBOR Spot Curve on 1/30/2015 (valuation date): Present Value Factors: 60-Day Spot Rate: 6.00% (annualized) 150-Day Spot Rate: 6.50% (annualized) 240-Day Spot Rate: 7.00% (annualized) 330-Day Spot Rate: 7.50% (annualized) 27

28 = PV of Fixed Leg per $1 of notional
Example – Fixed Leg **Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Receive $ Receive $ Receive $ Receive $ $1.00 = $ $ * $ $ * $ $ * $ $ * $ Present Value Factors: 60-Day Spot Rate: 6.00% (annualized) 150-Day Spot Rate: 6.50% (annualized) 240-Day Spot Rate: 7.00% (annualized) 330-Day Spot Rate: 7.50% (annualized) $ = PV of Fixed Leg per $1 of notional 28

29 Example – Float Leg **Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Calculate present value of FLOAT LEG: Determine float leg payment per $1.00 of notional on first payment date of swap The swap resets quarterly, so on 3/31/2015, the floating rate of the swap will match the market rate. This makes the value of the swap leg equal to par ($1.00) on 3/31/2015 Since the value of the swap leg is known at first payment date, we do not have to know the value of the remaining cash flows after 3/31/2015 Discount the first payment and par value back to valuation date of 1/30/2015 (60 days prior to 1st payment date) Sum present value of cash flows Result is the 1/30/2015 value of the FLOAT LEG per $1 of notional 29

30 Example – Float Leg 90 180 270 360 Effective Date 12/31/2014
**Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Receive $ $1.00 = $ ? ? ? Quarterly payments per $ of notional principal : Float Rate : 90-day spot rate was 5.50% annually when swap was initiated on 12/31/2014 Float Rate : * 90/360 = per quarter Quarterly Payment per $ of notional = $1 * = $ per quarter Pay coupon payment of $ in 60 days The first payment in 60 days will also include hypothetical par value of the swap leg of $1.00 30

31 = PV of Float Leg per $1 of notional
Example – Float Leg **Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Pay $ $1.00 = $ ? ? ? **It does not matter what the floating rate coupon payments are at the last three settlement dates because the floating leg will be worth $1.00 plus the coupon of $ at day 90** $ * $ $ = PV of Float Leg per $1 of notional Present Value Factors: 60-Day Spot Rate: 6.00% (annualized) 150-Day Spot Rate: 6.50% (annualized) 240-Day Spot Rate: 7.00% (annualized) 330-Day Spot Rate: 7.50% (annualized) 31

32 Example – Valuation of Swap as Fixed/Float Bonds
**Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 $ = PV of Fixed Leg per $1 of notional (Positive since swap is RECEIVE FIXED) ($ ) = PV of Float Leg per $1 of notional (Negative since swap is PAY FLOAT) ($ ) = Net PV of Swap Position per $1 of notional x 100 (0.9721)% = Bond-like Price of Swap (% of Par) (0.9721) / 100 x $30,000,000 Notional = $(291,630) = Market Value of Swap Position (from Receive Fixed perspective) 32

33 SunGard – Valuation Interpretation - VSPR
Based on net market value of the position: One leg will be priced with positive value Other leg will be priced at worthless ( ) If net payment is to be received from counterparty: RECEIVE LEG (BLANK date qualifier) will have value If net payment is to be paid to counterparty: PAY LEG (00001 date qualifier) will have value 33

34 SunGard Price – VSPR - RECEIVE LEG
34

35 SunGard Price – VSPR - PAY LEG
35

36 SunGard – EMS Review 36

37 SunGard – EMS Review Initial review Current Price vs. Alternate Price
These will be slightly different, but should be in line Day over day % movement of prices should be directionally in line Further review EMS Exception Display Fields Currency is used to identify which floating swap rate index caused valuation change SunGard - BOSB Identify Leg Type– Fixed or Float Accrual Method <> E or F  FIXED leg Accrual Method = E or F  FLOAT leg Maturity Date – Determines remaining term of the swap 37

38 SunGard – EMS Review Floating swap rate movements usually explain changes in IRS valuation: Leg Type SunGard - BOSB Floating Rates DECREASED Floating Rates INCREASED Fixed Leg Accrual Method <> E,F SWAP LEG PRICE INCREASES SWAP LEG PRICE DECREASES Float Leg Accrual Method = E,F 38

39 SunGard – EMS Review Swap Currency Curve Type Bloomberg Ticker Prefix
Auto-fill Dropdown AUD ADSWAP AUD SWAP BRL BCSWN BRL SWAP CAD CDSW CAD SWAP CHF SFSW CHF SWAP CLP CHSWP CLP SWAP COP CLSWIB COP SWAP CZK CKSW CZK SWAP EUR Annual Pay EUSA EUR SWAP ANNUAL Semi-Annual Pay EUSS EUR SWAP SEMI Quarterly Pay EUSQ EUR SWAP QUARTERLY GBP BPSW GBP SWAP HUF HFSW HUF SWAP INR Non-Deliverable IRSWN INR SWAP ND Onshore IRSWO INR SWAP ON MIFOR IRSWM INR SWAP MIFOR JPY JYSW JPY SWAP KRW KWSWN KRW SWAP ND KWSWO KRW SWAP ON MXN MPSW MXN SWAP MYR MRSWN MYR SWAP ND Quarterly Pay On Shore MRSWQ MYR SWAP QUARTERLY NOK NKSW NOK SWAP NZD NDSW NZD SWAP PLN PZSW PLN SWAP SEK SKSW SEK SWAP THB TBSWN THB SWAP ND TBSWO THB SWAP ON Quarterly Pay, Onshore TBSWQ THB SWAP QUARTERLY USD USSA USD SWAP ANNUAL USSW USD SWAP SEMI USSQ USD SWAP QUARTERLY ZAR SASW ZAR SWAP 39

40 Bloomberg – Floating Swap Rates HCPI Screen
40

41 Example Price Movement – VSPR - RECEIVE FIXED LEG
41

42 Example Price Movement – VSPR – PAY FLOAT LEG
42

43 Example- Bloomberg Model
Terms are provided on trade ticket: Swap Type: Receive Fixed / Pay Float Notional: USD 1,000,000 Effective date: 12/31/2014 Maturity date: 12/31/2015 Fixed Payment Frequency: Quarterly Float Payment Frequency: Quarterly Reset Frequency: Quarterly Floating index: US0003M (ICE 3 Month LIBOR) Fixed Day Count: 30/360 Float Day Count: 30/360 Fixed Rate: % (annualized)* 90-Day Spot at initiation: % (annualized) *Fixed rate is calculated based on floating rate curve at swap initiation to make PV of fixed and floating cash flows net to 0.00 43

44 Bloomberg Swap Valuations Model (SWPM)
44

45 Bloomberg Swap Valuations Model (SWPM)
45

46 Bloomberg Swap Valuations Model (SWPM)
46

47 Example 90-Day Spot Rate: 0.2551% (annualized)
Annualized US0003M Spot Curve on 12/31/2014 (swap initiation): 90-Day Spot Rate: % (annualized) 180-Day Spot Rate: % (annualized) 270-Day Spot Rate: % (annualized) 360-Day Spot Rate: % (annualized) This curve is used to calculate the swap rate a.k.a. the fixed rate that makes the swap value 0.00 at initiation The spot rates are also used to calculate the payments for the floating leg 47

48 Example **Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Annualized US0003M Spot Curve on 1/30/2015 (valuation date): 60-Day Spot Rate: % (annualized) 150-Day Spot Rate: % (annualized) 240-Day Spot Rate: % (annualized) 330-Day Spot Rate: % (annualized) 48

49 Example 90 180 270 360 ___________1______________
**Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 ___________1______________ PV Factor Calculation: # of Days Discounting 360 [1 + (Rateannualized * ] Annualized US0003M Spot Curve on 1/30/2015 (valuation date): Present Value Factors: 60-Day Spot Rate: % (annualized) 150-Day Spot Rate: % (annualized) 240-Day Spot Rate: % (annualized) 330-Day Spot Rate: % (annualized) 49

50 Example 90 180 270 360 Effective Date 12/31/2014 1st Pay Date
**Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Receive $1,250 Receive $1,250 Receive $1,250 Receive $1,250 + $1,000,000 = $1,001,250 $1,250 * $1,249.73 $1,250 * $1,249.27 $1,250 * $1,248.50 $1,001,250 * $999,056.26 $1,002,803.76 = Present Value MV of Fixed Leg Present Value Factors: 60-Day Spot Rate: % (annualized) 150-Day Spot Rate: % (annualized) 240-Day Spot Rate: % (annualized) 330-Day Spot Rate: % (annualized) 50

51 Example 90 180 270 360 Effective Date 12/31/2014 1st Pay Date
**Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 Pay $637.75 Pay $689.85 Pay $956.01 Pay $1, $1,000,000 = $1,001,365.29 $ * $(637.61) $ * $(689.45) $ * $(954.86) $1,001, * $(999,171.30) $(1,001,453.22) = Present Value MV of Float Leg Present Value Factors: 60-Day Spot Rate: % (annualized) 150-Day Spot Rate: % (annualized) 240-Day Spot Rate: % (annualized) 330-Day Spot Rate: % (annualized) 51

52 Example – Valuation of Swap as Fixed/Float Bonds
**Valuation Date** 1/30/2015 90 180 270 360 30 Effective Date 12/31/2014 1st Pay Date 3/31/2015 2nd Pay Date 6/30/2015 3rd Pay Date 9/30/2015 Maturity Date 12/31/2015 $1,002,803.76 = PV of Fixed Leg (Positive since swap is RECEIVE FIXED) $(1,001,453.22) = PV of Float Leg (Negative since swap is PAY FLOAT) $1,350.54 = Net PV of Swap Position (Market Value of swap position) / $1,000,000 Notional x 100 0.1351% = Bond-like Price of Swap (% of Par)* *Quoted dirty in example. Bloomberg model strips out net accrued interest to calculate clean price of % 52

53 Summary Interest rate swap is an agreement between two counterparties where a stream of future interest payments are exchanged based on a predetermined notional principal over a specified period of time IRS are used to hedge, speculate, and manage risk Vanilla IRS are valued based on the net present value of two legs combined In SunGard, one leg will be priced with the net value of the position, the other leg will be priced at worthless ( ) depending on whether payment is to be received or paid Interest Rate Swap valuations are mainly affected by movement in floating interest rates BOSB – Majority of IRS terms can be found on this SunGard screen SunGard setup Rate qualifier = : RECEIVE LEG Rate qualifier = : PAY LEG Accrual Method = E or F : FLOAT LEG Accrual Method <> E or F : FIXED LEG CCP IRS R or P at end of security number denominates RECEIVER or PAYER swap 53

54 Questions ? 54

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