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Derivative Securities (Fach) / Swaps (Lektion)
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- Definition A swap is an agreement between two parties to exchange a series of future cash flows
- Swap Characteristics Series of payments No initial costs (excepts currency swaps where the notional amount are exchanged) Payments are made at settlement date The final payment is made at the termination date The original time to maturity is the tenor No exchange of payments for payments in the same currency (netting) Over the counter market early termination is possible (by paying the value to the counterpary or by entering a separate and offsetting swaps By selling the swaps to a counterparty)
- Currency swaps each party makes interest payments in a different currency
- Interest rates swaps: interest payments are made in the same currency
- equity swaps interest payments are made in the same currency. The variable payments depend on the return of a stock (index)
- Valuation of interest rate swaps The value of the contract at time 0 is 0 Evaluating the interest rate swap contract means finding the fixed rate that make the value of the contract 0. Value of the contract is 0 if the present value of the all the fixed payments is equal to the present value of all the variable payments.
- Principal protected note Call + zero-coupon Bond Example: invest 1000 850 in a bond with a principal of 1000 150 in a call on an index with a strike price of 1000 Final value of the index above 1000 then there is a return Otherwise the initial investment is given back
- Covered Call Write a call and buy the underlying Value at expiration VT =ST −max(0,ST −X) Profit = VT − S0 + c0 Maximum profit = X − S0 + c0 Maximum loss = S0 − c0 Breakeven ST = S0 − c0
- Protective Put Buy a put and the underlying Value at expiration VT = ST + max(0, X − ST ) Profit=VT −S0−p0 Maximum profit = inf . Maximum loss = S0 + p0 − X Breakeven ST = S0 + p0
- Spreads Involve taking positions on two or more options of the same type Bull spreads Buy a call with strike price K1 Sell a call with strike price K2 (K2 ≥ K1 and same maturity) Bear spreads Sell a put with strike price K1 Buy a put with strike price K2 (K2 ≥ K1 and same maturity)
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- Straddle Buy a call and a put with the same strike price K You expect large price movements on a specific day
- Strangle Buy a call and a put with the different strike price (strike of the put lower) You expect very large price movements on a specific day