Chapter 16

Interest-rate swaps

Chapter Summary

This chapter defines interest rate swap contracts and introduces basic swap terminologies. Pricing formulas are developed for generic and forward swaps. We develop a simple arbitrage-free model for determining swap spreads and relate them to underlying economic factors. Empirical evidence is presented on swap spreads. Use of Eurodollar futures in pricing swaps and the concept of convexity adjustment are discussed. The relationship between the credit reputation of counterparties swap offer rate, swap bid rate, and the bid-offer spreads in swap markets are explained. Risk management issues pertaining to swaps are presented.

16.1 Swaps and Swap-Related Products and Terminology

Transactions in which two parties ...

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