Mastering Interest Rate Risk Strategy

8

Linear derivatives

Introduction

Interest rate swap

FRA

INTRODUCTION

Firms can use interest rate swaps and FRAs to mitigate interest rate risk. These derivatives exchange a variable for a fixed interest cash flow stream or vice versa.

The worldwide OTC market for swaps and FRAs is massive. Table 8.1 shows the notional amounts outstanding in billions of US dollars!¹ Be aware that all counterparties are incorporated in the figures, including financial institutions.

Table 8.1 - Notional amounts outstanding

We’ll discuss two types of linear interest rate derivatives: interest rate swaps and FRAs. Interest rate swaps can be split into payer’s ...