Chapter 33 Swaps Revisited

Swaps have been central to the success of over-the-counter derivatives markets. They have proved to be very flexible instruments for managing risk. Based on the range of different contracts that now trade and the total volume of business transacted each year, swaps are arguably one of the most successful innovations in financial markets ever.

Chapters 7 and 9 discussed how plain vanilla LIBOR-for-fixed interest rate swaps can be valued. The standard approach can be summarized as: “Assume forward rates will be realized.” The steps are as follows:

  1. Calculate the swap’s net cash flows on the assumption that LIBOR rates in the future equal the forward rates calculated from instruments trading in the market today. (As ...

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