Principles of Financial Engineering, 2nd Edition

CHAPTER 4

Engineering Simple Interest Rate Derivatives

1. Introduction

Foreign currency and commodity forwards (futures) are the simplest types of derivative instruments. The instruments described in this chapter are somewhat more complicated. The chapter discusses financial engineering methods that use forward loans, Eurocurrency futures, and forward rate agreements (FRAs). The discussion prepares the ground for the next two chapters on swap-based financial engineering. In fact, the FRA contracts considered here are precursors to plain vanilla swaps.

Interest rate strategies, hedging, and risk management present more difficulties than FX, equity, or commodity-related instruments for at least two reasons. First of all, the payoff of an interest ...