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Swaptions

admin — Sat, 12 Dec 2009 14:15:13 +0000

A swaption is an option to enter into a swap. Although swaptions can be designed in a variety of ways, we shall focus exclusively on the most widely used swaption, the plain vanilla interest rate swaption. This is a swaption to pay the fixed rate and receive the floating rate or the other way around. It allows the holder to establish a fixed rate on the underlying swap in advance and have the option of entering into the swap with that fixed rate or allowing the swaption to expire and entering into the swap at the fixed rate that prevails in the market.

Capped swap

admin — Fri, 04 Dec 2009 14:14:10 +0000

In a capped swap, the floating payments have a limit as to how high they can be. Similarly, a floored swap has a limit on how low the floating payments can be.
There is no limit to the number of variations that can be found in swaps, and it is not worthwhile to examine them beyond the basic, most frequently used types. We must, however, cover an important variation of a swap that combines elements of both swaps and options.

An Inspirational Statement of Intent

admin — Tue, 01 Dec 2009 14:13:04 +0000

For most companies, stating that their goal is to maximize shareholder value is not enough to excite employees, focus organizational energy, or direct their long-term ambitions. Thus, companies often develop broader statements of purpose. A good example is Disney, whose mission is ”To offer quality entertainment that people will seek out” and whose vision is “To create shareholder value by continuing to be the world’s premier entertainment company from a creative, strategic, and financial standpoint.”
A statement of intent will only excite and unite stakeholders if it is perceived to reflect how management actually acts day-to-day. Otherwise it may even be counterproductive, if employees then suspect the other elements of making value happen to be equally insincere. Therefore it is important for companies’ statements to reflect a raison d’être that the entire organization can identify with and support. Examples of causes that can really inspire passionate support are to save the company from an imminent crisis; to defeat another competitor; to build something new; to serve a noble purpose, or to create wealth. To be practical, the aspiration should also answer the questions: What business(es) are we in and what do we aspire to be known for? Finally, the aspiration should be written in a language that people can relate to, avoiding lofty or abstract phrasings.

Arrears swap

admin — Sat, 28 Nov 2009 14:12:06 +0000

An arrears swap is a special type of interest rate swap in which the floating payment is set at the end of the period and the interest is paid at that same time. This procedure stands in contrast to the typical interest rate swap, in which the payment is set on one settlement date and the interest is paid on the next settlement date.

Build Your Knowledge Base Systematically

admin — Tue, 24 Nov 2009 14:10:58 +0000

The third step to creating a successful investment plan is to systematically build a solid base of innovative strategies from which to invest wisely. Most investors start the same way. They read a few books, open a small account, and lose every- thing very quickly. However, there is one way to differentiate the winners from the losers. Winners persist at learning as much as they can by start- ing slowly and collecting tools to beat the market consistently. Successful options traders first learn to walk, then to run. Usually traders begin with simplistic strategies such as going long or shorting the market, and using stops to limit losses. Some just listen to their brokers and follow their trading ideas. Once initiated, traders accelerate their learning at the right time to become successful.
Successful traders usually specialize in one area or just a few areas. This specialization allows the trader to develop strategies that consistently work in certain recognizable market conditions. A successful investor realizes that, in all likelihood, these situations will reoccur and the same strategies can be used profitably over and over again. At my alma mater, Harvard Business School, the same systematic approach is used. I never realized what the school was attempting to accomplish until after graduation when I had time to apply this approach to the real world—all those case studies on businesses I had no interest in fostered my ability to learn how to think in any environment. This systematic building of knowledge will enable you to quickly get up and running as a successful trader in the marketplace.

Overview of Asset/liability Management

admin — Thu, 19 Nov 2009 14:09:40 +0000

The two goals of a financial institution are (1) to earn an adequate return on funds invested and (2) to maintain a comfortable surplus of assets beyond liabilities. The task of managing funds of a financial institution to accomplish these goals is referred to as asset/liability management or surplus management. This task involves a trade-off between controlling the risk of a decline in the surplus and taking on acceptable risks in order to earn an adequate return on the funds invested. With respect to the risks, the manager must consider the risks of both the assets and the liabilities.
Institutions may calculate three types of surpluses: economic, accounting, and regulatory. The method of valuing assets and liabilities greatly affects the apparent health of a financial institution. Unrealistic valuation, although sometimes allowable under accounting procedures and regulations, is not sound investment practice.
The economic surplus of any entity is the difference between the market value of all its assets and the market value of its liabilities. That is,
Economic surplus = Market value of assets – Market value of liabilities
The market value of the liabilities is simply the present value of the liabilities, where the liabilities are discounted at an appropriate interest rate.
Institutional investors must prepare periodic financial statements. These financial statements must be prepared in accordance with “generally accepted accounting principles” (GAAP). Thus, the assets and liabilities reported are based on GAAP accounting and the resulting surplus is referred to as accounting surplus.
Institutional investors that are regulated at the state or federal levels must also provide financial reports to regulators based on regulatory accounting principles (RAP). RAP accounting for a regulated institution need not use the same rules as set forth in GAAP accounting. Liabilities may or may not be reported at their present value, depending on the type of institution and the type of liability. The surplus, as measured using RAP accounting, is called regulatory surplus or statutory surplus, and, as in the case of accounting surplus, may be materially different from economic surplus.

Diff swaps

admin — Mon, 16 Nov 2009 14:08:32 +0000

Diff swaps combine elements of interest rate, currency, and equity swaps. In a typical diff swap, one party pays the floating interest rate of one country and the other pays the floating interest rate of another country. Both sets of payments, however, are made in a single currency. So one set of payments is based on the interest rate of one country, but the payment is made in the currency of another country. This swap is a pure play on the interest rate differential between two countries and is basically a currency swap with the currency risk hedged. Alternatively, in equity diff swaps, the return on a foreign stock index is paid in the domestic currency.

Develop a Flexible Investment Plan

admin — Sat, 14 Nov 2009 14:07:32 +0000

The second step in reducing risk and stress is to develop an investment plan that is flexible. Flexibility allows a trader to cultivate a matrix of strategies with which to respond to market movement in any direction. Erratic market movement can change your position dramatically in seconds. Each price move (tick) rearranges everyone’s assumptions about what the market is about to do. This dynamic environment borders on schizophrenia, where the bulls and bears do battle trying to outmaneuver each other. This, in turn, creates profitable opportunities for the knowledgeable investor with a smart and flexible investment plan and creates nightmares for the uninitiated trader without a plan, only a hunch as to where the market appears to be going. Investors and traders have to be entrepreneurial by nature to survive. One of the greatest attributes of entrepreneurs in any industry is the ability to recognize a roadblock and change direction when one is reached. Traders must also exhibit this flexibility if they are to survive in the marketplace.

Define Your Risk

admin — Fri, 13 Nov 2009 14:02:53 +0000

As a trader you have the ability to make large profits with the risk of potentially large losses. This is no secret. Unfortunately, that old maxim “cut your losses and let your profits run” is easier said than done. By defining your risk, you are assured that you cannot lose more money than the amount you have established as being the maximum position loss. You will also be able to develop strategies that create the potential for large rewards by predefining your acceptable risk parameters and by applying strategies that combine stocks and options on stocks, or futures and options on futures.

Accreting swaps

admin — Thu, 12 Nov 2009 14:02:42 +0000

Amortizing and accreting swaps are those in which the notional principal changes according to a formula related to the underlying. The more common of the two is the amortizing swap, sometimes called an index amortizing swap. In this type of interest rate swap, the notional principal is indexed to the level of interest rates. The notional principal declines with the level of interest rates according to a predefined schedule. This feature makes the swap similar to certain asset-backed securities, such as mortgage-backed securities, which prepay some of their principal as rates fall. An index amortizing swap is often used to hedge this type of security.