RSM435H1 Lecture Notes - Lecture 11: Credit Default Swap, Interest Rate Swap, Risk-Free Interest Rate
Document Summary
There is a fixed rate payer and a floating rate payer. Floating rate payment depends on prevailing libor at beginning of period. Can be used to transform liability from fixed to floating. Can transform asset from paying fixed to paying floating. Swap rate: average of bid and offer fixed rates. Some companies are treated more favorable in one debt market than the other. May be favorable for them to borrow either fixed or floating. Can swap to transform from floating to fixed. Fixed rate in a swap is chosen so swap initially worth zero. Calculate forward rate for each of the libor rates that will determine swap cash flows. Calculate swap cash flows assuming libor rates equal forward rates. Discount swap cash flows at risk free rate. Exchanging principal and interest payments at fixed rate in one currency for principal/interest payments at fixed rate in another currency. Principal must be specified in each of the currencies.
