ANALYZING INTEREST RATE EXPOSURE

Transcription

1 ANALYZING INTEREST RATE EXPOSURE STEFFAN TSILIMOS INTEREST RATE DERIVATIVES SPECIALIST PH:

2 2 ARKET ONDITIONS

3 Market Conditions While the market is stabilizing from panic levels, yields are still at historic lows. The increased commodity pressures from the middle east combined with the huge amounts of sovereign debt issued have caused the yield curve to steepen to historic levels. This has increased the value of many types interest rate products FORWARD RATES ARE MUCH HIGHER Given the historically steep yield curve forward swap rates are expected to increase rather dramatically over the next few years. The 2 yr swap rate 5 yrs forward is 250 bps over spot. RECOVERY COULD TAKE LONGER THEN EXPECTED If the rates stay lower for longer amid global turmoil investors would benefit from strategies that fade this very high implied forward rates. POLITICAL RISK IS EXTREMELY HIGH During the upcoming election year, job stimulus and market growth will be key goals for the current administration. Implementation of regulations and requirements could vary significantly, depending on who wins the general election. 3

4 FORWARD INTEREST RATE CURVES FWCM <GO>

5 rates still historically low 5

6 6 THE ROLE OF INTEREST RATE SWAPS

7 CONSIDER FIXED TO FLOATING MIX DDIS <GO>

8 Interest Rate Swaps for Corporations Moving rates cause an interest rate risk For example, if IBM issued a 10-year fixed rate coupon bond, it would be exposed to interest rate risk from rising (falling) rates and uncertainty of how much they would rise (fall) Is there any way IBM can eliminate their risk from rising rates create floating rate coupon?

9 Swaps SWAP DESK Investor 5% 5% IBM swap: an exchange of streams of payments over time according to specified terms

10 What is a swap? Exchange of interest payments (cash flows) At agreed intervals - semi annual, quarterly etc Over an agreed period, 5yr, 10yr Usually fixed to floating. If Party A is receiving fixed, Party A is also paying floating; Payment is settled on a net basis Floating side is reset periodically off some index, such as 3 month LIBOR Important features of swaps Coupon = Fixed rate Spread = Constant number of bps over Floating rate Market value = Value of swap at a given time DV01 = change in market value when underlying curve moves by 1 bp

11 SWAPPING BONDS FIXED TO FLOAT SWPM <GO>

12 UNDERSTANDING WHERE THE MARKET IS TREASURIES SWAP SPREADS SWAPS

13 Yield Curves SWAP SPREAD = DIFFERENCE BETWEEN SWAP RATE (AA) AND GOV RATE (AAA)** SWAP YIELD Y I E L D SWAP SPREAD GOV YIELD Maturity **As of 4/27 US GOV is still rated AAA

14 Gov t Yield + Swap Spread = Swap Rate How the swap rate is derived

15 ANALYZE LIABILITY TERM STRUCTURE DDIS <GO>

16 LIBOR IS AT HISTORIC LOWS US0003M INDEX GP <GO>

17 STRATEGY: RECEIVE FIXED ON 10Y SWAP: => REC 2.15% => PAY 0.47% POSITIVE CARRY OF 168BPS ( )

18 MAXIMIZE POSITIVE CARRY POSITIVE CARRY OF 244 bps

19 EDGING 19 TRATEGIES

20 Treasury Rate Locks 20

21 TREASURY RATE LOCKS 21 ADVANTAGES DISADVANTAGES INEXPENSIVE HEDGES RATE RISK EASY TO UNDERSTAND VERY LIQUID DOESN T HEDGE SPREAD RISK CAN T MATCH CASH FLOWS EXACTLY HARDER TO HEDGE THE CURVE DOESN T HEDGE VOLATILITY 21

22 Forward Starting Swap 22

23 Forward Starting Swap Advantages Disadvantages Hedges rate and spread risk Can match cash flows Can hedge the curve More customized the less transparency Does not hedge volatility Can be more expensive 23

24 Swaption 24

25 Cap 25

26 INTEREST RATE OPTIONS: SWAPTIONS, CAPS & FLOORS 26 ADVANTAGES DISADVANTAGES HEDGES VOLATILITY CAN MATCH CASH FLOWS HEDGES SPREAD RISK HEDGES THE CURVE CAN CUSTOMIZE CAN BE LESS LIQUID THE MOST COMPLEX SO THE MOST EXPENSIVE 26

27 OIS Discounting for Interest Rate Swaps SWPM <GO>

28 WHAT S GOING ON? SWAP DEALS ARE INCREASINGLY BEING SENT TO CLEARING HOUSES (LCH, DTCC,CME) DODD-FRANK WILL REQUIRE THIS INSULATED FROM COUNTERPARTY RISK SUBJECT TO COLLATERAL REQUIREMENTS COLLATERAL EARNS OIS, NOT LIBOR CHANGING THE WAY WE DISCOUNT CASHFLOWS OF A SWAP AND OTHER DERIVATIVES LIBOR-> OIS

29 WHO IS AFFECTED? EVERYBODY THAT HAS INTEREST RATE SWAPS SWAP VALUES WILL CHANGE! GREATEST EFFECT AND DEALS WITH LARGE MK-TO-MKT VALUES AND LONG DATED SWAPS

30 What if you don t use a clearing house? Swaps should be discounted based on how the swap is collateralized or funded CSA Agreement Referenced Collateral Uncollateralized swaps will be discounted at a rate that reflects the credit rating of the customer Counterparty Valuation Adjustment 30

31 Counterparty Valuation Adj (CVA) 31

32 Counterparty Valuation Adj (CVA) 32

33 Analyzing Hedge Effectiveness HEFF <GO>

34 Why use Hedge Effectiveness Accounting? FAVORABLE ACCOUNTING TREATMENT (FAS 133) COMPARE BOND PRICE CHANGE VS SWAP OR FX LESS VOLATILITY ON INCOME STATEMENT

35 Hedge Effectiveness Testing 35

36 Hedge Effectiveness 36

37 HANK YOU 37 STEFFAN TSILIMOS INTEREST RATE DERIVATIVES SPECIALIST PH: