Interest Rate Derivatives - A Primer

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Contents
Preface ...................................................................................................................................................................................................................................................................................................................3
Introduction ........................................................................................................................................................................................................................................................................................................4
Why use derivatives? ..............................................................................................................................................................................................................................................4
How to think about derivatives..........................................................................................................................................................................................................................5
What to consider before entering into derivatives..............................................................................................................................................................................5
A bit of theory...............................................................................................................................................................................................................................................................6
What is a derivative strategy?...........................................................................................................................................................................................................................7
Derivative markets....................................................................................................................................................................................................................................................7
Documentation............................................................................................................................................................................................................................................................8
Interest rates.....................................................................................................................................................................................................................................................................................................9
The basic definitions and conventions .........................................................................................................................................................................................................9
Pricing swaps...........................................................................................................................................................................................................................................................11
Yield curves: Can identical cash flows be different?.......................................................................................................................................................................12
Yield curves and their dynamics ..................................................................................................................................................................................................................13
Risk management.......................................................................................................................................................................................................................................................................................15
Measuring uncertainty .......................................................................................................................................................................................................................................15
Yield curve risk – the classical approach ...............................................................................................................................................................................................15
Yield curve risk – the modern approach..................................................................................................................................................................................................16
Risk managing options or just speaking Greek?................................................................................................................................................................................17
Delta ...............................................................................................................................................................................................................................................................................17
Gamma .........................................................................................................................................................................................................................................................................17
Vega................................................................................................................................................................................................................................................................................18
Theta ..............................................................................................................................................................................................................................................................................18
Choosing your risk profile – interacting greeks..................................................................................................................................................................................18
Pricing options – the put-call parity ............................................................................................................................................................................................................21
Outright strategies ....................................................................................................................................................................................................................................................................................22
Where are rates going?.....................................................................................................................................................................................................................................22
Curve strategies ..........................................................................................................................................................................................................................................................................................23
Introducing relative bets....................................................................................................................................................................................................................................23
Swaps versus bonds ............................................................................................................................................................................................................................................23
Spot versus forward – hedge stability ......................................................................................................................................................................................................25
Spot versus forward – convenience of no payments......................................................................................................................................................................27
Introducing swaptions.........................................................................................................................................................................................................................................27
What determines the price of a swaption?...........................................................................................................................................................................................28
Conditional versus unconditional – using swaptions in a one-sided steepener strategy........................................................................................29
Conditional versus unconditional – using swaptions to take positions on the entire curve..................................................................................29
Conditional versus unconditional – using caps and floors to take positions on the entire curve......................................................................31
Protection: Extendable and retractable swaps ..................................................................................................................................................................................33
Constant maturity strategies.........................................................................................................................................................................................................................34

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关键词：derivatives Derivative interest Primer prime derivatives Rate interest Primer

Asset Swaps...................................................................................................................................................................................................................................................................................................37
Levelling out the playing field ..........................................................................................................................................................................................................................37
What is an asset swap?.....................................................................................................................................................................................................................................37
What are asset swaps used for?.................................................................................................................................................................................................................37
Types of asset swaps...........................................................................................................................................................................................................................................37
Volatility Strategies..................................................................................................................................................................................................................................................................................39
What is volatility?...................................................................................................................................................................................................................................................39
Why look at volatility?..........................................................................................................................................................................................................................................39
Implied volatility .......................................................................................................................................................................................................................................................39
Implied versus realised volatility..................................................................................................................................................................................................................40
Skews, smiles and term structure of volatilities...............................................................................................................................................................................40
The dynamics of implied volatilities............................................................................................................................................................................................................42
An example of the dynamics ...........................................................................................................................................................................................................................43
Tracking an options market.............................................................................................................................................................................................................................44
What determines the price of volatility? ................................................................................................................................................................................................45
Strangles and straddles - simple volatility bets using caps/floors.......................................................................................................................................45
Selling strangles or buying butterflies?...................................................................................................................................................................................................46
A 1X2 Zero cost structure using swaptions.......................................................................................................................................................................................47
Calendar spreads...................................................................................................................................................................................................................................................48
Combined Strategies...............................................................................................................................................................................................................................................................................50
Taking relative positions....................................................................................................................................................................................................................................50
Swap spread trading ............................................................................................................................................................................................................................................50
Relative curve strategies ..................................................................................................................................................................................................................................51
Picking up the DKK-EUR risk premium....................................................................................................................................................................................................51
Shorting options: Range accruals................................................................................................................................................................................................................53
Pricing range accruals: Digital options ....................................................................................................................................................................................................54
Pure curve plays: CMS spread options....................................................................................................................................................................................................54
Derivative formats.....................................................................................................................................................................................................................................................................................56
Which wrapping do you prefer?....................................................................................................................................................................................................................56
Structured swaps...................................................................................................................................................................................................................................................56
Structured notes.....................................................................................................................................................................................................................................................57
Structured deposits..............................................................................................................................................................................................................................................57
Conclusion........................................................................................................................................................................................................................................................................................................58
D A

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