Hi, Regarding the differences between commodity and interest rate swaps: Settlement- interest rate is financially settled and commodity swaps might have a physical delivery- correct ? Schweser’s book 4 page 47 does not state this.
MV of both swaps are computed the same way: Value = PV of the cash flow that can be locked in using offsetting forwards or futures contracts. At inception, both swaps have value of 0. Value of both swaps are affected by changes in interest rates and forward rates. But commodity swaps value are also affected by forward prices for the commodity, and also convenience yields.
Commodity swaps are normally financially settled and not physically delivered. Have fund delivering 1,000 barrells of oil for example. Not say its not done, but typically its not for the speculator/investor.
Bigwilly, Your point is well taken from the practical point but my point is theoretical. If there is a q -like state the differences between the two, my point is valid or not-that’s all. shoiho, You are correct from the point of view of valuation, but that was not my question. Thanks guys
Commodity swaps are almost never physically settled. Let’s see, I’ve seen commodity swaps used for: a) Including the transaction fee in the swap price on wrap-fee accounts so the manager gets to keep the wrap fee b) Getting around speculator position limits by swapping with a prime broker without such restrictions c) Holding oil through the front month despite restrictions meant to stop you from doing it d) All sorts of abusive tax games etc, etc. Commodity swaps are the way of jumping out of highly regulated futures markets into highly unregulated swap agreements. Edit: Interest rate swaps are done for all kinds of good reasons. Commodity swaps probably are too.
Thanks JoeyDVivre-it makes sense.