Hi all, I dont know how you all feel, but these interest rate derivatives can be pretty confusing and hard to keep straight. I have some questions and some outline which I will put down below. Please add or correct any mistakes you feel i have made. Long FRA - allows you to “borrow” at rate of FRA. If rates go up, you win and can borrow at a lower rate than market rate. Used to protect from rising rates Short FRA - allows you to “lend” at rate of FRA. If rates decrease, you win because you can lend at rates higher than market. Used to protect from decreasing rates. (Instrument, Use for Long) Payer Swaption, used for hedging floating rate liability Receiver Swaption - used for hedging floating rate asset Cap, used to protect floating liability from rising rates Floor, used to protect floating asset from decreasing rates Collar, used to protect floating liability from rising rates and funded partly by selling the floor Reverse collar, used to protect floating asset from decreasing rates, funded partly by selling the cap I have trouble with the use of these for a short side, so if anyone could fill me in i would appreciate it. For example, is a short side on a payer swaption trayinig to get exposure to floating rate? what is the purpose of selling this swaption? etc etc. I will try to continue adding, but i thought id get it started and hopefully we can get a good list here.
Ill take a shot at the short payer swaption: This would also be a receiver swaption. A payer swaption allows you to pay fix receive float, a receiver swaption allows you to pay float receive fixed. A firm may do this if they are already receiving a floating rate through a lending program and would like to convert it to fixed; much in the same way that a firm who borrows float enters a plain vanilla in order to pay fixed.
A short payer swaption isn’t a receiver swaption, it’s a short position in an option. The reason for entering a short position in one of these is the same as the reason for entering any short option position - you want to make money on the option premium and you don’t think that the option will be exercised.
good call…what an idiot *shakes head in shame* So then a short payer swaption is obligating you to lend at a fixed rate and receive a floating rate should the counter party choose to exercise, which they would if rates went up. A long receiver swaption on the other hand gives you the option to receive fixed and pay floating, which you would exercise if rates went down. My mistake was that both are on the same side of the market, that is someone believing that rates will go down may take either position, but it was like saying a covered call is the same thing as buying a put.
So really, the short side of all of these is to make some income, and if rates move against you then you end up losing, while the long sides use it to speculate or to hedge assets and liabilitites…
So lets talk about collars: A long collar: Defined as long calls and short puts to finance the calls - A series of caplets/floorlets - Either way we pay fixed rate and receive floating rate - Entered so that you set a range for your fixed payments (ie. if rates go above your call, then you exercise your call and pay fixed and receive the higher floating. If rates go down, your short put gets exercised against you and you pay fixed and receive the lower floating, a bad thing but a partial hedge since it offset the costs to our caps) A short collar: Defined as long puts and short calls to finance the puts - A series of caplets/floorlets - Either way we pay float and receive fixed - Entered so that we set a range for the fixed rate we will receive (ie. if rates go up, our short call will get exercised and we will be obligated to pay the higher float and receive the fixed strike rate. If rates go down, we will exercise our long put and receive a fixed rate above our floating rate payments)
Spanishesk Wrote: ------------------------------------------------------- > So really, the short side of all of these is to > make some income, and if rates move against you > then you end up losing, while the long sides use > it to speculate or to hedge assets and > liabilitites… Pretty much nails it I think.
nielsendc Wrote: ------------------------------------------------------- > good call…what an idiot *shakes head in shame* > > So then a short payer swaption is obligating you > to lend at a fixed rate and receive a floating > rate should the counter party choose to exercise, > which they would if rates went up. > > A long receiver swaption on the other hand gives > you the option to receive fixed and pay floating, > which you would exercise if rates went down. > > My mistake was that both are on the same side of > the market, that is someone believing that rates > will go down may take either position, but it was > like saying a covered call is the same thing as > buying a put. *this should have read: “So then a short payer swaption is obligating you > to lend at a fixed rate and PAY a floating rate”
Nielsen - are you in Washington DC? I think you are correct - a collar, where you buy the cap and sell the floor, is used to hedge a floating liability from rising rates (if it exceeds the cap strike, you can exercise. Although your floating liability has gone up, you get payment from exercising the cap which offsets the higher liability). A reverse collar, where you sell the cap and buy the floor protects a floating asset (if rates move down, you exercise the floor, receiving payments that offset the decrease of floating rate payments). Each of these is fully or partially funded by selling the other side short (sell a floor and use proceeds to buy a cap and vise versa) The way i keep these straight is thinking about it from trading options. A collar is used to protect a stock that has gains (sell calls ont eh stock, use proceeds to buy a protective put). This is the same idea as a reverse collar on the interest rates (sell the cap and buy the floor).
Good stuff…that definitely makes sense. No I’m in Sacramento, CA…possibly the worst city in the country to currently own a home lol