“A payer swaption permits the holder to enter a swap as fixed-rate payer and floating-rate receiver. If swap fixed rates increase (as interest rates increase), the right to enter the pay-fixed side of a swap (a payer swaption) becomes more valuable.” can anyone explain this? I don’t get how when fixed interest rates increase the swaption becomes more attractive. wouldn’t it be the opposite? the higher the rate the more I have to pay right?
no because you are paying fixed -low and receiving floating - high
So if you’re paying fixed rates and the interest rates are increasing, you are paying a fixed amount but you’re receiving more because of the interest rate increases, sounds like an ideal place to be making it more valuable!
so for a swaption, is the fixed rate agreed upon at some point in time prior? Like, if fixed rates are 3% when we agreed on the swaption, and the fixed rates go to 6%, I would pay 3% and then get some variabel rate, 6%+some add on?
Fixed rate is agreed upon the initiation of the swaption, as you said 3%. If rates increases (fixed rates go to 6% - you mean the interest rate, fixed rate is 3%), to 6%, then payer swaption would recieve 6%, pay out 3%, netting 3%.
exactly remember it’s just an option with a strike price - the agreed fixed rate then depending on how interest rates go you decide to exercise the option or not
The other explanations are obviously correct, I will try and explain it how I remember it: A payer swaption is the right to enter into a swap where you pay fixed and receive floating (swap 1). If the fixed rate on a swap increases in the market due to an increase in LIBOR related rates then you can exercise your option to enter the pay fixed and receive floating swap (i.e. swap 1) and additional enter into a pay floating and receive fixed in the market (swap 2) which has a higher fixed rate than swap 1. Effectively, the floating payments on swap 1 and swap 2 cancel each other out and you make the spread between the higher fixed rate received on swap 2 and make the payments on the lower fixed rate you pay on swap 1. That leads to an annuity earned. Hope that helps. -Amit
sweetheart I thought about that but then I thought that the spread would be constant, like prime+3 or something. it would always be 3. does the spread b/n fixed and floating change? it’s hard to address you as sweatheart without laughing by the way
thanks everyone, crystal clear now it’s amazing how you can post a question on here and get a good answer, this is better than logging into schweser…