cfai goes hardcore into swaps and covers topics that schweser doesn’t even touch. which are people focused on? here is the list in my head: -plain vanilla int rate swaps - turning a floating rate loan to fixed and vice versa. fine, no big deal here. -using swaps to adjust duration of fixed income portfolio. not a huge deal either, if you have a fixed rate portfolio, use a pay floating receive fixed swap to increase duration and vice versa. notional principal required in the swap = portfolio value * [(target duration - current portfolio duration)/swap duration] -currency swaps -converting a loan in one currency into a loan in another -synthetically removing calls from debt. good lord. -using a swaption to terminate a swap. doesn’t seem too bad. -equity index swaps
yup! this sh$% is too much given the weight they represent in the exam.
Make sure you look the LOS’. There’s a lot int he CFAI text that’s not needed for the exam. e.g. .synthetically removing calls from debt. It’s not in the LOS. Don’t waste your time with it.
I believe that you are reading the LOS wrong again!!! every time I read your posts you seem to get the question mixed up in your mind or mis-interpet the LOS… my advise would be to take it easy and do not rush reading your question…this is the third or fourth time I read your posts, which have made no sense whatsoever…so please read your questions more carefully before you post… best and i hope you found this useful!!! AA
He might have meant converting non-callable bonds to callable bonds and vice versa… like they said be careful with your interpretation of words…
calculations are VERY little for CFA exam. The exam is 90% concepts. Is it worth wasting all time on 10% of calculations? I rather know 90% well
agreed i left those obscure swaps calcs in the dust and resigned myself to trying to understand the concepts
The Swap LOSs are not that complicated: A) Use an IRS to convert a floating to a fixed = plain vanilla interest rate swap. B) Calculate & Interpret the duration of an IRS: - For floating rate instruments duration is close to zero b/c cash flows adjust with int. rates. This is why a swap lowers duration. Rules to remember for calculations: 1) Dur of fixed rate is 75% of maturity & 2) for floating, use a Dur of 0.125 for quarterly payments and 0.25 for semiannual payments (max duration of floating is the length of reset period so avg of 0.5 and 0 is 0.25). -formulas: D pay floating = D fixed - D floating : D pay fixed = D floating - D fixed C) Impact on Cash flow risk & Mkt value risk when a fixed rate loan becomes a floating rate. - cash flow risk increases with a floating rate loan because cash flows are reset every period. Market value does not change very much on a floating rate loan, this is a bigger risk for fixed rate loans. D) Determine Notional Principal for a target duration: - formula NP = Value of portfolio x [(MD target - MD port)/ MD swap] E) How does a currency swap generate savings - 1) a company may receive better terms on a bond issued in its home country, and swap allows better matching if those funds are used for intl expansion. 2) by assuming the credit risk inherent in a currency swap (remember NP is exchanged @ origination) a company can lower borrowing costs. F) Demonstrate a currency swap on foreign cash receipts - 1) divide foreign cash flows by foreign interest rate to determine the foreign denominated NP. 2) use current exchange rate to to convert foreign NP into domestic NP. 3) enter a swap where you pay the foreign cash flows and receive the domestic cash flow. G) How are equity swaps used to diversify a portfolio - equity swap means payments are based on the returns of some equity index. Thus, you can diversify by swapping the returns on a concentrated portfolio for a diversified one, you can swap domestic returns for the returns on an international index, or alter an allocation by swapping form small caps to large caps. H) Demonstrate using an interest rate swaption to 1) change the payment pattern & 2) terminate a swap - Recall that there are 2 types of swaptions, so know what you are dealing with, but a receiver swaption allows the holder to enter into a swap as the fixed rate receiver, floating payer. This a fixed rate loan can be converted to a floating rate loan (see example 12). 2) Terminate a swap early by entering into a swap (or swaption) with the same terms but reversing the payments. If the counterparty is the same, the swap is eliminated. That’s it in a nutshell. Read the examples in the text, and work some problems, but the focus of the LOS is not as complicated as the material in the chapter appears on your first pass through it.
great write up the only thing i would add is that swaps can be used to both increase and decrease duration. if you want less exposure to changes in interest rates, you decrease duration by entering into a pay fix swap (duration pay fix = duration (receive float) - duration (pay fix) < 0. you increase duration. if you want more exposure to changes in interest rates, you increase duration by entering into a receive fix swap (duration receive fix = duration (receive fix) - duration (pay float) > 0.
*if you want less exposure to changes in interest rates, you decrease duration by entering into a pay fix swap (duration pay fix = duration (receive float) - duration (pay fix) < 0.