Dudes, I’m seriously about to throw my PC off the 48th-floor here in CHI, so if anybody is planning on walking down Wacker Dr. in the next couple hours…beware of shite falling from the heavens. I am having MAJOR difficulty with this shite. Thought I had a handle on it when I did a bunch of Schweser questions last night and then it all went pear-shaped. I was ready to put a hole in Pinkman’s wall by 10pm. F@CK. I thought I had it figured on who makes the payment/CF when it talks about market price or exercise price, ie. if it’s 6.6% and fixed rate is 6%, then fixed payer benefits…right? (.066-.06) x 90/360 x $1MM But then in another question, it seems like it’s completely opposite. (Specifically, Schweser…#'s 8 & 9 in Concept Checkers…sorry I don’t have the page number)…where it asks for the MV and who makes the payment and the answer is $0.01166 and the payment made by the fixed-rate payer. Here’s another one I’m having a fooked up time getting my head around: Consider a 2-year interest rate swap in which we pay LIBOR quarterly and receive 8% fixed semiannually. The notional value is $10M. Assume the yield curve is flat. The receive-fixed side of this swap can be replicated with which of the following portfolios of interest rate options? Long Position Short Position A. Puts @ 8% Calls @ 8% B. Puts @ 8% Puts @ 8% C. Calls @ 8% Puts @ 8% D. Calls @ 8% Calls @ 8% Pink was trying to explain this to me last night about how A. would create a fixed-rate payment and I thought I had it, but today, I’ve lost that magic. Can somebody please break this down super simple for me from both position perspectives and unde both scenarios (ie. rates up/down), as my head’s about to explode. This chapter is truly some f@cked-up material.
If you want 8% fixed you would want the be long put and short call. If rates drop to 6% you receive 6% + the 2% from being long the put = 8% If rates rise to 10% you receive 10% but pay 2% because you are short the call = 8%
If you receive fixed, and LIBOR goes to 0%, you are in the money big stylie. So you must have a long put. Obviously going simultaneously long and short of a put does nothing, which leaves you with A).
Long put will help you when the interest rates go below 8% and short call will behave like a cap to your returns. Short Call Premium received goes in the Long Put Premium, so they net out to zero. Thus you have emulated a receive-fixed side of the swap. Ans should be A? EDIT: chrismaths, I liked your analysis!!
Of course the other way to look at it is long put @ x and short call @ x is a forward contract to recieve x…
you are short interest rate -> A
Thanks boys - will print this out and take another stab at getting my head wrapped around this tonight.
If that can help you, here is the simple way I memorize it. You pay LIBOR so you are screwed if rates go up. So you gain if they go down. You gain when something goes down by going long put. So you mimic: - your “I gain if it goes down” by going long a put and - your “I am screwed if that goes down” by shorting a call. If you pay fix and receive LIBOR, that works the other way. Hope that helps
But aren’t you worried that prices will go up…instead of down…when you short a call?
If prices (or rates) go up, then you lose money by paying LIBOR. The same happens when you short a call. Basically: - buying the put is equivalent to you benefiting from the drop in rates in your SWAP, - and selling the call is equivalent to you being screwed by an increase in the rates in your SWAP (as you pay LIBOR).
Gotcha… !!..should have read your first post more carefully…
I have nothing constructive to add about swaps…however i did just google WTFOMGBBQ and had a good chuckle. Actually swaps have been killing me too. On the 16 week online schwesser class last night Dr. Holmes said at least 3 times “you need to think about how much time you’re going to spend on this topic”. Obviously it’s very testable and 5-15% weighting. Schweser’s point is that FSA and Equity is more important. I’m comfortable with a lot of it…the shiate that’s killing me is valuing currency swaps 60 days later after the exchange rate changes. Me no like.
if it makes you all feel better, i work on a swap desk, and this shite is still pretty hard at times, but not that bad 
jabroni Wrote: > Actually swaps have been killing me too. On the 16 > week online schwesser class last night Dr. Holmes > said at least 3 times “you need to think about how > much time you’re going to spend on this topic”. > Obviously it’s very testable and 5-15% weighting. > Schweser’s point is that FSA and Equity is more > important. I’m comfortable with a lot of it…the > shiate that’s killing me is valuing currency swaps > 60 days later after the exchange rate changes. Me > no like. They say it in Stalla too…specifically worry about learning how to value a currency swap only if you are comfortable with absolutely everything else and have some time to spare