Who the fuck actually understands financial derivatives (interest rate swaps)?
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Date: March 28th, 2017 6:38 PM Author: spruce dashing depressive lodge
I don't really, and I discovered that the lender's lawyers don't either.
My client has no idea how a swap works and sending him the generic ISDA master agreement and a rudimentary explanation is not helping anyone.
I feel like this is just something lawyers ignore and tell their clients to sign.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940069) |
Date: March 28th, 2017 6:43 PM Author: ocher private investor
You swap a floating for a fixed rate, or vice versa
Not hard
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940086) |
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Date: March 28th, 2017 7:00 PM Author: spruce dashing depressive lodge
I get that, and I get you pay out net amounts.
And I even kind of get how you calculate the fixed rate based on the libor curve - though not really.
But what are the swap breakage costs if a deal dies? shouldn't the present value of the swap at closing always be zero, minus fees?
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940221) |
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Date: March 28th, 2017 7:13 PM Author: filthy school tattoo
The fixed rate is marked up, because the broker is pocketing money. Most likely a small borrower's counterparty (a bank) is going to the swap market and doing an inverted identical trade to a swap dealer to reduce their interest rate risk exposure to zero. The dealer pays your borrower's bank a nice chunk of change because the fixed payments are marked up.
In the deal's early life, floating cash flows are lower than the fixed. At later life, floating are supposed to be higher than fixed (the curve projects, as a rule, higher rates over time).
If the discounted differences all sum up to zero, the present value would be zero. But the fixed rate is marked up, so the fixed payments end up being more than the floating payments over all of the deal, or most of it, unless there's an unforeseen spike in rates. The amount of this surplus is the present value
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940314) |
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Date: March 28th, 2017 7:16 PM Author: spruce dashing depressive lodge
thanks.
1) the curve projects higher rates over time because the longer term contracts have higher rates? Or just because we expect interest rates to go up forever? That cant be true.
2) The present value surplus - is that the expected mark up (which is the only amount not netted out at closing)? Is that paid right away or as a chunk of the regular interest payments?
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940334) |
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Date: March 28th, 2017 7:32 PM Author: filthy school tattoo
Not that much. The longer a contract is, the more valuable it is, because that's 12 additional fixed rate payments per year. Each fixed rate payment represents additional profit for the recipient of the fixed rate payment--the more that there are, the more value is in the deal.
When you do the swap, you're promising those payments to the lender. You can break it at any time, but you have to make up for the expected profit they lose via the breakage fee. If there are a LOT of payments left on the deal, you'll owe them the sum of the profit they expect to get on each one. If there are FEW, it will be less.
If rates have moved to the point where the fixed payment recipient is actually expected to LOSE money over the life of the deal, they will pay you to break the swap. The odds are against this happening because the markup tilts the table in favor of the fixed payment recipient.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940458) |
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Date: March 28th, 2017 7:47 PM Author: filthy school tattoo
It's the profit the lender expects, but it can be negative if rates move drastically in favor of the fixed rate payer (your borrower, that is, rates go up)
[behind the scenes, the lender breaks a swap with a dealer on the same day your borrower breaks the swap. Under normal circumstances, the lender will pay to the dealer and equal fee that your borrower pays to the lender--a net change for the lender of zero. If rates have gone way up, the lender will pay your borrower....and then the dealer pays your lender and equal amount. The lender ends up at zero no matter what]
The Swap Rate curve is more determinative than the LIBOR curve for this. "USSW0001" or whatever number for the term in bloomberg. Actually forecasting/calculating it is a bit out of my lane
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940556)
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Date: March 29th, 2017 12:12 AM Author: appetizing selfie
this "profession" is a joke
i want to stick my head in a blender
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32942749) |
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Date: March 28th, 2017 8:24 PM Author: filthy school tattoo
ignore nutella's advice here, and I say this not only because I hate nutella, which I do.
she is talking about a different kind of swap, one that banks are doing behind the scenes to hedge their own risk on the swap your borrower is doing.
the payments she's talking about, where there are periodic margin payment calculations calculated by calculation agents, that can be disputed by the subordinate party, aren't going to apply to your situation.
The only payments your borrower are going to owe are the monthly interest payments (loan plus swap adding up to fixed rate) and potentially a breakage fee/receipt
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940760) |
Date: March 28th, 2017 7:05 PM Author: spruce dashing depressive lodge
Okay so help me with this.
My client is paying a floating rate of one month LIBOR + 3% spread, lets say. Loan matures in 5 years for simplicity.
The lender is forcing him to take out a swap to effective pay fixed interest. How does that rate get measured?
If you look at a LIBOR curve, you have the present value (in interest rates) of LIBOR contracts of various times out to the 5 year maturity. Today LIBOR may be 1% for a one month contract. The 5 year contract may be 2.5% or whatever.
How do you use the curve to calculate what the fixed rate should be now? Is the fixed rate higher than one month LIBOR + spread only because we expect rates to go up over 5 years? Or is it because the present value of a contract with a 5 year maturity is higher, that this somehow increases the fixed rate? I get that when you plot a fixed rate onto the libor curve, at closing the area above and below the line (the derivative amount) should zero out.
I never took any finance so this is confusing me.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940260) |
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Date: March 28th, 2017 7:21 PM Author: sticky avocado theater stage useless brakes
There is no swap payment at closing, typically you just pay monthly scheduled payments
Look up the definition of exposure in paragraph 11 of the credit support Annex. Exposure is basically the price the out of the money party would pay if the deal was terminated. The method of valuation specifically depends on what is negotiated in the isda (whether you need quotes etc )
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940379)
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Date: March 28th, 2017 7:27 PM Author: filthy school tattoo
correct. the borrower does not pay anything at closing, just the monthly fixed rate scheduled payments.
The lender does get paid, however, it's just by a swap dealer. This payment is passed on to the borrower over the life of the swap in marked-up fixed rate payments.
If LIBOR spikes huge, the borrower wins regardless and the dealer ends up getting screwed. The lender doesn't care--lender got paid on day one by the dealer.
If LIBOR falls off a cliff, the dealer wins big and the borrower ends up paying way more than otherwise would have with the floating rate
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940424) |
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Date: March 28th, 2017 7:38 PM Author: filthy school tattoo
The "dealer" is in the background. Your client, if I understand correctly, will never have anything to do with the bank I'm calling the "dealer." But the dealer is the reason your lender is pushing the swap--the dealer is how the lender gets paid. It's normal for the "same bank" to do the swap and the loan, as you say is the case here. That's the lender.
Your client is doing a floating rate loan with the lender. Your client is also doing a swap with the lender. The floating rate on the loan will be identical to the floating piece of the swap. Since your client gets PAID the floating piece of the swap, it effectively cancels out with the payment they make on the loan. What's left is the fixed piece of the swap, which they pay to the lender.
It's billed separately though. If the fixed rate is X and the floating rate is L, they'll get a loan bill for L that they have to pay. Then they'll get a swap bill for X minus L that they have to pay. The two bills together add up to X, which is the fixed rate.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940491) |
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Date: March 28th, 2017 7:54 PM Author: filthy school tattoo
the bank(lender) gets it's money from a bigger bank(dealer).
When your borrower calls in to do the swap, pledging a fixed rate to the lender in exchange for a floating rate, they are going to get put on hold.
While your borrower is on hold, the lender calls a swap dealer. The lender is going to pledge a fixed rate to the dealer in exchange for a floating rate. The terms will be identical to to the swap your borrower does. The dealer will tell the lender what the fixed rate would be for a present value of zero--that is, the discounted value of all the fixed monthly payments equals the discounted value of all the floating monthly payments--plus a few basis points of profit for the dealer.
The lender will then tell the dealer to mark that rate up about 30 basis points in exchange for cash. The lender is OFFERING to pay a higher fixed rate, in exchange for upfront cash from the dealer. The lender then takes that marked up fixed rate (so the PV-Zero rate, plus a few basis points, plus about 30 basis points), takes your borrower off of hold, tells them that THAT will be the fixed rate, and asks your borrower if they want to do the swap at that rate
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940592)
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Date: March 28th, 2017 8:08 PM Author: filthy school tattoo
I think this diagram is confusing. It seems to represent a scenario where the counterparties are only swapping a portion of their interest rate obligation, which I've never really seen. (I've seen swaps of partial principal amounts, but not partial interest rates. Six of one/half dozen of other, I guess, but not what this diagram reflects)
If you look at only the top part, so the arrows going left and right, that illustrates the swap between your borrower and the lender. Ignore the arrows pointing down. Imagine your borrower on the left, paying a fixed rate of 7.5% and receiving LIBOR plus .5% and the lender on the right.
[Between box A is also paying box B a floating rate of LIBOR plus .5%. That's the loan]
[NOW imagine there's another box FURTHER on the right...counter party C. Counterparty B is in the middle. Imagine the same arrows and the same amounts between boxes B and C as there are between A and B. Counterparty C is the dealer.]
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940656) |
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Date: March 28th, 2017 8:22 PM Author: filthy school tattoo
not party B, but BANK. On this one, ignore box B because it's confusing again. Look at box BANK and box FLOATING. Your lender is both, and the floating rates should be equal. There's a floating payment to your bank at box FLOATING, there's a fixed payment to your borrower from box BANK. Box BANK also pays your borrower, box A, a rate equal to the rate paid A pays out to FLOATING.
I believe these diagrams are for more complex risk management arrangements between financial institutions--or they're just academic. I remember researching them before interviewing and then realizing they don't apply at all to these hedges for business financing.
[I believe these diagrams are illustrating
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940744) |
Date: March 28th, 2017 7:44 PM Author: provocative location legend
lawyers aren't doing math problems to determine the essential financial terms of a swap, derivative or any security.
they deal with the various other terms related to the transaction. An ISDA just contains a bunch of other terms. I don't have a familiarity with them but I think they are interesting in how someone successfully standardized a type of business contract but then lawyers go and ruin it again.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940523) |
Date: March 28th, 2017 8:20 PM Author: domesticated faggotry
Finance guy here.
There is a market determined swap rate.you dont need to discount stuff yourself. You can look up the 5 yr swap rate to see what the market considers to be the fixed rate equivalent over five years of paying floating rate over five years. If you dont have access to a bberg terminal try googling.
Add the 3pct spread over that swap rate to arrive at the market determined fixed equivalent in your case
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940728) |
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Date: March 28th, 2017 8:34 PM Author: spruce dashing depressive lodge
That makes sense. So my client is paying 1mL + 3% on the loan.
The swap arrangement should result in them getting paid 1mL + 3% and paying some fixed rate that is calculated magically.
I got hung up because my client thought he could calculate the fixed rate for a 5 year LIBOR contract and do comparison shopping himself by adding the 300 bps spread to the 5 year LIBOR, which did not make sense to me, but I could not articulate why that was wrong - basically apples and oranges.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940855) |
Date: March 28th, 2017 8:30 PM Author: spruce dashing depressive lodge
Thank you everyone, especially Wilbur. I owe him 3 shots of tequila.
I am more confused than I was before in one way, but that's because I expected the wikipedia entry to make some sense.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32940810)
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Date: March 28th, 2017 11:54 PM Author: Pearly queen of the night
Earl, no homo, but this is why you are partner material.
Not that your digging into the details is important in this particular case. But I get the feeling that you are legitimately curious about the clients you serve and go the extra mile. When I'm dropping a few hundo an hour to talk to counsel, that's exactly what I want.
Grab yourself a Starbucks croissant tomorrow. It's breakfast, on me. And FFS sell that Accord and buy an M240i like you know you want. Get the 6-speed. :D
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32942619) |
Date: March 29th, 2017 12:56 AM Author: balding hilarious idea he suggested partner
Looks like a lot of smart people here. Does anyone know how a retail guy like me can hedge interest rates or get a floating to fixed swap?
I have several million of credit lines that are floating interest rate loans, and I would really prefer to swap them into fixed than take the risk that LIBOR/Prime keep going up. I am not quite at the $10 million market yet in notional exposure, so is there anything retail I could buy?
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32943078) |
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Date: March 29th, 2017 1:17 AM Author: balding hilarious idea he suggested partner
Can you explain a bit - how can I trade CME Treasury futures and Eurodollar using my retail brokerage account? Or could I open something at say Interactive Brokers or a more advanced shop and do this?
I've called my private bankers and they are useless, said I am too small and they don't deal in retail.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32943187)
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Date: March 29th, 2017 1:49 AM Author: impressive contagious dysfunction
Ha, this thread was timely
IB offers treasury futures (and options on treasury futures)
https://www.interactivebrokers.com/en/index.php?f=2222&ns=T&exch=ecbot
I found this example from the CME to be instructive (http://www.cmegroup.com/trading/interest-rates/files/basics-of-us-treasury-futures.pdf):
Example 1: A trader believes that the US economy is strengthening and intermediate Treasury yields will increase (5-Yr and 10-Yr).
This trader sells 10 contracts of March 2014 5-year US Treasury Note futures at 120 25/32. The trader’s view proves correct. The economic numbers continue to show that the US economy is strengthening. 5-Yr
Treasury yields rise, and the March 2014 5-year T-Note futures price declines. The trader buys back the 100 March 2014 5-year T-Note futures contracts at 120 03/32.
Profit on this example trade = 10 * (120 25/32 – 120 03/32) * $1000 = $6,875 (Profit or Loss = Number of contracts * Change in price * $1000)
The profit calculation in this example can also be expressed in terms of minimum ticks or simply referred to as ticks. The tick size for 5-year contract is ¼ of 1/32nd of 1 point.
The $ value for minimum tic of the 5-year contract is $7.8125.
Number of ticks made on the trade = (25/32 – 3/32) * 4 = 88 Ticks
Profit on this example trade = 10 Contracts X 88 Ticks X $7.8125 = $6875.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32943307) |
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Date: March 29th, 2017 6:28 AM Author: domesticated faggotry
You can just open an account with Interactive brokers. As the guy above said, you can just short eurodollar futures.
If rates rise your short eurodollar futures will make money, while your variable interest rate expense on your loans will increase.
The trick is to short enough notional value in eurodollar futures such that the gain on the futures position off sets the increase in interest costs on your loans.
You don't need to hedge all of it, maybe just having some short position to hedge some of the risk would be enough for you.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32943655) |
Date: March 29th, 2017 6:17 AM Author: abusive turquoise office
The questions I have are do all of these flavors of assets offer more options along the risk reward curve that can't be offered with simpler vehicles? Are they useful for transforming one asset to another, and thus improving liquidity?
Because if the answer to those questions is no I don't know why people deal in such opaque investments unless the opacity is intended to con the less knowledgeable.
(http://www.autoadmit.com/thread.php?thread_id=3566945&forum_id=2#32943649) |
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