How to Price Swaps in Your Head - An Interest Rate Swap & Asset Swap Primer
96 Pages Posted: 31 Jul 2016 Last revised: 10 Apr 2017
Date Written: April 9, 2017
Interest rate swaps are an actively traded product in the financial marketplace and are popular for hedging mortgage and corporate loan exposures against rises in interest rates. Asset swaps on the other hand provide a form of asset financing, where investors borrow funds to purchase an asset, typically a bond. Asset swaps are also a good bond rich-cheap analysis tool. Both types of swaps can of course be used for speculative purposes.
In this paper we provide an overview of both interest rate swaps and asset swaps, we explain the products and examine how they are priced & quoted in the market. Analytical and numerical risk is also considered. We conclude with a review of swap pricing formulas and examine how to price swaps quickly in one's head. We do this using simple approximations that hold extremely well in the current low interest rate environment.
Keywords: Interest Rate Swap, Asset Swap, Par Rate, Swap Rate, PV01, DV01, Duration, Convexity, Credit Risk, Asset Swap Spread, Yield-Yield Method, Par-Par Method, Par Adjustments, Excel Pricing & Risk
JEL Classification: C00, C02, D40, D46, E40, E43, E44, F30, G10, G12, G15
Suggested Citation: Suggested Citation