Abstract
Ten years ago if you had suggested that a sophisticated investment bank did not know how to value a plain vanilla interest rate swap, people would have laughed at you. But that isn’t too far from the case today. We will now give an introduction to yield curve constructions and how this has been changed since after the financial crisis.
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Notes
- 1.
Wrong-way risk is defined by the International swaps and Derivatives Association (ISDA) as the risk that occurs when “exposure to a counterparty is adversely correlated with the credit quality of that counterparty”.
- 2.
International swaps and Derivatives Association, ISDA (2010).
- 3.
This tenor spread is usually called basis spread, but I think tenor spread is a better name. In the following I will call this spread basis spread
- 4.
James M. Hyman. Accurate monotonicity preserving cubic interpolation. SIAM Journal on Scientific and Statistical Computing, 4(4):645–654, 1983.
- 5.
It is also common that payment of short-tenor leg is compounded and paid at the same time with the other leg.
- 6.
If the trader is a person who funds the trade with his/her savings from his/her own money-market account, he/she will typically earn less interest on this amount than the running rate on his/her own money-market account.
- 7.
Source Bloomberg.
- 8.
Source Bloomberg.
- 9.
Usually, there is only one payment for tenors (maturities) shorter than a year.
- 10.
See Piterbarg (2010).
- 11.
Vladimir Piterbarg (2010), “Funding beyond discounting: collateral agreements and derivatives pricing”, RISK, Feb.
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Röman, J.R.M. (2017). A New Framework. In: Analytical Finance: Volume II. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-52584-6_21
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DOI: https://doi.org/10.1007/978-3-319-52584-6_21
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