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Nasdaq OMX Interest Rate Swap Future Group: Nazmul Hoque Hailong Zhao Hong Cui

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Introduction This report is to study the general mechanism of the newly traded financial instrument on the Swedish market - Nasdaq OMX Interest Rate Swap Future (NOIS), and to study how to value these contracts by help of Excel program.

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Background The market for trading in interest-rate swaps has advanced in recent years The rapid growth of the swap market point to the need for an exchange-listed futures contract to help participants in managing their risk exposures. The contract is cash settled on the expiration day against the NASDAQ OMX SEK Swap Fixing for the relevant tenor.

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Theoretical Framework Interest-rate swaps The London Interbank Offer Rate (LIBOR) is regarded as the floating rate in most interest rate swap agreements. This type of swaps could be used to transform a floating rate load loan into a fixed rate loan. Example : Suppose that company Alfa has arranged to borrow 100 million at LIBOR plus 10 is basis points. (One basis point is one hundredth of 1%, so the rate is LIBOR plus 0.1%), and suppose that company Beta has 100 million loan outstanding on and the company pays 5.2%.

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Theoretical Framework Cash flows for each of them will look like as followings: So for the company Alfa, the swap can have the effect of transforming borrowings at a floating rate of LIBOR plus 10 basis points into borrowings at a fixed rate of 5.1%. and for the company Beta, the swap could have the effect of transforming borrowings at a fixed rate of 5.2% into borrowings at a floating rate of LIBOR plus 20 basis points. Cash flows for AlfaCash flows for Beta 1)It pays LIBOR + 0.1% to its outside lenders.1) It pays 5.2% to its outside lenders. 1) It receives LIBOR under the terms of the swap.2) It pays LIBOR under the terms of the swap. 1)It pays 5% under the terms of the swap 3) It receives 5% under the terms of the swap.

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Theoretical Framework Alfa 5 % Beta LIBOR LIBOR + 0.1% 5.2% Directly Arrange a Swap Alfa 5.015 % Beta LIBOR Financial Institution LIBOR LIBOR + 0.1% 5.2% Financial institution Involved 4.985%

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Theoretical Framework Valuation of Interest-rate swaps Valuation in terms of bond prices V swap =B fix – B fl V swap = B fl – B fix Value of the floating rate bond today V B(fl) = (L + K) e -r.t r is the LIBOR t is maturity

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Theoretical Framework Valuation in terms of FRAs The procedure is a.Use the LIBOR/swap zero curve to calculate forward rates for each of the LIBOR rates that will determine swap cash flows. b.Calculate swap cash flows on the assumption that the LIBOR rates will equal the forward rates. c.Discount these swap cash flows using the LIBOR/swap zero curve to obtain the swap value.

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Theoretical Framework The present value of the difference between these interests payments are as followings: For the company who receive the R k on the principal L: For the company who pays R K rather than receive, its value is similarly given by R k = The rate of interest agreed to in the FRA R F = the forward LIBOR interest rate for the period times T 1 and T 2 R 2 = the continuously compounded riskless zero rate for a maturity T 2 L = the principal underlying the contract

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Theoretical Framework Valuation of NOIS Value of the long position: Value of the short position: r = traded rate n= number of periods N=number of contracts x nominal value

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Valuation of NOIS Inspired by valuation of CBOT Interest rate swap future But Tick Size of CBOT is One half of one thirty-second of one point

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Conclusions Interest rate swap futures are highly effective tools for financial risk managers to hedge a wide variety of interest rate exposures. They virtually eliminate counterparty credit risk, allowing users to easily adjust swap rate exposure without tying up credit lines. Using Swap futures counterparty can eliminates the administrative costs and liabilities, Swap futures make synthetic swap rate exposure readily available to market participants who would prefer not to be directly involved in OTC swap transactions.

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THANK YOU! & MERRY CHRISTMAS!

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