1. © K. Cuthbertson and D. Nitzsche Figures for Chapter 14 SWAPS (Financial Engineering : Derivatives and Risk Management)

2. © K. Cuthbertson and D. Nitzsche Figure 14.1 : Liabilities : using swaps Floating to Fixed : Liability Fixed to Floating : Liability Issue Floating Rate Bond Firm’s Swap LIBOR LIBOR + 0.5 6% fixed Net Payment = 0.5 + 6.0 = 6.5% (fixed) Issue Fixed Rate Bond Firm’s Swap 6% fixed 6.2% fixed LIBOR Net Payment = 0.2% + LIBOR (floating)

3. © K. Cuthbertson and D. Nitzsche Figure 14.2 : Assets : using swaps Floating to Fixed: Asset Fixed to Floating: Asset Hold Floating Rate Bond Firm’s Swap LIBOR LIBOR - 0.5% 6% fixed Net Receipts = 6.0 - 0.5 = 5.5% (fixed) Hold Fixed Rate Bond Firm’s Swap 6% fixed 5.7% fixed LIBOR Net Receipts = LIBOR - 0.3% (floating)

4. © K. Cuthbertson and D. Nitzsche Figure 14.3 : Financial intermediary : using swaps Financial Intermediary FI’s Swap 11% fixed 12% fixed LIBOR After swap Net Receipts = (12% - 11%) + LIBOR - (LIBOR - 1%) = 2% (fixed) LIBOR - 1% Without swap if LIBOR > 13% financial intermediary makes a loss

5. © K. Cuthbertson and D. Nitzsche Figure 14.4 : Cash flows in a swap (receiving fixed and pay floating) Receive Fixed Pay Floating 0t6m12mn... t = 3-months A dashed line indicates an uncertain cash flow 18m 0 t 6m12mn... 18m

6. © K. Cuthbertson and D. Nitzsche Figure 14.5 : Firm B : floating rate receiver (fixed rate payer) 15th September (LIBOR = 10%) 15th March (LIBOR=11%) $ 100m(0.11-0.10)(1/2) = $ 5,000 $ 100m(0.10-0.10)(1/2) = $ 0 Fixed Rate = 10%

7. © K. Cuthbertson and D. Nitzsche Figure 14.6 : Interest rate swap (A and B) 3) B pays A fixed 9.95% Firm BFirm A 2) A pays B at LIBOR 1a) Issues(Borrows) Floating at LIBOR + 1% 1a) Issues(Borrows) Fixed at 10% IN THE SWAP: B is floating rate receiver and fixed rate payer A is floating rate payer and fixed rate receiver

8. © K. Cuthbertson and D. Nitzsche Figure 14.7 : Swap dealer Swap Dealer Firm B Firm A 1a) Issues Floating at LIBOR + 1% 1b) Issues Fixed at 10% 2b) Floating LIBOR2a) Floating LIBOR 3b) Fixed 10%3a) Fixed 9.9% Note: Assume swap dealer makes 0.1 and A and B gain 0.2 each. Swap Dealer makes no profit on the floating rate leg

9. © K. Cuthbertson and D. Nitzsche Figure 14.9 : Outset of a currency swap French Bondholders FRF500m US Bondholders $100m EffelUncle SamSwap Dealer FRF 500m $ 100m FRF 500m $ 100m 8% FRF 500m 12%

10. © K. Cuthbertson and D. Nitzsche Figure 14.10 : Interest flows on currency swap French Bondholders FRF 500m US Bondholders $ 100m EffelUncle SamSwap Dealer ($ 9.2m) 9.2% (FF 60m) 12% $ 8m 8% FRF 60m 12% ($ 8m) 8% (FF 56m) 11.2% Swap Dealer : USD Gain = 9.2 - 8 = 1.2% FRF loss = 12 - 11.2 = 0.8%. Net position = 1.2 - 0.8 = 0.4%

11. © K. Cuthbertson and D. Nitzsche Figure A14.1 : Cash flows : FRN at t = 0 0123 Q r1Q r1 Q f 12 Q (1+f 23 ) f 12 f 23 r1r1 r2r2 r3r3

12. © K. Cuthbertson and D. Nitzsche Figure A14.2 : Cash flows : FRN after 1 year (Original time t = 0) 012 Q r1Q r1 Q (1+f 12 ) Note : We redate end of year-1 as time t = 0.

13. © K. Cuthbertson and D. Nitzsche Figure A14.3 : Cash flows : FRN between payment dates 0123 Q r1Q r1 t Q f 12 Q (1+f 23 ) r1r1 f 12 f 23 r 1-t r 2-t r 3-t Note : If t = 0.25 years into the swap, then 1-t = 0.75 years, 2-t = 1.75 years, 3-t = 2.75 years

14. © K. Cuthbertson and D. Nitzsche Figure A14.4 : Equivalent cash flows FRN between payment dates 0123 Q (1 + r 1 ) t

15. © K. Cuthbertson and D. Nitzsche Figure A14.5 : Currency swap Time t 123 n F1F1 CdCd CdCd CdCd CdCd CdCd Cf1Cf1 Cf2Cf2 Cf3Cf3 CfnCfn F2F2 F3F3

16. © K. Cuthbertson and D. Nitzsche Figure A14.6 : Interest rate swap 0 Time t123 C f1 + Q C X + QCXCX CXCX r 01 t1t1 f 12 f 23 t2t2 t3t3