CFA Level 2 | Derivatives: Valuing Interest Rate Swaps (IRS)

[@yyman9100]

Fabian, this video is clear and really helps us who'd no idea where to start when we do derivatives questions! Thanks for sharing!

[@johnlin8588]

thanks for the video! one thing i noticed when valuing and pricing swaps. if you ignore the PV element to all this, and just simply compare the fixed and floating cashflows (which are obviously calculated using the given curves and discounting cashflows), one leg actually ends up better-off (assuming the libor curve stays constant throughout the trade) on ABSOLUTE terms. i know there is a time value of money to this but say i ignore all the time value of money, as an investor i can actually just make 'free money' off engaging in a swap that has better absolute cash flows. for example, if the total floating cashflows (ignoring PV) are less than the total fixed cashflows (ignoring pv too), i can receive fixed and pay floating to make money! I am assuming the floating/libor curve is constant throughout the trade of course.

[@samanthachen5813]

Thank you for the video! Can you please also add a video to explain the pricing and valuation of equity swap? Thank you

[@seanaldmcseansington]

Thank you so much for all of your videos.

[@8ll8n]

Thank you so much Fabian!

[@FabianMoa]

You're welcome!

[@sabrinaazrad2688]

Sorry I am still wrapping my head around this but all in all this was a fantastic explanation. But do we not discount to PV the value of the swap? (The -$3.53m)

[@johnnywong9652]

clear explanation

[@jacobsteenhuysen7526]

so clear. thank you.

[@FabianMoa]

Glad it was helpful, Jacob!

[@joserivas9609]

Hi Fabian, thanks for your video. do you have any example for quartely resets?

[@NamanJain-ot2wz]

Why do we enter into offsetting positions while valuing swaps?

[@VannAleXX]

This is great! If your example was using a swap that had quarterly payments, would your final equation be V=(SFRnew-SFRold)(SumZ)(NA)(t/360)? t being the length in days between swap payments. Also, would the rate the fixed leg is paying be reset every payment? In that case, would we not use the rate he entered into 2 years ago? Thank you!

[@FabianMoa]

That's right. In this case t = 90. But SFRnew and SFRold must be in annualized terms

[@VannAleXX]

@@FabianMoa Fantastic. Thank you for your help!

[@FabianMoa]

😎👌

[@rinasharma6063]

@@FabianMoa I truly appreciate your posting these helpful videos! Could you please elaborate how you're getting the numerator term (1 - 0.8811), esp. the minus sign, in the FS2 equation at around 4:30 into the video)? Many thanks in advance.

[@FabianMoa]

@@rinasharma6063 For the (1 - 0.811), "1" represents the PV of the floating leg and 0.811 is the PV of the last cashflow on the fixed swap (with 3 years remaining to maturity). You can watch my previous video on pricing interest rate swap here. Then for the next part, we are in a pay fixed swap initially, so that is -3%, then we do a receive fixed at the latest rate to close the swap, so that is +4.267%. Combine those two and you have (+4.267% - 3%).

[@lzra8111]

Hi Fabian, great stuff thank you very much. One thing i always wondered how it worked in practice as opposed to in theory is the yield curve and interest rates to use. How a swap works in theory is completely clear to me (i got my CFA charter in February so that helps haha). I work in real estate and i was given the task to value a swap that is hedging a variable rate loan on a property. the floating payer pays 3M EURIBOR, while the fixed payer pays 0,208% with a maturity to 30th Sept 2024. And that is where it gets unclear to me. EURIBOR curve does not extend until that maturity, since max maturity is 12M. so i got 1M, 3M, 6M and 12M EURIBOR. So the EURIBOR forward curve determines the future floating payments, so far so good. but what rate do i use to discount those future payments (both fixed and variable)? i cant use forward rates to discount and i have no spot rates above 12M. pls help and sorry for the long message! cheers all the best

[@FabianMoa]

Hi L Zra, just my opinion. If you have the Euribor forward curve, you can use it to work out the spot rates, then use the spot rates to discount both legs. Some interpolation may be needed if you don't have the spot rate for the specific maturity

[@lzra8111]

@@FabianMoa Hi Fabian, thank you for your response. I also thought of that and it could technically work but how is this done in practice? usually you infer the forward curve from the spot curve and not vice versa. which spot curve is the correct one in this case? i could also use libor but we would have the same problem since it doesnt extend over 12M plus its a USD curve. and in cfa and youtube content the Libor rates and discount rates are always given, which is not very helpful in practice..

[@hughlam3588]

What's the difference between an interest rate swap and a forward rate agreement?

[@daniellopezborgecfa3970]

Wow this is good!!!!!!!

[@FabianMoa]

Thank you!

[@kakacricket]

Dr Fabian what app do you use for ur calculator on desktop. I need itt!

[@FabianMoa]

You have to apply for the dongle from Texas Instruments. I got mine from one their local distributor.

[@mahmoudkadrynafei]

Sir, Thank you. But why when we discount interest rates, is not like usual discounting 1/(1+r)^n

[@FabianMoa]

For LIBOR based rates, use simple interest. For spot rates, use compound interest

[@TheKirank98]

thank you

[@AmberJieyiChen]

why the pv process of each libor year is not 1/(1+2.5%) , 1/(1+3.7%)^2 and 1/(1+4.5%)^3 ? but to multiply the maturity years directly?

[@FabianMoa]

For LIBOR rates, use simple interest, i.e. 1/(1 + r x n/360)

[@ashwiiniinandesshwar3062]

In my BA2 Professional PV value is coming different.

[@FabianMoa]

You can share your calculation and output