Pricing and Hedging of Interest Rate Swap

• Main Authors: Lee, Yi-Chuan, 李怡娟
• Other Authors: Lee, Shyan-Yuan
• Format: Others
• Language: zh-TW
• Published: 2001
• Online Access: http://ndltd.ncl.edu.tw/handle/65069556549026120554

碩士 === 國立臺灣大學 === 財務金融學研究所 === 89 === Interest Rate Swap (IRS) constitutes 51% of world OTC derivatives position, which is the largest portion. It is obvious that IRS is the most important interest rate risk management tool in the word, but in Taiwan the IRS only constitutes 2% of OTC derivatives trading volume. The Securities and Futures Commission (SFC) plans to license securities firms for trading IRS now. Because securities firms are major players in the bond market, the participation of securities firms will stimulate not only the liquidity of NT dollar IRS market but also that of whole interest rate-related markets. As a trader in IRS market, the participator needs to understand the pricing and risk characters of IRS. Conventions of IRS can be modified to satisfied customers’ needs. This research discusses IRS convention variations and how to pricing IRS after those modification. Because of the illiquidity of NT Dollar IRS Market, IRS quotation (All in Cost, AIC) is usually used as discount rate in IRS settlement. As we know, the IRS quotation represents the geometric mean of the whole yield curve. Using the market quotation as discount rate will induce pricing error. This research use simulation to show the effect of using AIC as discount rate instead of using true yield curve. Referring to interest rate risk of IRS, form simulation we can find that the first order risk (Dollar Duration) and second order risk (Collar Convexity) of IRS are negatively related to interest rate level and the slope of yield curve and positively related to time to maturity. At floating rate reset date, the IRS Dollar Duration and Dollar Convexity both jump down but the Dollar Duration increase between two floating rate reset dates while Dollar Convexity decrease. Having those risk factors, IRS can be hedged through constructing a risk neutral portfolio with bond or be hedged as a fix rate position and a float rate position separately.