Q&A: How is an interest rate swap different from a package of forward contracts?

  • Maturities for forward or futures contracts do not extend out as far as those of an interest rate swap. An interest rate swap with a term of 20 years or longer can be obtained.
  • An interest rate swap is a more transactionally efficient instrument.
  • Interest rate swaps provide more liquidity than forward contracts, particularly long-dated forward contracts.

Bonus Points

  • A swap position can be interpreted as a package of forward (futures) contracts: for each swap period, the fixed rate payer has agreed to buy a LIBOR based commodity (ie. 1-year LIBOR + 1%) for a fixed amount. This is effectively a 1-year forward contract where the fixed payer agrees to pay a fixed amount in exchange for delivery of the commodity.
  • A swap position can be interpreted as a package of cash market instruments. From the perspective of the fixed-rate payer, it is equivalent to buying a floating-rate note (with the reference rate for the note being the reference rate for the swap) and funding by issuing a fixed-rate bond (with the coupon rate for the bond being the swap rate).

Category: C++ Quant > Derivatives > Swaps

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