Details of a Swaps Trader - what do you need to know?

What exactly does an interest rate swaps trader/ market maker, in the long end of the curve, need to know, in terms of the mechanics / math of an interest rates swap?

For example, assume you understand the basics of a swap (swapping fixed for floating, and the market convention for quoting each leg has a different daycount convention...30/360 fixed leg vs actual/360 floating LIBOR leg).

Beyond that, i know that traders don't do the actual math when bidding / offering swap rates on a day to day basis, because their systems / spreadsheets will do that for you. For the most part, if the market for 10yr swap spreads is -12 / -11, then all you need to watch to trade the 10yr swap spread is the spread curve, and the outright level of rates. Since you are just trading that one number (-12 / -11). Ops takes care of the details of booking the trades, beyond the initial treasury spot price, and the swap rate.

I know there are lots of other things involved in calculating cash flows, the daily LIBOR fix, etc...but on a day to day basis, to trade 10yr swap spreads, there is nothing to do / think about regarding these things (or so i think) other than putting these inputs into the model?

However, i'm wondering, is there some kind of intuition or knowledge that sprouts from having a familiarity with how the swap math operates, that helps make trading decisions?

What about when a customer asks for a 20yr swap rate, starting in 10yrs (so a 10yr forward, 20yr rate).
I'm assuming that the swap trader just inputs to the "system" (whether it be a spreadsheet with a swaps math addin, or some other system), the trader just inputs the 10yr start date & 20yr (30yr) end date, the the system will calculate the 10yr20yr mid swap rate, based on the firms swap curve model. Then the swap trader needs to decide what the appropriate bid/offer spread is for that 10yr20yr swap rate, based on liquidity, and maybe skewed based upon their view of that rate and the curve.

What else am i missing? In these examples, the new swaps trader doesn't need to know the discount factors being used, the shape of the forward curve, or even how to calculate the swap rates down to the actual leg calculations....because the system does all that for you (assuming the system has already been built..and for all the big banks, this is true). So what is left for the trader, but to gauge market liquidity, skew, and market direction? Is there anything else?

 
Best Response

I think the main component of the art is, basically, finding the optimal hedge. Obviously, you could just go and hedge your 10y20y flow by lifting/hitting 10y20y in the market, but that's unlikely to make your bid/offer competitive. Hence, you need to come up with a more efficient way to deal with the risk. This could include running it in expectation of some offsetting flow, or hedging it with futures or spot swaps and dealing with the resulting slippage efficiently.

This is my understanding, anyways...

 

generally, dealers (BB banks) provide more liquidity to customers than they can get in the screens themselves.

So, the screens for 10y20y market might be 3.01% / 3.00% 40mm x 80mm (i have no idea if this is close to market..haven't looked at swaps rates for a while).... ...and a customer might do 500mm 10y20yr with a swap desk...the desk might show 3.00% because they want to have large market share....they probably can't lift that 3.00% offer for 500mm...so they need to find other sources of liquidity. They would probably first buy the most liquid long duration instrument they can find...probable 10yr notes, 10yr rate, then classic bond futures, then 30yr bonds, then 30yr swaps...and then after they get basically dv01 neutral, they then would then need to work out of the resulting swap spread position that they've put themselves into, and also the implicit curve position. Standard Spreads (10yr...30yr) usually trade more size, and are easier to manage than the non-standard, because they are more stable that the outrights for similar size...not always...but usually. So, all this extra work (and risk) because the dealer provided more liquidity for a specific structure than they themselves can get in the interdealer broker screens. Thats the game.

just google it...you're welcome
 

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