I have been reading about interest rate swaps, and I am a bit confused on what exactly the "swap rate" is. Can you explain it dumbed down?
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It's the rate that makes the swap worth zero (i.e. makes you indifferent between being on one or the other side of the deal).
Dumbass question: Are the XVA's already baked into that number I see on BBG or you give clients a different number after talking to risk?
XVA is not baked in... The rate you see quoted is the predominant mkt convention that trades.
This is not a dumbass question at all... it's a really good point
Swap rates quoted on the screen (Bloomberg like you said) are assumed to cleared trades with OIS discounting on the funding, so there is no CVA/FVA charge. Swap rates are swap rates regardless of counterparty
there is a good video on the topic on youtube
Can you link pls?
When two bankers make a deal by spitting in their hands then shake hands.
what part are you having trouble grasping? We need 2 parties to create an interest rate swap, in this example lets call them Party A and Party B
Lets say Party A currently has income coming in at a fixed rate, but it believes that with a floating rate, it could increase its income even more. So theyll go to a broker and ask for exposure into floating rates. That broker will then match them up with Party B, who currently has a floating rate of income, but doesnt like the volatility and wants to have a steady stream of income instead.
So Party now has floating rate exposure and Party B now has fixed rate exposure.
The swap could be a number of rates but usually youll see the floating rate be LIBOR (for usd IRS') and maybe a 1.5% interest rate.
Let me know if that helps you out with your understanding
To hypothetically price a 5Y swap (find swap rate) you need 2 curves
We need a libor forward curve - this tells how much is expected to be received, assuming we are paying fixed, over the life of the trade - there are 20 forward rates.
We need a discount curve - which plots discount factors vs time that cash flows are received. Discount factors are the theoretical prices of zero coupon bonds that when multiplied by an amount of cash (say $1) returns the pv of the cash flow; As we move down the discount curve, the discount factors decline.
Divide the expected cash flows from the forwards by the sum of the discount factors (which is the duration) and returned is the par swap rate
The swap rate is defined as a pv-weighted 3ml forward rate
At inception: PV (floating cash flows derived from forwards = pv (fixed rate), when rates move around/time passes there is either +/- P&L
thanks
swap rate is short for 'par swap rate'. Ex: the par rate for a bond is the coupon rate that would make it trade at 100 (par for a bond), while the par rate for a swap is the fixed rate that would make it trade at 0 PV (par for a swap). a par rate is likely to be similar to the government bond yield/rate for the same currency/maturity, and can be though of (roughly) as others pointed out as the 'average' Libor rate over the tenor of the swap.
interest rate swaps can trade at any agreed upon fixed coupon- but most of these wouldn't necessarily be 0 PV. so there would be a cash payment in the beginning to make things fair.
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