Yields, Swaps, & Corp Fin Paul Laux Teaching thoughts Yields, Swaps, Yield curves Swap pricing & Corporate Finance Corporate finance More teaching Financing Tactics Teaching with Bloomberg thoughts In this web version of the slides, you can click on the Paul Laux outline at the top right to navigate. You can zoom in Exelon Center Finance Labs Conference on any graphic to examine University of Delaware it in more detail. August 2013
Gratitude Yields, Swaps, & Corp Fin Paul Laux Teaching thoughts Yield curves Swap pricing Thanks, Rich, for our Conference. Corporate finance More teaching thoughts Thanks to all of you for the opportunity to show you some of my teaching ideas.
Stage setting Yields, Swaps, & Corp Fin Paul Laux Teaching thoughts Yield curves The teaching application I have to share is from Swap pricing Corporate finance an undergraduate capstone course, “Advanced More teaching Corporate Finance.” As a capstone, the point thoughts is to integrate the students’ prior learning and send them on their way to apply it. Especially, the course links financial markets to corporate finance applications. This application specifically links yields and interest rates to swaps to corporate financing opportunities.
Outline Yields, Swaps, & Corp Fin Paul Laux Teaching thoughts Teaching thoughts 1 Yield curves Swap pricing Yield curves 2 Corporate finance More teaching thoughts Swap pricing 3 Swap Manager intro The value of fair value Corporate finance 4 Benchmarking borrowing costs Application to fixed rate loans More teaching thoughts 5
Thoughts on a teaching approach Yields, Swaps, & Corp Fin Paul Laux Never miss the chance to reinforce and Teaching thoughts link the basics to practice; “Everything I Yield curves needed to know I learned in...” Swap pricing Corporate finance Example:Yield curves poster—assigned as More teaching pre-work, review in a prior class or podcast thoughts Bloomberg analytics apps build finance concepts into practical form, e.g., as in Swap Manager for swap pricing The details can be a bit intense, but also open doors for extended study later Markets solve problems...interest rate and swap markets solve corporate finance problems Market information is of practical help even for those who may never transact in the specific market
The big picture of yield curves... Yields, Swaps, & Corp Fin Paul Laux ... reinforcing and extending with little pictures: see paper poster ... can’t use swaps unless can use interest rate reasoning Teaching thoughts Yield curves The forward curve matrix: Type FWCM <Go>, and specify a Swap pricing Understanding yield curves, with help from Bloomberg. curve family, like I23 US Treasury Actives, US Treasury coupon-paying From spot curves to implied forward rates of interest bonds. Corporate finance Bloomberg's curve finder -- type CRVF <Go> -- provides access to a long list of yield curves. you can search by keyword, or lookup by country. More teaching Bloomberg refers to the curves by ID number. Prominent curves are the I25 US thoughts Treasury yield curve, and the S23 US dollar denominated swaps curve (of which more elsewhere on this page). When you know the curve you want, one way to get started with it is to type GC Note that the implied <Go>, for "Graph curves." You can then forward curves are all enter the ID number of upward sloping. That the curve that suggests that, at each interests you, and date, the economy has obtain a chart. The The chart shows rest of this page is to expected interest rates for several snapshots of help you understand the "forward curve." In specific periods farther some of the key yield order, from top to into the future to be curves you will want to bottom, they are from higher than for periods use. 10 years ago (white), 5 closer to the present. Of years ago (green), 1 year ago (blue, barely course, the succession of visible) and Mar 2013 curves (each one lower (now or 'spot'--meaning than the previous one) the spot time not spot curve). Interest rates says it has not turned out have been falling all that way. If the Fed decade long! controls rates with monetary policy and QE, this suggests their actions have been unanticipated. Or perhaps market forces, which are harder to anticipate, have been more important. Swap curves: Plain vanilla interest rate swaps promise the periodic payout (or receipt) of a floating rate cash flow (often at a LIBOR rate) in return for the periodic receipt (or payout) of a fixed rate cash flow. The fixed interest rate used to compute the fixed rate receipt is called the "swap rate." The swap rate is what market participants bargain about, as it sets the present The green lower curve is the I25 value of the swap. Eyes-wide-open bargaining will lead to a swap with zero NPV at the start. Later, as interest rates change, one party will tend to win or lose as the NPV rises or falls, and the swap becomes "off market" rate. Treasury actives coupon paying The curves below are swap curves, showing swap rates for plain vanilla swaps of different tenors (or lengths of agreement). In curve. The blue these swaps, the exchanges happen semi-annually. Two swap curves are shown--one relative to EUR LIBOR (with payments in upper curve is the I39 US Strips EUR), and one relative to USD LIBOR (with payments in USD). The Treasury curve is shown for comparison. curve. Swap curves depend on both spot and forward curves. They depend on spot curves because future cash flows must be discounted to determined their value---a job for which spot curve rates are well suited. They depend on forward curves The green top This GC graph curve is the S23 because the future payments on the floating leg depend on future interest rates---and forward curves give us a sense for shows the I25 USD swap curve. expected future interest rates. The red curve Treasury "actives" usually in the yield curve, which has The bottom panel shows coupon-paying T bond middle is the I25 the spread between the Strips coupon Treasury YTMs. The chart also shows the yield curve curve and the Treasury actives curve. The blue curve. The spread is always curve at the for Treasury Strips. A positive. This will always be bottom is the S45 Treasury Strip is a pure-discount (zero- the case for an upsloped EUR swap curve. coupon curve. The reason is coupon) bond version of a TBond, with only that the coupon curve is really an average of the spot curve one cash flow, at maturity time. The elements for all dates up to the The bottom panel shows interest rate differential between the various Strips curve is one maturity, since the coupon bonds has cash flows at all curves. In this picture, the US swap case of a spot curve. curve is subtracted from each of the One way to think those dates. The near-in dates have spot curve yields that are other curves. S23 - I25 would be about a coupon bond is that it is really a lower than the ones that are called the "swap spread," so Bloomberg's red curve (shown by collection of strips or further out in maturity. default--I made no special choices zeros, engineered to on this GC screen) is the negative of have just the right the swap spread. (Also note that red payouts at each time. and blue have different meanings in the top panel vs. the bottom.) Details of the recent The snapshots shape and changes in Swaps are usually quoted for a AA the USD swap curve (at on this page credit situation. Thus it may seem left) and EUR swap What are spot curves useful for? When you know the yield off the spot curve, you were taken in natural that USD swap rates are March 2013. curve (above). The long know how to form the present value of a dollar received at that date. Just form the discount higher than Treasuries. But it needn't end of the USD swap factor (i.e., (1+SpotYield)^-N). If the curve is for riskless bonds, the PV is for a risk free dollar. If be like that, as there are additional curve has been the curve is for, e.g., AA bonds, then the PV is for a dollar with that riskiness. considerations. For example, at the steepening slightly long end of the curve, the USD swap lately, suggesting that What else are spot curves useful for? They are the observed rates from which forward rates of rate is lower (the swap spread is The EUR swap rate is generally lower than the USD swap long term fixed interest can be calculated. Forward rates give insight into the future rates of interest that negative). Since the swap rate is paid rate, suggesting that payments at that fixed rate in EUR payments are being market participants expect. See the next section for more on this (up and to the right). are regarded as quite desirable. One possible reason, just in return for a floating rate, that seen as somewhat less suggests that market participants as an example, would be if the USD floating rate is valuable relative to expect the floating rate to be quite expected to track higher more than the EUR floating rate, floating rate payment low, or else that there is low liquidity making it more attractive (higher demand) to fix payments (i.e., so the market Questions or comments? Paul Laux, on the fixed pay side of the market at in EUR terms. requires larger fixed Department of Finance, laux@udel.edu the long end (allowing fixed rate payments to make a fair payers to get a better deal). deal).
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