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requirement, or a certain credit rating which, unless met, would
trigger an early termination of the contract or the posting of
collateral in support of the counterparty’s obligations under the
contract. Dealers during the relevant years generally did not
adjust interest rates to account for credit risk, nor did they
quote different bid and ask rates on the basis of credit rating.
3. Techniques Used To Minimize Market Risk
The market risk of interest rate swaps arose from the high
level of volatility in the value of interest rate swaps. A small
movement in interest rates, for example, could have a large
impact on the value of an interest rate swap. Swaps dealers
attempted to reduce or eliminate market risk by hedging their
portfolios so that a portfolio’s value would not change
significantly with either a rise or fall in interest rates.
In the early days of the swaps market, dealers employed
simple hedging strategies. Transactions designed to meet a
customer’s requirements were immediately hedged by entering into
an offsetting transaction, such as a matched swap. In the later
years, many dealers (including FNBC) adopted more sophisticated
portfolio strategies for hedging market risks. Under this
approach, all of the dealer’s transactions were broken down into
their component cashflows to yield a measure of the net
(residual) market exposures arising from all of the dealer’s
positions. The residual market exposures were then hedged in
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