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3. Value at Origination
Swaps generally originate close to par, at a rate
approximately equal to either the prevailing market bid or ask,
depending upon which side of the swap the dealer is on. The
small initial divergence from par is the dealer’s profit on
making the market. When a dealer buys a swap at the prevailing
market bid rate, it will have a positive value. The dealer does
not typically pay this positive market value to the counterparty
but keeps it as the profit on origination. Similarly, when a
dealer sells a swap at the prevailing market ask rate, it will
also have a positive value which is the dealer’s profit on
origination.
Whereas dealers generally originated swaps at prices near
the prevailing market bid and ask rates, a particular dealer at
any given time could set a higher or lower bid or ask rate for a
given maturity swap, thereby producing a higher or lower profit
on that swap. The dealer’s ability to set the higher or lower
rate depended upon the dealer’s own business situation, on the
risk structure of the dealer’s entire portfolio, on the profile
of the dealer’s full set of counterparties, and/or upon other
commercial considerations. Dealers seldom agreed to a rate on a
swap which gave the swap a negative value at origination, unless
the dealer was seeking to develop a client relationship and was
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