-62-
ready to incur an upfront cost in pursuit of longer term sources
of profit.
4. Change in Market Value
A swap may originate at par and become an above-market swap
on account of a fall in interest rates. A swap also may
originate at par and become an above-market swap without a fall
in interest rates. The latter occurs if the term structure is
upward sloping so that short-maturity swaps are negotiated with a
lower fixed rate than long-maturity swaps. Because the fixed
rate is typically constant over the life of the swap, a decline
in the swap’s remaining maturity means that the swap’s fixed rate
is above the at-market rate for a newly originated swap with the
identical remaining maturity. Assume, for example, that the
2-year swap rate is 5 percent, the 3-year swap rate is 6 percent,
and the 4-year swap rate is 7 percent. Assume further that a
4-year swap is initiated at par (i.e., at a fixed rate of 7
percent). Assuming that the swap rates remain the same at the
end of the first year, at the beginning of the second year, the
7-percent fixed rate on the remaining 3-year swap now exceeds the
6-percent rate for a newly originated 3-year swap. The swap is
considered above-market relative to newly originated swaps which
have a par rate of 6 percent.
Page: Previous 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 NextLast modified: May 25, 2011