Principles of Financial Engineering, 3rd Edition

Chapter 4

Introduction to Interest-Rate Swap Engineering

This chapter expands on the concept of swaps, outlined in the introductory chapter, and their replication. It applies the concept to fixed-income instruments. We discuss the replication of plain vanilla interest-rate swaps. An interest-rate swap can be used to synthetically create its component parts, such as floating rate notes. Analogies to the replication of other swaps, such as equity swaps, are highlighted. The real-world uses of interest-rates swaps are discussed. Real-world complications such as transaction costs are illustrated in an interest-rate swap application involving a new bond issue. Several uses of swaps are discussed in different asset class and the role of taxes and regulation ...