Question 4 states that under the expectations of decreasing interest rates one should enter into a SWAP to receive a fixed rate.
It appears to me that it depends on what the market expects. For example if the market expects rates to be 10,8,6,4 that will be built into the swap price, essentialy those are the rates you will get by entering the swap. if you expect them to be 10,9,8,7, then even though you expect rates to decline, you should not enter to receive fixed swap because you will get better rates in the market.
For simplicity of understanding: Co. looking to get euros by converting dollar denominated bonds thru Currency Swap… After issuance of Bonds Liability: interest....using currency swap it can have an access to Euro funds... So Actual on loan Interest pay…enter swap receive & pay euros.....if we expect Interest to fall down..we gain if we have fixed rate asset & floating rate liability....we were to receive interest we enter pay floating (euros)-receive fixed ($)…we gain if int. rates climbs down…we less & receive more… Any inputs to above view are welcome!
Let me try to bring you to my side. page 150, i am going to use the example in top of the page say you expect interest rates to rise, you are telling me the proper thing to do is enter into a swap to get variable and pay fixed so you enter to pay 6.95 and get variable what if at time 1 interest rate is 6.8, interest rates did rise from 6 to 6.8, but you have to pay in the swap !
I guess you are mixing it with Interest rate swap: Swap rate available in the case : 6.95% when current market price is 6%…Swap rate at 6.95% should be determined by market forces only meaning by keeping in view the future interest rate. If not then arbitragers will chip in bearing different view on interest rates. If int rate increase 80 bps from 6-6.8 then Swap price will not be at 6.95% now it should be less than this. Otherwise what you r trying to say is probably current. In currency swap, forex spot rate & future rates (as reflected in forward market) will help to determine whether to hedge or pay fixed. Forward curve is upward or downward sloping and we expect the interest rate to be otherwise we take a different stance (by using IRP)… Do u get what i mean?
Thank you rahuls, i think my problem may be in understanding what is ment by “interest rate decrease” If the spot is 6%, and the one year forward rate one year from now is 4% and they say you expect interest rates to decrease, instantaniously for simplicity does that meen you expect the one year forward rate to be less than 4, or less than 6 which is ment by expect them to decrease. ie relative to the spot, or relative to the rates built into the curve. if it is relative to the rates built into the curve, then i get it. if relative to the spot, i dont get it. thanks
yield curve consists of the spot and a series of forward rates built on a principle of no-arbitrage. A rise in short term rates affects the spot more than the forward usually , unless it is a level shift . The words “expects rates to rise” loosely means level shift , which would affect every point on the yield curve. It affects adversely fixed receivers and float payers if rates rise AFTER a swap is entered.
“Question 4 states that under the expectations of decreasing interest rates one should enter into a SWAP to receive a fixed rate” I also rthink of this as a rate change “after” the swap is entered. I read this stament to imply that YOUR expectations are of a decrease in interest rates and not general market consensus.