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Bauer College (2010n)Lecture Notes: Swapshere

Summary

"Swaps markets have rapidly developed into a huge market. From their initial inception in 1979, notional principal outstanding has grown from virtually zero to more than forty six trillion dollars, in 1999. Annual growth rates have exceeded 30 percent every year. Swaps offer an efficient and flexible means of transforming cash flow s streams. The swaps market has little or no government regulation and provides a high degree of privacy. The original swap products have given way to hundreds of different arrangements designed to serve very special purposes. Today, swaps are used by corporations, world organizations, banks, and governments. They are used to reduce the cost of capital, manage risks, arbitrage the world's financial markets, enter new markets, and to create synthetic instruments.

Swaps are one of the most important classes of what have come to be known as derivative instruments. More than any other market, the swaps markets are dependent upon the existence and liquidity of other markets. These other markets include the market for U.S. Treasury debt, the market for corporate debt, the futures and options markets, the spot markets, and the forward markets. It is not surprising that the explosive growth in swap volume has been accompanied by an extraordinary growth in volume in these other markets.

In this chapter, we will study the four basic types of swaps: interest rate swaps, currency swaps, commodity swaps, and equity swaps. We will examine the most basic form of each type. The basic forms are called plain vanilla or generic swaps. We will study how the swaps market is organized, how to price swaps, and how to use swaps. We will also study how complex financial structures can be built by combining a number of different swaps."


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