The role of interest rate swaps in financial institutions

Section I of this dissertation develops the following topics: the mechanics of an interest rate swap, the reasons for usage of swaps, and the history of how the instrument evolved. An interest rate swap is an agreement between two agents to trade interest payment obligations. The most powerful reason for the existence of interest rate swaps is the ability to hedge interest rate risk;Section II theoretically and empirically examines the relationship between the use of interest rate swaps and the level of capital in savings and loan associations. The results suggest that savings and loan associations tend to allocate more capital when they engage in swaps and that an increase in capital increases the likelihood of more swap market activity;The final section tests whether interest rate swaps can reduce fluctuations in stock prices of savings and loans by unanticipated interest rate changes. The results seem to suggest that interest rate swaps have only an indirect effect in reducing stock price variability.