Other Interest Rate Swaps

This chapter demonstrates how to hedge the credit risk of a swap position using collateral, netting and credit enhancements. One party to the swap has cash flows determined by a foreign interest rate but these foreign cash flows are based on a notional principal in the home currency. They embed a fixed currency exchange rate in the swap deal. The chapter utilizes the methods to value a variety of ‘non-standard’ interest rate swaps, these include: a swap with a variable notional principal; a spread-to-LIBOR swap; an off-market swap; a zero-coupon swap and a swap with a variable swap rate. The mark-to-market swaps position would then be largely protected from both large and small changes in interest rates. Hedging credit risk in the swap's book is a key issue for a swap dealer. The most common method to limit credit risk is to pledge some sort of collateral.