82,892
edits
Template:M intro isda Party A and Party B: Difference between revisions
Template:M intro isda Party A and Party B (view source)
Revision as of 08:38, 12 December 2023
, 12 December 2023→Derivatives as engines of hypothesis
Amwelladmin (talk | contribs) Tags: Mobile edit Mobile web edit |
Amwelladmin (talk | contribs) Tags: Mobile edit Mobile web edit |
||
| Line 111: | Line 111: | ||
Swaps changed all that. It was only once the [[Children of the Woods|Children of the Forest]] wrought their wristy magic on the [[First Men]] in the dark thickets of [[Bretton Woods|Woods of Bretton]] that the ways of the [[Single agreement|Single Agreement]] came into common understanding. Only then were leaden, earth-bound notions of principal swept away; the swap market took wing upon the nuclear power of infinite leverage. Income flows could bust free of their leaden principal host and frolic in ISDA’s glittering starlight. | Swaps changed all that. It was only once the [[Children of the Woods|Children of the Forest]] wrought their wristy magic on the [[First Men]] in the dark thickets of [[Bretton Woods|Woods of Bretton]] that the ways of the [[Single agreement|Single Agreement]] came into common understanding. Only then were leaden, earth-bound notions of principal swept away; the swap market took wing upon the nuclear power of infinite leverage. Income flows could bust free of their leaden principal host and frolic in ISDA’s glittering starlight. | ||
''But''. Income implies principal, remember. A swap can have disembodied fixed and floating rates only because, when they are set against each other, the principal investments to which they would normally be attached ''cancel each other out''. Make no mistake: those principal investments are there, but they are just ''assumed''. Taken as a given. | ''But''. Income implies principal, remember. A swap can have disembodied fixed and floating rates only because, when they are set against each other, the principal investments to which they would normally be attached ''cancel each other out''. Make no mistake: those principal investments are there, but they are just ''assumed''. Taken as a given. The customer does not need to fund its payments independently; they come from its existing portfolio. But the dealer does. It is not changing its position. To flatten out its exposure to the customer, it must buy a hedge. That will require either explicit funding — if the dealer hedges with a physical asset — or implied funding, if the dealer hedges with a derivative. Somewhere along that chain, someone will buy a physical asset. | ||
====Leverage is a state of mind (or balancesheet)==== | |||
Consider the respective parties’ economic positions before and after trading. The customer does change its net position; the [[dealer]] does not. Swapping a fixed cashflow for a floating one is to ''keep'' the “asset” that funds that cashflow (which logically must be a “fixed-rate asset”), and to acquire a new floating-rate asset in the same principal amount. This is also the principal amount of the implied loan the customer must take out to acquire the floating-rate asset. That being the case, the principal of the floating-rate asset cancels out against the principal of the loan, and the customer left with just the floating rate cashflows, for which it must pay the fixed rate it has agreed. The customer’s position is the present value of the floating rate it has bought minus the present value of the fixed rate of its financing. | Consider the respective parties’ economic positions before and after trading. The customer does change its net position; the [[dealer]] does not. Swapping a fixed cashflow for a floating one is to ''keep'' the “asset” that funds that cashflow (which logically must be a “fixed-rate asset”), and to acquire a new floating-rate asset in the same principal amount. This is also the principal amount of the implied loan the customer must take out to acquire the floating-rate asset. That being the case, the principal of the floating-rate asset cancels out against the principal of the loan, and the customer left with just the floating rate cashflows, for which it must pay the fixed rate it has agreed. The customer’s position is the present value of the floating rate it has bought minus the present value of the fixed rate of its financing. | ||