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Template:M intro isda a swap as a loan: Difference between revisions
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But, hang on: this is a bilateral arrangement, right, so isn’t the converse also true, of the dealer? Isn’t the dealer, in a sense, “borrowing” by paying the total return of the asset to get “exposure” to the floating rate in the same way? Is not a “short” swap position, for a dealer, exactly the same as a “long” swap position for a customer? | But, hang on: this is a bilateral arrangement, right, so isn’t the converse also true, of the dealer? Isn’t the dealer, in a sense, “borrowing” by paying the total return of the asset to get “exposure” to the floating rate in the same way? Is not a “short” swap position, for a dealer, exactly the same as a “long” swap position for a customer? | ||
No, because in providing these swap exposures to its customers, the dealer simultaneously [[Delta-hedging|delta-hedges]]. It does not | No, because in providing these swap exposures to its customers, the dealer simultaneously [[Delta-hedging|delta-hedges]]. It does not change its own market position. The customer ''buys'' an exposure: that is, starts ''without'' and ends up ''with'' a “position”; the dealer manufactures and then ''sells'' an exposure: it starts ''without'' a position, takes an order, creates a position, transfers it to the customer and ends up where it started, ''without'' a position. | ||
Provided the [[dealer]] knows what it is about, its main risk in running a swap portfolio is not, therefore, market risk — it should not have any — but ''customer credit'' ''risk''. Should a customer fail, the dealer’s book is no longer matched: its delta-hedge is now an outright long or short position. | Provided the [[dealer]] knows what it is about, its main risk in running a swap portfolio is not, therefore, market risk — it should not have any — but ''customer credit'' ''risk''. Should a customer fail, the dealer’s book is no longer matched: its delta-hedge is now an outright long or short position. | ||
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Aren’t “''normal''” swaps truly bilateral? How about a good old fashioned [[interest rate swap]]? Surely ''paying'' a [[fixed rate]], and ''receiving'' a [[floating rate]], has none of these same characteristics of borrowership about it? | Aren’t “''normal''” swaps truly bilateral? How about a good old fashioned [[interest rate swap]]? Surely ''paying'' a [[fixed rate]], and ''receiving'' a [[floating rate]], has none of these same characteristics of borrowership about it? | ||
The first | The first thing to say here is that in the real universe of actual, non-[[derivative]] instruments, interest rate cashflows ''do not exist independently of an investment in principal''.<ref>This is just as true of [[dividend]]<nowiki/>s on equities, of course.</ref> This is because an interest rate is, by definition, the ''income'' on a capital investment. | ||
Oh, sure, you can detach and sell a strip of [[coupon]]<nowiki/>s off a [[Debt security|bond]]: okay. But to do that, there must first ''be'' a bond, and you must buy it, cut it up and sell the stripped bond principal back into the market. Once you’ve done that, you have your disembodied interest cashflow, all right — but someone else has its dark inversion: this weird, mutilated, principal-only, [[Zero-coupon bond|zero-coupon]] instrument that trades at a heavy discount to its fully-limbed equivalent. It will exist, but unhappily: like Weird Barbie or one of those intercised children with no daemon in ''His Dark Materials''. Once you have sold the principal you might not be able to ''see'' it any more, ''but it is still there''. | Oh, sure, you can detach and sell a strip of [[coupon]]<nowiki/>s off a [[Debt security|bond]]: okay. But to do that, there must first ''be'' a bond, and you must buy it, cut it up and sell the stripped bond principal back into the market. Once you’ve done that, you have your disembodied interest cashflow, all right — but someone else has its dark inversion: this weird, mutilated, principal-only, [[Zero-coupon bond|zero-coupon]] instrument that trades at a heavy discount to its fully-limbed equivalent. It will exist, but unhappily: like Weird Barbie or one of those intercised children with no daemon in ''His Dark Materials''. Once you have sold the principal you might not be able to ''see'' it any more, ''but it is still there''. | ||