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Template:M intro isda a swap as a loan: Difference between revisions
Template:M intro isda a swap as a loan (view source)
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Only then did the swap market take wing, upon the nuclear power of infinite [[leverage]]. Income could flow, at last, broken free of its leaden ''principal'' host, and could nudely frolic in ISDA’s glittering starlight. | Only then did the swap market take wing, upon the nuclear power of infinite [[leverage]]. Income could flow, at last, broken free of its leaden ''principal'' host, and could nudely frolic in ISDA’s glittering starlight. | ||
The [[synthetic]] world is an alternative, magical realm. In it, there are imaginary tools with which we can do impossible things. ''Hypothetically', | The [[synthetic]] world is an alternative, magical realm. In it, there are imaginary tools with which we can do impossible things. ''Hypothetically'', we can isolate [[income]] from [[principal]] and trade them as discrete instruments. Normal rules of [[spacetime]] do not apply. | ||
But gravity is not banished; only ''postponed''. At some point, our [[swappist]] fantasia must alight on planet Earth and engage with real-world instruments, ''because that is what it is all derived from''. Ultimately, somewhere down the chain, someone needs to construct each enchanting payoff from grubby, real old-fashioned, corporate rights and obligations. Those rights and obligations will come with principal attached. And ''that'' must be financed. | But gravity is not banished; only ''postponed''. At some point, our [[swappist]] fantasia must alight on planet Earth and engage with real-world instruments, ''because that is what it is all derived from''. Ultimately, somewhere down the chain, someone needs to construct each enchanting payoff from grubby, real old-fashioned, corporate rights and obligations. Those rights and obligations will come with principal attached. And ''that'' must be financed. | ||
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====Leverage is a state of mind (or balance-sheet)==== | ====Leverage is a state of mind (or balance-sheet)==== | ||
{{smallcaps|One last way}} to look at this: an [[interest rate swap]] is a levered investment in a fixed income asset. Interest rate swaps are, in this sense, “synthetic ''fixed income'' prime brokerage”: a [[margin loan]] to buy a fixed income asset. | |||
One last way to look at this: an [[interest rate swap]] is a levered investment in a fixed income asset. Interest rate swaps are, in this sense, “synthetic ''fixed income'' prime brokerage”: a [[margin loan]] to buy a fixed income asset. | |||
We can see this by considering the parties’ respective economic positions before and after trading. The customer changes its net position; the [[dealer]] does not. Swapping a fixed cashflow for a floating one is to ''keep'' the “asset” funding that fixed cashflow, and to borrow the funds required to buy the new floating-rate asset. Because that borrowing has the same principal amount as the purchased floating-rate asset, the principal amounts cancel out, and the customer left with just the floating rate cashflow, for which it must pay the fixed rate cashflow it has agreed. | We can see this by considering the parties’ respective economic positions before and after trading. The customer changes its net position; the [[dealer]] does not. Swapping a fixed cashflow for a floating one is to ''keep'' the “asset” funding that fixed cashflow, and to borrow the funds required to buy the new floating-rate asset. Because that borrowing has the same principal amount as the purchased floating-rate asset, the principal amounts cancel out, and the customer left with just the floating rate cashflow, for which it must pay the fixed rate cashflow it has agreed. | ||