Business
SWAPS
Swaps are contracts where two parties exchange financial obligations.
Vanilla Swap: A company wants to stabilize its interest payments, so it enters a swap to pay a fixed rate while receiving a floating rate tied to SOFR. Example: IBM swaps $10 million fixed-rate debt for floating-rate payments with JPMorgan.
Total Return Swap (TRS): A hedge fund wants exposure to Tesla stock without owning it. It enters a TRS with a bank that delivers total returns on Tesla shares, while the fund pays interest. Example: Hedge fund receives stock performance; bank receives LIBOR + spread.
FX Swap: An exporter in Japan receives payments in USD but needs JPY for local expenses. They swap USD for JPY with a counterparty, reversing the trade at a future date. Example: USD/JPY swap over 6 months with Bank of Tokyo-Mitsubishi.
Structured notes' returns are derived by another underlying product(s). It combine a bond with a derivative linked to asset performance.
Example: A note pays a coupon tied to the S&P 500, with principal protection if the index doesn’t fall below 70% of its initial value. Used by: Wealth managers to offer exposure with downside limits.
An FRA is a contract between two parties to lock in an interest rate on a loan or deposit that will start at a future date. It's a pure interest rate hedge—no principal exchanges hands.
Example: A bank expects to borrow €10 million in 3 months for 6 months and fears interest rates will rise. It enters into a 3x9 FRA at 3.5%. If the actual rate in 3 months is 4.0%, the bank receives the difference from its counterparty. Use: Protects against short-term rate volatility in treasury or corporate finance.
Fixed-income instruments representing loans to issuers.
Government Bonds: Example: Hungarian 10-year government bond paying 5% annually. Investor appeal: Low risk, sovereign backing.
Non-Government Bonds: Example: Vodafone issues a corporate bond at 6% for infrastructure funding. Investor appeal: Higher yield than government bonds.
Standardized contracts to buy/sell bonds at a future date. It obligate the contract holder to purchase or sell a bond on a specified date at a predetermined price. A bond futures contract trades on a futures exchange market and is bought or sold through a brokerage firm that offers futures trading. The contract's terms (price and expiration date) are decided when the future is purchased or sold.
Example: U.S. Treasury Bond futures traded on the CME. Use: Hedge against rising interest rates.
Interest rate futures are financial contracts obligating the holder to buy or sell a debt instrument, like a bond or Treasury bill, at a predetermined future date and price. These contracts are used by investors and businesses to manage risk related to fluctuating interest rates..
Example: Eurodollar futures traded on the CME, linked to 3-month USD LIBOR. Use: Banks hedge against funding cost volatility.
- Example: A pension fund agrees to buy German Bunds in 3 months at today’s price. Use: Lock in bond prices ahead of actual purchase.
Insurance-like contracts protecting against credit events.
Example: Investor buys CDS on Argentina’s sovereign bonds fearing default. Outcome: Receives compensation if Argentina misses payments.
Publicly traded funds holding diversified assets.
Example: iShares MSCI Emerging Markets ETF (EEM) tracks a basket of EM equities. Advantage: Instant diversification and liquidity.