INTEREST RATE DERIVATIVES 2: Second Generation Techniques

Course Outline

A comprehensive seminar on pricing and managing second generation interest rate derivatives.

What used to be called exotic interest rate derivatives are now commonplace and an essential part of the financial marketplace.

This intensive seminar is for anyone who wishes to be able to use, price, manage, market or evaluate standard second generation interest rate derivatives such as Constant Maturity Swaps and Quantos. Seminar groups are kept small and more than half of the course is devoted to practical workshops. The exercise answers include fully worked scenario spreadsheets containing relevant Excel functions and macros for participants to take away.

Who The Course is For

This course is designed for anyone who wishes to be able to price, use and manage second-generation interest rate derivatives:

• Quantitative Analysts
• Risk Managers
• Financial Engineers
• Traders and Structurers

• Researchers and others who manage interest rate risk

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Prior knowledge

A good understanding of vanilla interest rate derivatives is an essential prerequisite for this course.

This program is eligible for 16 Continuing Education credit hours from the CFA Institute. If you are a CFA Institute member, CE credit for your participation in this program will be automatically recorded in your CE Diary.

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Day One

Variations on the normal swap: Libor in Arrears

• Basic structure
• Why do swaps with Libor set in arrears
• LIA and the yield curve
• Hedging LIA
• Introduction to convexity adjustments and timing corrections

Workshops: The impact of volatility on LIA value

Introduction to correlation: Quantos

• Description of quanto structures
• Why use quanto swaps
• Relative yield curve trades and carry
• Determinants of value
• Hedging
• The importance of correlation and its limitations
• Measuring correlation

Workshops: Pricing and using Quantos

Day Two

Review of Swaption Volatility

• Interpreting swaption volatility (basis point/lognormal)
• Smile and Skew with Normal and Lognormal assumptions
• How “Vol of Vol” explains smile and skew
• The SABR model and it’s benefits

Using CMS: The Impact of Volatility

• Constant Maturity Swaps and their uses
• CMS for asset/liability management
• CMS structures in a flat yield curve environment
• Steepeners and CMS spread options
• CMS caps
• Hedging CMS with a portfolio of swaptions
• The interaction between CMS and swaption volatility

Workshops: Using and structuring Steepener notes

Range Accruals

• Examples of typical range accrual products and how they are used
• The link with Libor caps and floors
• Hedging digital options
• The impact of yield curve shape
• The importance of volatility
• Libor and CMS range accruals
• Call features

Bermudan Swaptions

• What Bermudans are for and how they work
• Users and uses of Bermudan swaptions
• The relationship between Bermudan and European swaptions
• Issues in pricing and hedging Bermudans

Workshops: Structured Notes