Overview

An in-arrears swap is a variation of a traditional interest rate swap. The difference between the two relates to the floating rate payment. With a traditional swap, floating rate payments are based on the level of the reference index at the start of the interest period. With an in-arrears swap, floating rate payments are based on the level of the reference index rate at the end of the interest period.

In-arrears swaps are used to speculate on changes in the shape of the yield curve and are particularly well suited to steep yield curve environments. This tutorial looks at how in-arrears swaps are structured and describes in detail how they are priced. Other topics, such as price sensitivities and hedging, are also covered.

Objective

On completion of this tutorial, you will be able to:

- Structure an in-arrears swap
- Price an in-arrears swap
- Identify the three sources of mark-to-market sensitivity for in-arrears swaps
- Explain the hedging of an in-arrears swap
- Calculate the convexity adjustment required for in-arrears swaps
- Target market conditions that make in-arrears swaps an ideal client product

Content

Topic 1: Structure of an In-Arrears Swap
Topic 2: Pricing an In-Arrears Swap
Topic 3: Pricing Sensitivity
Topic 4: Hedging an In-Arrears Swap
Topic 5: Favourable Market Conditions
Topic 6: Understanding Convexity Adjustments