Yields, Swaps,
& Corp Fin
Paul Laux
Yields, Swaps,
& Corporate Finance
Financing Tactics Teaching with Bloomberg
Teaching thoughts
Yield curves
Swap pricing
Corporate finance
More teaching
thoughts
In this web version of the
slides, you can click on the
outline at the top right to
Exelon Center Finance Labs Conference navigate. You can zoom in
on any graphic to examine
University of Delaware
it in more detail.
Paul Laux
August 2013
Gratitude
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Thanks, Rich, for our Conference.
Corporate finance
More teaching
thoughts
Thanks to all of you for the opportunity to
show you some of my teaching ideas.
Stage setting
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
The teaching application I have to share is from
an undergraduate capstone course, “Advanced
Corporate Finance.” As a capstone, the point
is to integrate the students’ prior learning and
send them on their way to apply it. Especially,
the course links financial markets to corporate
finance applications. This application
specifically links yields and interest rates to
swaps to corporate financing opportunities.
Swap pricing
Corporate finance
More teaching
thoughts
Outline
1
Teaching thoughts
2
Yield curves
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
3
Swap pricing
Swap Manager intro
The value of fair value
4
Corporate finance
Benchmarking borrowing costs
Application to fixed rate loans
5
More teaching thoughts
Corporate finance
More teaching
thoughts
Thoughts on a teaching approach
Never miss the chance to reinforce and
link the basics to practice; “Everything I
needed to know I learned in...”
Example:Yield curves poster—assigned as
pre-work, review in a prior class or podcast
Bloomberg analytics apps build finance
concepts into practical form, e.g., as in
Swap Manager for swap pricing
The details can be a bit intense, but also
open doors for extended study later
Markets solve problems...interest rate and
swap markets solve corporate finance
problems
Market information is of practical help even
for those who may never transact in the
specific market
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Corporate finance
More teaching
thoughts
The big picture of yield curves...
... reinforcing and extending with little pictures: see paper poster
... can’t use swaps unless can use interest rate reasoning
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Understanding yield curves, with help from Bloomberg.
The forward curve matrix: Type FWCM <Go>, and specify a
curve family, like I23 US Treasury Actives, US Treasury coupon-paying
bonds.
From spot curves to implied forward rates of interest
Swap pricing
Corporate finance
Bloomberg's
curve finder -- type
CRVF <Go> -- provides
access to a long list of
yield curves. you can
search by keyword, or
lookup by country.
Bloomberg refers to
the curves by ID
number. Prominent
curves are the I25 US
Treasury yield curve,
and the S23 US dollar
denominated swaps
curve (of which more
elsewhere on this
page). When you know
the curve you want,
one way to get started
with it is to type GC
<Go>, for "Graph
curves." You can then
enter the ID number of
the curve that
interests you, and
obtain a chart. The
rest of this page is to
help you understand
some of the key yield
curves you will want to
use.
More teaching
thoughts
The chart shows
several snapshots of
the "forward curve." In
order, from top to
bottom, they are from
10 years ago (white), 5
years ago (green), 1
year ago (blue, barely
visible) and Mar 2013
(now or 'spot'--meaning
the spot time not spot
curve). Interest rates
have been falling all
decade long!
Swap curves: Plain vanilla interest rate swaps promise the periodic payout (or receipt) of a floating rate cash flow (often at
a LIBOR rate) in return for the periodic receipt (or payout) of a fixed rate cash flow. The fixed interest rate used to compute the
fixed rate receipt is called the "swap rate." The swap rate is what market participants bargain about, as it sets the present
value of the swap. Eyes-wide-open bargaining will lead to a swap with zero NPV at the start. Later, as interest rates change,
one party will tend to win or lose as the NPV rises or falls, and the swap becomes "off market" rate.
The green lower
curve is the I25
Treasury actives
coupon paying
curve. The blue
upper curve is
the I39 US Strips
curve.
This GC graph
shows the I25
Treasury "actives"
yield curve, which has
coupon-paying T bond
YTMs. The chart also
shows the yield curve
for Treasury Strips. A
Treasury Strip is a
pure-discount (zerocoupon) bond version
of a TBond, with only
one cash flow, at
maturity time. The
Strips curve is one
case of a spot curve.
One way to think
about a coupon bond
is that it is really a
collection of strips or
zeros, engineered to
have just the right
payouts at each time.
The bottom panel shows
the spread between the Strips
curve and the Treasury actives
curve. The spread is always
positive. This will always be
the case for an upsloped
coupon curve. The reason is
that the coupon curve is really
an average of the spot curve
elements for all dates up to the
maturity, since the coupon
bonds has cash flows at all
those dates. The near-in dates
have spot curve yields that are
lower than the ones that are
further out in maturity.
What are spot curves useful for? When you know the yield off the spot curve, you
know how to form the present value of a dollar received at that date. Just form the discount
factor (i.e., (1+SpotYield)^-N). If the curve is for riskless bonds, the PV is for a risk free dollar. If
the curve is for, e.g., AA bonds, then the PV is for a dollar with that riskiness.
What else are spot curves useful for? They are the observed rates from which forward rates of
interest can be calculated. Forward rates give insight into the future rates of interest that
market participants expect. See the next section for more on this (up and to the right).
Questions or comments? Paul Laux,
Department of Finance, laux@udel.edu
The snapshots
on this page
were taken in
March 2013.
Note that the implied
forward curves are all
upward sloping. That
suggests that, at each
date, the economy has
expected interest rates for
specific periods farther
into the future to be
higher than for periods
closer to the present. Of
course, the succession of
curves (each one lower
than the previous one)
says it has not turned out
that way. If the Fed
controls rates with
monetary policy and QE,
this suggests their
actions have been
unanticipated. Or perhaps
market forces, which are
harder to anticipate, have
been more important.
The curves below are swap curves, showing swap rates for plain vanilla swaps of different tenors (or lengths of agreement). In
these swaps, the exchanges happen semi-annually. Two swap curves are shown--one relative to EUR LIBOR (with payments in
EUR), and one relative to USD LIBOR (with payments in USD). The Treasury curve is shown for comparison.
The green top
curve is the S23
USD swap curve.
The red curve
usually in the
middle is the I25
coupon Treasury
curve. The blue
curve at the
bottom is the S45
EUR swap curve.
Swap curves depend on both spot and forward curves. They depend on spot curves because future cash flows must be
discounted to determined their value---a job for which spot curve rates are well suited. They depend on forward curves
because the future payments on the floating leg depend on future interest rates---and forward curves give us a sense for
expected future interest rates.
The bottom panel shows interest rate
differential between the various
curves. In this picture, the US swap
curve is subtracted from each of the
other curves. S23 - I25 would be
called the "swap spread," so
Bloomberg's red curve (shown by
default--I made no special choices
on this GC screen) is the negative of
the swap spread. (Also note that red
and blue have different meanings in
the top panel vs. the bottom.)
Swaps are usually quoted for a AA
credit situation. Thus it may seem
natural that USD swap rates are
higher than Treasuries. But it needn't
be like that, as there are additional
considerations. For example, at the
long end of the curve, the USD swap
rate is lower (the swap spread is
negative). Since the swap rate is paid
in return for a floating rate, that
suggests that market participants
expect the floating rate to be quite
low, or else that there is low liquidity
on the fixed pay side of the market at
the long end (allowing fixed rate
payers to get a better deal).
The EUR swap rate is generally lower than the USD swap
rate, suggesting that payments at that fixed rate in EUR
are regarded as quite desirable. One possible reason, just
as an example, would be if the USD floating rate is
expected to track higher more than the EUR floating rate,
making it more attractive (higher demand) to fix payments
in EUR terms.
Details of the recent
shape and changes in
the USD swap curve (at
left) and EUR swap
curve (above). The long
end of the USD swap
curve has been
steepening slightly
lately, suggesting that
long term fixed
payments are being
seen as somewhat less
valuable relative to
floating rate payment
(i.e., so the market
requires larger fixed
payments to make a fair
deal).
Next: Bloomberg Swap Manager
Start with 5-year plain-vanilla interest rate swap.
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Type SWPM <Go> to enter Bloomberg's "Swap Manager" facility. Pricing rooted in present values of
cash flows forecasted using OIS swap rates as the basis for discount rates and forecasting cash
flows based on cash/futures interest rates and yield curves. Three screen regions (red boxes) show
each counterparty (leg) details and market pricing.
Yield curves
Swap pricing
Swap Manager intro
The value of fair value
Corporate finance
More teaching
thoughts
Zero premium indicates
semiannual USD fixed coupon at
1.778% pa over 5 years is marketvalue-equivalent to quarterly USD
LIBOR floating (recently at
0.263% pa)
Cross-currency basis swaps
A basis for making cost of finance comparisons across currencies
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
SWPM can also value cross-currency basis swaps (float-float swaps across
two currencies). Use PRODUCTS pull-down menu to chose this swap.
Yield curves
Swap pricing
Quarterly- reset quarterly-pay 5-year x-crncy basis swap across
USD-EUR has zero premium for deal to receive USD LIBOR and
pay EUR LIBOR minus a 23 b spread. Market conditions are
USD LIBOR at 26.310 bp and EUR LIBOR at 22.6bp pa.
Swap Manager intro
The value of fair value
Corporate finance
More teaching
thoughts
This is useful info...and not only for
swap counterparties
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
• Usefulness: If I’m a treasurer with a
borrowing need, this analysis tells me what
interest rate in someone else’s currency is a
good deal in my currency
• Claim: Borrowing five years floating at
semiannual USD LIBOR is the same as cost of
financing as borrowing five years floating at
quarterly EUR LIBOR minus 23 bp
• Evidence for claim: One can be swapped into
the other, with zero premium paid/received...a
zero NPV trade
Swap pricing
Swap Manager intro
The value of fair value
Corporate finance
More teaching
thoughts
Swap manager is flexible...
... to deal with various deals. Here is an annual pay swap.
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Use pull-downs to change reset and pay
freq to "Annual".
At annual reset and pay frequency, the -23 bp spread
results in an "off-market" premium swap, with a
positive market value of 0.5955 bp, i.e. $5954 per $10
million of notional principal.
Yield curves
Swap pricing
Swap Manager intro
The value of fair value
Corporate finance
More teaching
thoughts
The fair-value annual swap
Ask SWPM to calculate EUR LIBOR spread for zero premium. The at-market swap has a spread
of -21.81 bp pa. Comparing to the quarterly EUR LIBOR case, increasing the rate paid to the
EUR LIBOR leg a little reduces the PV of the deal to the USD LIBOR paying leg, so it is no
longer positive.
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Swap Manager intro
The value of fair value
Corporate finance
More teaching
thoughts
Behind the scenes...
Curves, cash flows, and valuation scenarios are on the SWPM tabs
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Swap Manager intro
The value of fair value
Corporate finance
More teaching
thoughts
BB help docs provide pricing and
key-punch details
... green help key explains a lot of the finance I am skipping over
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Swap Manager intro
The value of fair value
Corporate finance
More teaching
thoughts
What’s it got to do with corp fin?
If I’m a treasurer with a borrowing need, this analysis can tell us what
interest rate in someone else’s currency is a good deal in my currency.
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
hhType XCF, for pictorial cross-currency basis swap premium analysis. Choose single currency analysis
from Views pulldown, EUR (vs USD LIBOR) and 5 year term. Note results show spreads for a zero premium
at various dates (including Today). Note this is bid view, i.e., the leg receives USD LIBOR.
Swap pricing
Corporate finance
Benchmarking
borrowing costs
Application to fixed
rate loans
More teaching
thoughts
Recall -23 bp is same
spread we say with
quarterly reset in earlier
detailed analysis---numbers
here are result of same
analysis.
USD vs EUR LIBOR floating rates
A lower EUR rate is PV-equivalent to a higher USD rate. Di↵erential
level at 22-23 bp for maturities of 2+ years; was 45-ish bp last year.
Same analysis (XCF <Go>), but now choose more maturities and mid-point quotes. We are moving
toward a full comparison of financing opportunities in dollars and euros, from the point of view of
a US based treasurer. The x-crncy basis swap market tells us what spread (EUR LIBOR differential
vs USD LIBOR) would make for an at-market swap today---thereby telling us what would be an atmarket deal comparison on floating rate loans.
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Corporate finance
Benchmarking
borrowing costs
Application to fixed
rate loans
More teaching
thoughts
Today's market, for
various maturities
Today's market is the rightmost set of bars,
with history to the left.
Can view info in various formats...
... to answer various questions; e.g., a yield curve view helps
treasurer evaluate floating rate loan comparisons of various terms
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Corporate finance
Benchmarking
borrowing costs
Application to fixed
rate loans
More teaching
thoughts
Analyze x-crncy fixed rates too
... by snapping on same-currency fixed-for-floating swap to each leg
... remember, swap manager prices those too
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Corporate finance
Here is the USD side of the analysis. We have seen both these SWPM screens before. On left is a USD
fixed-for-floating swap. On right is a USD-EUR LIBOR floating-floating swap (cross-currency basis
swap).
Benchmarking
borrowing costs
Application to fixed
rate loans
More teaching
thoughts
1.78% fixed is PV-equivalent to
USD LIBOR floating (i.e., with
timing details as shown).
And USD LIBOR floating is PV-equivalent to EUR LIBOR - 23
bp. So if treasurer with a 1.77% fixed USD borrowing
opportunity can beat EUR LIBOR - 23 bp, it is a good deal (in
PV terms; appropriate-for-the-use is a different question). To
compare to a fixed rate EUR loan, snap a EUR fixed-for-floating
swap onto this analysis.
Not a fantasy
... research has established that searching for good funding
opportunities this way is profitable for AA-rated credits
... Journal of Financial Economics 86 (2007), 145-177
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Corporate finance
Benchmarking
borrowing costs
Application to fixed
rate loans
More teaching
thoughts
Teaching tactics
• This sort of thing works best hands-on—but
pound the points, as students will want to lose
the forest for the trees
• My favorite routine: See one, do one, teach
one
• Force more than is comfortable: Detailed,
graphical briefing books; recordings; class lab
exercises
• Better for depth than breadth; takes a lot of
time
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Corporate finance
More teaching
thoughts
The end. Thank you for your time
and e↵ort!
Yields, Swaps,
& Corp Fin
Paul Laux
Teaching thoughts
Yield curves
Swap pricing
Corporate finance
That’s all I know about Bloomberg and most
of what I know about fixed income.
Questions?
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thoughts