Derivatives: Understanding Swaps and Interest Rate Caps

Running head: DERIVATIVES
Finance
Name of the Student:
Name of the University:
Author’s Note:

1DERIVATIVES
Table of Contents
Question 2........................................................................................................................................2
References........................................................................................................................................6

2DERIVATIVES
Question 2
A Swap is a derivative contract that allows two parties that allows switching the cash
flows associated with the two parties for exchanging the same from the financial instruments. In
case of financial swaps, parties do not sell their assets but instead change the position or the
exposure of the investor in association with the assets (Du, Tepper and Verdelhan 2018).
Financial Swaps are the most commonly used technique for changing the exposure of the
investors towards a security/asset. The most common form of swap is the interest rate swaps.
a) The client is currently exposed with the floating interest rate based debt where the
investor is expecting a rise in the interest rate, which is one of the action, which the
Federal Reserve can take depending on the rising inflation rate. The financing
requirement desired by the client in the form of expanding business solutions of the
company should be carefully done depending on the business and macro-economic
condition of the economy. The client can enter into a plain vanilla interest rate swap
which is the most common interest rate swap used for transferring the exposure of asset
(Henrard 2014). The client would be entering into a financial interest rate swap where it
would be paying fixed interest rate and would be receiving floating interest rate from the
other party (Benos, Payne and Vasios 2018).
The client wants to hedge the interest rate risk by paying fix rate of interest, which
would be done easily with the help of swaps. The client would pay the floating interest