Overview of Interest Rate Swaps An Interest Rate Swap represents a contractual arrangement between two parties, often referred to as "counterparties." These counterparties agree to exchange payments based on a specified principal amount over a fixed period. In an interest rate swap, the actual principal amount is not swapped between the counterparties. Instead, they exchange interest payments based on a "notional amount" or "notional principal." Each counterparty commits to paying either a "fixed" or "floating" interest rate to the other. As mentioned earlier, the notional amount is used solely for calculating the size of the cashflows to be exchanged. The most common type of interest rate swap involves one counterparty paying a fixed rate (known as the swap rate) while receiving a floating rate, typically based on LIBOR. The fixed leg of the swap is the part that is sensitive to changes in interest rates, akin to a fixed-rate bond. Con
1. Learning Objectives Learn the key features of a Forward Contract (FWC). Explain the reasons why an investor would engage in FWC trading. Understand the complete cycle of a FWC trade, including initiating, valuing, liquidating, and taking delivery of a contract. 2. Content 2.1. Key Features of a FWC A Forward Contract (FWC) is an agreement to buy or sell an asset, typically a currency, at a predetermined price on a future date. Key features of FWCs include: 2.1.1. Underlying Asset: FWCs are often based on currency exchange rates. 2.1.2. Trading Venue: FWCs are traded over-the-counter (OTC), meaning they are privately arranged contracts facilitated by brokers. Despite being OTC, they are highly liquid. 2.1.3. Cash Settlement: Unlike some other derivatives, cash settlement in FWCs occurs on the contract's maturity date rather than during the closing trade. This means that profits or losses are realized only at maturity. 2.2. Why Investors Use FWCs Hedge funds engage in FWC tradi