ABSTRACT
Swaps, caps, floors, and swaptions are very useful interest rate securities. This chapter explores fixed- and floating-rate loans. Fixed- and floating-rate loans are common methods used for borrowing funds. Floating-rate loans are “long-term” debt contracts whose interest payments vary with respect to short-term interest rates. An interest rate swap is a financial contract that obligates the holder to receive fixed-rate loan payments and pay floating-rate loan payments. There are three basic ways of creating a swap synthetically. The first is to use a buy and hold strategy. A second method for synthetically creating this swap is to use a portfolio of forward contracts written on the spot rate at future dates. A third method for synthetically creating this swap is to use a dynamic portfolio consisting of a single zero-coupon bond and the money market account.
