INTEREST RATE SWAPS AND THEIR DERIVATIVES

Interest rate swaps and their derivatives have become an integral part of the fixed income market, but many of the pricing and risk management issues for these now mainstream products can only be learned on a trading floor. While there are many books on fixed income and interest rate derivatives, they generally suffer from being either too elementary and bond-centric, mentioning swaps in passing, or too technical and focused on exotics and the myriad implementation issues and algorithms used to tackle them.

Rather than focusing on exotics, Interest Rate Swaps and Their Derivatives thoroughly covers the mainstream products?swaps, flow options, Bermudans, semi-exotics?showing the common pricing techniques while also explaining how to generalize the concepts to more nuanced products.

Author Amir Sadr, experienced as a quant, trader, financial software developer, and academic in the fixed income field, begins by presenting plain-vanilla swaps as an extension of fixed rate bonds?revealing how techniques for pricing these instruments are a generalization of similar methods used for pricing bonds and repos, and for the most part involve the concepts of financing cost, discount factors, and projection of forward curves. He then moves on to cover the options markets for flow products, including options on futures, caps and floors, and European swaptions?with detailed attention to the actual trading practice of these products. Sadr explains how, as with any option product, the pricing and risk management of these requires dealing with volatility as the main risk factor?and he shows that one does not need to have a PhD in math to understand options. Sadr presents risk-neutral valuation as the fundamental pricing paradigm for derivatives, and illustrates the core idea of dynamic replication in a simple binomial setting. This unified framework is used to derive industry-standard Black formula for flow products, and is developed into short-rate and full term-structure models for more complex interest rate exotics including Bermudans.

For current or aspiring practitioners in interest rate products, Interest Rate Swaps and Their Derivatives provides a sound working knowledge and appreciation of the main features of these products and their pricing and risk management issues.