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Role of Front OfficeHSBC - Case Study Example

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 This study "Role of Front Office–HSBC" discusses volume traded in HSBC. The study considers unlike a regular CMS swap where each payout is based on the CMS rate fixing, the CMS spread swap is based on a formula of the spread between two predefined indices…
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Role of Front OfficeHSBC
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ROLE OF FRONT OFFICE -HSBC PRODUCTS TRADED VOLUME TRADED SPREAD CMSX CMSY IRG A CMS spread swap is an interest rate swap where one leg is usually set by reference to a floating index, e.g., 3M LIBOR, and the payout of the other leg (the CMS leg) is set by reference to a long-term swap rate. However, unlike a regular CMS swap where each payout is based on the CMS rate fixing, the CMS spread swap is based on a formula of the spread between two predefined indices. This spread is the difference on each fixing date between the yields of two distinct long-term swap rates. For example, if the 10-year swap and a 2-year swap are selected, and we assume the yield on a 10-year swap rate is 10% and the yield on a 2-year swap rate is 3%, the spread used in the payout calculation will be 7% per annum. The general formula for the payout is as follows: Min(Max Coupon, Max(Min Coupon, (Gearing1*Index1 - Gearing2*Index2 + Strike))) This payout is then accrued for the chosen day count basis. CROSS CURRENCY SWAP A cross currency swap is similar to a vanilla swap, while giving each counterparty access to a different foreign currency. That is, one counterparty makes payments in one currency; the other makes payments in a different currency. Because there are two currencies involved (and therefore two notionals) the payments made not only include interest rate payments (on the set payment periods in the relevant currency on the respective principal) but also an exchange of principals at maturity and (optionally) at the start of the swap. A cross-currency swap: Lets you convert a liability or an asset from one currency to another, with reduced costs. Is a simple and effective solution to long-term currency hedging needs. CANCELLABLE SWAP cancelable swap is a vanilla swap where the one of the counterparties has the right but not the obligation to terminate the swap on one or more pre-determined dates during the life of the swap. There are two types of this swap, depending on who has the right to terminate the underlying swap: In a callable swap, the fixed rate payer has the right to terminate the swap on a number of specified dates. This is the combination of a vanilla swap and a receiver swaption. In a puttable swap, the fixed rate receiver has the right to terminate the swap on a number of dates. This is the combination of a vanilla swap and a payer swaption. There is no penalty for terminating the swap on any of the pre-defined dates, but if the right to terminate the swap early belongs to the: Payer the fixed rate is higher than that of a regular IRS. Receiver the fixed rate is priced at a discount to a regular IRS. The fixed rate is based on a number of elements, such as the number of rights to cancel, time to first right to cancel, and interest rate volatility (higher volatility will lead to higher costs), etc. Advantages of a cancelable swap A cancelable swap has the following advantages: The swap can be cancelled without any penalties. There is no premium to be paid upfront. INFLATION SWAPS In a typical inflation swap, two counterparties agree on a long-term contract based on an agreed inflation rate. If, at the end of the contract, prices are higher than originally expected, the seller of inflation makes a payment to the buyer. If prices turn out lower than expected, the buyer pays the seller. STRADDLE/STRANGLE IRG INFLATION IRG COLLAR An Interest Rate Collar is an instrument that gives you protection against rising rates by guaranteeing that you will never pay above a pre-agreed rate but at the same time sets a downside (floor) rate below which you cannot benefit if rates do fall further. It effectively creates an interest rate range with an upper and lower limit and depending upon where the floor level is set, will reduce or eliminate the requirement for a premium. An Interest Rate Collar provides known upside protection against a rise in rates with the potential to benefit from a fall in rates, down to a pre-agreed level l Collars can be structured to avoid requirement for a premium CMS/CMT SWAP A Constant Maturity Swap (CMS) swap is a swap where one of the legs pays (respectively receives) a swap rate of a fixed maturity, while the other leg receives (respectively pays) fixed (most common) or floating. A CMT swap is very similar to a CMS swap, with the exception that one pays the par yield of a Treasury bond, note or bill instead of the swap rate. More generally, one calls Constant Maturity Swap and Constant Maturity Treasury derivatives, derivatives that refer to a swap rate of a given maturity or a pay yield of a bond, note or bill with a constant maturity. Since most likely, treasury issued on the market will not exactly match the maturity of the reference rate, one needs to interpolate market yield CMS IRG EUROPEAN DIGITAL SWAP It is a product that lets the user specify a coupon based upon the fixing level of some underlying index, for example, 6 month Euribor. A digital swap can be used by either of the following: Asset managers looking for an increased yield. Liability managers looking for a way to reduce funding costs given a view on the likely level of the observation variable. Given the ease of setting the payout and the huge variety of possible coupons, the structure can be used to build a payoff profile to suit both sides of the investment spectrum. BARRIER DOWN&IN SWAP AVERAGE SWAP CMT SWAP STRUCTURE REVERSE FLOATER CALL CMS SWAP A CMS (constant maturity swap) is an interest rate swap where at least one of the legs is a floating rate set by reference to a long-term capital market rate (e.g., a swap curve) rather than by reference to a short-term published reference rate. A CMS can be either a single currency or a cross-currency swap. The advantages of a CMS are that: There is no premium. You can set a floating rate to a longer tenor than is available in the short-term published indexes. It is a flexible way of hedging or speculating against the shape of the yield curve. PACKAGE IRG BARRIER UP&IN SWAP LIFE TIME IRG CUMULATIVE INVERSE FLOATER An inverse floater swap is similar to a vanilla swap in that one of the legs can be based on either a fixed or a floating reference rate. The difference is in the second leg, which is based on a formula which produces coupons which increase as the defined floating reference rate decreases. These trades are very popular (in bond format) when investors feel that short term rates are likely to fall. The greater the fall in the chosen index, the larger the resultant coupon. BARRIER UP&OUT SWAP QUANTO FIXED FLOATING SWAP RATCHET SWAP BARRIER DOWN&IN IRG BARRIER SWAP BARRIER UP&OUT IRG QUANTO CMS SWAP BARRIER UP&IN IRG BARRIER IRG EXTENDABLE SWAP A swap whose life can be extended at the option of one side to the contract. QUANTO DIGITAL SWAP EUROPEAN DIGITAL IRG IN ARREARS SWAP BARRIER DOWN/OUT COLLAR QUANTO IRG AVERAGE DIGITAL SWAP REFERENCES http://www.hsbcnet.com/treasury/attachments/markets/pdf/mr_base_rt_colr.pdf http://www.superderivatives.com/Glossary/Default.aspxHP&crt=d http://ericbenhamou.net/documents/Encyclo/swaps%20CMS%20CMT.pdf Read More
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