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Interest Rate Swaps and Their Derivatives: A Practitioner's Guide


Praise for Interest Rate Swaps and Their Derivatives

"This is it! I have been looking for a practitioner's guide to interest rate derivatives for over ten years! Most 'new joiners' on Wall Street only gain this knowledge over years of apprenticeship with seasoned professionals. In his book, Amir Sadr explains not only the math behind the products, but the street lingo and, most importantly, the mechanics of everything from overnight repos to Bermudans."
—George Nunn, Head of Fixed Income Structuring, Americas, BNP Paribas

"Dr. Sadr has produced a single, comprehensive guide to the interest rate swap market. Bank dealers and corporate risk professionals already active in this market will find the book to be one of the best trading floor reference guides out there. Students who want the real-world insights of a seasoned professional will also discover Dr. Sadr's book to be an invaluable resource."
—Morris Sachs, Chief Risk Officer, 5:15 Capital

AMIR SADR, PhD, has experience as a quant, trader, financial software developer, and academic in fixed income markets. He traded options and exotics at HSBC in New York from 2005 to 2006 and traded at the proprietary desk for Greenwich Capital Markets (GCM) for four years prior to that. Sadr also has experience at Morgan Stanley as a vice president in the derivatives products group where he traded interest rate derivatives and exotics. Since 1996, Sadr has served as an adjunct professor at New York University in the Department of Finance and Accounting.

"Rates" Market.


Book Structure.


About the Author.

List of Symbols and Abbreviations.

PART ONE Cash, Repo, and Swap Markets.

CHAPTER 1 Bonds: It's All About Discounting.

Time Value of Money: Future Value, Present Value.

Price-Yield Formula.

PV01, PVBP, Convexity.

Repo, Reverse Repo.

Forward Price/Yield, Carry, Roll-Down.

CHAPTER 2 Swaps: It's Still About Discounting.

Discount Factor Curve, Zero Curve.

Forward Rate Curve.

Par-Swap Curve.

Construction of the Swap/Libor Curve.

CHAPTER 3 Interest Rate Swaps in Practice.

Market Instruments.

Swap Trading—Rates or Spreads.

Swap Spreads.

Risk, PV01, Gamma Ladder.

Calendar Rules, Date Minutiae.

CHAPTER 4 Separating Forward Curve from Discount Curve.

Forward Curves for Assets.

Implied Forward Rates.

Float/Float Swaps.

Libor/Libor Basis Swaps.

Overnight Indexed Swaps (OIS).

PART TWO Interest-Rate Flow Options.

CHAPTER 5 Derivatives Pricing: Risk-Neutral Valuation.

European-Style Contingent Claims.

One-Step Binomial Model.

From One Time-Step to Two.

From Two Time-Steps to . . .

Relative Prices.

Risk-Neutral Valuation: All Relative Prices Must be Martingales.

Interest-Rate Options Are Inherently Difficult to Value.

From Binomial Model to Equivalent Martingale Measures.

CHAPTER 6 Black's World.

A Little Bit of Randomness.

Modeling Asset Changes.

Black-Scholes-Merton/Black Formulae.



Call Is All You Need.

Calendar/Business Days, Event Vols.

CHAPTER 7 European-Style Interest-Rate Derivatives.

Market Practice.

Interest-Rate Option Trades.

Caplets/Floorlets: Options on Forward Rates.

European-Style Swaptions.

Skews, Smiles.

CMS Products.

Bond Options.

PART THREE Interest-Rate Exotics.

CHAPTER 8 Short-Rate Models.

A Quick Tour.

Dynamics to Implementation.

Lattice/Tree Implementation.

BDT Lattice Model.

Hull-White, Black-Karasinski Models.

Simulation Implementation.

CHAPTER 9 Bermudan-Style Options.

Bellman's Equation—Backward Induction.

Bermudan Swaptions.

Bermudan Cancelable Swaps, Callable/Puttable Bonds.

Bermudan-Style Options in Simulation Implementation.

CHAPTER 10 Full Term-Structure Interest-Rate Models.

Shifting Focus from Short Rate to Full Curve: Ho-Lee Model.

Heath-Jarrow-Morton (HJM) Full Term-Structure Framework.

Discrete-Time, Discrete-Tenor HJM Framework.

Forward-Forward Volatility.

Multifactor Models.

HJM Framework Typically Leads to Nonrecombining Trees.

CHAPTER 11 Forward-Measure Lens.

Numeraires Are Arbitrary.

Forward Measures.

BGM/Jamshidian Results.

Different Measures for Different Rates.

"Classic" or "New Improved": Pick Your Poison!.

CHAPTER 12 In Search of "The" Model.

Migration to Full-Term Structure Models.

Implementation Era.

Model versus Market: Liquidity and Concentration Risk.

Complexity Risk.

Remaining Challenges.

APPENDIX A Taylor Series Expansion.

Function of One Variable.

Function of Several Variables.

Ito's Lemma: Taylor Series for Diffusions.

APPENDIX B Mean-Reverting Processes.

Normal Dynamics.

Log-Normal Dynamics.

APPENDIX C Girsanov's Theorem and Change of Numeraire.

Continuous-Time, Instantaneous-Forwards HJM Framework.

BGM Result.