CHAPTER 6

Interest Rate Derivatives—Theory

LEARNING OBJECTIVES

After studying this chapter you will be able to get a grasp of the following:

DERIVATIVES IN A FINANCIAL INSTRUMENT

A derivative instrument is a financial instrument, such as an option or futures contract, whose value depends on the performance of an underlying security or asset. Futures contracts, forward contracts, options, and swaps are the most common types of derivatives. Derivatives are generally used by institutional investors to increase overall portfolio returns or to hedge portfolio risk. A derivative is a financial instrument that does not constitute ownership, but a promise to convey ownership.

All derivatives are based on some underlying financial or non-financial item. For example, the underlying products could be any of the following:

Various types of derivative contracts

Table 6.1 gives a list various types of contracts with the corresponding underlying variable:

Table 6.1 Derivative contracts & underlying variables

Type of Contract Underlying Variable
Interest rate swap Interest rates
Currency swap Currency rates
Commodity swap Commodity prices
Equity swap Equity prices (equity of another entity)
Credit swap Credit rating, credit index or credit price
Total return swap Total fair value of the reference asset and interest rates
Purchased or written equity option (call or put) Equity prices
Purchased or written equity index option (call or put) Equity index
Purchased or written treasury bond option (call or put) Interest rates
Purchased or written currency option (call or put) Currency rates
Purchased or written commodity option (call or put) Commodity prices
Equity futures Equity prices
Equity index futures Equity index
Currency futures Currency rates
Commodity futures Commodity prices
Currency forward Currency rates
Commodity forward Commodity prices

In this chapter we will cover interest rate derivatives in particular even though much of these concepts are applicable for other types of derivatives as well.

DEFINITION OF DERIVATIVES AS PER ACCOUNTING STANDARDS

As per US GAAP

As per IFRS

As per IAS 39, the key definitions for derivatives are as follows:

A derivative is a financial instrument with the following three characteristics:

In the definition of a derivative it has been clarified that a contract will meet the definition of a derivative regardless of whether it is settled net or gross. In this regard this definition is different from the US GAAP, which excludes contracts that are settled gross.

An interest rate swap would be a derivative financial instrument even if the parties pay the interest payments to each other on a gross settlement basis or settle the same on a net basis.

Even though the definition of a derivative requires that the instrument is settled at a future date, it is clarified that this criterion is met even if an option is expected not to be exercised (for example, it is out of the money). This is so because expiry at maturity is a form of settlement even though there is no additional exchange of consideration.

ACCOUNTING STANDARDS FOR INTEREST RATE DERIVATIVES

In the subsequent chapters we will cover the accounting requirements for interest rate derivatives in the form of interest rate swaps, caps, floors, collars and reverse collars. Also we will cover cross currency swaps and swaption contracts. An interest rate derivative instrument is a form of derivative and if used as a hedging instrument requires special hedge accounting treatment.

The accounting treatment under the US GAAP for interest rate derivatives is covered in Table 6.2. The relevant International Financial Reporting Standards, IAS (International Accounting Standard) are also given:

Table 6.2 Relevant accounting standards

US GAAP Topics IFRS
220—Comprehensive Income IFRS 7—Financial Instruments: Disclosure
320—Investments—Debt and Equity Securities IFRS 9—Financial Instruments
820—Fair Value Measurements and Disclosures IAS 21—The Effects of Changes in Foreign Exchange Rates
825—Financial Instruments IAS 32—Financial Instruments: Presentation
830—Foreign Currency Matters IAS 36—Impairment of Assets
946—Financial Services—Investment Companies IAS 39—Financial Instruments: Recognition and Measurement

DIFFERENCES BETWEEN US GAAP AND IFRS

Table 6.3 shows the differences between US GAAP and IFRS in respect of treatment of derivatives.

Table 6.3 Derivatives treatment

Topic US GAAP IFRS
Definition A derivative is a financial instrument: Same as US GAAP except that there is requirement that the contract should permit net settlement
• whose value changes in response to a specified variable or underlying rate (for example, interest rate);
• that requires no or little net investment;
• that is settled at a future date; and
• that permits net settlement
Initial measurement Measured at fair value and on acquisition date and presented in balance sheet Same as US GAAP
Subsequent measurement Measured at fair value on subsequent valuation date and presented in balance sheet. This is irrespective of whether the derivative instrument is a hedging instrument or not Same as US GAAP except that a derivative that should be settled by delivery of an equity shares that is unquoted and whose fair value cannot be reliably measured is carried at cost less impairment until settlement
Changes in Fair Value of derivative instrument Recognized in the income statement. However if the instrument qualifies as a hedge then income recognized as per the hedge accounting norms Same as US GAAP

OVER-THE-COUNTER CONTRACTS

Over-the-counter (OTC) derivatives are contracts that are traded directly between two parties, without going through an exchange or other intermediary. These are privately negotiated trades and the terms are structured in such a way to suit the parties involved in the trade. Interest rate swaps, forward rate agreements, and other exotic options are usually traded as over-the-counter derivatives. The OTC derivative market is the largest market for derivatives and is largely unregulated when it comes to disclosure of information between the parties. The predominant players in this market segment are banks and other less regulated entities like hedge funds. Reporting of OTC contracts is difficult because trades often occur privately between the counterparties and as such are not recorded on any exchange.

As OTC derivatives are not traded on an exchange, there is no central counterparty and this means that the contracts suffer from counterparty risk, like any other private contract between two parties where each one of them relies on the other to perform the contract. The counterparty risk faced by a derivatives trader is often in the form of replacement risk.

As per the market survey results provided by the International Swaps and Derivatives Association (ISDA), the notional amount outstanding of interest rate derivatives (IRD) was at US$426.75 trillion at the end of Dec 2009.

EXCHANGE-TRADED DERIVATIVE CONTRACTS

Exchange-traded derivative contracts are those derivatives instruments that are traded in specialized derivatives exchanges or other exchanges. A derivatives exchange is a market where different counterparties trade standardized contracts which are defined by the respective exchange. A derivatives exchange acts as an intermediary to all related transactions, and takes an initial margin as well as a variation margin from both sides of the trade to act as a guarantee for the performance of the contract. We can say that the counterparty risk is greatly reduced for exchange-traded derivative contracts because the settlement of exchange-traded futures and options is guaranteed by the clearing house associated with the exchange and therefore the clearing house acts as the central counterparty.

BENEFITS OF INTEREST RATE DERIVATIVES

Reasons for using interest rate swaps

Interest rate swaps are used by a wide range of commercial banks, investment banks, non-financial operating companies, insurance companies, mortgage companies, investment vehicles and trusts, government agencies and sovereign states for one or more of the following reasons:

To hedge interest rate exposure

An entity that provides fixed rate loans is exposed to pre-payment risk when faced with falling interest rates. The borrowers may prefer to close the existing mortgage and re-finance the same at a lower rate. The entity can protect against this risk by entering into an interest rate swap by receiving fixed and paying floating interest. Depending upon the risk management policy of the entity, the entity can opt to convert a portion of their lending portfolio from fixed rate to floating rate by entering into appropriate interest rate swap contracts.

To take speculative positions in relation to future movements in interest rates

The entity may want to take a speculative position on short-term interest rates and lower its cost of borrowing even further if in its judgment the level of future interest rates is expected to fall. There are also many exotic combinations of these interest rate derivatives, such as “indexed principal swap” where the notional principal amount continually amortizes in line with say a mortgage pre-payment index but the amortization rate increases when interest rates fall and the rate decreases when interest rates rise. The existence of the interest rate derivative market enables the entity to take a speculative position that best suits its specific requirement considering the overall portfolio of its loans and its judgment about the future rates of interest. Interest rate derivatives are used extensively to manage positions in a cost effective manner.

To lower the cost of funding

Interest rate derivatives are used to effectively lower the cost of funding. For example, a U.S. industrial entity with a good credit rating may want to raise funds for a six-year fixed-rate debt that would be callable at par after three years. In order to reduce its funding cost the entity can issue a six-month commercial paper and simultaneously enter into a six-year interest rate swap under which it receives a six-month floating rate of interest (LIBOR) and pays a series of fixed, semi-annual interest payments. The cost saving in this case would be quite handsome.

To implement the overall asset-liability management strategies

Interest rate derivatives are predominantly used by financial institutions and other market participants who have assets or liabilities that are sensitive to interest rates for hedging interest rate risk arising from the maturity mismatches between the asset and the liabilities. An entity with a high asset duration coupled with a low liability duration may “correct” its duration by entering into appropriate interest rate swap contracts to pay fixed interest and receive floating interest, despite losing some return percentage on its net worth. It is also common to find very highly leveraged institutions using interest rate swaps to fine-tune their duration gaps.

Comparative cost advantage to both parties

Whenever market inefficiencies exist there is scope for arbitrage opportunities and the interest rate derivative market is no exception to this. An entity can execute an interest rate swap contract to exploit the arbitrage opportunities, which is also known as the comparative cost advantage.

INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION (ISDA)

The International Swaps and Derivatives Association (ISDA) is a trade organization of participants in the market for over-the-counter derivatives. Headquartered in New York, it has created a standardized contract (the ISDA Master Agreement) to enter into derivatives transactions. ISDA has more than 830 members in 57 countries; its membership consists of derivatives dealers, service providers and end users.

Since its inception, ISDA has pioneered efforts to identify and reduce the sources of risk in the derivatives and risk management business. Among its most notable accomplishments are: developing the ISDA Master Agreement; publishing a wide range of related documentation materials and instruments covering a variety of transaction types; producing legal opinions on the enforceability of netting and collateral arrangements (available only to ISDA members); securing recognition of the risk-reducing effects of netting in determining capital requirements; promoting sound risk management practices, and advancing the understanding and treatment of derivatives and risk management from public policy and regulatory capital perspectives.1

The ISDA Master Agreement was first published in 1992, and a second edition was published in 2002. The second edition was drafted in response to market difficulties in the late 1990s, and could be adopted either in a unified form or as standard form amendments to the first edition.

Netting provisions of ISDA

The most important aspect of the ISDA Master Agreement is that the Master Agreement and all the confirmations entered into under it form a single agreement. This is very important for regulated financial entities as it allows the parties to an ISDA Master Agreement to aggregate the amounts owed by each of them under all of the transactions outstanding under that ISDA Master Agreement and replace them with a single net amount payable by one party to the other. Netting allows the parties to net out amounts payable on the same day and in the same currency.

The main use of a netting provision is close-out netting, whereby the outstanding transactions under it are terminated following a credit event as defined by ISDA and the value of each of the terminated transactions is assessed.

Assume that in an interest rate derivative contract between parties A & B, A profits $1,000,0000 in one transaction and B profits $5,000,000 in another transaction simultaneously. And before the transactions are settled, B becomes insolvent. The danger for A is that B’s liquidator will cherry pick profitable transactions and disclaim unprofitable transactions thereby requiring A to pay $5 million while requiring A to join the line of other creditors to claim the $1 million against B’s estate. Needless to say that A will recover only a fraction of $1 million. If the close-out netting was effective, then A could have simply knocked off the $1 million from the $5 million payable to B and would have paid B a net amount of $4 million.

Credit support annex

ISDA also produces a credit support annex which further permits parties to an ISDA Master Agreement to mitigate their credit risk by requiring the party which is “out-of-the-money” to post collateral corresponding to the amount which would be payable by that party were all the outstanding transactions under the relevant ISDA Master Agreement terminated.

TYPES OF INTEREST RATE DERIVATIVES

Forward rate agreements

A forward rate agreement (FRA) is a contract between two parties to exchange interest payments on a specified notional principal amount for one future period of predetermined length (i.e., one month forward for three months). Effectively, an FRA is a short-term, single-period interest rate swap. Only interest flows are exchanged and no principal is exchanged. In a generic FRA one party pays fixed and the other party pays floating. This exchange allows for conversion of variable rate funding to fixed rate exposure or fixed rate funding to variable rate exposure.

Settlement: Settlement of an FRA is on a net basis and can occur on the start date or the maturity date. If the FRA is settled on the start date, the settlement is on a present value basis. If the FRA is settled on the maturity date, the settlement is on a same day basis. The settlement reflects the difference between the FRA rate and the floating rate set for the period. The determination of the floating rate depends upon its underlying index (i.e., LIBOR, Commercial Paper, Prime, etc.).

Normally there is a buyer and a seller of an FRA. The buyer is the fixed-rate payer and the seller is the floating rate payer. If interest rates increase, the value of the FRA increases to the buyer. If interest rates decline, the value of the FRA increases to the seller. An FRA can be terminated at any time with the consent of both parties. The termination amount (market value) will depend on the relationship between the fixed rate of the FRA and the current market rates. If one party is paying fixed rates and interest rates decline, that party will most likely have to pay to terminate the FRA. Conversely, if one party is paying fixed rates and interest rates rise, that party receives the added value upon termination.

If the fixed rate equals the floating rate, there is no FRA payment. If the fixed rate is greater than the floating rate, the fixed-rate payer pays the net amount. If the fixed rate is less than the floating rate, the floating-rate payer pays the net amount.

Forward rate agreement applications

Typically this type of interest rate derivative is used to fine-tune the proportion of fixed interest debt and floating interest debt. Assume for instance that a large corporate borrower’s debt structure is 40 percent fixed and 60 percent floating. Their treasury department foresees interest rates rising at the end of the year and the corporation wants to increase its fixed rate debt to 75 percent during that period. To achieve this objective the corporation could pay off some of its floating rate debt and issue or borrow an additional fixed rate debt which, however, could cause very high transaction costs apart from the task itself being daunting. An easier and less expensive process is to enter into a forward rate agreement. The FRA converts the borrower’s floating rate exposure to a fixed rate at the end of the year.

Where a corporation expects that interest rates are going to rise, the corporation can use an FRA to lock in the rate on the additional borrowing that they will need.

Interest rate swaps

Interest rate swaps are over-the-counter instruments where two parties agree to “swap” or exchange periodic interest payments. The amount of the interest payments exchanged is based on some predetermined principal also known as the notional principal. In a generic interest rate swap one party pays fixed and the other party pays floating. This exchange allows for conversion of variable rate funding to fixed rate exposure or fixed rate funding to variable rate exposure. The amount one counterparty pays to the other is the agreed-upon periodic interest rate—either fixed or floating based on some agreed benchmark—applied on the notional principal. Only the interest component on the notional principal is exchanged between the parties and not the notional principal itself.

Exchange of payments occurs at preset payment dates over a specified term (for example, semi-annual payments for five years). Exchanges reflect differences between the fixed rate and each period’s floating rate. The calculation or determination of the floating rate depends upon its underlying index, say, LIBOR.

Where the swaps are a discrete setting, the floating interest rate is set at the beginning of the period. The floating interest rate is also set at the end of the period based on the average of the underlying index during the period. The fixed and floating payments are usually netted and the counterparty owing the difference pays the net amount on the payment date. If an entity is paying a fixed rate and interest rates increase, the value of the swap increases to the fixed rate payer.

Termination of interest rate swaps

An interest rate swap can be terminated at any time with the consent of both parties and the termination amount depends upon the relationship between the fixed rate on the swap and current market rates. If a party is paying a fixed rate and interest rates decline, that party has to pay to terminate the swap. However, if a counterparty is paying a fixed rate and interest rates rise, that party receives the market value upon termination.

Caps

An interest rate cap is an interest rate derivative contract, which has a ceiling viz. cap strike—on a floating rate of interest on a specified notional principal amount for a specific term. The cap buyer effectively uses the cap contract to limit the entity’s maximum interest rate payable. If the buyer’s floating rate rises above the cap strike, the cap contract provides for payments from the seller to the buyer of the cap for the difference between the floating rate and the cap strike. If the floating rate remains below the cap strike, no payments are required. The cap buyer is required to pay an upfront fee for the cap, which is known as the premium for the contract. The interest rate cap can be thought of as a series of call options, or caplets, which exist for each period the cap agreement is in existence.

The cap premium charged by the seller depends upon the market’s assessment of the probability that rates will move through the cap strike over the time horizon of the deal. The premium for the cap contract is paid on trade date 1 2 days. The cap premium takes the form of an upfront charge that is usually expressed in basis points as a percentage of the notional principal amount.

If the cap strike is greater than the floating rate, there will be no payment on the cap. However, the amortized premium increases the effective interest rate paid by the buyer of the cap. If the floating rate is greater than the cap strike on the reset date, the seller of the cap will pay the buyer at settlement an amount calculated as notional principal x (floating rate—cap strike) x actual days/365.

Floors

An interest rate floor is a form of interest rate derivative contract that has a minimum value—floor strike—on a floating rate of interest on a specified notional principal amount for a specific term. The floor buyer uses the floor contract to limit his minimum interest rate receivable. The seller of the floor agrees to pay a minimum rate of interest on the notional for which the seller gets a premium. One of the uses for this interest rate derivative is to offset the cost of a purchased interest rate cap. If the floating rate drops below the floor strike, the floor contract enables the floor buyer to get from the floor seller the difference between the floor strike and the floating rate. An interest rate floor is a series of put options, or floorlets, on a specified reference rate, usually LIBOR.

Just like the cap, in the case of floor the premium charged by the seller depends upon the market’s assessment of the probability that rates will drop below the floor strike over the life of the contract. The premium for the floor contract is paid on trade date 1 2 days. The floor premium takes the form of an upfront charge that is usually expressed in basis points as a percentage of the notional principal amount.

If the floor strike is greater than the floating rate, there will be no receipt from the floor. If the floating rate is lower than the floor strike on the reset date, the seller of the cap will pay the buyer at settlement an amount calculated as notional principal x (floor strike—floating rate) x actual days/365. The floor buyer’s effective interest rate is equal to the higher of the floating rate or the strike, less, in each case, the amortized cost of the floor premium.

Interest rate collar

An interest rate collar is a form of interest rate derivative, which is the simultaneous purchase of an interest rate cap and sale of an interest rate floor on the same index for the same maturity and notional principal amount.

An interest rate collar is a combination of an interest rate cap and an interest rate floor. The buyer of the collar purchases the cap that places a ceiling on the interest rate he will pay, and sells the floor to obtain a premium to pay for all or part of the cap.

This type of derivative contract is very useful especially because it pegs interest rate payment commitments by the buyer of the collar to a range specified by the strike rates of both the cap and floor. If the floating rate rises above the cap strike, the collar contract ensures receipt from the seller of the collar to the buyer for the difference between the floating rate and the cap strike. On the other hand, if the floating rate falls below the floor strike, the collar buyer pays the collar seller the difference between the floor strike and the floating rate.

Similar to a cap or a floor contract, the collar premium charged by the seller depends upon the market’s assessment of the probability that rates will move above the cap or below the floor level over the life of the contract. The premium for the floor contract is paid on the trade date 1 2 days. The premium takes the form of an upfront charge that is usually expressed in basis points as a percentage of the notional principal amount. There are also collar contracts that are available at virtually no cost, as the price paid for the cap equals the price received for the floor, and no net premium is exchanged between the buyer and seller of the collar.

Reverse collars

An interest rate reverse collar is a form of interest rate derivative, which is the simultaneous sale of an interest rate cap and purchase of an interest rate floor on the same index for the same maturity and notional principal amount.

An interest rate reverse collar is a combination of an interest rate cap and an interest rate floor. It is similar to that of a collar except that in this case the buyer of the collar sells the cap and buys the floor.

This type of derivative contract is also very useful especially because it protects the buyer from falling interest rates. If the floating rate rises above the cap strike, the reverse collar contract ensures payment by the buyer of the reverse collar to the seller for the difference between the floating rate and the cap strike. On the other hand, if the floating rate falls below the floor strike, the reverse collar buyer receives from the reverse collar seller the difference between the floor strike and the floating rate.

Similar to a cap or a floor contract, the reverse collar premium charged by the seller depends upon the market’s assessment of the probability that rates will move above the cap or below the floor level over the life of the contract. The premium for the floor contract is paid on the trade date 1 2 days. The premium takes the form of an upfront charge that is usually expressed in basis points as a percentage of the notional principal amount. There are also reverse collar contracts that are available at virtually no cost, as the premium received for selling the cap equals the price paid for buying the floor, and no net premium is exchanged between the buyer and seller of the reverse collar.

Swaption

A swaption is an option granting the buyer the right but not the obligation to enter into an underlying swap. Although swaptions can be traded on a variety of swaps, the term “swaption” typically refers to options on interest rate swaps.

There are two types of swaption contracts:

Both the counterparties of the swaption agree on certain basic terms of the contract, such as:

Swaption—payer’s

An interest rate swaption is an option to enter into an interest rate swap agreement on agreed terms at the option of the buyer of the swaption on a future date. The terms of the swaption contract includes among other things the expiration date; option type—payer’s swaption or receiver’s swaption, exercise style—European or American or Bermudan; the terms of the underlying swap and the type of settlement—cash or physical.

Until the expiration date, the buyer of the swaption contract can either notify the writer of the instrument of the entity’s intention to exercise the option contract resulting in the creation of an interest rate swap contract as per the terms already agreed with the writer, or can let the option expire.

A payer’s swaption is the right to pay a fixed rate. A payer’s swaption is similar to a put on a fixed rate instrument or the fixed rate side of the swap. The main motive in buying a payer’s swaption is to obtain protection from paying a substantially higher fixed rate of interest over the life of the swap agreement.

If interest rates rise over the life of the payer’s swaption, the swaption buyer will exercise the right to pay the pre-set fixed rate as it will be lower than the market rate. If interest rates fall, the value of the fixed rate payments will fall and the payer’s swaption will not be worth exercising.

Swaption—receiver’s

A receiver’s swaption is the right to receive a fixed rate. A receiver’s swaption is similar to a call on a fixed rate instrument or the fixed rate side of the swap. The main motive in buying a receiver’s swaption is to obtain protection from receiving a substantially lower fixed rate of interest over the life of the swap agreement.

HEDGED OR HEDGING INSTRUMENT—STATUS OF VARIOUS FINANCIAL INSTRUMENTS

Table 6.4 shows the status of various financial instruments from the perspective of being designated as a hedged item or a hedging instrument.

Table 6.4 Various financial instruments designated as hedged or hedging instrument—status

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SUMMARY

EXERCISE

Theory questions

1. Define a derivative instrument as per the accounting standards—both US GAAP as well as IFRS.

2. What are the major differences between US GAAP and IFRS as far as derivative contracts are concerned?

3. What are over-the-counter derivative contracts? How are these different from exchange-traded derivative contracts?

4. What is an interest rate derivative?

5. What are the benefits of interest rate derivatives?

6. What is ISDA and how is it useful to over-the-counter derivative trades?

7. What is meant by close-out netting? Is it really useful for the counterparties to a trade?

8. What is meant by forward rate agreements?

9. Explain the nuances of an interest rate swap contract.

10. What is a cap and floor? Compare and contrast caps vs. floors.

11. What is y an interest rate collar? How is it different from a reverse collar instrument?

12. “An interest collar should always command a premium.” Explain this myth.

13. What is a swaption contract, and what are the two types of swaption contracts?

Objective—questions

1. Derivatives are generally used by ______.

a) Retail investors

b) Institutional investors

c) Insurance companies

d) All of the above

2. All derivatives are based on some underlying _________ product.

a) Asset

b) Cash

c) Credit

d) All of the above

3. A purchased or written treasury bond option (call or put) is a derivative contract with the underlying as ________.

a) Currency rates

b) Commodity prices

c) Interest rates

d) None of the above

4. Derivatives are settled at a_______.

a) Trade date

b) Forward date

c) Future date

d) None of the above

5. An interest rate derivative is measured at _______.

a) Face value

b) Fair value

c) Dirty price

d) None of the above

6. The OTC market is largely _________when it comes to disclosure of information between the parties.

a) Regulated

b) Unregulated

c) Measured

d) None of the above

7. An entity that provides fixed rate loans is exposed to pre-payment risk when faced with falling _________.

a) Bank rates

b) Interest rates

c) Currency rates

d) None of the above

8. A forward rate agreement is a_______, single period interest rate swap.

a) Long-term

b) Medium-term

c) Short-term

d) None of the above

9. During termination of an interest rate swap, if a party is paying _____ rates and interest rates decline, that party has to pay to terminate the swap.

a) Floating

b) Fixed

c) Nominal

d) None of the above

10. The cap buyer effectively uses the cap contract to limit the entity’s maximum _________.

a) Interest payable

b) Interest income

c) Interest receivable

d) None of the above

11. An interest rate collar is a form of interest rate derivative which is the simultaneous purchase of an interest rate cap and sale of an __________.

a) Interest rate cap

b) Interest rate reverse collar

c) Interest rate floor

d) None of the above

12. An interest rate reverse collar is a form of interest rate derivative which is the simultaneous sale of an ___________and purchase of an interest rate floor.

a) Interest rate cap

b) Interest rate reverse collar

c) Interest rate floor

d) None of the above

13. A payer swaption gives the buyer of the swaption the right to enter into a swap where they pay the fixed leg and receive the ______leg.

a) Fixed

b) Floating

c) Nominal

d) None of the above

14. A receiver swaption gives the buyer of the swaption the right to enter into a swap where they will receive the __________ leg, and pay the floating leg.

a) Fixed

b) Floating

c) Nominal

d) None of the above

1 ISDA, October 25, 2010, http://www.isda.org