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Interest Rate Swaps and Other Derivatives resources

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P R EFAC E The emergence of swaps with options embedded in them opened up new avenues for the use of this market. Typically, investors short the options embedded in such swaps. As compensation for shorting these options, in- vestors receive a higher fixed coupon than could otherwise be obtained in a “plain vanilla” swap. This led to the formation of a class of trades known as yield-enhancing swaps that competed with products found in other mar- kets (e.g., the mortgage market) and offered new opportunities not otherwise available in any market. There are many, many different types of swaps with embedded options that have emerged and are attractive to a wide range of investors. The market evolved in another direction as well: the structured note market. The advent of the structured note market represented the marriage of bonds and derivatives. A whole new slew of investors who previously were not involved in the derivatives markets were now gaining access to some of the most sophisticated derivative products that had ever been created. This was a period of time in the derivatives market synonymous with the creation of highly sophisticated products and the use of leverage and, sometimes, excess. Liquidity in the interest rate swaps market has improved dramatically over the years. A variety of investors have come to regard this market as an avenue of choice for putting on speculative trades in order to express a view on the market. Hedge funds and other proprietary trading accounts use these markets to establish both relative value and macro trades and are an essential part of the market. The continued theme of innovation has presented itself again more re- cently. The development and popularity of new types of trades in recent years have created new opportunities for buy-side investors to express views on the market that they could not (easily) express before. Such trades in- troduce new types and more sophisticated risks that buy-side accounts are exposed to and that sell-side firms have had to manage. Unique trading op- portunities have become available as these products have taken off, again indicative of the flexibility that these markets provide to their participants. The purpose of this book is to provide students and practitioners who are interested in the interest rate swaps market and other closely related OTC derivative markets with an introduction to and understanding of these and other topics. This book is intended to provide the reader with a framework to analyze basic trades, a basis for dissecting more complex trades (i.e., how they are structured, how they work, how we rip them apart), and an ability to structure trades on his or her own. The book was developed in conjunction with a course I have taught at Columbia Business School for the past 16 years. xiv

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