This video looks at the pricing and valuation of interest rate swaps.
We first show how to construct a 'zero coupon curve' using a method called 'bootstrapping'. This bootstrapping methodology takes the prices of liquid fixed income instruments and incrementally builds up a zero coupon curve as instruments of longer and longer maturities are added.
We then see seen how we can use this zero coupon curve to get the present value of future cashflows.
We also illustrate how we can use this curve to forecast floating rates. Both of these capabilities help us to price swaps.
Finally we show how useful a zero coupon curve is for risk management. Shifts, steepening & flattening of the curve as well as twists and flexes will give us different discount and forward rates. We can therefore asses the sensitivity of our swap portfolio to any set of real or invented scenarios we
choose by represented this scenario a a change in curve shape. We show how an understanding of these sensitivities is essential to sound risk management.
