In Chapter 6 we have described in overview various methods of quantifying risk in standard swap structures (i.e. those which involve the periodic exchange of flows between two parties). While generic swaps are by now well established in the financial markets, there are various complex swap structures which are receiving increased attention and use by financial and corporate participants; in this chapter we describe and analyze a variety of these instruments. Note that while in past chapters we have described derivative structures generically (capable of use in a broad range of underlying markets), in this chapter we are required to narrow our discussion slightly and analyze complex swaps in terms of the markets in which they are normally used; not all swap structures are applicable to all underlying reference markets. The specific swaps which we describe and analyze below include inverse floater swaps, leveraged swaps, differential swaps, amortizing swaps, mortgage swaps, and index principal swaps/reverse index principal swaps (which are utilized primarily in the interest rate and/or currency markets), credit swaps (including credit forwards, default swaps and total return swaps) (which are utilized in the credit markets), and equity-index swaps (which are used in the equity markets). We shall not discuss other ‘non-standard’ structures such as putable and callable swaps, forward swaps, premium-discount swaps or zero coupon swaps, as these have been described in a previous volume (see Banks, 1993). In the first section of this chapter we provide product description on each derivative and in the second section we discuss the credit risk quantification of these instruments.
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- The Credit Risk of Complex Swaps
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