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BANKS AND DERIVATIVES: EXPLORING THE FINANCIAL CHARACTERISTICS OF BANKS THAT USE INTEREST RATE SWAPS
Abstract
One of the derivative securities is IRS and this implies the values of these instruments are determined by the assets that are underlying. IRS are a derivative security, and it implies their valuation is determined by the underlying assets. In that regard, assets refer to interest rates and loans. A swap involves the exchange of two cash flow streams by two parties. On the contrary, when dealing with swap interest rate, the cash flows refer to the payments of interest based on an amount of money. In this context, the money that is underlying is called notional amount and it does not involve the change of hands. In that connection, it is only the exchange of interest rate payments which would be done if they would borrow the notional amount. The three kinds of swaps of interest rate established using rates that are swapped are fixed for fixed, vanilla or fixed-for-floating and floating-for-floating. The main idea of this article is to scout the financial characteristics of banks that use IRS in order to save their profits from different risks. The article presents empirical hypothesis, the definition and explanation of variables, and the GARCH model.
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