Callable Swap
What is 'Callable Swap'
An exchange of cash flows in which one counterparty makes payments based on a fixed interest rate, the other counterparty makes payments based on a floating interest rate and the counterparty paying the fixed interest rate has the right to end the swap before it matures.
An investor might choose a callable swap if interest rates are expected to change in a way that would adversely affect the fixed rate payer.
Explaining 'Callable Swap'
The additional features of a callable swap make it more expensive than a plain vanilla interest rate swap - the fixed rate payer will pay a higher interest rate and possibly might have to pay additional funds to purchase the option. The opposite of a callable swap is a putable swap, which allows the floating interest rate payer to end the swap early.
Further Reading
Interest rate swaps in an agency theoretic model with uncertain interest rates
www.sciencedirect.com [PDF]
… rate funding also have several options: (1) non-callable bonds, (2) callable bonds, and … Hammond, GMS, 1987, Recent developments in the swap market, Bank of England Quarterly Review, 66 … Loeys, JG, 1985, Interest rate swaps: A new tool for managing risk, Federal Reserve …
www.sciencedirect.com [PDF]
… rate funding also have several options: (1) non-callable bonds, (2) callable bonds, and … Hammond, GMS, 1987, Recent developments in the swap market, Bank of England Quarterly Review, 66 … Loeys, JG, 1985, Interest rate swaps: A new tool for managing risk, Federal Reserve …
www.jstor.org [PDF]
… rate funding also have several options: (1) non-callable bonds, (2) callable bonds, and … Hammond, GMS, 1987, Recent developments in the swap market, Bank of England Quarterly Review, 66 … Loeys, JG, 1985, Interest rate swaps: A new tool for managing risk, Federal Reserve …
papers.ssrn.com [PDF]
… rate funding also have several options: (1) non-callable bonds, (2) callable bonds, and … Hammond, GMS, 1987, Recent developments in the swap market, Bank of England Quarterly Review, 66 … Loeys, JG, 1985, Interest rate swaps: A new tool for managing risk, Federal Reserve …
www.jstor.org [PDF]
… rate funding also have several options: (1) non-callable bonds, (2) callable bonds, and … Hammond, GMS, 1987, Recent developments in the swap market, Bank of England Quarterly Review, 66 … Loeys, JG, 1985, Interest rate swaps: A new tool for managing risk, Federal Reserve …
search.proquest.com [PDF]
… rate funding also have several options: (1) non-callable bonds, (2) callable bonds, and … Hammond, GMS, 1987, Recent developments in the swap market, Bank of England Quarterly Review, 66 … Loeys, JG, 1985, Interest rate swaps: A new tool for managing risk, Federal Reserve …
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Q&A About Callable Swap
Why don't we see many Bermudan options traded in markets today?
Because they're difficult for market makers to hedge and because there aren't many natural buyers/sellers for them (i.e., people who want insurance against something happening).
Does this mean that all Bermudan options are illiquid instruments with little trading volume ?
No, not necessarily – there may be lots of trades taking place behind closed doors between
What does "plain vanilla" mean?
Plain vanilla means basic or standard.
How do you know if an option is European or American?
If you can exercise it at any time during its life then it's American; otherwise, it's European.
Can you give an example of an option that isn't American but also isn't European?
Yes, for example, some options are Bermudan (e.g., barrier options).
What is a callable swap?
A callable swap exchanges cash flows in which one counterparty makes payments based on a fixed interest rate, the other counterparty makes payments based on a floating interest rate and the counterparty paying the fixed interest rate has the right to end the swap before it matures.
Who might choose a callable swap?
An investor might choose a callable swap if interest rates are expected to change in a way that would adversely affect the fixed rate payer.
What does "additional features" refer to?
The additional features of a callable swap make it more expensive than plain vanilla interest rate swaps - the fixed rate payer will pay higher interest rates and possibly have to pay additional funds to purchase options. The opposite of this is put-table swaps, which allow floating-rate payers to end early.
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