TAILIEUCHUNG - The Role of Interest Rate Swaps in Corporate Finance

In March 1997 the Bank started conducting daily money market operations in gilt repo. Since this date we have used GC repo data to estimate the short end of the nominal yield curve, and so the short end of the nominal curve is provided down to very short maturities after this date. No corresponding instrument is available to help model the short end of the real yield curve. Since implied inflation rates are calculated as the difference of the nominal and real curves, an absence of either real or nominal interest rate data at a given maturity implies an absence of corresponding implied. | The Role of Interest Rate Swaps in Corporate Finance Anatoli Kuprianov An interest rate swap is a contractual agreement between two parties to exchange a series of interest rate payments without exchanging the underlying debt. The interest rate swap represents one example of a general category of financial instruments known as derivative instruments. In the most general terms a derivative instrument is an agreement whose value derives from some underlying market return market price or price index. The rapid growth of the market for swaps and other derivatives in recent years has spurred considerable controversy over the economic rationale for these instruments. Many observers have expressed alarm over the growth and size of the market arguing that interest rate swaps and other derivative instruments threaten the stability of financial markets. Recently such fears have led both legislators and bank regulators to consider measures to curb the growth of the market. Several legislators have begun to promote initiatives to create an entirely new regulatory agency to supervise derivatives trading activity. Underlying these initiatives is the premise that derivative instruments increase aggregate risk in the economy either by encouraging speculation or by burdening firms with risks that management does not understand fully and is incapable of controlling. 1 To be certain much of this criticism is aimed at many of the more exotic derivative instruments that have begun to appear recently. Nevertheless it is difficult if not impossible to appreciate the economic role of these more exotic instruments without an understanding of the role of the interest rate swap the most basic of the new generation of financial derivatives. The views expressed herein are those of the author and do not necessarily represent the views of either the Federal Reserve Bank of Richmond or the Board of Governors of the Federal Reserve System. The motivation for this article grew out of discussions .

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