Saturday, November 5, 2011

going long Libor -- means...?

If you are long an instrument, you are longing for it to rise
If you are short an asset, you have a shortage for it and hope it depreciates
-- my latest "cheat-sheet"
--------
Q: Look at any financial instrument with a fluctuating price. An instrument not necessarily transferable or tradable, but always bettable. What does it mean if I "long" this instrument?
A:
- i pay a fixed price for it, today or predefined dates. No runaway -- i must pay.
- i get the right to demand cash flow from this instrument
- I long this instrument because I benefit from appreciation.

This complicated explanation is needed in the Libor and IRS context.

Simplest example -- if I long IBM, i buy the stock and stand to gain if it rises.
Simple example -- if I long copper, i buy a copper futures contract at $800 ie I pay this price today, and hope the price at contract expiration is higher.
example -- if I long 10-year T bond, i buy a futures contract at $101....

In Libor IRS, I'd say every fixed-payer is long Libor. Let me repeat --

* Fixed rate payer is long Libor.
* You BUY a swap if you are long Libor. [1]
Also
* you buy a swap if you are short the bond-market [2]

[2] because you want bond prices to drop and yield to rise along with Libor.

[1] because the fixed rate agreed today is based on current Libor. If I go long on Libor, say, the 90-day eurodollar deposit rate, then I enter IR swap
- I pay a fixed rate of 222 bps/year -- ie the "price", computed at current Libor
- I receive a yet-unknown floating rate, hopefully above 222 bps
- I am long Libor therefore I stand to gain when Libor rises

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New York (Time Square), NY, United States
http://www.linkedin.com/in/tanbin