Wednesday, May 28, 2014

IRS - off-balancesheet, briefly

The LTCM case P12 illustrated (with an example) a key motivation/benefit of IRS -- off balance sheet. The example is related to the swap spread trade briefly described in other posts.

For a simple T-bond purchase with repo financing, the full values (say $500m) of the bond and the loan appear on the balance sheet, increasing the fund's leverage ratio. In contrast, if there's no T-bond purchase, and instead we enter an IRS providing the same interest rate exposure, then the notional $500m won't appear on balance sheet, resulting in a much lower leverage ratio. Only the market value of the existing IRS position is included, usually a small value above or below $0. (Note IRS market value is $0 at inception.)

An IRS position receiving fixed (paying float) is considered similar to the repo scenario. The repo rate is kind of floating i.e. determined at each rollover.

Other positions to be recorded off balance sheet include futures, FX swaps,

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