Since its beginning in the 1980s, the interest rate swap market grew rapidly because of its properties such as the ease of execution, the availability of large sizes, the flexibility of structuring, and the ability to manage risks in new ways not previously obtainable. And swap has grown to be an indispensable product and has proven to be a major advancement in the evolution of the world financial market. However there has not been an interest rate swap transaction and any bank who operates swap warehouse in Korean financial markets.
This thesis, as a major point, tried to show how to price the Korean Won interest rate swap and use it for various purposes in commercial banks.
An interest rate swap is an agreement between two parties to exchange interest payments at prespecified intervals based on agreed-upon indexes. Therefore we had to build the term structure of interest rate based on market rates for proper pricing of future cashflows. In order to build the term structure, I chose the market yields which reflect the funding costs of commercial banks in the financial markets and used continuously compounding and linear interpolation method. And I calculated the implied forward rates, discount factors sequentially for the determination of the mid-point swap rate. And then I tested whether it had any implied tendency or not by using t-statistics.
After introducing a pricing method of the interest rate swap, I explained how to use it for hedging interest rate risks in commercial banks and tested the effectiveness of it by using regression analysis. Also, I showed how to use it for making excess return and other purposes with combining the assets and liabilities in commercial banks.
In conclusion, the Korean-Won interest rate swap can be one of the financial instruments which our commercial banks have comparative advantages. And it will provide new and efficient ways to manage assets and liabilities of every market participants and it will promote the efficiency of the financial markets.
