Advanced Search
MyIDEAS: Login to save this paper or follow this series

Effectively Hedging the Interest Rate Risk of Wide Floating Rate Coupon Spreads


Author Info

  • Schröder, Thomas

    (John F. Welch College of Business, Sacred Heart University)

  • Dunbar, Kwamie

    (John F. Welch College of Business, Sacred Heart University)


Bond issuers frequently immunize/hedge their interest rate exposure by means of interest rate swaps (IRS). The receiving leg matches all bond cash-flows, while the pay leg requires floating rate coupon payments of form LIBOR + a spread. The goal of hedging against interest rate risk is only achieved in full if the present value of this spread is zero. Using market data we show that under a traditional IRS hedging strategy an investor could still experience significant cash flow losses given a 1% shift in the underlying benchmark yield curve. We consider the instantaneous interest-rate risk of a bond portfolio that allows for general changes in interest rates. We make two contributions. The paper analyzes the size of hedging imperfections arising from the widening of the floating rate spread in a traditional swap contract and subsequently proposes two new practical, effective and analytically tractable swap structures; Structure 1: An Improved Parallel Hedge Swap, hedges against parallel shifts of the yield curve and Structure 2: An Improved Non-Parallel Hedge Swap, hedges against any movement of the swap curve. Analytical representations of these swaps are provided such that spreadsheet implementations are easily attainable.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL:
Our checks indicate that this address may not be valid because: 404 Not Found. If this is indeed the case, please notify (Dr. Khawaja Mamun)
File Function: First version, 2010
Download Restriction: no

Bibliographic Info

Paper provided by Sacred Heart University, John F. Welch College of Business in its series Working Papers with number 2010001.

as in new window
Length: 30 pages
Date of creation: Mar 2010
Date of revision:
Handle: RePEc:she:wpaper:2010001

Contact details of provider:
Postal: 5151 Park Avenue, Fairfield, Connecticut 06825-1000
Phone: (203) 371-7880
Web page:
More information through EDIRC

Related research

Keywords: Portfolio Immunization; Interest Rate Swaps; Hedging; Floating Rate Spreads; Interest Rate Risk and Yield Curve;

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:


References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Li, Haitao & Mao, Connie X., 2003. "Corporate use of interest rate swaps: Theory and evidence," Journal of Banking & Finance, Elsevier, Elsevier, vol. 27(8), pages 1511-1538, August.
  2. Nance, Deana R & Smith, Clifford W, Jr & Smithson, Charles W, 1993. " On the Determinants of Corporate Hedging," Journal of Finance, American Finance Association, American Finance Association, vol. 48(1), pages 267-84, March.
  3. Huang, Ying & Chen, Carl R., 2007. "The effect of Fed monetary policy regimes on the US interest rate swap spreads," Review of Financial Economics, Elsevier, Elsevier, vol. 16(4), pages 375-399.
  4. Bicksler, James & Chen, Andrew H, 1986. " An Economic Analysis of Interest Rate Swaps," Journal of Finance, American Finance Association, American Finance Association, vol. 41(3), pages 645-55, July.
  5. Sun, Tong-sheng & Sundaresan, Suresh & Wang, Ching, 1993. "Interest rate swaps: An empirical investigation," Journal of Financial Economics, Elsevier, Elsevier, vol. 34(1), pages 77-99, August.
  6. Hugues Pirotte & Didier Cossin, 1997. "Swap Credit Risk: An Empirical Investigation on Transaction Data," Working Papers CEB, ULB -- Universite Libre de Bruxelles 97-001, ULB -- Universite Libre de Bruxelles.
  7. Duffie, Darrell & Huang, Ming, 1996. " Swap Rates and Credit Quality," Journal of Finance, American Finance Association, American Finance Association, vol. 51(3), pages 921-49, July.
  8. Minton, Bernadette A., 1997. "An empirical examination of basic valuation models for plain vanilla U.S. interest rate swaps," Journal of Financial Economics, Elsevier, Elsevier, vol. 44(2), pages 251-277, May.
  9. Larry D. Wall & John J. Pringle, 1988. "Interest rate swaps: a review of the issues," Economic Review, Federal Reserve Bank of Atlanta, Federal Reserve Bank of Atlanta, issue Nov, pages 22-40.
  10. Lang, Larry H. P. & Litzenberger, Robert H. & Luchuan Liu, Andy, 1998. "Determinants of interest rate swap spreads," Journal of Banking & Finance, Elsevier, Elsevier, vol. 22(12), pages 1507-1532, December.
  11. Balsam, Steven & Kim, Sungsoo, 2001. "Effects of interest rate swaps," Journal of Economics and Business, Elsevier, Elsevier, vol. 53(6), pages 547-562.
Full references (including those not matched with items on IDEAS)



This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.


Access and download statistics


When requesting a correction, please mention this item's handle: RePEc:she:wpaper:2010001. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dr. Khawaja Mamun).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.