Cash market instruments, package

There are two ways that a swap position can be interpreted (1) a package of forward/futures contracts and (2) a package of cash flows from buying and selling cash market instruments. 

To understand why a swap can also be interpreted as a package of cash market instruments, consider an investor who enters into the transaction below ... 

The terminology used to describe the position of a party in the swap markets combines cash market jargon and futures market jargon, given that a swap position can be interpreted as a position in a package of cash market instruments or a package of futures/forward positions. As we have said, the counterparty to an interest rate swap is either a fixed-rate payer or floating-rate payer. Exhibit 19.2 describes these positions in several ways. 

As explained earlier in this chapter, a swap position can be interpreted as a package of forward/futures contracts or a package of cash flows from buying and selling cash market instruments. It is the former interpretation that will be used as the basis for valuing a swap. In the case of a EURIBOR-based swap, the appropriate futures contract is the 3-month EURIBOR futures contract. For this reason, we will briefly describe this important contract. 

As we have seen, interest rate swaps are valued using no-arbitrage relationships relative to instruments (funding or investment vehicles) that produce the same cash flows under the same circumstances. Earlier we provided two interpretations of a swap (1) a package of futures/forward contracts and (2) a package of cash market instruments. The swap spread is defined as the difference between the swap s fixed rate and the rate on the Euro Benchmark Yield curve whose maturity matches the swap s tenor. 

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