- Joined
- 2/8/14
- Messages
- 41
- Points
- 18
Hello, I'm curious about how IRS are actually traded.
Does every trade result in the creation of a new IRS, or are IRS passed along?
For example, if I entered a vanilla swap with fixed coupon S with party A and then took the opposite position in an identical contract with party B, am I creating a second contract with party B, or am I giving my contract with party A to party B?
It seems like there must be a second contract created due to credit worthiness affecting the pricing that A would be willing to give us versus the price they would give B (and hence contracts are never passed along, they are always created anew). However, creating new contracts leads to a huge buildup of risk not accounted for by metrics such as PV01. Indeed, having no position is less risky than having offsetting positions with different parties since a default by one party leaves you fully exposed to the other, while the sensitivity to the yield curve is zero everywhere while a default doesn't occur (or if the default risk is symmetric in some sense).
Perhaps this is something accounted for which I simply haven't seen in coursework or while interning, but if it's not accounted for, banks, especially market makers, are likely sitting on far more risk than they are accounting for.
Does every trade result in the creation of a new IRS, or are IRS passed along?
For example, if I entered a vanilla swap with fixed coupon S with party A and then took the opposite position in an identical contract with party B, am I creating a second contract with party B, or am I giving my contract with party A to party B?
It seems like there must be a second contract created due to credit worthiness affecting the pricing that A would be willing to give us versus the price they would give B (and hence contracts are never passed along, they are always created anew). However, creating new contracts leads to a huge buildup of risk not accounted for by metrics such as PV01. Indeed, having no position is less risky than having offsetting positions with different parties since a default by one party leaves you fully exposed to the other, while the sensitivity to the yield curve is zero everywhere while a default doesn't occur (or if the default risk is symmetric in some sense).
Perhaps this is something accounted for which I simply haven't seen in coursework or while interning, but if it's not accounted for, banks, especially market makers, are likely sitting on far more risk than they are accounting for.
