DIFFERENTIAL INTEREST RATE FIX
DESCRIPTION
A
Differential Interest Rate Fix (DIRF) is a contract that moves with reference
to the SLOPE of a yield curve. The DIRF is meant for those who wish to profit
from a steepening or flattening of one yield curve. The DIRF is customised with
defined settlement dates, a defined value per basis point, and two defined
points on the yield curve.
EXAMPLE
Assume
an investor believes that the Italian yield curve will flatten over the next
year more than that implied in the market. The client would enter into a
flattening DIRF, say 2 years versus 7 years, for settlement in one year. The
investor selects the amount per basis point they wish to transact, say ITL
1,000,000 per point. The DIRF price is given in terms of basis points. If at
maturity the difference between the 2yr and 7yr ITL Swap rates has flattened
below the DIRF level, the investor will receive ITL 1,000,000 for every basis
point lower. If the difference is higher than the DIRF level, i.e. the curve
has steepened, the investor will lose ITL 1,000,000 per basis point.
PRICING
The
entry price is calculated by taking the difference between the implied forward
rates for the two yield curve points chosen. This means in the above example,
we calculate the one year forward 2yr rate and the one year forward 7 yr rate.
The DIRF price is the difference. Investors who BUY the DIRF look to see the
curve steepen, investors who SELL the DIRF look to see the curve flatten.
TARGET MARKET
This is
a product for people who wish to take a position on the SLOPE of the yield
curve without taking an outright position on a curve.
ADVANTAGES
·
Available in all major currencies
·
Can utilise any two points on the yield curve
·
Can be reversed at any time with reference to the then
prevailing implied rates
·
Investor determines amount per point sensitivity
·
Settlement at maturity is against independent mid rate
quoted on Telerate
·
No Exposure to parallel movement in yield curve
DISADVANTAGES
·
The attractiveness of DIRFs is dependent on the Implied
Forward, rates not the spot rates, therefore expected movements can already be
built in.
PRODUCT SUITABILITY
Simple Aggressiv
