What is a ‘swap pillow’

Replacing airbags is a type of interest rate swap, whose nominal value is adjusted in response to fluctuations in interest rates. The development of these derivatives was to provide a way for counterparties on the link of interest payments associated with the swap to changes in interest rates.

Penetration change of airbags’

While the theoretical value to change the airbags will adjust to a change in interest rates, other derivatives such as swap will use the same notional principal amount. In a swap, the notional amount remains unchanged from the beginning, as it determines the interest rate for each leg of the swap. The swap makes payments based on the original conditional for the validity period of the swap.

The swaps have a floating leg, which is usually connected to a common rate index such as the London Interbank offered rate. Floating leg Airbag to change references to the constant maturity swap (CMS) rate is reset periodically against the fixed maturity of the instrument.

CMS responds to changes in prevailing interest rates and counterparty the equity notional amount of the credit on the basis of this relationship. As a result, rises or falls with changes in interest rates the par value of the underlying loan. These fluctuations, in turn, changes the amount of interest paid as interest you counted on more or less the size of the conditional.

When counterparties to establish a connection between the floating legs of the swap and the notional amount of the swap, they can do it in favor of the rate changes in one direction or another. Depending on the ratio between the floating leg and CMS, the nominal value can move either in the same direction as price or the opposite direction depending on the effect of counterparties wish to achieve.

In any case, the increase in theoretical or notional value of the swap leads to an increase in interest payments and the fall in the notional amount will reduce the number of interest payments. Swaps of the airbag are therefore useful for companies wanting to hedge investments are sensitive to interest rate fluctuations. The structuring of these tools can generate greater success than swaps under the same circumstances.

An example of a replacement airbag

A company with high sensitivity to rising interest rates by increasing the maturity in the bond market may try to compensate part of its losses through the swap airbag, aimed at increasing the nominal value of the swap as rates increase. The increase in the par value will generate profit for the company, because the amount of the payment, exchange for a higher interest rate will be higher than its net amount at lower interest rates.