Trading Case SW2


This case is the same as SW1 except that it has private information as described below.


Case Objective

In this case approximately one third of the trading crowd are trading desks for large financial institutions and two thirds of the trading crowd are firms.  Each firm’s objective is to manage interest rate risk by trading swaps as market takers and each desk’s objective is to make money by making market in swaps.  In addition, financial institutions can deal among themselves in two offshore deposit markets.  As a trader in SW1 you will be randomly assigned to being either a firm or a financial institution and this role may change across market trials.  Financial institutions will open each trading trial with a flat position – zero endowments of cash and securities.  As a result, a trading desk’s end of trial cash represents their dealing gains or losses from trading in the market.  Each firm will open with a position that has a zero net present value given prior information.  Part of this position, (i.e., coupon bonds) is non tradable.  This locks each firm into an interest rate risk exposure which they can only manage by trading interest rate swaps.  Different firms will have opposing starting positions so that managing interest rate risk will generate both buy and sell orders from the market taking firms in the swap markets.  Offsetting demands in the swap markets from market taking firms can be filled from the dealing activities of financial institutions competing against other financial institutions.  All firms will start with a position that has a zero present value with respect to prior information (i.e., information available before the trading trial starts). 


As a firm, at the beginning of the first trading period you will have additional access to private information that is relevant for predicting future interest rates.  Firms can assess their exposure to interest rate risk given whatever current information they possess. 


Key Concepts

Eurodollar deposits, interest rate swaps, managing a swap book from both the client and dealers perspectives.


Cash (or Money) Market:  Firms will either have a long or short initial position in the cash or money market.  As a result, in this market you are either receiving or paying the realized 1-period spot rate of interest each period. 

Coupon Bond:  Firms will have an initial long or short position in a three period coupon bond.  Coupon rates are paid relative to LIBOR (the realized spot London Interbank Offer Rate).  This market cannot be traded and so an Institution’s opening balance represents the institutions exposure to fixed interest rate risk.  The face value of this bond is USD$1,000,000 and the coupon rate is 2% applied relative to face using an Actual/Actual day count convention and quotation is in decimals rather than fractions (the International Swaps and Derivatives Association (ISDA) euro bond market conventions).  Coupon frequency, however, is semi-annual in this case.

2-Period Eurodollar deposit:  This is a deposit market open to among dealer trading.  The initial deposit per unit is USD$1,000,000 and the rate for the deposit is the price you negotiate in the market.  That is, rates are bid or asked for.  The rate determines the terminal value of your deposit at the time of maturity assuming an Actual/360 day count.  Quotations for rates are annualized and in percentages consistent with the real world markets.  For example, if you hit a quote of 1.5 this is applied is applied as 1.5% assuming Actual/360 day count in the simple or add-on interest rate form to the initial deposit..  In this market you have both dealing (i.e., market making rights) as well as regular market taking rights.  In the example titled market making vrs market taking below we will illustrate precisely what the differences are.

3-Period Eurodollar deposit:  This is the same as the previous market except the life is three periods.

3-Period Interest Rate Swap Trading Desk Set A:  This is a swap market quoted in terms of the rate applicable to the fixed leg.  That is, long a swap pays fixed and receives floating relative to the notional principal of $1,000,000.  Trading desk A contains quotes from a subset of swap dealers from in the market.  The quotation convention for the swap is an annualized fixed rate quoted as a decimal.  It is applied to the fixed leg on a 180/360 day count convention across reset periods.

3-Period Interest Rate Swap Trading Desk Set B:  This trading desk contains quotes from a second subset of dealers in the market and the quotes relate to the same swap contract as being quoted for by Desk A.

3-Period Interest Rate Swap Trading Desk Region C:    This trading desk contains quotes from a third subset of dealers in the market and the quotes relate to the same swap contract as being quoted for by desks A and B.


Side Note:  The reason for three identical swap markets is that it permits different bid/ask spreads to be posted that may vary in terms of how many contracts the market maker is willing to buy/sell.  It is also set up for Industrial Firms to be able choose among different financial intermediaries as market takers.


Market Trials


A market trial covers three periods of calendar time (i.e., 18-months).  Trading takes place in only the first two periods.  In period 3 markets will open and immediately close so that all positions are marked to market in period 3 at the realized LIBOR rate but no further trades are permitted.


Actual Days per 6-month period:  Period 1 covers 182 days, period 2 181 and period 3 182 days.  The money market convention for a year is 360 so day count convention applied to Eurodollar deposits and the floating side of the swap is Actual/360.  The day count convention applied to the fixed leg of the swap is 30/360 (i.e., 180/360 for 6-months) and the day count convention applied in the coupon bond market is Actual/Actual.  These day count conventions are consistent with real world International Swap Dealer Association (ISDA) practices.


Spot and Expected Spot Rates

The spot interest rate for the first 182 days is 1.29% per annum.  The future rates covering the next 181 and 182 days are stochastic when viewed from the beginning of a trading trial.  The possible set of realized spot rates at the beginning of periods 2 and 3 contain three possibilities each period.  The three possibilities are high, medium and low.  For period 2, the high rate is 1.5%, medium is 1.25%, and low is 1%.  Each rate is equally likely.  For period 3 the possibilities are 1.99%, 1.39%, 1% again each is equally likely.  Each of these rates is applied to the cash balance in your money market at the end of each trading period on an Actual/360 day count basis (assume actual equals 182, 181, and 182 days respectively).


In this case institutions will receive private information about the possible realizations but swap dealers  will not receive any private information.  The nature of private information is described in the next section.  Over repeated trials, as a trader, your role may change from dealer to institution or it may remain the same but change across desks.


You can short sell any security and borrow and lend at the current realized spot LIBOR rate for the period.

Prices in this case are determined by the traders, so all trades will take place at bids and asks that either you or another trader in the system puts in.


Private Information

Each firm gets private interest rate information about period 2 and period 3.  The private information will be displayed as follows:

Per2:  Not low rate, Per2: Not middle rate, Per2:  Not high rate, Per3:  Not low rate, Per3: Not middle rate and Per3: Not high rate. 

This information is never false.  Per3:  Not high rate tells the trader that the realized spot rate for period 3 cannot be 1.99% and so on.

This information lets you form a view about the future movement of the yield curve.  You should try to incorporate this information into your assessment your firm’s exposure to shifts in the yield curve and trade in accordance with this assessment.


Viewing Private Information in FTS Trader

A single click on the name CpBnd (Security 1 under the heading Security Name and after the market starts) reveals your private information in the text box (top middle of the FTS Trader screen).


Case Data

The cash flows from the bonds are:



Payout at end of

Period 1

Payout at end of

Period 2

Payout at end of

Period 3

Cp Bond




Deposit 2-Per


If purchased in period 1: $1M*(1+price*363/360)

If purchased in period 2:  $1M*(1+price*181/360)





If purchased in period 1: $1M*(1+price*545/360)

If purchased in period 2:  $1M*(1+price*363/360)

If purchased in period 3:  $1M*(1+price*182/360)



Reset Period 1:  Long swap pays $1M*price*180/360 and receives $1M* realized decimal spot rate * 182/360

Notional is not exchanged

Reset Period 2:  Long swap pays $1M*price*180/360 and receives $1M* realized decimal spot rate * 181/360

Reset Period 3:  Long swap pays $1M*price*180/360 and receives $1M* realized decimal spot rate * 181/360

Notional is not re-exchanged


Same as DESKA

Same as DESKA

Same as DESKA


Same as DESKA

Same as DESKA

Same as DESKA


Price in the above is the quoted decimal “annualized rate.”  That is, price is day count adjusted in accordance with the money market convention.

Note the fixed side of the swap has a day count convention of 180/360 (implying fixed side is an equal series of cash flows as is common in the real world swap markets).  The floating leg uses the standard money market convention of Actual/360 for the day count convention.


Money Market Time Line


In the money market your cash balance will either accrue or pay interest at the spot rate for the current period times your closing balance.  That is, within trading day transactions do not attract interest.  You can borrow or lend from your cash account during trading.




Trading in the money market is different to trading in regular bond and stock markets.  As a result, we will work through some examples that illustrate what happens when you either make market or take market in the Eurodollar deposit markets or the swap markets.  In particular, you should become acquainted with what it means to have a “long” or “short” position in these markets and how the cash flows work relative to how they are quoted.


Example 1 (Market Making versus Market Taking Eurodeposit Market):  By dealing and trading in this market the trading crowd determines a bid/ask spread.


What is a bid and ask?


In the deposit market a “bid” is the dealer’s posted “borrowing rate.”  That is, if you submit a bid to this market at i% for 1 unit, you are prepared to borrow $1,000,000 for the remaining life of the deposit at i% (applied on an Actual/360 day count basis.  If some other trader hits your bid then your cash balance will increase by $1,000,000 and at the end of the deposit’s life you will repay $1,000,000*(i/100)*(Actual days/360)  from the time you purchase the $1,000,000 until the time of maturity.


Similarly, the ask is the dealer’s “lending rate.”  If you submit an Ask at j% for 1 unit then you are prepared to lend $1,000,000 for the remaining life of the deposit at j% applied on an Actual/360 day count basis. 


A positive bid ask spread in the Eurodollar deposit market implies that the market maker is prepared to borrow at a lower rate than the market maker is prepared to lend.   For example, suppose the following set of transactions are realized.


Transaction 1:  Market maker posts a bid of 1.5% for 100 units.  That is, the market maker is prepared to pay 1.5% for up to $100 Million of deposits

If the dealer’s bid is hit for 1 unit (i.e., $1M) the dealer receives $1,000,000 from the client and the client’s cash account is decreased by $1,000,000.  At the end of the deposits life the dealer repays the client $1,000,000*1.015*Actual/360.


If any trader double clicks the security name on the trading screen they will see the trading book plus how it adjusts in real time.  On this screen you will also see your future obligation associated with your current position in this Eurodollar market.  For example, the active market maker whose bid was successful will see the obligation (i.e., a negative number) of $1,000,000*1.015*Actual/360).  The client who hit the bid will see +$1,000,000*1.015*Actual/360.


The “Ask side of a deposit market”


This is a “loan market” and the dealer is prepared to lend to the client at the Ask %.  Continuing this example suppose the dealer has posted the bid/ask spread at 1.5% for 10 units bid, and 2.0% for 10 units ask.  In this case the dealer is prepared to lend cash to the client at the rate of 2% per annum.  As a result, if the client hit’s the dealer’s Ask then the client receives +$1,000,000 and is obligated to payback a terminal amount equal to $1,000,000*1.02*Actual/360.  So cash at the time of the transaction increases and the obligation is negative and equal to $1,000,000*1.02*Actual/360.


Example 2 (Market Making versus Market Taking Swap Market)


If a dealer posts a bid/ask spread of 1.5 for 10 units and 2.0 for 10 units to the swap market it works as follows. 


First, a bid of 1.5 for 10 units implies that the market maker is prepared to buy up to 10 swaps (up to a total notional principal of $10,000,000) for a fixed rate of 1.5% fixed each reset in exchange for the floating rate each reset period.  No cash is exchanged at the time of entering into 10 swaps, but at the end of reset period the buyer (i.e., long side) is obligated to pay fixed applied as $10,000,000*(1.5/100)*(180/360) in exchange for receiving $10,000,000*(Realized spot rate % for the current reset period/100)*(Actual Days/360).  At the end of the life of the swap no notional is exchanged only the final net interest rate payment.


Market Takers Perspective:  Suppose you hit the market makers bid for the 10 swaps at 1.5%.  The market maker is long 10 swaps and you will be short 10 swaps.  Being short implies that you are obligated to pay Libor flat in exchange for 1.5% applied to the notional principal at their respective day count conventions.  That is, at the end of each reset period you receive from the market maker $1,000,000*0.015*180/360 and in exchange you pay the market maker the realized 1-period Libor applied as $1,000,000*realized Libor as a decimal*Actual/360.


Summary of Cash flow implications:  No cash is exchanged at the time of entering into the swap.  At the end of each reset period the long side pays the fixed rate obligation day count adjusted and receives the floating rate in exchange day count adjusted.  In both cases the rates are applied to the notional principal.  Finally, at the swaps maturity no notional is exchanged but the final interest rate transfer is realized.


Earning Grade Cash

Your goal is to manage both your risk and return of your position.  All traders will commence with a position that has a net present value equal to zero at the beginning of trial 1 (before any private information is observed).  That is, all traders commence with an ex ante position that has an equal net present value relative to the set of possible interest rate paths across the three periods.  Your goal is to implement the objective associated with your assigned role.  Your terminal market value is computed from your final cash balance after your position is marked to market at the end of period 3.

Performance Evaluation:  After the trading session you will be evaluated as follows.  Each trial your rank in terms of the current trial’s market cash is computed and across trials your average ranking on a per trial basis is computed relative to your assigned role (dealer or firm). 


Spreadsheet Support for SW1

The FTS trader lets you create and link in real time to your own spreadsheet support system.


If you choose to create a spreadsheet support system for this trading case the following cell information is relevant:


Spreadsheet Cols run from A (blank), B (Security), C (Bid), D (Bid Qty) etc., and rows run from Row 1 (Headings), Row 2 (CpnBond), Row 3 (Deposit 1Yr), Row 4 (Deposit 18M), Row 5 (SwpBk1) etc.,



The above cells are fixed and general across FTS cases.  That is, the first security’s bid comes into cell C2, etc., whenever you perform the Spreadsheet link.


Performing spreadsheet link is simple.  First open Excel.  In the FTS Trader click on the File Menu item and then select  Excel link. 


Next click on the button Find Excel Workbooks.  Select the work book you want to link to.  Be sure to link Market Data and Trading History to two different sheets.  Then click OK.  The link is maintained in real time.


If you have multiple copies of Excel open you may have to use the bottom half of the above screen to locate the workbook you are looking for. 


Tip:  It is recommended that you only have 1 copy of Excel running if possible.