Features of Interest Rate Swaps

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Dexter's statements regarding swaps are correct. Let's break down each statement and explain why they are accurate:

1. "In a plain-vanilla interest rate swap, there is one floating rate-payer and one fixed-rate payer."

This statement is correct. In a plain-vanilla interest rate swap, two parties agree to exchange interest payments based on a notional principal amount. One party, known as the floating rate-payer, pays interest based on a floating rate, typically linked to a reference rate such as LIBOR (London Interbank Offered Rate). The other party, known as the fixed-rate payer, pays a predetermined fixed interest rate. The floating rate is usually reset periodically, such as every six months, based on the reference rate plus a spread.

2. "The netting arrangements typical to plain vanilla swaps reduce the credit risk for both counterparties."

This statement is also correct. Netting arrangements in interest rate swaps refer to the process of offsetting the payment obligations between two parties. Rather than exchanging the full interest payments, the net amount is calculated, and only the party with the larger payment obligation pays the difference to the other party. This netting process helps reduce credit risk by minimizing the amount of cash flow exchanged between the counterparties. By reducing the number of transactions and cash flows, the credit exposure is reduced, making it less likely for one party to default on their payment obligations.

3. "Some interest rate swaps may have two floating rate payers."

This statement is correct as well. While the traditional structure of an interest rate swap involves one party paying a fixed rate and the other paying a floating rate, it is possible to have variations in swap structures. In some cases, there can be two floating rate payers in an interest rate swap. This means that both parties in the swap pay interest based on floating rates tied to the same reference rate, such as LIBOR. The specific terms and conditions of the swap agreement determine the payment obligations for each party.

In summary, both of Dexter's statements are correct. In a plain-vanilla interest rate swap, there is one fixed-rate payer and one floating rate-payer. The netting arrangements in such swaps help reduce credit risk for both counterparties. Additionally, while less common, it is possible to have interest rate swaps with two floating rate payers.