This note introduces interest-rate swaps, financial contracts wherein two parties agree to exchange interest-rate cash flows, typically in the form of an exchange between fixed-rate payments and floating-rate payments. Interest-rate swaps are valuable risk-management tools for entities seeking to alter the composition of their interest-rate exposure, as swaps enable them to hedge against fluctuations in interest rates. This note covers how these swaps are priced, the understanding of which is essential for effective risk management and corporate financing decision-making. At the Darden School of Business, this technical note is taught in the first-year "Valuation in Financial Markets" class; it would also be suitable in a module covering interest rates in a derivatives elective course.
In this note, we cover how bond prices change as yields change. Students are shown that the price of a bond is a function of its promised payments and the prevailing required rate of return by investors: the bond's yield. Since the promised payments are generally fixed, changes in the price of a bond relate to changes in its yield. The note introduces the most common measures of interest-rate risk (the sensitivity of bond prices to changes in yield), the Macauley duration and modified duration, and it guides students through calculating their value for two bonds issued by Amazon.com. At the Darden School of Business, this technical note is taught in the first-year "Valuation in Financial Markets" class; it would also be suitable in a module covering bond pricing and interest rates within the first-year core finance course of an MBA program, or to introduce the pricing of bonds in an investment course.
Just before Warren Buffett's company, Berkshire Hathaway Inc, acquired H. J. Heinz Company on February 14, 2013, rumors had been circulating that the Omaha investing oracle had set eyes on the condiment giant. By the time the official acquisition was announced, questions had arisen about some unusual trading activity in financial markets. A very profitable trade was made on the option market just a few days before the announcement: a $90,000 trade that resulted in profits of around $1.8 million. The case puts students in the shoes of a fictional SEC analyst in charge of investigating rumors of insider trading in the context of Berkshire Hathaway's acquisition of Heinz. Which market would an informed investor with limited capital choose? Which option contract would the insider choose, and why? The case allows the instructor to introduce option "Greeks," measures of sensitivity of option contracts to underlying risk factors. The Greeks are presented in an intuitive fashion, and the analysis provides an applied, true-to-life setting to a topic that students often consider very abstract.