PROFITABILITY CALCULATION AND ANALYSIS FOR INTEREST RATE SWAP USING THE HULL WHITE MODEL
Abstract
The London Inter-Bank Offered Rate (LIBOR) volatility had resulted in higher interest rate risks faced by many big companies and financial institutions whose assets depend on the interest rate. Eventually, there was an appearance of the new financial product development that can be used for hedging, such as interest rate swap, one of the most popular methods, utilized by most financial institutions and big companies which use LIBOR as their benchmark. In fact, it is not uncommon for numerous companies to gain negative return from this swap transaction. Therefore, in this paper, we used the Hull-White model to predict the LIBOR rate, since this model has a decent level of accuracy, calculated using Root Mean Squared Error (RMSE) method. Furthermore, the estimation of LIBOR rate was used to calculate the net value of interest rate swap transaction, in three scenarios, using, respectively, the minimum value, the average value, and the maximum value of the LIBOR’s estimation results to provide an analysis of potential P/L (Profit & Loss) exposure due to the realization of interest rate swaps.
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