Default Risk and Innovations in the Design of
Interest Rate Swaps
Keith C. Brown
Donald J. Smith
Financial Management 22, 1993, pp. 94-105
This paper analyzes two design innovations to the structure
of an interest rate swap intended to minimize financial loss if the
counterparty to the agreement defaults.
First, we show how default risk exposure can be substantially reduced by
periodic marking to market of the swap’s fixed rate. Second, we demonstrate the mechanics of a
‘forward rate’ swap, which would have a time-varying fixed rate
rather than a uniform rate for all settlement periods. We develop numerical examples for each
innovation and discuss practical considerations in implementing the designs.
Download this paper (PDF format)
Return to
Keith Brown’s Published Paper Page