Question

Explain the main features of receiver and payer swaptions, their equivalence to options on bonds and their pay-off structure.

Answer 1

Swaption is an option to enter swap at Fixed rate.

Main features of receiver swaption-

1. It is an option to enter into swap as a fix rate receiver.

2. It helps in speculation regarding to interest rates.

3. It also helps hedging against unfavourable interest rate moves.

Main features of payer swaption-

1. It is an option to enter into swap as a fix rate payer

2 They can also anticipate the need of terminating any existing swap and entering into another.

they are the equivalent to option as they are in fact an option to enter the swap but they have to be entered at a fixed rate.

The pair of structure is that it allows the holder to establish fix rate on the underlying swap in advance and have an option for entering into the swap at that fixed rates. There is a payment of premium involved.