Risk Latte - Fixed Income & Swaps

The bank has the right to cancel this swap after the global coupon accumulation has reached a target of 16% of Notional.

This is a product that satisfies the expectation that rates will move up slowly. In the first year, the bank will pay the investor a coupon of 9%. The product has a coupon cap of 16%. So the flat return on notional that you can enjoy from this point onwards is another 7%. Lets say in Year 2, Libor in arrears fixes at 1.50%. This means that the investor gets a coupon of 7% in the second year. This effectively causes cancellation of the swap, and the investor would have walked away with a 8% p.a. coupon for the first two years, and paid 6 month Libor. Of course, the risk is that if rates go up rapidly, it might take some time for the accumulated coupon to reach 16%, as a result of which, in certain periods the investor might end up with a negative carry. But given the huge carry in the beginning, and the fact that rates are expected to remain low, this is a very attractive swap.