Explain various types of Swaps. Or Explain briefly principles of an Active Portfolio Strategy (APS).

The various types of Swaps are as follows: (i) Plain Vanilla Swap: Also called Generic Swap or Coupon Swap and it involves the exchange of a fixed rate loan to a floating rate loan over a period of time and that too on notional principal. Floating rate basis can be LIBOR, MIBOR, Prime Lending Rate etc. For example, Fixed interest payments on a generic swap are calculated assuming each month has 30 days and the quoted interest rate is based on a 360-day year. Given an All-In-Cost of the swap, the semi-annual fixed-rate payment would be: (N)(AIC)(180/360), Where, N denotes the notional principal amount of the agreement. AIC denotes the fixed rate Then, the floating-rate receipt is determined by the formula: (N)(R)(dt/360) Where, dt denotes the number of days since the last settlement date R denotes the reference rate such as LIBOR, MIBOR etc. (ii) Basis Rate Swap: Also, called Non-Generic Swap. Similar to plain vanilla swap with the difference that payments are based on the difference between two different variable rates. For example, one rate may be 1 month LIBOR and other may be 3-month LIBOR. In other words, two legs of swap are floating but measured against different benchmarks. (iii) Asset Swap: Like plain vanilla swaps with the difference that it is the exchange fixed rate investments such as bonds which pay a guaranteed coupon rate with floating rate investments such as an index. (iv) Amortising Swap: An interest rate swap in which the notional principal for the interest payments declines during the life of the swap. They are particularly useful for borrowers who have issued redeemable bonds or debentures. It enables them to do interest rate risk hedging attached with redemption profile of bonds or debentures. OR There are four principles of an Active Portfolio Strategy (APS). These are: (i) Market Timing: This involves departing from the normal i.e., strategy for long run asset mix to reflect assessment of the prospect of various assets in the near future. Market timing is based on an explicit or implicit forecast of general market movement. In most cases investors may go largely by their market sense. Those who reveal the fluctuation in the market may be tempted to play the game of market timing but few will succeed in this game. Further an investment manager has to forecast the market correctly and 75% of the time he is only able to break even after taking into account the cost of errors and cost of transactions. (ii) Sector Rotation: Sector or group rotation may apply to both stock and bond component of the portfolio. It is used more compulsorily with respect to strategy. The components of the portfolio are used when it involves shifting. The weighting for various industry sectors is based on their asset outlook. With respect to bond portfolio sector rotation it implies a shift in the composition of the bond portfolio in terms of quality as reflected in credit rating, coupon rate, term of maturity etc. (iii) Security Selection: Security selection involves a search for under-priced security. If one has to resort to active stock selection he may employ fundamental / technical analysis to identify stocks which seems to promise superior return and concentrate the stock components of portfolio on them. As far as bonds are concerned security selection calls for choosing bonds which offer the highest yields to maturity and at a given level of risk. (iv) Use of Specialised Investment Concept: To achieve superior return, one has to employ a specialised concept/philosophy particularly with respect to investment in stocks. The concept which have been exploited successfully are growth stock, neglected or out of favour stocks, asset stocks, technology stocks and cyclical stocks.