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Adfin Swaps

Theory Guide
Adfin Swaps - Theory Guide

Adfin Swaps - Theory Guide

Last Revised 05 March 03

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Adfin Swaps - Theory Guide

TABLE OF CONTENTS

1. INTRODUCING ADFIN SWAPS .................................................................................... 5

1.1. PRODUCT DESCRIPTION ...........................................................................................................5

1.2. FUNCTIONS OVERVIEW .............................................................................................................5

1.3. DEFAULT SETTINGS ...................................................................................................................5

2. INTEREST RATE HEDGING INSTRUMENTS .............................................................. 7

2.1. HEDGING PRINCIPLES ...............................................................................................................7


2.1.1. Interest Rate Hedging ................................................................................................................7
2.1.2. Single Period Hedging vs Multiple Periods Hedging .................................................................7
2.1.3. Interest Rate Guarantee vs Option Based Products .................................................................7

2.2. SINGLE PERIOD HEDGING.........................................................................................................7


2.2.1. FRAs and Interest Rate Futures ................................................................................................7
2.2.2. IRGs and Interest Rate Futures Options ...................................................................................8

2.3. MULTIPLE PERIODS HEDGING ..................................................................................................8


2.3.1. Interest Rate Swaps...................................................................................................................8
2.3.2. Caps, Floors and Collars ...........................................................................................................8

3. SWAP MARKET OVERVIEW ...................................................................................... 10

3.1. MARKET CONVENTIONS ..........................................................................................................10


3.1.1. Interest Rate Convention .........................................................................................................10
3.1.2. Day Count Basis ......................................................................................................................10
3.1.3. Date Moving Convention..........................................................................................................11
3.1.4. End-of-Month Convention ........................................................................................................12

3.2. CHARACTERISTICS OF A SWAP..............................................................................................12


3.2.1. Notional Principal .....................................................................................................................12
3.2.2. Interest Payments ....................................................................................................................13
3.2.3. Effective Date...........................................................................................................................13
3.2.4. Reset Dates .............................................................................................................................13
3.2.5. Calculation Periods ..................................................................................................................13
3.2.6. Payment Dates.........................................................................................................................14
3.2.7. Rounding Capabilities for Swaps.............................................................................................14

3.3. SWAP VALUATION AND PRICING ............................................................................................15


3.3.1. Terminology .............................................................................................................................15
3.3.2. Swap Valuation ........................................................................................................................16

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3.3.3. Swap Pricing ............................................................................................................................17

3.4. OVERNIGHT INDEXED SWAP...................................................................................................18


3.4.1. OIS Definition ...........................................................................................................................18
3.4.2. Cash Flow Structure ................................................................................................................18
3.4.3. Valuation and Pricing ...............................................................................................................19

4. IRS STYLE DATABASE .............................................................................................. 20

4.1. IRS STYLE ..................................................................................................................................20

4.2. IRS STYLE MANAGEMENT WINDOW ......................................................................................20

4.3. IRS STYLE STRUCTURE WINDOW ..........................................................................................21

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1. INTRODUCING ADFIN SWAPS

1.1. PRODUCT DESCRIPTION


Adfin Swaps is a module of PowerPlus Pro 4.5 not only dedicated to the valuation of existing swaps
but also to the pricing of new swap structures providing ready-to-use models and user-friendly
functions.

Adfin Swaps covers most interest rate swaps and currency swaps based on all types of floating rate
references, either pre-determined (i.e. the rate that applies is known at the beginning of the period)
such as the 3-month LIBOR, or post-determined (i.e. the rate that applies is known at the end of the
period) such as the Overnight Indexed Swap. Adfin Swaps also supports non-standard swap types
such as broken and backset swaps.

All standard day count, end-of-month and date moving conventions are supported by Adfin Swaps.
Calendar management and date calculation are handled by a separate software module called Adfin
Dates. Adfin Dates includes preset calendars corresponding to the world´s major countries, and no
prior knowledge of foreign holidays is required to perform accurate calculation on non-working days.

Please refer to the Adfin Dates documentation and on-line help for further information concerning the
corresponding topics.

1.2. FUNCTIONS OVERVIEW


Adfin Swaps is also a function library designed to handle most swap analytics. It provides the user
with an easy-to-use toolbox for creating his/her own templates with the spreadsheet application.

Adfin Swaps functions include:

net present value calculation


cash flow generation
swap solving

1.3. DEFAULT SETTINGS


Adfin Swaps uses default settings for some of its calculations. To set any of these default settings, use
the default setting dialog box.

The available settings are described below.

Paid Leg Type

The sign applied by Adfin Swaps to the fixed and floating payments depends on the paid leg type. The
default type is used unless another type is specified with the keyword PAID in the IrsStructure
Argument.

Adjustment Mode

The adjustment mode is the method used to calculate the coupon dates of the swaps (see Calculation
Periods). This method is used unless another mode is specified using the keyword CFADJ in the
IrsStructure Argument.

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Date Conventions

The date moving convention is the convention that applies when a calculated date falls on a non-
working day. This convention is used unless another convention is specified using the keyword DMC
in the IrsStructure Argument.

The end-of-month convention is the convention that applies when a calculated date falls on the last
day of a month. This convention is used unless another convention is specified using the keyword
EMC in the IrsStructure Argument.

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2. INTEREST RATE HEDGING INSTRUMENTS

2.1. HEDGING PRINCIPLES

2.1.1. Interest Rate Hedging

Hedging is a technique that allows an entity already exposed to risk, to reduce or eliminate this
exposure by adopting an opposite position using hedging instruments.

The interest rate risk arises from the impact of fluctuating interest rates. The most common exposure
is simply the level of interest rates, but some entities may be vulnerable to the shape of the yield
curve.

2.1.2. Single Period Hedging vs Multiple Periods Hedging

One key factor in hedging is the term during which the entity wants to be protected against the interest
rate risk.

Single period instruments such as FRAs and interest rate futures can be used to obtain protection
against rate movements for a specified future period. For longer terms, hedging can be achieved with
strips of single-period instruments covering the term in several successive periods such as interest
rate swaps.

2.1.3. Interest Rate Guarantee vs Option Based Products

Another key factor in hedging is the type of protection required.

A complete protection against interest rate risk means a guaranteed interest rate for months or years
into the future. This complete elimination of risk also means the avoidance of beneficial outcomes as
well as bad ones. Option-based products such as caps, floors and collars are the alternative solution
to provide protection against the downside while preserving the opportunity to benefit from the upside.

2.2. SINGLE PERIOD HEDGING

2.2.1. FRAs and Interest Rate Futures

FRAs and futures are contracts made between two parties that call for some specific action, usually
the delivery of some underlying asset, to take place at a future date. Futures contracts differ from
forward contracts in several ways as described below.

FRAs

An FRA, or Forward Rate Agreement, is an agreement between two parties concerning a forward-
forward loan granted at a fixed interest rate. It provides a protection against a movement in interest
rates. The buyer of an FRA is the borrower, and is therefore protected against a rise in interest rates.
The seller of an FRA is conversely protected against a fall in interest rates.

No actual lending or borrowing takes place under an FRA. The notional principal amount is not
exchanged, but it is used to calculate the settlement sum which compensates for the difference
between the interest rate originally agreed and that prevailing when the FRA expires.

In practice, the rate is generally not determined at the beginning of the contract period (settlement
date), but two days earlier on the fixing date. Moreover, the settlement sum is usually paid on the
settlement date, that is at the beginning of the underlying loan or deposit. That is why this sum is

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adjusted to compensate the interest that could be earned if it was invested from the settlement date to
the maturity date.

Interest Rate Futures

Unlike FRAs, future contracts trade on futures exchanges and are highly standardized. A short-term
interest rate futures contract fixes the interest rate that will apply during a future period which begins
on a pre-defined delivery date. Buying a futures contracts is equivalent to making a fixed-rate deposit,
whereas selling a futures contract is equivalent to borrowing.

Interest rate futures contracts are quoted on an indexed price defined as 100 minus the reference
interest rate in percent. This definition ensures that, no matter what occurs during the life of the
contract, its final price always matches that in the cash market.

2.2.2. IRGs and Interest Rate Futures Options

FRAs and interest rate futures prevent from benefiting from positive interest rate fluctuations. Option-
based products such as IRGs and interest rate futures options allow to benefit from better cash market
conditions when the option expires.

IRGs

A borrower wishing to be protected for a single short period in the future against a rise in interest rates
can fix his borrowing rate, either by buying FRAs, or by selling futures. He then avoids the risk but he
loses the opportunity to take advantage of lower borrowing rates at the beginning of the hedging
period.

On the other hand, a call on a FRA (Interest Rate Guarantee) provides the interest rate protection by
capping the borrowing rate at the strike price, but also allows to benefit from a fall in interest rates
simply by letting the option expire.

Interest Rate Futures Options

Option on an interest rate futures contract if similar to IRGs except that they are traded on futures
exchanges and the terms of such contracts are completely standardized.

2.3. MULTIPLE PERIODS HEDGING

2.3.1. Interest Rate Swaps

If a borrower requires finance for a long term, it would normally only be available on a floating-rate
basis. The term would be split into a number of periods, and the interest rate for each successive
period would be fixed at the start of the period.

To obtain protection under such circumstances, the borrower could fix the rate by buying a strip of
FRAs, or by selling a strip of futures. The interest rate swap, or IRS, is simply a tailor-made instrument
equivalent of a strip of FRAs.

2.3.2. Caps, Floors and Collars

Caps, floors and collars are interest rate risk management products based on strips of options. Like
interest rate swaps, they allow to hedge a long-term exposure that spans multiple periods, each of
which succeeds the other. Contrary to Interest Rate Swaps, they still allow benefiting from
advantageous market conditions.

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Caps

Borrowing at a fixed-rate while being able to benefit from lower interest rates on a long term period is
possible using a strip of call options on FRAs (or put options on interest rate futures), or interest rate
cap. Each one of the individual options is called a caplet.

In practice, the seller of the cap will pay the cap holder (purchaser) the difference between the
prevailing market reference rate and the contract ceiling rate each time the market rate is greater than
the cap rate. Thus, the borrower buying a cap obtains protection against higher market rates.

Floors

An interest rate floor is a multi-periodic interest rate option identical to an interest rate cap except that
the seller of a floor pays the purchaser when the reference rate drops below the floor rate. If interest
rates fall through the floor level on any reset date, the relevant option or floorlet will be exercised.

Collars

The combination of selling a floor at a lower strike rate and buying a cap at a higher strike rate is
called a collar. Collars are widely used for hedging interest rate risk over an extended period because
they provide protection against a rise in interest rates as well as benefit from a fall.

Collars can be defined as:

Collar = Cap − Floor


Where

Cap : caplet value


Floor : floorlet value

Vanilla, Barrier, and Digital Caps and Floors

Adfin Analytics enables you to price standard Vanilla caps and floors, as well as Barrier and Digital
ones.

See Also

Vanilla caps pricing


Barrier caps pricing
Digital caps pricing

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3. SWAP MARKET OVERVIEW

3.1. MARKET CONVENTIONS

3.1.1. Interest Rate Convention

The calculation of the interest paid by an investment of principal P, at a fixed annual interest rate r,
during the time in years t, requires the choice of an interest rate convention.

Money Market Basis

The money market basis calculation assumes that the interest is proportional to the length of the
investment (pro rata temporis):

Interest = P. r . t

Actuarial basis

The actuarial basis calculation assumes that the interest is compounded (reinvested) during the length
of the investment:

Interest = P ((1 + r ) t − 1)

Notes

To be fully defined, the coupon calculation method must include an interest rate convention and a
day count convention that indicates how the maturity factor t is calculated. See Day Count Basis for
detail.
The term compounding may also be used to indicate that some coupons are not actually paid but
reinvested. See Payment Dates for detail.

See also

Coupon calculation method keyword CCM in:

IrsStructure Argument
CsStructure Argument
SwapStructure Argument

3.1.2. Day Count Basis

The day count basis is used to calculate the payments exchanged in the swap transaction. The basis
applicable should be defined for each leg of the swap.

The available bases are described below.

Actual/Actual

For the calculation or compounding period or portion of period that falls on a non-leap year:

Nb Days : Actual number of days in the period or portion of period


Year Length : 365

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For the calculation or compounding period or portion of period that falls on a leap year:

Nb Days : Actual number of days in the period or portion of period


Year Length : 366

Actual/365 (Fixed)

Nb Days : Actual number of days in the calculation or compounding period (regardless of leap
years)
Year Length : 365

Actual/360

Nb Days : Actual number of days in the calculation or compounding period


Year Length : 360

30/360 or Actuarial basis

Nb Days : Actual number of days in the calculation or compounding period calculated on the
basis of a year of 360 days with twelve 30-day months unless:
• The last day of the period is the 31st day of a month and the first day
of the period is a day other than the 30th or 31st day of a month, in
which case the month that includes the last day shall not be
considered to be shortened to a 30-day month
• The last day of the period is the last day of the month of February, in
which case the month of February shall not be considered to be
lengthened to a 30-day month
Year Length : 360

30E/360 or Eurobond Basis

Nb Days : Actual number of days in the calculation or compounding period calculated on the
basis of a year of 360 days with twelve 30-day months (regardless of the date of the
first day or last day of the period)
Year Length : 360

Notes

To be fully defined, the coupon calculation method must include a day count convention and an
interest rate convention that indicates on which basis the interest is calculated. See Interest Rate
Convention for detail.
The day count basis of an interest rate swap is generally consistent with the basis on which the
floating rate reference is quoted.

See also

Coupon calculation method keyword CCM in:

IrsStructure Argument
CsStructure Argument
SwapStructure Argument

3.1.3. Date Moving Convention

The date moving convention is used to adjust the period dates and the payment dates when they fall
on a non-business day.

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The available conventions are described below.

None

The date is not moved.

Preceding

The date is moved to the preceding business day.

Following

The date is moved to the following business day.

Modified Following

The date is moved to the following business day, unless it causes the date to be pushed into the next
month (in this latter case, the last working day of the month is used).

See also

Date moving convention keyword DMC in:

IrsStructure Argument
CsStructure Argument
SwapStructure Argument

3.1.4. End-of-Month Convention

The end-of-month convention is used when a period is added to either the thirtieth day of a month
other than February, or the last day of the month of February. The resulting date depends on the
convention used as shown below.

Same

The date numerically corresponds to the calculation date (unless there is no such day, in which case
the date is set to the last day of the month).

Last

The date is set to the last day of the month in all cases.

See also

End-of-month convention keyword EMC in:

IrsStructure Argument
CsStructure Argument
SwapStructure Argument

3.2. CHARACTERISTICS OF A SWAP

3.2.1. Notional Principal

In a swap contract, both parties agree to exchange at certain times in the future some cash flows
(called interest payments or coupons) calculated on different bases. One element needed for the
calculation of those cash flows is the nominal principal amount in the agreed currency.

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The notional principal may or may not be actually exchanged. For interest rate swaps, the principal is
never exchanged. For currency swaps, the principals in both currencies are exchanged sometimes at
the swap start date, and always at the swap end date.

Instead of remaining constant, the notional principal can vary through the life of the swap according to
a pre-determined pattern. In an amortizing swap, the principal reduces in successive periods. In an
accreting or step-up swap, the principal increases gradually over time. If the principal reduces in some
periods and increases in others, the swap is described as a roller-coaster swap.

3.2.2. Interest Payments

Two of the key items which must be agreed for a swap contract are the payment basis and the
payment frequency. Interest payments are usually annual, semi-annual, or quarterly, but their
frequency may differ for both the paid and the received legs.

In a standard interest rate swap, one party makes to the other party periodic payments based on a
fixed rate (this series of cash flows is referred to as the fixed leg), while the other party pays to the first
party, on the same or another periodic basis, some floating amounts determined during the lifetime of
the swap by reference to a specific market rate, called the floating rate reference or floating rate option
(this series of cash flows is referred to as the floating leg).

In a currency swap, the legs may be either both fixed, or both floating, or one fixed and the other
floating. Besides, the currencies of the two legs are different, and the notional principal is always
exchanged on the swap maturity date.

3.2.3. Effective Date

The effective date is the date when interests start to accrue on both legs. This date is usually one or
two business days after the trade date.

3.2.4. Reset Dates

The reset date is the date when the floating rate for the next period is determined. It generally occurs
one or two business days before the beginning of the period on which the floating rate applies.

The first reset date for a pre-determined floating rate reference occurs always before the swap
effective date and is usually equal to the trade date.

3.2.5. Calculation Periods

The calculation period is the period during which the paid and received rates defined for the period
apply. Coupons start to accrue at the calculation period start date, and end to accrue at the calculation
period end date. This period is also called the compounding period.

The start date of the first period is always equal to the effective date. Subsequent period start dates
are also always equal to the preceding period end dates. The calculation periods are then fully
determined as soon as all period end dates are known.

Adfin Analytics enables you to handle the calculation periods by specifying a combination of the cash
flow adjustment keyword CFADJ and the reference date keyword REFDATE in the SwapStructure or
IrsStructure arguments.

The three algorithms available in Adfin Swaps for the end dates calculation are described below.

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Unadjusted Mode

Use the combination CFADJ:NO REFDATE:MATURITY to apply the Unadjusted Mode. The i-th period
end date occurs the day that numerically corresponds to the swap end date in the month that is i
periods after the month of the effective date. The end-of-month convention applies if there is no such
day.

Standard Mode

Use the combination CFADJ:YES REFDATE:MATURITY to apply the Standard Mode. The i-th period
end date occurs the day that numerically corresponds to the swap end date in the month that is i
periods after the month of the effective date (the end-of-month convention applies if there is no such
day), unless this date is a non-business day (in which case the date is adjusted using the date moving
convention).

FRN Mode

Use the combination CFADJ:YES REFDATE:ISSUE to apply the FRN Mode. The first period end date
occurs the day that numerically corresponds to the swap start date in the month that is one period
after the month of the effective date, unless this date is a non-business day. The (i+1)-th period end
date occurs the day that numerically corresponds to the i-th period end date in the month that is one
period after the month of the i-th period end date, unless this date is a non-business day.
Adjustments are made using the end-of-month convention and the date moving convention like in the
Standard Mode.

Note

Since the payment frequencies for the paid and the received legs can be different, the number of
calculations periods in the swap lifetime can be different for both legs.

See also

Reference date keyword REFDATE and cash flow adjustment method keyword CFADJ in IrsStructure
Argument and SwapStructure Argument

3.2.6. Payment Dates

One interest payment ends accruing at the end of the calculation period of the corresponding leg.
However, there may be a delay between the calculation period end date and the actual payment date.
When existing, this delay is generally defined as a number of business days.

The payment frequency for the floating leg may also be different from the coupon frequency. In other
words, the floating rate interest is compounded on several calculation periods until payment occurs (in
such cases, the floating leg payments generally occur on the fixed leg payment dates).

See also

Payment delay keyword PDELAY in IrsStructure Argument

3.2.7. Rounding Capabilities for Swaps


Adfin Swaps supports the new keyword CRND to define the rounding mode for the output coupon
value. The available rounding modes with their respective formulas are the following:

CRND:0.001:UP:

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CRND:0.001:DOWN:

CRND:0.001:NEAR:

Where

x : the value to round


floor : the whole part

The precision i is specified by CRND:i:{UP, DOWN, NEAR}. In the previous formulas, i is equal to
0.001.

See also

Coupon calculation rounding keyword CRND in:

IrsStructure Argument
SwapStructure Argument

3.3. SWAP VALUATION AND PRICING

3.3.1. Terminology

Several different terms are used in the field of swaps financial engineering to describe different
techniques. This section aims at clarifying those terms.

Valuation

Valuing a swap consists in finding the net present value of an existing swap for which the rates have
been already set.

Netting

Netting is very similar to valuation. The only difference lies in the fact that netting generally describes
how the swap should be valued in case of a counterparty failure. The terms netting and valuation will
therefore be considered as synonymous in the remainder of this documentation.

Pricing

Swap pricing usually implies the calculation of a swap rate such as the net present value equals a
predefined value (generally zero).

See also

Swap Valuation
Swap Pricing

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3.3.2. Swap Valuation

Any swap, no matter how complex, can be described as two series of cash flows, one for the paid leg
(cash outflows), and another for the received leg (cash inflows). The net present value of any of those
legs is the sum of the present value of the corresponding cash flows.

The calculation of the net present value of a swap leg is a two-step process. First, the payment
amounts (or cash flows) have to be estimated. Second, those payments have to be valued by applying
zero-coupon rates. Both steps involve the use of a zero-coupon curve.

Cash Flows Amount

The interest payments are calculated using the standard formulas:

P. d . r
CFi = for a money market basis
B

d
CFi = P ((1 + r ) B − 1) for an actuarial basis

Where

CFi : future cash flow occurring at time i


P : notional principal
d : number of days in the calculation period
r : fixed or floating annualized interest rate applicable for the period
B : day count basis

For the fixed leg of an interest rate swap, the coupon rate r applicable for the period is known right
from the trade date, so all fixed payments are known in advance.

On the contrary, floating rate payments have to be estimated calculating the forward floating rates
from the zero-coupon yield curve. The only exception to this is the next cash flow (i.e. paid or received
at the end of the current calculation period) that can be precisely calculated for pre-determined floating
rate options (the coupon rate r applicable for the period is indeed known a few days before the period
start date).

In Adfin Swaps, the CCM keyword allows the user to specify the coupon calculation method (see the
IrsStructure, CsStructure, and SwapStructure Arguments for detail).

Cash Flows Present Value

A set of discount factors di can be determined from the zero-coupon yield curve.

For periods longer than one year, zero-coupon rates are calculated assuming compounded interest,
and discount factors can be obtained using the formula:

1
di =
(1 + ri ) t i

Where

di : discount factor at time i


ri : zero-coupon rate from value date to time i
ti : time in years from value date to time i

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If a cash flow occurs at a time in the future for which the zero-coupon rate is not known, the zero-
coupon rate or the corresponding discount factor must be interpolated (Adfin Swaps offers appropriate
methods for both coupon rate and discount factor interpolations).

The present value of a cash flow is then:

PFi = d i . CFi

Where

PFi : present value of the future cash flow occurring at time i


CFi : future cash flow occurring at time i
di : discount factor at time i

Net Present Value of Interest Rate Swaps

The net present value of an interest rate swap is the difference between the net present values of the
received and the paid legs:

N M
NPV = ∑
i =1
d i . CFi − ∑d
j =1
j . CF j

Where

CFi : cash flow received at time i


CFj : cash flow paid at time j
N : number of cash flows in the received leg
M : number of cash flows in the paid leg

Net Present Value of Currency Swaps

In a currency swap, one of both currencies is chosen to be the discount currency. The net present
value of the leg of the discount currency is calculated as described above for an interest rate swap.
The net present value of the other leg is calculated converting each cash flow to the discount currency
using the corresponding outright rate (calculated from the spot rate and the swap point at the cash
flow date) and discounting them using the zero-coupon curve of the discount currency.

Notes

For accounting purposes, it may be useful to calculate the accrued interest, i.e. the portion of the
current coupon already due or owned since the calculation period start date (the accrued interest is
calculated pro rata temporis from the coupon value).
CURVESHIFT enables you to apply a shift of i to the rates of your yield curve. Adfin Swaps then
gives you the ability to take into account the risk of a swap in your calculations using Adfin Swaps
functions. You can apply the parallel shift, whatever the rate model you use (Yield to Maturity, Hull
and White, Vasicek-Fong, Black and Scholes, etc.).
For more information about the calculation of implied forward rates and discount factors, see the
Adfin Term Structure online help.

3.3.3. Swap Pricing

Two counter parties contracting a swap will generally choose either the fixed rate, or the margin above
or below the floating reference rate option, such that the net present value of the swap is zero.

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Fixed Rate Pricing

To price the fixed rate for any kind of interest rate swap, the floating leg is first valued using a set of
zero-coupon rates (or discount factors), and the fixed rate you search is the one which makes the
present value of the fixed leg equal to the present value of the floating leg:

∑ P .d .t .r
i =1
i i i i

r= M

∑ P .d
j =1
j j .t j

Where

r : annualized interest rate of the fixed leg


ri : implied forward rate of the floating leg calculation period i
dj : discount factor at the fixed leg calculation period end date j
di : discount factor at the floating leg calculation period end date i
tj : time in years of the fixed leg calculation period j
ti : time in years of the floating leg calculation period i
Pj : notional principal of the fixed leg calculation period j
Pi : notional principal of the floating leg calculation period i
M : number of cash flows in the fixed leg
N : number of cash flows in the floating leg

In standard swap contracts, the notional principal is constant through the swap life. The above formula
becomes simpler, and the fixed rate can be determined without the knowledge of its value.

3.4. OVERNIGHT INDEXED SWAP

3.4.1. OIS Definition

An Overnight Indexed Swap, also called call money swap, is a fixed/floating interest rate swap with
the floating leg tied to a daily overnight (or Tom/Next in some markets) rate reference. The term
generally ranges from one week to one year.

3.4.2. Cash Flow Structure

The two parties to an OIS agree to exchange at maturity, on the agreed notional amount, the
difference between interest accrued at the agreed fixed rate and interest accrued through
compounding the floating index rate. There is no exchange of principal.

Fixed
coupon

Trade Start Net


date date Floating payment
coupon

The start date is generally two trading days or more (forward transactions) following trade date, but it
can also be the same as the trade date. The maturity date is on the same day as the start date of the
maturity month (or next open business day). The payment is always netted on the maturity date, even
if it can be actually deferred a couple of days later.

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Adfin Swaps - Theory Guide

Coupon Calculations

Consider an OIS with a fixed rate R, a notional amount N and d days from effective date (i.e. start
date) to maturity date.

The fixed coupon is calculated as follows:

d
Pfix = N × R ×
basis

The compounded settlement rate is given by:

 p  r × ni   basis
CSR = ∏ 1 + i  − 1 ×
 i =1  basis   d

Where

i : index for open business days


p : number of open business days
ri : overnight or Tom/Next index rate for day i (rp is the rate one or two business before
maturity)
ni : number of days from which ri is valid (normally one day or three days for
weekends)

Therefore we have:

∑n
i =1
i =d

This compounded settlement rate is then rounded, and the floating coupon is calculated as the fixed
coupon:

d
Pfloat = N × CSR ×
basis

3.4.3. Valuation and Pricing

Common swap techniques for pricing and valuing are used for OIS. Briefly, since OIS replicate cash,
building a zero-coupon yield curve from them is the same as building from cash rate. For each
benchmark, with Z the zero-coupon rate and R the OIS swap rate, we have:

 d 
(1 + Z )365
d
= 1 + R × 
 basis 

Valuing is done projecting unknown rates using a zero-coupon yield curve built from benchmark swap
rates, and then discounting the cash flows using the same zero curve. Pricing is done calculating the
present value and solving for the fixed rate that gives a present value of zero.

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Adfin Swaps - Theory Guide

4. IRS STYLE DATABASE

4.1. IRS STYLE


In order to avoid fastidious definitions of numerous attributes in the extended parameter
IrsStructure, Adfin Swaps includes an IRS style database.

This IRS style database contains about 20 different swap structures which correspond to the major
countries, and is therefore ready-to-use. Those default IRS styles may be edited but cannot be
modified by the user. However, new IRS styles can be added to the database if needed.

Each IRS style stored in the database is referred to by a code (such as USD_AM32L,...). This code
can be used as a new keyword (with no corresponding value) for any IrsStructure Argument. For
instance, using DEM_AB6L as IrsStructure argument stands for "LBOTH CLDR:GER ACC:AA
ARND:NO CFADJ:YES CRND:NO DMC:MODIFIED EMC:SAMEDAY IC:S1 PDELAY:0
REFDATE:MATURITY RP:1 RT:BULLET XD:NO LPAID LTYPE:FIXED CCM:BB00 FRQ:Y
LRECEIVED LTYPE:FLOAT SPREAD:0 CCM:MMA0 FRQ:S". This new keyword can be followed by
others attributes which will overwrite part of the data defined for the IRS style (e.g. the default coupon
frequency for the fixed leg will be set to semi-annual using the string "DEM_AB6L LFIXED FRQ:2").

Note

Holidays are managed through calendars defined in the Adfin Dates calendar style database.

4.2. IRS STYLE MANAGEMENT WINDOW


The IRS styles defined in the database are displayed in the IRS style list.

From that window, the user can manage the IRS style database as detailed below.

Editing an Existing IRS Style

An IRS style should be edited to view or modify its features.

To edit an IRS style

Select an IRS style in the IRS style list, and choose Open.
Or double click the IRS style.

See IRS Style Structure Window for information about working with the edited IRS style.

Deleting an Existing IRS Style

To delete an IRS style

Select an IRS style in the IRS style list, and choose Delete.

Creating a New IRS Style

When creating a new IRS style, the user has the option to create it from scratch or make a copy of an
existing IRS style.

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Adfin Swaps - Theory Guide

To create an IRS style

Select an IRS style in the IRS style list, and choose New to create a new IRS style as the copy
of an existing one.
Or choose New without selecting any IRS style to create an IRS style from defaults.

See IRS Style Structure Window for information about working with the newly-created IRS style.

Exiting the IRS Style Management Window

To exit the IRS style management window

Choose Close.

4.3. IRS STYLE STRUCTURE WINDOW


The IRS style structure window is used to view or modify the features of an IRS style.

The available options are detailed below.

Defining the IRS Style

To define the IRS style

1. Enter the IRS style Code.


2. Enter the IRS style Name.
3. Select the proper option for Paid Leg Type.
4. Enter the code of the Calendar that describes the swap holidays.
5. Select the proper option for the fixed and floating legs Coupon Frequency.
6. Select the proper option for the fixed and floating legs Coupon Calculation Method.
7. Select the proper option for the fixed and floating legs Date Moving Convention.
8. Select the proper option for the fixed and floating legs End-of-Month Convention.
9. Select the proper option for the fixed and floating legs cash flows Adjustment Mode (see
Calculation Periods).
10.Select the proper option for the fixed and floating legs Payment Delay (see Payment Dates).
11.Select the proper option for the fixed and floating legs Reference Dates (see Calculation
Periods).
12.Select the proper option for the floating leg Index Reference.

Testing the IRS Style

To test the IRS style

Choose Structure to display the equivalent IRS structure string.

Exiting the IRS Style Structure Window

To exit the IRS style structure window

Choose OK to exit and save changes, or Cancel to exit without saving.

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