# Monthly Archives: May 2010

## Online Finance – Pricing Interest Rate Swaps – Pricing Basis Swap

Pricing Basis Swaps or Floating for Floating Swaps The same methodology will be used to price floating for floating or basis swaps, except that zero curves and forward rates will be derived for both legs of the swap accordingly. The following basis swap has been

## Online Finance – Pricing an Interest Rate Swap – Calculating the MTM of the Swap

Step 13: Determine the cash flows The cash flows for the receiving and paying legs are as follows: Fixed Leg Payment Floating Leg Payment Period End Rate Cash flow Rate Cash flow 01/01/2011 12.00% 7,200.00 12.65% 7,590.00 01/01/2012 12.00% 12,000 12.77% 12,772.30 01/01/2013 12.00% 12,000

## Online Finance Course – Pricing Interest Rate Swaps – Calculating the forward curve

Deriving the Forward Curve Step 9: Deriving forward rates In order to derive forward rates from the zero coupon rates for successive interest rate periods the bootstrapping methodology has been employed. In particular the following formula has been used: Where t is the tenor in

## Online Finance Course – Pricing Interest Rate Swaps – Calculating the forward curve

Deriving the Forward Curve Step 9: Deriving forward rates In order to derive forward rates from the zero coupon rates for successive interest rate periods the bootstrapping methodology has been employed. In particular the following formula has been used: Where t is the tenor in

## Online Finance Course – Pricing Interest Rate Swaps – Calculating the zero curve

Deriving the Zero Curve We use the bootstrapping method for deriving the zero curve from the par term structure. This is an iterative process that allows use to derive a zero coupon yield curve from the rates/ prices of coupon bearing instruments. The step by

## Online Finance Course – Pricing Interest Rate Swaps – Fixing the term structure

Defining the Par Term Structure Step 1: Select an appropriate term structure Based on the interest rate swap being priced an appropriate term structure or structures will be chosen. This is an important process because both the zero curve and the forward curves are derived

## Online Finance Course – Pricing Interest Rate Swaps – Process

Pricing Interest Rate Swaps The following process will be followed when determining the value or price of an interest rate swap. Firstly, a default par term structure will be defined. This consists of selecting an appropriate par term structure based on the terms of the

## Online Finance Course – Pricing Interest Rate Swaps – What is a Swap?

Swaps This is an agreement between two parties, usually institutions, to exchange cash flows according to a predefined calculation at specified periodic intervals in the future. The calculation may be based on the future value of interest rates, foreign exchange rates or some other market

## Online Finance Course – Pricing Interest Rate Swaps – More terminology

Relationship between Spot and Forward Rates The following formulas summarize the relationship between the spot and forward rates of interest: ft-1,t = (1+st)t ÷ (1+st-1)t-1 – 1 or alternatively As can be seen above the spot rates are geometric averages of the forward rates of

## Online Finance Course – Pricing Interest Rate Swaps (IRS) – Terminology and Notation

Online Finance – Pricing Interest Rate Swaps – Session One Definitions Cash flows The key to pricing or valuing any instrument is to estimate the cash flows of the instrument and discount each cash flow using an appropriate rate of interest. Cash flow is simply

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