PECULIARITIES OF INTEREST RATE SWAPS VALUATION

Abstract

Because of interest rate swap total market value have been noticed to grow recently in the OTC derivatives market, understanding the basic concepts underlying interest rate swap valuation takes on more importance in the global financial crisis conditions. This article deals with the interest rate swap pricing. Because a interest rate swap is equivalent to an asset and a liability, one can just value each of them to derermine the value of the interest rate swap at any moment in time. At origination, a swap will have zero value. Measuring the current market value of an interest rate swap involves five distinct stages: constructing a zero coupon yield curve, because it requires no assumptions about reinvestment rates on intermediate cash flows; determining forward rates to establish the amount of each future floating rate cash flow; deriving discount factors; discounting and present valuing all fixed and floating swap cash flows; determining swap rate. In this article we describe how to calculate the market value of a simple interest rate swap with a practical example.