Discount factor in swaps

CFA Level II Portfolio Management
#1

Hi everyone, I’m confused on little things now. Maybe I just need a knowledge refresh.

Before the reading about swaps, I think when it comes to PV calculation, I always discount the CF like this:

FutureCF/[(1+AnnualizedInterestRate)^T], where T can be between 0 and 1 — maybe I’m wrong here?

But when doing PV in swaps, the way is FutureCF/(1+AnnualizedInterestRate x T/360), where 0

Just suddently realized this, and I suspect that the first way of discounting is right. If it’s wrong, can anyone tell the the right way.

Please feel free to correct me. Thanks.

#2

swaps are based on LIBOR which is discounted in the way as (1+AnnualizedInterestRate x T/360)

it is an accepted convention.

#3

Thanks!

#4

A better way to think of it is that LIBOR rates are annual, nominal rates, not annual _ effective _ rates. So when they give you a 60-day (annual, nominal) LIBOR rate of 4.5%, the effective, 60-day rate is 4.5% × (60/360) = 0.75%; you will divide by (1 + 0.75%) = 1.0075. When they give you a 3-year (annual, nominal) LIBOR rate of 6.2%, the effective, 3-year rate is 6.2% × (1080/360) = 18.6%; you will divide by (1 + 18.6%) = 1.186.

EURIBOR works the same way: the rates are annual, nominal rates.