I am having problems understanding the entire concept of swaps right know. primarily this formula 1-z4/sum (z’s) can anyone please shed some light on this? thanks in advance.
Those are just the discount rates at each point on the LIBOR curve. You use that formula to caculate the fixed rate of the swap.
Right, but why do we subtract z4 in the numerator?
It’s derived from a full formula when you would discount everything back and make the calculation. I believe the CFAI book takes you through all steps. That’ll shed some light.
agreed with mcpass ^ i think it has to do with the principal, that you get a small amount discounted back by each rate and then principal at the end. probably worth looking in the CFAI book or just memorizing it
If you can price a bond, then rearrange the formula to solve for the coupon that would generate a par bond at current rates. The “z” formula is just the short cut to solving for the coupon on a bond so that the price is 100 at current market rates. It would help to see an example so I agree with mcpass and mike.
http://www.analystforum.com/phorums/read.php?12,702537,page=1 This helped me a lot to understand swaps