CFAI Text V5 P.516 : Using I/R Swaption to terminate a Sawp Anyone can summarize the key points in this topic ?
Buy a reciever swaption prior to maturity of interest rate swap with a strike rate equal to the current pay fixed rate. At expiry of the swaption choose one of the following: Option 1: If the new implied swap rate for a swap that matures on the same date as underlying swap, then buy a reciever swap and earn spread between new and exisiting swap rate. Option 2: if the new implied swap rate is below the underling swap rate then exercise swaption and 100% offset the cashflows of underlying swap. Example. Underlying SWAP ============ Pay fixed of 5% Matures 31st December 2012. Reciever Swaption ============= Recieve fixed of 5% starts 31st December 2010 Matures 31st December 2012 Implied Swap Rate on the 31st December 2010 ================================= Recieve fixed 6% Maturity 31st December 2012 Option 1 = Ignore option purchased and buy a reciever swap currently available. Spread of 6%-5% earned and the cashflows cancel on the 31st December 2012. Option 2 = Exercise Reciever Swaption and recieve 5% on swaption and pay 5% on the underlying swap. Cashflows are 100% cancelled from the 31st December 2010. Given the opportunity to earn a spread is available, option 1 would be chosen.
eadesr, TKVM for your summary, I will try to digest.