Im ok on the steps until I get to the part where you find the PV of the floating payment. I have no ideas where the numbers come from in the examples provided in CFAI.
can anyone shed some light please?
It would be like valuing a floating-rate bond, which is simply the PV of all future cash flows.
You take the PV of the upcoming payment due on the floating leg (discounting at current rates, and remember this next payment is “off-market” since the floating rate was set in the past but due on the upcoming payment date).
Then, since the floating rate will reset to current market rates at the upcoming payment date, the PV of all future payments from that date forward will be equal to the notional of the swap (i.e.par on a floating rate bond, which would be represented by a discount factor of 1 in the swap valuation). Take the PV of this “par” value back to the valuation date.
Add these two together for your floating leg value.
I wrote a couple of articles that may be of some help here:
- Pricing plain vanilla interest rate swaps: http://financialexamhelp123.com/pricing-plain-vanilla-interest-rate-swaps/
- Valuing plain vanilla interest rate swaps: http://financialexamhelp123.com/valuing-plain-vanilla-interest-rate-swaps/
thank you thank you thank you
I may punt on floating rate swap valuation. Or maybe I’ll try to read S2000’s article.
(You’re welcome.)³
You can imagine which way I’d encourage you to lean.
(Seriously: it’s not difficult.)