Please help- I understand the part where a swap is priced at swap rates not FRA rates that make it zero value interim, but does this imply that the IRS starts off as an off market FRA?
All they’re saying is that you use the same fixed rate for the entire swap, but you would have different fixed rates on each of the FRAs if they were market FRAs. If you created a series of FRAs all with the same fixed rate as the swap, then each of the FRAs would (most likely) be an off-market FRA: the present value of each would not be zero. (However, the sum of the present values would obviously be zero: some will have a positive PV and others a negative PV.)
Got it - so its a figurative comparison - but the actual interest rate swap would still have no value to either side at initiaion…
Thanks again S2000!!
Correct, and you’re quite welcome.
(Recall, too, that they’re equivalent, but not identical, because the swap is paid in arrears, whereas the FRAs will be paid in advance.)
Thanks for that - the devil is in the details!!! You are the best S2000Magician
It’s quite common in the IRS market to enter swaps that have an accrued at initiation, so essentially both legs don’t match perfectly, and there is an accrued that leads to a fee payment from the party having the better receive leg.
With the Swap Execution Facility (SEF) regulation coming Mutually Agreed Coupons (MAC) are becoming popular where fixed coupon are set at various levels 1, 2, 3 pc etc and dealers quote the price to enter the swap.
Having said that, I reckon as far as level 2 is concerned value at initiation =0.