Choosing Forecast and Discount Curves for Interest Rate Derivatives

Summary

The document explains how to select curves for valuing interest rate swaps and swaptions when floating indices have different tenors, such as three or six months. The curve associated with the floating index is used to forecast its cash flows: a swap referencing a three-month rate uses the three-month curve to estimate those payments.

Forecasting and discounting serve distinct purposes. Once the cash flows are estimated, they are discounted using a curve aligned with the derivative's funding or collateral arrangements. The answer gives the overnight indexed swap curve as the usual discounting curve for cleared swaps and says that the three- and six-month curves are rarely used for that purpose. This is a practical rule tied to the instrument's index and collateral or funding setup; the document does not cover detailed curve construction, market conventions, or exceptions for particular contracts. Its core distinction is between projecting index-linked cash flows and discounting those cash flows.

Key ideas

• Use the curve associated with a swap's floating index to forecast its floating cash flows.
• A three-month floating leg is forecast using the three-month curve.
• Choose the discounting curve to reflect the derivative's funding or collateral arrangements.
• The answer identifies the overnight indexed swap curve as the usual discount curve for cleared swaps.
• Forecasting and discounting are separate valuation steps.

Tags

# 3M curve vs 6M Curve, which one to use for valuation of IR Derivatrives


# 3M curve vs 6M Curve, which one to use for valuation of IR Derivatrives












Sorry, this might be basic for some of you but I'm very confused when it comes to know which curve (6m or 3m) we can use for valuations of swaps and swaptions. Could someone please explain when to use the 6M curve or 3M curve ? and why ? Thank you

## Answer by Attack68 (score 6, accepted)

https://quant.stackexchange.com/a/49929

You use the curve that describes the floating rate index to estimate the floating rate cashflows, a swap against floating 3M uses a 3M curve to forecast the cashflows.

And then you use a discounting curve to discount the future cashflows that aligns with the funding/collateralisation of the derivative. For example almost all cleared swaps will use the OIS curve for discounting. Very few use either the 3M or 6M curve.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.