Mapping a Forward Starting Payer Swaption to Swap Counterparty Exposure

Summary

The document translates a described swap exposure into a payer swaption: an option expiring in 15 months on a five-year forward-starting swap beginning two years after trade date, with a strike one percentage point above the at-the-money forward swap rate. The buyer’s exposure is the option’s value.

At expiry, the underlying swap has rolled forward: it starts nine months later and runs for five years. The buyer exercises if the then-current forward swap rate exceeds the agreed strike, entering a swap that pays fixed and receives floating. The answer specifies semiannual fixed payments and three-month LIBOR floating receipts, and notes that exercise may instead be cash settled at the swap’s present value. This is a brief description of the contract and exposure perspective; it gives no valuation formula, market inputs, or treatment of netting and collateral.

Key ideas

• The described position is a payer swaption expiring in 15 months on a five-year forward-starting swap.
• The underlying swap start date rolls forward as the swaption approaches expiry.
• The buyer exercises when the forward swap rate at expiry is above the agreed strike.
• The exercised swap pays fixed and receives floating, or may be cash settled at its present value.
• For the buyer, counterparty exposure is the value of the option.

Tags

# Counterparty exposure for a swap


# Counterparty exposure for a swap












What is the exact details of swap option whose PV gives the counterparty exposure at horizon of t=15months for a payer swap of strike 1% above ATM and length 5y starting at 2y?

## Answer by AlRacoon (score 1)

https://quant.stackexchange.com/a/49503

What you are describing is a payer swaption expiring in 15 months, with the strike being 1% above the current at the money forward swap rate for a forward starting swap where the swap starts 2yrs from now and ends 7 years from now (a 5 year forward starting swap).

The buyer of the payer swaption will exercise the swaption if at maturity in 15 months, the forward swap rate for a 5 year swap starting in 9 months and ending in 5years and 9 months is greater than the strike agreed on trade date. The terms of the underlying swap agreed to at trade date rolls down during the term of the swaption.

If exercised, they will enter into a forward starting swap where they will pay fixed strike rate (semi annually) and receive the floating rate (3M Libor) starting in 0.75 years and ending in 5.75 years from exercise date. Alternatively this can be cash settled at exercise for the then PV of that swap.

The counter party exposure is the value of that option if you are the buyer.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

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