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johnnyenglish
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Joined: January 2nd, 2013, 5:55 am

Basis swaps valuation

July 29th, 2013, 5:32 pm

I am trying to value a 10 year 3m Fixed for floating swap on USD LIBOR.I am confused on how do I do the projection of the LIBOR rates for the 10 years, which means 30 payments.The approach which i thin kI can use is : From the yield curve bootstrapped from Money market, futures and Swaps. I can pull the 3M points from the yield curve for the expiry point every quarter and then value it accordingly.now, the qustion in my mind if I do the above approach, I will be misspricing as I wont pick the basis that exists between 1m vs 3m and 3m vs 6 m during valuation.Can someone help me on how do I do this valuation ? It might be a silly question, but I am having trouble in choosing a starting point to think !!! :-(Thanks a lot for your help
 
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Martinghoul
Posts: 3255
Joined: July 18th, 2006, 5:49 am

Basis swaps valuation

July 29th, 2013, 11:41 pm

So you're trying to value a vanilla swap? What do the 1m3m and 3m6m bases have to do with anything here, if you take the 3m points from the curve?
 
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johnnyenglish
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Joined: January 2nd, 2013, 5:55 am

Basis swaps valuation

July 30th, 2013, 6:25 am

So if I value the floating leg from the 3m curve I will be projecting the rates for 10 y time. Now wouldn't a basis exist between the 3m vs 6m risk ? As far as I understand longer the projection using shorter end curves higher the chances a basis risk exist.?? Is this core t
 
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Martinghoul
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Joined: July 18th, 2006, 5:49 am

Basis swaps valuation

July 30th, 2013, 6:55 am

Yes, but you're projecting quarterly fixings, aren't you? You're not trying to project a 10y zero rate here, using the vanilla swaps curve...
 
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johnnyenglish
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Joined: January 2nd, 2013, 5:55 am

Basis swaps valuation

July 30th, 2013, 7:19 am

Yes, but then If I project the quarterly fixing using the 3M curve and the quarterly fixing using the 6M curve, there is going to be a difference right ?Isnt that an issue I should consider ?
 
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acastaldo
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Joined: October 11th, 2002, 11:24 pm

Basis swaps valuation

July 30th, 2013, 7:57 am

Since it is a swap of fixed vs 3 mo LIBOR, you use the 3mo curve to project. I don't understand what the 6mo curve has to do with it.You may also want to recheck your calculation re: 10 year swap, quarterly payments => 30 payments
 
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Samsaveel
Posts: 433
Joined: April 20th, 2008, 5:47 am

Basis swaps valuation

July 30th, 2013, 10:13 am

are there SA resetting USD swaps ;annual fixed vs 6m USD LIBOR ?
 
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johnnyenglish
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Posts: 8
Joined: January 2nd, 2013, 5:55 am

Basis swaps valuation

July 30th, 2013, 11:36 am

just plain vanilla swaps.Sorry acastaldo, not 30, payments there are 40pmts.Well it has nothing to do with 6M per se.But if thats the case, then.... If i project the payments using 6M curve for 3M expiry tenors and 3M curve for 3M expiry tenors . I should get the same valuation right ?
 
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Samsaveel
Posts: 433
Joined: April 20th, 2008, 5:47 am

Basis swaps valuation

July 30th, 2013, 12:20 pm

if you project your 3m libor off of your 6m libor curve then you need to capture your basis risk
 
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johnnyenglish
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Joined: January 2nd, 2013, 5:55 am

Basis swaps valuation

July 30th, 2013, 5:52 pm

Why is it wrong to value the 3m off 6m Libor ?That was the whole point I am trying to understand, actually !Thanks a lot
 
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DavidJN
Posts: 1733
Joined: July 14th, 2002, 3:00 am

Basis swaps valuation

July 30th, 2013, 6:18 pm

"Why is it wrong to value the 3m off 6m Libor ?"Ask yourself this, why is there a basis between 3-month and 6-month floating resets?
 
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johnnyenglish
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Joined: January 2nd, 2013, 5:55 am

Basis swaps valuation

July 30th, 2013, 9:29 pm

@DavidJN.A basis exits between 3M Libor and a 6M Libor because lending cash for 3M is less riskier(and so less costly) than lending cash for 6M. And so a basis exists the 2 curves. And, so valuing a 3M on a 3M Libor and a 6M off a 6M Libor makes sense. Is that right ?So, if I have a blended yield curve (made of money market instruments , futures and swaps) then, how do I value these floating leg portion of the Floating for swaps
 
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ThinkDifferent
Posts: 659
Joined: March 14th, 2007, 1:09 pm

Basis swaps valuation

July 31st, 2013, 12:47 am

as a matter of fact, tenor basis swaps are typically collataralized. so it is not counterparty credit risk that causes the spread....
 
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Samsaveel
Posts: 433
Joined: April 20th, 2008, 5:47 am

Basis swaps valuation

July 31st, 2013, 3:07 am

QuoteOriginally posted by: johnnyenglish@DavidJN.A basis exits between 3M Libor and a 6M Libor because lending cash for 3M is less riskier(and so less costly) than lending cash for 6M. And so a basis exists the 2 curves. And, so valuing a 3M on a 3M Libor and a 6M off a 6M Libor makes sense. Is that right ?So, if I have a blended yield curve (made of money market instruments , futures and swaps) then, how do I value these floating leg portion of the Floating for swapskeep your 6m curve,(-/+) basis swap spreads quoted in the market from the relevant nodes on the curve,do the usual bootstrap, get your DF,and forwards,reprice your swap off of the two curves separately.basis risk = NPV(Swap off Original 6m curve ) -NPV (swap off 6m curve (+/-) basis swap spreads )
 
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Martinghoul
Posts: 3255
Joined: July 18th, 2006, 5:49 am

Basis swaps valuation

July 31st, 2013, 4:53 pm

I don't understand the problem... What do basis swaps have to do with the valuation of a vanilla swap using a vanilla swap curve (in the case of USD, both are vs 3M LIBOR)?
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