A range accrual note is a structured product where the coupon of the bond (which can be either a fixed coupon or a floating coupon) is conditional on some event happening.
That is, interest only accrues on days when the observation index (usually the LIBOR index) falls within a specified range, set using an upper and a lower barrier. The observation rate is typically monitored on a daily basis within the coupon period, but it can also be monitored weekly or monthly. Accordingly, for each day the observation rate fixes within the predefined range, one day of interest is accrued. If the observation rate fixes within the predefined range every day of the monitoring (or accrual) period, then 100% of the fixed coupon rate is paid out. Generally, for each day the observation rate fixes outside the predefined rate, no interest is accrued. However, you can define a minimum coupon rate to be paid even if the observation rate is out of the predefined range on a fixing date.
There are two styles of range accrual note, the difference between them being in whether the instrument can be terminated (or called). In a:
Non-callable style range accrual note the instrument cannot be called.
Bermudan style of range accrual note (also known as a callable range accrual note), the issuer of the bond (i.e., the payer of the structured coupon) always has the right but not the obligation to terminate the range accrual note on any of the pre-defined fixing (or termination) dates during the life of the note, typically at par.
Although there is no penalty for terminating the instrument on any of the predefined dates, the coupon paid will generally be higher than that of a non-callable range accrual note. This higher coupon is the price paid for having the right to call the instrument.
Advantages of a Range Accrual Note
A structured bond has a structured swap behind it. In addition to being able to value the underlying swap using the range accrual swap, bond structurers can also directly structure the bond themselves using the range accrual note. This instrument lets the bond structurer enter the structure and see the price of the bond assuming a specific funding level.
Pricing a Range Accrual Note in SDX Interest Rates
When pricing a range accrual note in SDX Interest Rates you have to specify:
Whether the note is a Bermudan style (i.e., callable) or non-callable.
The Observed Index.
The high and low barriers.
The minimum coupon to be paid by the structured leg in the event that the observed index falls outside the specified range. The minimum coupon can be specified as a fixed or floating coupon.
The Face Amount.
It is also important to note that:
If you choose to make the note callable, then by default the system sets the call dates to match the start dates of the underlying coupons using the call frequency.
In the Callable Dates and Fees window (accessed by clicking the Call Dates button in the pricing page) you can then edit the notice dates and also cancel any of the automatically scheduled call dates. For more information on working in this window, see Working in the Callable Dates and Fees Window.
The system returns the bond price assuming a specific funding level.
SDX Interest Rates calculates the rates (either the market rate for the fixed coupon or the floating spread rate for the floating coupon) so as to give a zero NPV. However, you can edit these rates manually. If you do change these rates be aware that this will result in a non-zero NPV.