A snowball is both a generic term for an entire family of structured products as well as the name for one particular member of that family. The generic term snowball refers to those structured swaps or notes which have direct path dependence of the coupons. That is, the payout of each coupon (of course with the exception of the first coupon) is dependent on the payout of the coupon immediately preceding it.
As with all structured swaps, the snowball swap is most often used in the construction of snowball notes and bonds. It is a highly leveraged bet on the direction of the market. That is, due to its path dependency, any trend in the floating rate, whether increasing or decreasing, causes the coupon payments to increase or decrease faster than in vanilla swaps. Accordingly an investor whose view on the movement of interest rates is correct will receive higher coupons than would have been received in a vanilla swap. Conversely, an investor whose view on the movement of interest rates was incorrect will receive far lower coupons than would have been received in a vanilla swap.
Which Snowball Structured Products Does SDX Interest Rates Support?
SDX Interest Rates supports the following snowball structured products:
(Vanilla) snowball
The payout for a path dependent coupon in a vanilla snowball, commonly known simply as a snowball, is calculated as follows:
Payout = Min(Max Coupon, Max(Min Coupon, FixedRate + Prev Coupon * Previous Coupon Leverage - Index * Index Leverage))
The formula for the first coupon is necessarily different, as it of course cannot be path dependent. If the first coupon is based on a:
Floating rate then the payout formula is:
max(MinCoupon, min(MaxCoupon, Fixed Rate - Floating Rate Leverage * Floating Rate)
Fixed rate, then no calculation is needed to calculate the rate of interest paid.
As indicated by the fact that in the payout calculation the index (and also any index leverage) is subtracted from the other terms, this structure floats inversely with the floating rate. It is therefore a bull market structure. That is, as the floating rate falls, the potential coupon payments increase.
You would therefore enter into an investment with a regular snowball style coupon to express a bull market view, which says that you expect fixed income instruments to increase in value.
Reverse snowball
The payout for a path dependent coupon in a reverse snowball is calculated as follows:
Payout = Min(Max Coupon, Max(Min Coupon, FixedRate + Prev Coupon * Previous Coupon Leverage + Index * Index Leverage))
The formula for the first coupon is necessarily different, as it of course cannot be path dependent. If the first coupon is based on a:
Floating rate then the payout formula is:
max(MinCoupon, min(MaxCoupon, Fixed Rate + Floating Rate Leverage * Floating Rate)
Fixed rate, then no calculation is needed to calculate the rate of interest paid.
As indicated by the fact that in the payout calculation the index (and also any index leverage) is added to the other terms in the formula, this structure floats directly with the floating rate It is therefore a bear market structure. That is, as the floating rate increases, the coupon payments increase.
You would typically choose to receive a reverse snowball style coupon to express a bear market view, which says that you expect fixed income instruments to decrease in value.
It is important to note that for both the snowball and reverse snowball, both callable (or Bermudan) and non-callable styles are supported.
What is a Callable Snowball Structure?
In a Bermudan snowball structure, the payer of the structured leg (i.e., the leg whose payout is calculated according to the formulae described above) has the right to call (or terminate) the swap on any of the specified call dates.
The right to terminate the swap reduces the risk to the payer of the structured leg. In return, the coupon paid by the receiver of the structured leg is reduced.
In SDX Interest Rates, by default a snowball structure is automatically defined as a callable structure. You can of course then make it a non-callable structure.
Pricing a Snowball in SDX Interest Rates
Pricing a snowball centers mainly around the specification of the coupons and their payouts.
There are a number of parameters needed to define the coupon payouts as follows:
Coupon type
There are a number of coupon types:
Floating
Fixed
Path dependent
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Once you have defined a path dependent coupon, it can only be followed with another path dependent coupon. That is, you cannot subsequently add a fixed or floating coupon. |
The first coupon (also known as the seed coupon) can only be based on a fixed interest rate or a floating interest rate; that is, it cannot be path dependent. This is because once you have defined a path dependent type, you cannot subsequently add a floating or fixed type.
In addition to the first coupon, you may have additional fixed or floating coupons if you want the instrument to begin now, but you only want the path dependent part of it to begin at some point in the future.
Index
This defines which index is used for the floating rate value in the payout formula. It is used for any floating coupons, and for any path dependent coupons. It is always multiplied by a leverage factor. Accordingly, if you want to just use the floating rate, you should set the index leverage to 1. The index chosen must match the fixing frequency selected.
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This parameter is set globally. That is, it is used for all the coupons, and cannot be edited for individual coupons. |
There are two ways to specify the coupons’ payouts:
You can define the coupon payout parameters using the relevant fields in the pricing page (as seen in Figure 1), whereby the details you enter are then used for all coupons, as relevant.
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The details you enter in these fields are then used for all coupons, as relevant. By default, all coupons with the exception of the first one are assigned a path dependent type. |
Figure 1: Coupon Specification Fields in the Pricing Page
Using the Coupon Structuring window.
This window, which is accessed by clicking the Coupon Structuring button in the pricing page, lets you specify different parameters for each coupon payout as required.
For more information on working in this window see Working in the Coupon Structuring Window .
It is also important to note that if you define the style of the instrument to be 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.