Vanilla Swap

A vanilla swap, also known as an IRS or interest rate swap, lets you swap the interest rate basis of an asset or liability from a floating rate to a fixed rate or vice versa, or from one floating rate to another floating rate, without changing the characteristics of the underlying asset or liability.

Each of the parties pays a different rate to the other.

Either:

One of the parties pays a fixed rate and receives the floating rate (this party is called the payer), and the other party pays the floating rate and receives the fixed rate (this party is called the receiver).

Each party pays a floating rate based on a different reference rateFor a vanilla swap on BRL, one of the legs is always based on a fixed rate and the other leg is always based on a floating rate.1.

In both cases, both rates are paid in the same currency on a notional which is not exchanged.

For a leg that is based on a floating rate, you can also choose that the interest should be compoundedCompounded interest means that any interest earned over a defined period is not paid at the end of that period. Instead the generated interest is added to the principal amount, and therefore interest is earned on the already generated interest until the next payment date. Although this feature is actually technically known as compounding the interest (whereby any previously generated interest will then also generate interest), many people think of it as simply increasing the notional.2.

In a vanilla swap, generally the payment frequency and the fixing frequency of the floating leg need to be the same. However, if in the vanilla swap you enable the Compounding feature for the floating leg, you can then set the fixing (or compounding) frequency to be greater than that leg’s payment frequency. You can then also choose to have only one payment for this leg at maturity. In this case, the floating leg is referred to as the “zero-coupon” floating leg, since there are no coupon payments until the maturity date.

Advantages of a Vanilla Swap

A vanilla swap lets you:

Transfer your liability or asset to a preferable payment schedule.

Redefine your exposure to interest rate fluctuations. For example, you can lock in a favorable fixed rate, or transfer to a schedule of floating rate payments if you expect interest rates to decrease.

Fix rates for swaps that will start in the future (i.e., for forward swaps).

Pricing a Vanilla Swap in SDX Interest Rates

It is important to note that:

By default SDX Interest Rates automatically calculates the breakeven fixed rate for a fix-float trade and the breakeven spread for a float-float trade. However, if you manually define the fixed rate for a fix-float trade or the spread for a float-float trade, the system calculates the NPV.

For the vanilla swap only, the market rate result shows the clean rate, i.e., the price without any accrued interest. This will only have an effect on historical deals, i.e., on deals that began in the past and so necessarily have accrued interest.

By default, the system sets each payment on the relevant coupon’s end date. You can change these dates manually. In addition, you can instruct the system to set the payments on the coupons’ start dates instead.

For more information on this functionality see Configuring Payments to Coupon and Caplet Start Dates.

If you want to activate the compounding feature, you must then also choose the type of compounding that you want to implement. For more information see Compounding .

You can select a settlement currency that is different from the trade currency.

For more information see Changing the Settlement Currency.