When pricing a Digital Swap you must specify the coupon to be paid by the structured leg. As in a vanilla swap this coupon is dependent on the value of an observed index; the difference is that you then define payout conditions for a number of ranges of the value of the observed index.
For example, the parties can specify that the observed index for the structured leg will be the 6 month Libor. They can then specify that if, on the fixing date, the 6 month Libor is above 0% but less than or equal to 2%, the structured leg will pay a fixed rate of 4% for the coupon period, whereas if it is above 2% but less than or equal to 5%, the structured leg will pay a floating rate equal to the 3 month Libor plus a spread of 15 basis points.
The condition ranges of successive conditions must be continuous. For example, if the first condition is conditional on the defined index being larger than 0 and less than or equal to 4, then the condition defined for condition 2 must state that the index must be greater than 4, etc.
You set these conditions in the Digital Swap Coupon Builder window. In this window you specify different parameters for each payout condition as required. Each row indicates a different payout condition.
The window can be opened by:
Clicking the Coupon Structuring or Coupon button in the pricing page. This lets you make additions or changes to coupon specifications for all payment periods simultaneously.
Clicking the Variable button in the Coupon column in the Swap Cash Flow Dates window. This lets you make additions or changes to the coupon specifications for each payment period individually.
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After having customized coupon payment specifications for each payment period individually, do not make further changes by opening the Digital Swap Coupon Builder window by clicking the Coupon Structuring button in the pricing page. If you do, the coupon payment specifications for all payment periods will automatically be reset. |
To specify coupon payments in the digital swap coupon builder window:
| 1. | After defining a digital swap in the pricing page to: |
Make changes to coupon specifications for all payment periods simultaneously, click the Coupon Structuring button in the pricing page.
To make changes to the coupon specifications for each payment period individually, open the Swap Cash Flow Dates window and click the relevant Variable button in the Coupon column.
| 2. | Select the index from the Observation Variable dropdown list. |
| 3. | In the first row define the first condition by filling in the fields and columns. For an explanation of the fields and columns see Fields and Buttons in the Digital Swap Coupon Builder Window. |
| 4. | To add another row click Add or Insert and then specify its payment details and conditions. |
| 5. | To save your conditions click Accept. The conditions are saved and the window is closed. |