Plain vanilla swap

Interest Rate Swap

The exchange of interest rates for the mutual benefit of the exchangers. The exchangers take advantage of interest rates that are only available, for whatever reason, to the other exchanger by swapping them. The two legs of the swap are a fixed interest rate, say 3.5%, and a floating interest rate, say LIBOR + 0.5%. In such a swap, the only things traded are the two interest rates, which are calculated over a notional value. Each party pays the other at set intervals over the life of the swap. For example, one party may agree to pay the other a 3.5% interest rate calculated over a notional value of $1 million, while the second party may agree to pay LIBOR + 0.5% over the same notional value. It is important to note that the notional amount is arbitrary and is not actually traded. This is also called a plain vanilla swap.

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References in periodicals archive

ISSUES SPECIFIC TO THE PLAIN VANILLA SWAP ALTERNATIVE

Preferability and the private company alternatives: how a FASB principle for accounting policy decisions affects election of options developed by the PCC

A basic swap is called a plain vanilla swap and is shown in Figure 7-1.

Chapter 7 Swaps

(i) Enter into a plain vanilla swap for T + N periods with Firm A paying, and Firm B receiving, the fixed rate of [F.sub.-T, N+T];

Of course, this is the same net funding rate that the firm would have had if it could have found a counterparty willing to accept 9.00% as a fixed rate on a plain vanilla swap with otherwise comparable terms.

A departure from the structure of a plain vanilla swap to address this front-loading and back-loading problem would be to set a time-varying fixed rate on the swap.

However, it should be emphasized that if interest rates move significantly away from the implied forward path, the default risk can be even higher than on a plain vanilla swap structure.

With a plain vanilla swap, the firm would be obligated on that date to make a settlement payment of three percent times the notional principal because LIBOR at inception was eight percent.

Default risk and innovations in the design of interest rate swaps

For over 15 years the capital markets industry has implemented the software to independently price derivatives - from simple valuations on plain vanilla swaps, to complex hedge and scenario analyses of portfolios containing structured derivatives.

Principia Deploys Web Platform for Independent Valuation and Risk Surveillance of Investments and Derivatives