Interest Rate Swap Valuation and Applications › Key Parameters
Michael BrenndoerferUpdated January 5, 20261 min read
Quantitative FinanceAll chapters Part 4 of 15Swaps and Credit Derivatives
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The key parameters for swap valuation using the bond portfolio approach are fundamental inputs that determine the swap's cash flows and their present values:
- N: Notional principal amount. Used to scale the cash flows, though it is not exchanged in a standard swap. This amount determines the size of each interest payment and is the reference for calculating percentage-based coupon payments.
- K: Fixed interest rate. The rate received by you in the receive-fixed position, contractually determined at inception and remaining constant throughout the swap's life.
- r: Risk-free interest rate. Derived from the discount factors used to value the cash flows. In practice, this comes from the term structure observed in the market.
- : Accrual year fraction for payment period i; the regular semiannual example uses 0.5. Contractual day-count conventions determine coupon amounts, while payment dates determine discounting times. Payments per year is a separate frequency, equal to 2 for regular semiannual dates.