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
Chapter 21Interest Rate Swap Valuation and Applications › Key Parameters
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The key parameters for the FRA valuation approach connect swap pricing directly to the forward rate curve and the term structure of interest rates:

  • FiF_i: Simple-accrual forward rate for period ii, implied by the ratio of the endpoint discount factors. Its expectation interpretation depends on the pricing measure; it is not automatically a physical forecast.
  • KK: Fixed rate of the swap. Compared against the forward rate to determine the value of each period. The difference between KK and FiF_i drives each FRA's contribution to the swap value.
  • δi\delta_i: Contractual accrual year fraction (day-count fraction). Use the same fraction when annualizing the simple forward and calculating its coupon amount.
  • Z(0,t)Z(0, t): Discount factor. Used to bring the future FRA payoff back to present value. These factors encode the time value of money embedded in the current term structure.