BOND MATH: The Theory Behind the Formulas

Conclusion

Interest rate swaps demonstrate how once again we can employ a toolkit of bond math techniques to go beyond basic fixed-rate and zero-coupon securities. Interest rate swaps combine aspects of fixed-rate and floating-rate bonds. They can be interpreted as holding a long position in one and a short position in the other. That allows us to get reasonable estimates of the duration and convexity statistics for the swaps. Most important, pricing swaps at initiation and valuing them thereafter are direct applications of spot and forward curve analysis. Getting the “source” forward curve from futures markets is a difficult technical matter, and one that requires an adjustment factor drawn from a mathematical model of the term structure of ...