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108 lines
7.1 KiB
ReStructuredText
108 lines
7.1 KiB
ReStructuredText
Interest rate swaps
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===================
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The Interest Rate Swap (IRS) Contract (source: IRS.kt, IRSUtils.kt, IRSExport.kt) is a bilateral contract to implement a
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vanilla fixed / floating same currency IRS.
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In general, an IRS allows two counterparties to modify their exposure from changes in the underlying interest rate. They
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are often used as a hedging instrument, convert a fixed rate loan to a floating rate loan, vice versa etc.
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The IRS contract exists over a period of time (normally measurable in years). It starts on its value date
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(although this is not the agreement date), and is considered to be no longer active after its maturity date. During that
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time, there is an exchange of cash flows which are calculated by looking at the economics of each leg. These are based
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upon an amount that is not actually exchanged but notionally used for the calculation (and is hence known as the notional
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amount), and a rate that is either fixed at the creation of the swap (for the fixed leg), or based upon a reference rate
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that is retrieved during the swap (for the floating leg). An example reference rate might be something such as 'LIBOR 3M'.
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The fixed leg has its rate computed and set in advance, whereas the floating leg has a fixing process whereas the rate
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for the next period is fixed with relation to a reference rate. Then, a calculation is performed such that the interest
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due over that period multiplied by the notional is paid (normally at the end of the period). If these two legs have the
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same payment date, then these flows can be offset against each other (in reality there are normally a number of these
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swaps that are live between two counterparties, so that further netting is performed at counterparty level).
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The fixed leg and floating leg do not have to have the same period frequency. In fact, conventional swaps do not have
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the same period.
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Currently, there is no notion of an actual payment or obligation being performed in the contract code we have written;
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it merely represents that the payment needs to be made.
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Consider the diagram below; the x-axis represents time and the y-axis the size of the leg payments (not to scale), from
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the view of the floating leg receiver / fixed leg payer. The enumerated documents represent the versions of the IRS as
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it progresses (note that, the first version exists before the value date), the dots on the "y=0" represent an interest
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rate value becoming available and then the curved arrow indicates to which period the fixing applies.
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.. image:: contract-irs.png
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Two days (by convention, although this can be modified) before the value date (i.e. at the start of the swap) in the red
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period, the reference rate is observed from an oracle and fixed - in this instance, at 1.1%. At the end of the accrual period,
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there is an obligation from the floating leg payer of 1.1% * notional amount * days in the accrual period / 360.
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(Also note that the result of "days in the accrual period / 360" is also known as the day count factor, although other
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conventions are allowed and will be supported). This amount is then paid at a determined time at the end of the accrual period.
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Again, two working days before the blue period, the rate is fixed (this time at 0.5% - however in reality, the rates
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would not be so significantly different), and the same calculation is performed to evaluate the payment that will be due
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at the end of this period.
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This process continues until the swap reaches maturity and the final payments are calculated.
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Creating an instance and lifecycle
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----------------------------------
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There are two valid operations on an IRS. The first is to generate via the ``Agree`` command (signed by both parties)
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and the second (and repeated operation) is ``Fix`` to apply a rate fixing.
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To see the minimum dataset required for the creation of an IRS, refer to ``IRSTests.kt`` which has two examples in the
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function ``IRSTests.createDummyIRS()``. Implicitly, when the agree function is called, the floating leg and fixed
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leg payment schedules are created (more details below) and can be queried.
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Once an IRS has been agreed, then the only valid operation is to apply a fixing on one of the entries in the
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``Calculation.floatingLegPaymentSchedule`` map. Fixes do not have to be applied in order (although it does make most
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sense to do them so).
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Examples of applying fixings to rates can been seen in ``IRSTests.generateIRSandFixSome()`` which loops through the next
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fixing date of an IRS that is created with the above example function and then applies a fixing of 0.052% to each floating
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event.
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Currently, there are no matured, termination or dispute operations.
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Technical details
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-----------------
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The contract itself comprises of 4 data state classes, ``FixedLeg``, ``FloatingLeg``, ``Common`` and ``Calculation``.
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Recall that the platform model is strictly immutable. To further that, between states, the only class that is modified
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is the ``Calculation`` class.
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The ``Common`` data class contains all data that is general to the entire swap, e.g. data like trade identifier,
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valuation date, etc.
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The Fixed and Floating leg classes derive from a common base class ``CommonLeg``. This is due to the simple reason that
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they share a lot of common fields.
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The ``CommonLeg`` class contains the notional amount, a payment frequency, the effective date (as well as an adjustment
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option), a termination date (and optional adjustment), the day count basis for day factor calculation, the payment delay
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and calendar for the payment as well as the accrual adjustment options.
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The ``FixedLeg`` contains all the details for the ``CommonLeg`` as well as payer details, the rate the leg is fixed at
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and the date roll convention (i.e. what to do if the calculated date lands on a bank holiday or weekend).
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The ``FloatingLeg`` contains all the details for the CommonLeg and payer details, roll convention, the fixing roll
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convention, which day of the month the reset is calculated, the frequency period of the fixing, the fixing calendar and
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the details for the reference index (source and tenor).
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The ``Calculation`` class contains an expression (that can be evaluated via the ledger using variables provided and also
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any members of the contract) and two schedules - a ``floatingLegPaymentSchedule`` and a ``fixedLegPaymentSchedule``.
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The fixed leg schedule is obviously pre-ordained, however, during the lifetime of the swap, the floating leg schedule is
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regenerated upon each fixing being presented.
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For this reason, there are two helper functions on the floating leg. ``Calculation.getFixing`` returns the date of the
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earliest unset fixing, and ``Calculation.applyFixing`` returns a new Calculation object with the revised fixing in place.
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Note that both schedules are, for consistency, indexed by payment dates, but the fixing is (due to the convention of
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taking place two days previously) not going to be on that date.
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.. note:: Payment events in the ``floatingLegPaymentSchedule`` that start as a ``FloatingRatePaymentEvent`` (which is a
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representation of a payment for a rate that has not yet been finalised) are replaced in their entirety with an
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equivalent ``FixedRatePaymentEvent`` (which is the same type that is on the ``FixedLeg``).
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