ISDA: Introduction to.

Operations Training

Rate Sets & Settlements

Presented by:
Michael Pesce
Merrill Lynch Capital Services, Inc.
June 20,200
Definition of a Swap
Process & Control Cycle
Trade Details of a Swap
Swap Calculation
Reset Process
Types of Resets
Payment Process
 Swap Definition

A contractual agreement between two

or more parties to exchange sets of
cash flows over a period of time.
 Processing & Control Cycle

nIE. Credit / Price Risk Limit Rate Sets

n1
(0
1 Trade Capture

c2
Cash Settlement

Proof & Verification P&L / Valuation

I
V

s ISDA Documentation
ID

b
Reconciliation of P&L &
Cash post Value date I

, I '
 a
Trade Details of a Swap ..

* Trade Date
* Effective Date
* Maturity Date
* Notional
* Swap Coupon '(fixed rate)
* Reference Index rate page
* floating rate, i.e. London Inter-bank offer rate [LIBOR]
* Spreads
* Reset Date & Payment Date
* Calculation Period
* Dav Count Convention
I
~ - ~ - - - -

* Business Day Conventions

Details of a Swap -+d,hgehm
I
u
I Notional

2. Reference Index Rate

- LIBOR (London Inter Bank Offer Rate)
- Spreads

3. Coupon Period
- Monthly, Quarterly, Semi-annually, Annually

4. Day Count Fraction (underlying asset)

- Underlying Asset
- 301360 Actua1/360
 a a
Swap Flow

Interest rate swaps SCIRS (Single Currency Interest Rate Swap):

Party A has an initial position in a fixed rate debt instrument.

Party B has an initial position in a floating rate obligation.

Fixed: 7%
b
Party Party
A 4 B
Floating: UBOR
 a
Components Needed for a Swap Calculation:
SCIRS (Single Currency Interest Rate Swap)
Notional Amount * Rate * No.Days in Period / Basis = Interest
Party A Pays:
Fixed-10 mill * 7% * (901360) = $175,000

Party B Pays:
Float-10 mill * 5.0625 (LIBOR) * (901360) = $126,562.50

Party.A Pays Net coupon: - $48,437.50

Components Needed for a Swap Calculation:
# L&-$?#&
CCIRS (Cross Currency Interest Rate Swap.) -
-&+#7
@+
Party A & B exchange Notional for initial and final periods.

Party A pays fixed USD coupon payments.

Party B pays floating (index LIBOR) GBP coupon payments.

Fixed: 7% US Dollar Payments

b
Party Party
A 4 B
Floatino: LIBOR GBP Pavments
 e a a
Components Needed for a Swap Calculation:
CCY (Cross Currency Swap)

Party A Pays USD:

Fixed USD 10 mill * 7% * (901360) = $175,000
Party B Pays GBP:

Float GBP 6.25 mill * 5.2 (LIBOR) * (901360) = GBP 81,250

Party A Pays Gross Coupon USD: $175,000

Party B Pays Gross Coupon GBP: L;. GBP 81,250

 USD Rate Reset Process:
Client Services
approve rates in Is the deal
Manual
Rates Database paying that Process

Settlement
Client Services I Once settlement I
System sends Client services is confirmed
creates a payment is
rate type request approves rate payment
to Rates resets in
notice
Database Settlement
System

Client Services
faxes payment
Rates Database notice to Client
will download
rates four times
daily to Settlement
System
Client Services calls
client to confirm
Types of Rate Resets

Vanilla Rate Resets

Averaging

3. Compounding
Vanilla Rate Reset

Rate Types: 6%&@@

Advance +set two days before period start date.

Arrears eset two days before payment date.

Vanilla Rate Reset, cont..

01111 12: 15 GMT [BRITISH BANKERS ASSOCIATION LIBOR RATES] 3750

11/99]
[O I/ 01/11 11:31 GMT
INDEX PG 3745 OTHER CURRENCIES ON PGS 374013770 INQUIRIES 0171 832 9736
RATES AT 11:OO LONDON TIME 01/11/1999
I CCY I USD I GBP I DEM I CHF ( JPY I EUR I
I 1WK I 5.36750 1 5.12313 1 2.80000 1 1.10000 1 0.06750 1 2.80000 1
I 1MO 1 5.40750 1 5.43875 1 2.89400 1 1.18500 1 0.07625 1 2.89400 1
I 2M0 I 6.28000 1 6.00000 1 3.48563 1 2.08000 1 0.31125 1 3.48563 1
I 3M0 I 6.16125 1 6.00750 1 3.50000 1 2.05167 1 0.27438 1 3.50000 1
I 4M0 I 6.13375 1 6.06063 1 3.51625 1 2.07167 1 0.25875 1 3.51625 1
( 5M0 I 6.12250 1 6.10719 1 3.53000 1 2.09000 1 0.25000 1 3.53000 1
I 6M0 I 6.11125 1 6.15234 1 3.54563 1 2.11000 1 0.24000 1 3.54563 1
I 7M0 I 6.12125 1 6.19156 1 3.57563 1 2.16000 1 0.23625 1 3.57563 1
I 8M0 I 6.13125 1 6.25500 1 3.60563 1 2.21667 1 0.23625 1 3.60563 1
1 9MO I 6.14375 1 6.31250 1 3.64000 1 2.27500 1 0.23625 1 3.64000 1
I 10MO 1 6.16625 1 6.37813 1 3.68000 1 2.32500 1 0.23625 1 3.68000 1
I l l M O 1 6.19125 1 6.44031 1 3.72000 1 2.37167 1 0.23500 1 3.72000 (
I 12MO 1 6.22000 1 6.50375 1 3.75875 1 2.41833 1 0.23500 1 3.75875 1
*** *DJ U.S. SEPT. NEW HOME SALES -12.8OIo TO 811,000; EST. 950,O
Averaging Rate Reset Types
Rate Type:
Averaging 0takes average of daily rate
within period.
Types of Averaging Indexes:
Federal Funds Rate, Prime, T-Bill........
Types of Averaging Calculations:
- Weighted Average Method
- Unweighted Average Method
- Rate Cut-off
 0 a
Averaging Calculations

1. Weighted Average Method PQ

/

The arithmetic mean of the ~elevantRates in effect for

each day in that Calculation Period or Compounding
Period calculated by multiplying each Relevant Rate by
the number of days such Relevant Rate is in effect,
determining the sum of such products and dividing
such sum by the number of days in the Calculation
Period or Compounding Period.
 a
Averaging Calculations, cont..
2. Unweighted Average Method I%J
b %+
-3htk m-
d , b l
The arithmetic mean of the R e l e v a n f ~ a g f o%
rh of
those Reset Dates.

3. Rate Cut-off
The Relevant Rate for each Reset Date in the period
from, and including, a Rate Cut-off Date to, but
excluding, the next applicable Period End Date.
 a
Compounding Monthly Pays Quarterly
Variation:
Compounding before rate spread
Compound takes place on Notional + Interest
before adding the spread to the base rate.
Compounding after rate spread
Compounding takes place on Notional + Interest
after adding the spread to the base rate.
Flat Compounding
Calculates the interest of the flat Notional after
adding the spread'to the base rate.
Payment Process

Front Ofice Back Office

Trade Capture
Valuation system Settlement System
Payment Process, cont..
Back Office
Settlement System
w
Payment Confirm with
notices counterparty
I
Client service check ISDA Disagree Agree
documentation, check with the Client Service specialists make a
traders involved , agree with note of
Counterparty who must change time and individual settlement
the details of the payment. confirmed with.

Agreed with C/P

t-
Specialist approve
payments in Back Office CASH settlement system
I
t
; Manager approves
flows
SUMMARY

Definition of a Swap
Process & Control Cycle
Trade Details of a Swap
Swap Calculation
Reset Process
Types of Resets
Payment Process