Total fair value swap
A synthetic instrument known as a “Total Fair Value Swap” is disclosed. According to one embodiment, the Total Fair Value Swap may comprise an agreement between two counterparties, a “Fixed Rate Payer” and a “Floating Rate Payer”. According to the agreement, the Fixed Rate Payer makes a stream of payments to the Floating Rate Payer based on a fixed rate, and the Floating Rate Payer makes a second stream of payments to the Fixed Rate Payer based on a floating rate, wherein a first portion of the floating rate is based on a reference interest rate, and wherein a second portion of the floating rate is based on a credit spread associated with the Floating Rate Payer. The reference interest rate may be, for example, London Inter-Bank Offer Rate (LIBOR), prime interest rate, the US dollar swap rate, the U.S. Treasury Bond rate or any other widely traded interest rate that is reset periodically. The credit spread may be observed from the Credit Default Swap (CDS) market.
1. A computer-implemented method for facilitating a Total Fair Value Swap transaction between a first counterparty and a second counterparty, the method implemented using a transaction management processor, a rate monitor, and a database, the method comprising:
maintaining an electronic record in the database, the electronic record related to the Total Fair Value Swap transaction, the record reflecting the first counterparty's obligation to make one or more fixed payments to the second counterparty and the second counterparty's obligation to make floating payments to the first counterparty;
calculating an amount for each fixed payment using the transaction management processor, the calculation based on a reference interest rate determined by the rate monitor;
deriving, based on information retrieved by the rate monitor from a credit default swap market, a credit spread associated with the second counterparty at a specified time prior to each floating payment;
determining, based on each derived credit spread, an amount for each floating payment using the transaction management processor, such that the amount for each determined floating payment varies when the derived credit spread of the second counterparty varies; and
managing receipt of the one or more fixed payments and the floating payments using the transaction management processor, wherein managing comprises at least one of confirming, recording, and scheduling of the fixed and floating payments.
2. The method according to claim 1 , wherein the reference interest rate is determined based on one or more interest rates selected from a group consisting of: London Inter-Bank Offer Rate (LIBOR); prime interest rate; U.S. dollar swap rate; U.S. Treasury Bond rate; and federal funds rate.
3. The method according to claim 1 further comprising: resetting the reference interest rate on a periodic basis, thereby varying the one or more fixed payments.
4. The method according to claim 1 , wherein each floating payment amount is determined based on a floating rate comprising a first portion and a second portion, wherein the first portion is determined based on an interest rate unrelated to the credit spread, and wherein the second portion is determined based on the credit spread.
5. The method according to claim 4 , wherein the second portion is determined based on a predetermined percentage of the credit spread.
6. The method according to claim 5 , wherein the predetermined percentage causes a net present value of the Total Fair Value Swap transaction to be zero at initiation of the Total Fair Value Swap transaction.
7. The method according to claim 1 further comprising: setting a maximum amount for the one or more floating payments if the credit spread is above a predetermined level.
8. The method according to claim 1 further comprising: causing at least a portion of the Total Fair Value Swap transaction to terminate upon one or more credit events associated with the second counterparty or a third party.