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6. Lack of Payments at Inception
For most interest rate swaps during the relevant years,
neither counterparty made a payment at the inception of the swap
to effect the transaction. The entire consideration for a
party’s promise to make future payments to the counterparty lay
in the counterparty’s promise to make its agreed-upon future
payments. An initial payment was not generally required to
induce the counterparties to enter into the swap agreement.
One exception to the nonpayment rule was off-market swaps
which required upfront payments. In an off-market swap, a
counterparty agreed to receive or pay an interest rate that was
significantly different than the going market rate.
7. Example of an Interest Rate Swap
To illustrate the mechanics of an interest rate swap, assume
that a plain vanilla interest rate swap originated on
November 29, 1992, the trade date, with the following terms:
Notional principal $1 million
Fixed rate 5 percent per annum
Floating rate 6-month LIBOR rate
Effective date Dec. 1, 1992
Termination date Dec. 1, 1995
Payment dates June 1 and Dec. 1 of each year
Fixed-rate payor F
Floating-rate payor L
Day count conventions Actual/3601
1The computations as to swaps are generally based
on a 360-day year, a convention that is common in
banking.
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