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3. Midmarket Rate
The midpoint (average) of the bid and ask rates for a
specified maturity is known as that maturity’s midmarket rate.
The theoretical midmarket rate is the fixed interest rate for
which the present value of the cashflows from the fixed leg of a
swap equals the present value of the projected cashflows from the
swap’s floating leg. In other words, if a swap was entered into
at the midmarket rate, then the present value of the fixed-leg
payments would equal the present value of the anticipated
floating-leg payments. When any swap with a midmarket rate is
valued also using the same midmarket rate, then the swap has a
theoretical net present value of zero to both counterparties.
A plain vanilla swap with a fixed rate equal to the current
midmarket rate has by definition a market value of zero and is
called a “par swap”. It is also said to be “at-market” as
opposed to “off-market”. If the fixed interest rate is above the
current midmarket rate, the swap is said to be “above-market” and
has positive value to the party that sold the swap and is
receiving the fixed payments. If the fixed interest rate is
below the current midmarket rate, the swap is said to be
“below-market” and has negative value to the party that is
receiving the fixed payments. A swap is a zero-sum contract, so
if it has a positive market value to one counterparty, it has a
negative market value to the other counterparty.
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