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appropriate to the index on which the swaps were based (e.g.,
LIBOR-based swaps required LIBOR yield curves), (1) forecast the
floating interest rates on each date relevant to a swap agreement
and (2) determined the discount rate that should be used to
compute the present value of each payment (fixed and floating)
due under the swap agreement.
b. Constructing the Curve
In order to construct a yield curve, a user had to make at
least three critical decisions. First, the user had to decide
among the large amounts of available market information, such as
LIBOR deposit rates, Eurodollar futures prices, swap bid and ask
quotes, and yields on U.S. Treasury securities. The user had to
choose, for example, whether the 1-year point on the yield curve
would be based on LIBOR rates, Eurodollar future rates, or some
other rate. Because these rates fluctuated during the day, the
user then had to decide the time of day at which the rates would
be collected, for example, at 11 a.m. or 2 p.m. Because the
market data produced only a series of points corresponding to the
maturities available in the market, the user then had to decide
on a model that connected the dots in order to interpolate where
the floating interest rate would be on the particular dates
specified in each swap agreement.
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