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c. Imprecise Measure
The midmarket value computed using dealer-constructed yield
curves was a constructed, rather than an observed, number and was
not absolutely precise. Two dealers could calculate different
midmarket values for the same swap, although the differences
should not have been that large. Disparities could have
resulted, for example, because (1) the dealers relied on
different market indicators (e.g., one relied on futures prices
while the other relied on LIBOR), (2) the dealers used different
software with different interpolation techniques, or (3) the
dealers relied on prices quoted at different times during the
day. As to the latter, a small movement in interest rates of
just one basis point during a day could affect the midmarket
values, and the price of a swap could change within a few hours.
During the first quarter of 1990, for example, it was not unusual
for interest rates to move 10 basis points or more in a single
day.
D. Market Value
1. Net Present Value-–Forward Rate Pricing
The market value of a swap is equal to the net present value
of the expected net cashflows. The forward rate pricing approach
calculates this net present value in two steps. First, the
expected net cashflows are determined. Second, these expected
cashflows are discounted to produce a present value.
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