Reminder on Vanilla Interest rates

Didier Faivre

Didier.faivre@calyon.com

February 2006

Zero-coupon Deposit Libor, Euribor FRA Vanilla Swaps Swaps Forwards Caplet/Floorlet Caps/Floors Swaptions Volatity Cube CMS
2

Zero-coupon
o Price at date t of one 1 (or any currency) at date T :

o r(t,T) is called the zero-coupon rate at date t for maturity T o In the right side of above equation T-t is a year fraction calculated using ACT/365 convention (or sometimes ACT/ACT if one wants to take into account the leap years).

Deposit
o Loan on a period from 1 week to 12 months between two banks o Interest calculated using monetary interest rate, e.g. linear interest rates

Deposit
o Interest Calculated as :
If bank lends 1M on a period of 3months, in 3 months banks receives :
1M 1 Euribor 3M number of days 360

Number of days is exact number of days between start and end of the loan We speak about Libor1M, Libor3M.. For USD, LiborUSD1M, LiborUSD3M.. For EURO, Euribor1M, Euribor3M
5

Deposit
o For some currencies (GBP, AUD), replace 360 by 365

Deposit
o Example for a 3Month deposit o 30 january 2006,offered 3 months rate by BBVA is 2.56% o 3month loan is from 30 january 2006 + 2 business days to (30 january +2 business days)+3months business days o So from 2/2/2006 to 2/5/2006, so 89 days period of interest rates o For a 100M notional loan, redemption is 100*(1+2.56%*89/360)=100.6329M
7

LIBOR, EURIBOR
o LIBOR : London Interbank Offered Rate o Every day, fixing at 11am London Time on most currencies : USD, JPY, GBP o For EURO, fixing at FRANCFORT Euribor o Definition :
Average of offered rates for a given maturity, on a basket of banks, for deposits operations
Offered rate : means rate at which Bank wants to lend money, not to borrow (Bid/Ask spread) For various maturities from 1 week to 12 months : Using Monetary interest rates as previously explained
8

EURIBOR rates : reuter page

List of Euribor interests rate + fixing values + definition, as of 30/1/2006

o On the previous slide, we see that the fixing of Euribor 3M on the 30/1/2006 is 2.542% o The period of interest for a 3M deposit on the 30/1/2006 is from 2/2/2006 to 2/5/2006
30/1/2006 is called the Fixing date 2/2/2006 is called the Start date 2/5/2006 is called the End date

10

EURIBOR3M : reuter page

Quotations of 3 months offered rate by the official basket of banks as of 30/1/2006, for calculating the fixing of Euribor3M at this date

11

FRA
o Definition of FRA (Forward rate agreement)
A forward Euribor of maturity T is a forward contract on Euribor beginning at date T (fixing at date T-2D) and ending at date T+ . The maturity T is calculated taking account business days conventions, including various end of month rules. The value of the forward at date t is :

12

FRA
o Warning ! : on the the above equation, is a number of days when added to the date T, for example the numbers of days for a given standard reference period (3M, 6M) and otherwise on the right side of equation its a year fraction calculated using the monetary basis convention of the currency (ACT/360 or ACT/365)
This is usual rule for quants documents notations

13

Vanilla Swaps
o In a vanilla swap, two counterparties exchange variable cash flows based on Euribor (or Libor for other currencies) against cash-flow based on a fixed rate, in the same currency o Example : 2 years fixed rate against Euribor6M

14

Vanilla Swaps : Schedule

o First step of swap calculation is to set the schedule, we need :
Total maturity of the swap at initial date : 1Y, 2Y, 3Y Convention for non business days (holidays) Fixed leg conventions : period, basis Floating rate conventions : period, basis

15

Vanilla Swaps : Schedule

o Basis is a convention to calculate the year fraction between two cash flows dates for interest calculations o Cash Flow is : year fraction (calculated according to the basis ) * interest rate * Notional o Examples of period : 3M, 6M, 12M o Examples of basis : ACT/360, ACT/365, 30/360 o For terms linked to stochastic modelling (time value, convexity adjustment) always use ACT/365

16

Vanilla Swaps : Schedule

o Then :
Calculation of theoritical date of swap end Calculation of theoritical date of cash-flows for both legs Possible adjustement for taking into account non business days and convention for non-business days

o Theoritically, all combinations of period and basis are possible for the two legs o In practice a standard is set for every-market, used by default
17

Vanilla Swaps : Standard Conventions

o For the floating leg the basis is always the basis used for reference rate (Libor or Euribor), same thing for period o Examples :
Euro market
For 1 Year maturity swap
1Year period and 30/360 basis and for fixed leg, Euribor3M for floating leg

For maturities over than 1Year

1Year period and 30/360 for fixed leg, Euribor6M for floating leg
18

Vanilla Swaps : Standard Conventions

USD market : two standards, one for New-York working hours, one for before New-York market open
Before New-York opens
For all maturities, 1Year period and ACT/360 for fixed leg, LiborUSD3M for floating leg (Money Markets swaps)

After New-York opens

For all maturities, 6 months period and 30/360 for fixed leg, LiborUSD3M for floating leg (Bond Basis swaps)

Money markets swaps because ACT/360 is the basis for LiborUSD Bond Basis swaps because 30/360 is the basis for USD corporate bonds
19

Vanilla Swaps : Example

o 3Y swap against EURIBOR6M, as of 3/4/2002 ( a Wednesday) o Start date = 3/4/2002 + 2 Business days = 5/4/2002 (a Friday) o Step 1 : theoritical date of swap end : 5/4/2005 (a Tuesday)

20

Vanilla Swaps : Example

o Step 2 : Theoritical dates of cash-flows

21

Vanilla Swaps : Example

o Step 3 : taking account of non business days :

22

Vanilla Swaps : Example

o Step 4 : Calculation of interest periods, using true dates of cash Flows and basis of both legs :

o The and are called coverage, calculated as year fractions between cash-flows dates for both leg, using each basis.
23

Vanilla Swaps : Example

o From the cash-flow payment dates of the swaps, one can also calculate the fixing dates, using the -2 Business days rule.
For example, the fixing of the Euribor6M for the period 6/10/03 to 5/4/04 is the 3/10/03 (4/10/03 is a Saturday)

24

Vanilla Swaps : Example2

SWAP 3Y Fix Leg Frequency Basis 3M ACT360 Float Leg Frequency Basis 3M ACT360

Lib start Lib end coverage pay dates fix dates 17/02/06 17/05/06 0.247222 17/05/06 15/02/06 17/05/06 17/08/06 0.255556 17/08/06 15/05/06 17/08/06 17/11/06 0.255556 17/11/06 15/08/06 17/11/06 19/02/07 0.261111 19/02/07 15/11/06 19/02/07 21/05/07 0.241667 17/05/07 15/02/07 17/05/07 17/08/07 0.255556 17/08/07 15/05/07 17/08/07 19/11/07 0.261111 19/11/07 15/08/07 19/11/07 19/02/08 0.252778 18/02/08 15/11/07 18/02/08 19/05/08 0.252778 19/05/08 14/02/08 19/05/08 19/08/08 0.252778 18/08/08 15/05/08 18/08/08 18/11/08 0.252778 17/11/08 14/08/08 17/11/08 17/02/09 0.255556 17/02/09 13/11/08

Lib start Lib end coverage pay dates fix dates 17/02/06 17/05/06 0.247222 17/05/06 15/02/06 17/05/06 17/08/06 0.255556 17/08/06 15/05/06 17/08/06 17/11/06 0.255556 17/11/06 15/08/06 17/11/06 19/02/07 0.261111 19/02/07 15/11/06 19/02/07 21/05/07 0.241667 17/05/07 15/02/07 17/05/07 17/08/07 0.255556 17/08/07 15/05/07 17/08/07 19/11/07 0.261111 19/11/07 15/08/07 19/11/07 19/02/08 0.252778 18/02/08 15/11/07 18/02/08 19/05/08 0.252778 19/05/08 14/02/08 19/05/08 19/08/08 0.252778 18/08/08 15/05/08 18/08/08 18/11/08 0.252778 17/11/08 14/08/08 17/11/08 17/02/09 0.255556 17/02/09 13/11/08

25

Vanilla Swaps : Example2

SWAP 3Y Fix Leg Frequency 6 M Basis 30360 Float Leg Frequency 3 M Basis ACT360 Lib start Lib end coverage pay dates fix dates 17/02/06 17/05/06 0.247222 17/05/06 15/02/06 17/05/06 17/08/06 0.255556 17/08/06 15/05/06 17/08/06 17/11/06 0.255556 17/11/06 15/08/06 17/11/06 19/02/07 0.261111 19/02/07 15/11/06 19/02/07 21/05/07 0.241667 17/05/07 15/02/07 17/05/07 17/08/07 0.255556 17/08/07 15/05/07 17/08/07 19/11/07 0.261111 19/11/07 15/08/07 19/11/07 19/02/08 0.252778 18/02/08 15/11/07 18/02/08 19/05/08 0.252778 19/05/08 14/02/08 19/05/08 19/08/08 0.252778 18/08/08 15/05/08 18/08/08 18/11/08 0.252778 17/11/08 14/08/08 17/11/08 17/02/09 0.255556 17/02/09 13/11/08

Lib start Lib end coverage pay dates fix dates 17/02/06 17/05/06 0.5 17/08/06 15/02/06 17/08/06 17/11/06 0.505556 19/02/07 15/08/06 19/02/07 21/05/07 0.494444 17/08/07 15/02/07 17/08/07 19/11/07 0.502778 18/02/08 15/08/07 18/02/08 19/05/08 0.5 18/08/08 14/02/08 18/08/08 18/11/08 0.497222 17/02/09 14/08/08

26

Vanilla Swaps : Example2

SWAP 3Y Fix Leg Frequency 1 Y Basis 30360 Float Leg Frequency 3 M Basis ACT360 Lib start Lib end cov pay dates fix dates 17/02/06 17/05/06 0.247222 17/05/06 15/02/06 17/05/06 17/08/06 0.255556 17/08/06 15/05/06 17/08/06 17/11/06 0.255556 17/11/06 15/08/06 17/11/06 19/02/07 0.261111 19/02/07 15/11/06 19/02/07 21/05/07 0.241667 17/05/07 15/02/07 17/05/07 17/08/07 0.255556 17/08/07 15/05/07 17/08/07 19/11/07 0.261111 19/11/07 15/08/07 19/11/07 19/02/08 0.252778 18/02/08 15/11/07 18/02/08 19/05/08 0.252778 19/05/08 14/02/08 19/05/08 19/08/08 0.252778 18/08/08 15/05/08 18/08/08 18/11/08 0.252778 17/11/08 14/08/08 17/11/08 17/02/09 0.255556 17/02/09 13/11/08

Lib start Lib end cov pay dates fix dates 17/02/06 17/05/06 1.005556 19/02/07 15/02/06 19/02/07 21/05/07 0.997222 18/02/08 15/02/07 18/02/08 19/05/08 0.997222 17/02/09 14/02/08

27

Vanilla Swaps : Evaluation of Floating leg

is the schedule of the floating leg of the swap (for a 4 years with a 6Months period on floating leg, m = 8, for example). o The value of the floating leg is :

o It can be shown that it is also : o is the end date of the swap and schedule of fixed leg.

the
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Vanilla Swaps : Evaluation of the fixed rate

o At date 0, the value of the swap is 0, meaning the value of the fixed leg is the value of the floating leg o If S is a fixed rate, the value of a fixed leg using this rate is :

29

Vanilla Swaps : Evaluation of the fixed rate

o The swap rate is the rate same value at date 0
o We get :

such that both legs have

o The term is called the Level of the swap, its value is close to the sensitivity or duration of a standard bond of same maturity, period and with coupon rate of .
30

Vanilla Swaps : Evaluation of a forward swap rate

o A forward swap is a swap beginning in the future at date T. o The forward swap rate at date t is the rate such that the present value at date t of the two legs are
equal.

To get the value of a forward swap at date 0, just do t = T=0 !

31

Vanilla Swaps : Schedule of a forward swap

o Example : 2Years in 1Year (fixed against Euribor6M) as of 3/4/02 o 3/4/02 + 2 Business days is 5/4/02

5/4/03 is a saturday
32

Caplet, floorlet
o A caplet is a call option on a Euribor (or Libor..) forward o The caplet of strike K pays at date T+d the difference, if positive, between Euribor on the period starting T ending T+d :
pay-off of caplet at date T+d is :
Max(Euribor(T, T+d)-K;0)

The fixing of the Euribor is at T-2D, taking into account non business days.

o A floorlet is the same thing for a put option.

33

Caplet, floorlet
o The market practice to value a caplet at date t is :
B t ,T BSprice FRA t ,T ,T , K ,T t , , Lognormal,call

o The market pratice to value a floorlet at date t is

B t ,T BSprice FRA t ,T ,T , K ,T t , , Lognormal , put

BS for Black Scholes, details in next slide

o Of course, the parameter s , volatility of FRA(t,T,T+d) depends on d, K and T.

34

Caplet, floorlet
o After having defined the swaptions, we will also explain what is a volatility cube.

35

Black-Scholes for Lognormal forward

o Let FT follows a lognormal law with volatility s and expectation F0 :
2

FT

F0 e

N 0, T

o Then o Then

BSprice F0 , K ,T , , Lognormal ,call

EMax FT K ,0 E FT K

is defined as :

BSprice F0 , K ,T , , Lognormal , put

is defined as :
FT

EMax K

FT ,0

E K

36

Black-Scholes formula for a Lognormal forward

o If o then
dFt Ft dBt

E FT

F0 N d1
K N d2

K N d2
F0 N d1

E K FT
F K 1 2 T

ln d1

d2

d1

37

Black-Scholes for normal forward

o Let
FT

follows a normal law :

FT F0
K ,0

' N 0, T
E FT K

o Then o Then

EMax FT

is defined as : is defined as :

BSprice F0 , K ,T , ' , normal ,call

EMax K FT ,0 E K FT

BSprice F0 , K ,T , ' , normal , put

o Here s is a standard deviation, not a volatility.

38

Black-Scholes for normal forward

dFt ' dBt

E FT

F0

K N d

' Tn d

E K FT
d F0 K

K F0 N d

' Tn d

' T

N = distribution function of normal n(0,1), n density

39

Black-Scholes for normal forward

o Special case : ATM (At the money Option) : o Call = Put = ' T 0.4 ' T
2

o This formula shows that the price of an ATM option (caplet/swaption) depends in fact only on the standard deviation, not on F and on the volatility o We remind that a very good approximation of the relation between s (the standard deviation) and s (the volatility) for ATM is :
0

'

F0
40

Black-Scholes formulas : a few remarks

o The above Black-Scholes formulas give the prices of call and put that would be paid by the buyer of the option at maturity T o So at the same date the pay-off of the option would be paid by the seller of the option to the buyer of the option. o To get the price of call and put that would be paid at date 0, just multiply the above formulas by B 0,T .

41

Black-Scholes formulas : a few remarks

o Call put Parity : the call/put parity for standard european option is totally independant of the choice of the model (lognormal, normal or whatever): o If the buyer of the options pays the option (and get the pay-off at maturity) :
call put E FT K E K FT E FT K F0 K

o If the buyer of the options pays the option at date 0 (and get the pay-off at maturity):
call put F0 K B 0 ,T
42

Cap, floor
o A cap is a sum of caplets, a floor a sum of floorlets o Value of cap is the value of all the caplets included, same thing for floor o Example : 1 Year Cap on Euribor3M

Remark : most of the time, the first caplet is not included as the value today of the first Euribor is Known. So most of the times, only 3 caplets in the above example
43

Call/put parity for Cap & Floor

o Using previous definition of Caplet and Floorlet, we get easily call/put parity for Caplet/floorlet, so we have ( using the previous notation) :
m i 1

~ ~ ~ ~ B 0 ,T j i FRA 0 ,T j 1 ,T j

~ ~ B 0 ,T j i K

o So Cap-Floor = Value of floatLeg Minus Value of Fixed Leg (strike K) o The strike K such that Cap = Floor can be seen as a swap rate corresponding to the schedule of the Cap and floor, so using frequency and basis of this schedule.
44

Call/put parity for Cap & Floor

o To give an example, for 5Y Cap/Floor on Euribor3M, the strike such that Cap = Floor will be :
the 4.75Y rate in 3months, with frequency 3M and basis ex/360 if the first caplet/floorlet are not included. the 5Y swap rate, with frequency 3M and basis ACT/360 if the first caplet/floorlet are included.

45

Call/put parity for Cap & Floor

o The market practice for caplet/floorlet can be justified theoritically by introducing the forward neutral probability tool, but :
its important to understand the practice cannot lead to arbitrage because its consistent with the call/put parity The traders used this practice long time before quants used the forward neutral probability tool.

o The ATM rule (p 37) shows that the cheapness of ATM caplet/floorlet depends only of the standard deviation, so cheapness can be evaluated using the formula : ' F
0

46

Physical settlement Swaptions

o A physical settlement swaption of strike K on the swap is the right to enter into a swap at date T with fixed rate K. o Two types swaptions :
Receiver swaptions : receive the fixed rate and pays the floating rate ; if one buys a receiver swaption, one believe rates will go down. Payer swaptions : pays the fixed rate and receives the floating rate ; if one buys a payer swaption, one believe rates will go up.
47

Physical settlement Swaptions

o Example : payer physical swaption on 2Y (fixed against
Euribor6M) in 1Y as of 3/4/02

48

Physical settlement Swaptions

o The market practice to price a receiver physical settlement swaption at date t is :
n i i 1

B t ,Ti BSprice S t ,T ,Tn , K ,T t , , Lognormal , put

o The market practice to price a payer physical settlement swaption at date t is :

n i i 1

B t ,Ti BSprice S t ,T ,Tn , K ,T t , , Lognormal , call

49

Cash settlement Swaptions

o For a cash settlement swaption, at maturity there is no settlement of a swap o For a receiver cash settlement swaption, the buyer of the option receives at date T :
n i 1

1 1 S T ,Tn

Max K

S T ,T ,Tn ,0

o For a payer cash settlement swaption, the buyer of the option receives at date T :
n i 1

1 1 S T ,Tn

Max S T ,T ,Tn

K ,0

50

Cash settlement Swaptions

o Remarks : Previous formulae are for swap with a period of 1Y on the fixed leg, for a period of 6M, just replace 1
n i 1

1 S T ,Tn
1/ 2 1 S T ,Tn

By :

n i 1

i/ 2

n i 1

1
i n

1 S T ,T The number is called the level cash of the swap ; at maturity, the level cash is just calculated by replacing the zero-coupon rates by the swap rate to discount (and also replacing all coverages by 1).
51

Cash settlement Swaptions

o The market practice to price a receiver cash settlement swaption is :
n

B t ,T
i 1

1 1 S t ,T ,Tn

BSprice S t ,T ,Tn , K ,T , , Lognormal , put

o The market practice to price a payer cash settlement swaption is :

n

B t ,T
i 1

1 1 S t ,T ,Tn

BSprice S t ,T ,Tn , K ,T , , Lognormal , call

o Volatility depends on features of forward swap and strike

52

Cash settlement Swaptions

o For a same features (same swap forward and same strike), the volatility is the same for a physical or cash settlement swaption.

53

Call/Put Parity for swaptions

o Physical Payer Swaptions-Physical Receiver swaption =
n i i 1

B t ,Ti S t ,T ,Tn

o Cash settlement Payer Swaptions-Cash settlement Receiver swaption =

n

B t ,T
i 1

1 1 S t ,T ,Tn

S t ,T ,Tn

54

Swaptions : a few remarks

o The market practice can be justified by introducing the Q Level probability tool, but as for caps/floors :
Its important to understand the market practice cannot lead to arbitrage because its consistent with above call/put parity formulas for both kind of swaptions. The traders used the market practice long time before quants created the Q Level probability tool.
o The ATM rule (p 37) shows that the cheapness of ATM swaption (if we forget the level) depends only on the standard deviation, and so can be seen using the formula
' F0
55

Volatility cubes
o First lets define a volatility surface for a given reference rate, let say the Euribor3M o We need to be able to price a caplet on Euribor6M for any strike and any maturity o A volatility surface for this reference rate will be as following :

56

Volatility surface for Euribor3M, as of 31/1/06

3M 1M 3M 6M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y 15Y 20Y 25Y 30Y 0.50% 7.44% 10.60% 17.42% 33.20% 39.79% 43.64% 44.28% 43.71% 43.01% 42.18% 41.28% 40.33% 39.32% 36.16% 34.90% 34.47% 34.62% 1.00% 5.41% 8.16% 13.62% 25.22% 30.01% 32.97% 33.60% 33.36% 33.04% 32.58% 31.99% 31.33% 30.62% 28.20% 27.11% 26.63% 26.71% 2.00% 4.22% 6.76% 11.33% 19.94% 22.29% 23.56% 23.76% 23.61% 23.50% 23.33% 22.99% 22.60% 22.16% 20.40% 19.41% 18.91% 18.96% 2.50% 4.35% 6.75% 11.20% 19.68% 21.31% 21.65% 21.42% 21.08% 20.90% 20.72% 20.41% 20.06% 19.69% 18.07% 17.09% 16.60% 16.65% 3.00% 4.58% 6.86% 11.28% 20.01% 21.31% 20.96% 20.27% 19.63% 19.26% 18.98% 18.61% 18.28% 17.93% 16.35% 15.36% 14.92% 14.97% 3.50% 4.82% 7.02% 11.44% 20.52% 21.76% 21.02% 19.99% 19.05% 18.42% 17.97% 17.50% 17.12% 16.75% 15.15% 14.14% 13.77% 13.84% 4.00% 5.03% 7.18% 11.63% 21.06% 22.35% 21.44% 20.21% 19.04% 18.18% 17.54% 16.94% 16.49% 16.08% 14.40% 13.37% 13.09% 13.19% 4.50% 5.22% 7.33% 11.82% 21.59% 22.98% 21.99% 20.66% 19.35% 18.32% 17.51% 16.80% 16.27% 15.80% 14.02% 12.98% 12.80% 12.92% 5.00% 5.39% 7.46% 11.99% 22.08% 23.57% 22.58% 21.20% 19.80% 18.65% 17.71% 16.91% 16.32% 15.79% 13.91% 12.88% 12.79% 12.91% 6.00% 5.66% 7.70% 12.31% 22.92% 24.64% 23.69% 22.28% 20.79% 19.51% 18.42% 17.51% 16.81% 16.19% 14.17% 13.16% 13.17% 13.30% 7.00% 5.88% 7.90% 12.57% 23.63% 25.54% 24.67% 23.27% 21.74% 20.39% 19.21% 18.23% 17.47% 16.78% 14.67% 13.68% 13.72% 13.85% 8.00% 6.07% 8.07% 12.80% 24.21% 26.30% 25.50% 24.13% 22.58% 21.18% 19.95% 18.93% 18.12% 17.39% 15.21% 14.22% 14.29% 14.41% 9.00% 6.22% 8.21% 12.98% 24.71% 26.94% 26.22% 24.87% 23.31% 21.89% 20.61% 19.57% 18.73% 17.95% 15.72% 14.74% 14.81% 14.92% 10.00% 6.34% 8.32% 13.15% 25.13% 27.50% 26.84% 25.52% 23.96% 22.51% 21.21% 20.14% 19.27% 18.47% 16.20% 15.21% 15.28% 15.39% 11.00% 6.46% 8.43% 13.29% 25.49% 27.98% 27.38% 26.08% 24.52% 23.06% 21.73% 20.65% 19.76% 18.94% 16.62% 15.64% 15.70% 15.81% 12.00% 6.55% 8.51% 13.41% 25.81% 28.40% 27.86% 26.59% 25.03% 23.55% 22.20% 21.11% 20.20% 19.35% 17.01% 16.02% 16.08% 16.18% 13.00% 6.64% 8.59% 13.52% 26.10% 28.78% 28.29% 27.03% 25.47% 23.99% 22.63% 21.52% 20.60% 19.73% 17.36% 16.37% 16.43% 16.52% 14.00% 6.71% 8.66% 13.62% 26.35% 29.11% 28.67% 27.43% 25.88% 24.38% 23.01% 21.90% 20.96% 20.08% 17.68% 16.68% 16.74% 16.83%

Vertical axis : maturity of caplets/floorlets Horizontal axis : strikes of caplets/floorlets

57

Volatility cubes
o If we define these surfaces for all reference rates (Euribor1M, Euribor2M, 3M, 12M) and all swap (1Y, 2Y, 10Y, 30Y) we can price any vanilla cap or swaption o The set of vol surfaces is called a volatility cube o In practice, more complex models are used and calibrated on previous sufaces and used to get the volatilies for any caplet/floorlet/swaption o The purpose of these models is to avoid numerical problem due to non proper interpolation methods.
58

CMS, CMS options

o Everyday, fixing of fixed rate swap for every maturities (1Y, 2Y, 3Y, 10Y, 30Y) o Buying at date 0 a CMS n years at date T is buying the right to get the fixing of the swap rate n years at date T, ending at T . o The price at date 0 of this operation will be called :
n

CMS 0 ,T ,Tn

o A call on this CMS gives at date T :

max CMS T ,T ,Tn K ,0 max S T ,T ,Tn K ,0
59

CMS, CMS options

o A put on this CMS gives at date T :
max K CMS T ,T ,Tn ,0 max K S T ,T ,Tn ,0

o The pricing of CMS and CMS options is not straightforward derivation of swap forward and swaptions o but follows the call/put parity formula (p 39)

60