weighted average of forward rates difference, receiving, average, forward, because

adehbone

Having a lot of trouble with this one.
Vol. 5 page161 says the swap rate is a weighted average of the component forward rates.
However, page 144 goes to great lengths to explain that the swap rate is NOT an average of forward rates because of the benefit of receiving greater amounts early in the term.
I can't figure out the difference. Anyone help?

Unforseen

Oh ok I think I get that. So you take the pv of the forward rates and that determines the weights?
Thanks, that pulls everything together.

Darien

Actually, it's more intuitive than what is in L2 formula. It's basically stating that the pv(receiv floating leg cash flows)=pv(pay fixed leg cash flows).

Forwards determine the "future" cash flow payments in receive floating leg.

Swap rate, the fixed rate, can be derived from the above equation.



Edited 1 time(s). Last edit at Saturday, May 28, 2011 at 08:33PM by deriv108.