Fixed rate is paid once at the end of the agreement. In case of a zero coupon swap, the payments of the floating rate are done on the interval basis. These payments are based on the underlying zero coupon bond. The payment of the fixed rate changes to the one-time payment. This amount is paid at the end of the agreement. The zero coupon swap can be structured to that both the floating rate and fixed rate payments are done as a lump sum amount. Hence, this concludes the definition of Zero Coupon Swap along with its overview.
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Zero coupon swap
Management Dictionary. Related Business Content. Likewise, with a zero coupon inflation swap, both income streams are paid as one lump-sum payment when the swap reaches maturity and the inflation level is known, instead of actually exchanging payments periodically.
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- Zero Coupon Swap!
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- Definition: Zero Coupon Swap!
The payoff at maturity depends on the inflation rate realized over a given period of time as measured by an inflation index. In effect, the zero coupon inflation swap is a bilateral contract used to provide a hedge against inflation.
Zero-Coupon Inflation-Indexed Swap - Wikipedia
Under a zero coupon inflation swap, the inflation receiver or buyer pays a predetermined fixed rate and, in return, receives an inflation-linked payment from the inflation payer or seller. The side of the contract that pays a fixed rate is referred to as the fixed leg, while the other end of the derivatives contract is the inflation leg. The fixed rate is called the breakeven swap rate and depends on the current time and the inflation period. The payments from both legs captures the difference between expected and actual inflation.
If actual inflation exceeds expected inflation, the resulting positive return to the buyer is considered a capital gain.
As inflation rises, the buyer earns more; if inflation falls, the buyer earns less. While payment is typically exchanged at the end of the swap term, a buyer may choose to sell the swap on the over-the-counter OTC market prior to maturity.
Zero-Coupon Inflation-Indexed Swap
The inflation buyer pays:. If compounded inflation rises above 2. The currency of the swap determines the price index that is used to calculate the rate of inflation.
For example, a swap denominated in U. Like every debt contract, a zero coupon inflation swap is subject to the risk of default from either party either because of temporary liquidity problems or more significant structural issues, such as insolvency. To mitigate this risk, both parties may agree to put up collateral for the amount due. Other financial instruments that can be used to hedge against inflation risk are real yield inflation swaps, price index inflation swaps, Treasury Inflation Protected Securities TIPS , municipal and corporate inflation-linked securities , inflation-linked certificates of deposit, and inflation-linked savings bonds.
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