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{{ | {{def|Breakage costs|/ˈbreɪkɪdʒ kɒsts/|n|}} | ||
1. (''[[Loan]]s'') The opportunity cost to a [[lender]] of a [[borrower]] repaying a [[loan]] before its stated [[maturity]], arising because the [[lender]] must [[unwind]] its [[interest rate]] [[hedge]]s - usually the difference between the rate payable on the loan for the specified period and the overnight rate. The difference between the [[present value]] of the remaining loan repayments at their stated rate and their present value at the prevailing market rate — that is, the difference between [[present value]] of what I would get if we stuck with the original deal and you repaid the loan at term, and how much I could get if I lent that money out today, at today’s rate, for the period of the remaining term on the original [[loan]].<br> | |||
[[ | 2. (''[[Swap]]s'') the net [[present value]] of the remaining cashflows on a [[swap]]. On the [[Trade Date - ISDA Provision|trade date]] those values must have been equal and on any other day [[swap break costs]] will generally be simply the uncollateralised [[mark-to-market]] value, or the [[replacement cost]], of the existing transaction. You could also reach that conclusion by going through the motions: | ||
The difference between the [[present value]] of the remaining loan repayments at their stated rate and their present value at the prevailing market rate — that is, the difference between [[present value]] of what | |||
[[ | |||
*If I terminated this [[swap]] today, what would its [[MTM]] be? This is the equivalent of “the [[present value]] of the remaining payments". | *If I terminated this [[swap]] today, what would its [[MTM]] be? This is the equivalent of “the [[present value]] of the remaining payments". | ||
*If I traded a new [[swap]] at today’s prices, what would its [[MTM]] be? According to the theory of [[homo economicus]], this ought to be necessarily ''zero'' — any other value would mean I was entering into an off-market [[swap]].<ref>Note that upfront [[PV]] of fees — especially on exotic derivatives, [[CPPI]] and that sort of thing, might mean the MTM of a swap immediately drops to factor in that, whatever else the hell happens, the dealer will have its fee for the whole period, capisce?</ref> | *If I traded a new [[swap]] at today’s prices, what would its [[MTM]] be? According to the theory of [[homo economicus]], this ought to be necessarily ''zero'' — any other value would mean I was entering into an off-market [[swap]].<ref>Note that upfront [[PV]] of fees — especially on exotic derivatives, [[CPPI]] and that sort of thing, might mean the MTM of a swap immediately drops to factor in that, whatever else the hell happens, the dealer will have its fee for the whole period, capisce?</ref> |