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Breakage costs: Difference between revisions
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Amwelladmin (talk | contribs) (Created page with "Breakage costs , or break costs, on a loan are the opportunity cost to a lender of a borrower repaying a loan before scheduled maturity, meaning the lender mus...") Tags: Mobile edit Mobile web edit |
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[[Breakage costs]] , or [[break costs]], on a [[loan]] are the opportunity cost to a [[lender]] of a borrower repaying a loan before scheduled maturity, meaning 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 | ===[[Loan]]s=== | ||
[[Breakage costs]], or [[break costs]], on a [[loan]] are the opportunity cost to a [[lender]] of a borrower repaying a loan before scheduled maturity, meaning 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. | ||
===[[Swap]]s=== | |||
[[Swap break costs]] are the equivalent for a [[swap]]. Since there are cash flows running in both directions and the theory is therefore your swap has a mark-to-market of zero on day 1, [[swap break costs]] will generally be simply the uncollateralised [[mark-to-market]] exposure of the existing transaction. You could reach that conclusion by going through the motions: | |||
*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 opening up a new swap at today's market rates, 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> | |||
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*[[Present value]] | |||
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