Breakage costs: Difference between revisions

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+{{def|Breakage costs|/ˈbreɪkɪdʒ kɒsts/|n|}}
-===[[Loan]]s===
+. (''[[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.
-[[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.
+. (''[[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 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 a {{t|swap}} has [[cash flow]]s running in both directions, the [[present value]] of which on the [[Trade Date - ISDA Provision|trade date]] must have been equal, the theory is therefore that any swap must have a [[mark-to-market]] value of ''zero'' on day 1, [[swap break costs]] will generally be simply the uncollateralised [[mark-to-market]] value, or the [[replacement cost]], 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 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>