MATLAB: Is there a function or method for interest rate swaption evaluation

Financial Toolbox

I would like to compute the interest rate on a swaption using MATLAB.

Best Answer

This feature has been added in Financial Derivatives Toolbox 5.1 (R2007b). For all previous versions, use the following workaround.

It is possible to try to use short interest rate trees to build up pricing functions for more complex interest rate derivatives like swaptions.

We do provide several interest rate models. You can create your own instrument to price it with our models (such as BDT, HW, HJM, BK). As we do support the swap instrument, and since a swaption is just an option on a swap, you could create this instrument and adapt it to our pricing function.

Related Solutions

MATLAB: Do I get an error of cash flow dates spanning across tree nodes using FLOATBYBK in the Financial Instruments Toolbox 1.0 (R2012b)

The reason this error is thrown out is the mis-alignment between the dates in the Black-Karasinski tree that you built and the cash flow dates.

The way the tree in your use case is set up makes it impossible to determine the applicable rate used to compute the payoff at the tree nodes. The reason is that the information is lost during the recombination of the tree nodes.

One way to remedy this issue is to place the tree levels at the cash flow dates of the instrument, which is done when specifying the Time Specs in the BK tree.

Once you set up the Rate and Volatility Specs of the BK tree, you would need to define the Time Specs as follows:

Basis             = intenvget(RateSpec, 'Basis');
EOM               = intenvget(RateSpec, 'EndMonthRule');
resetDates        = cfdates(ValuationDate, Maturity, resetVector, Basis, EOM);
BKTimeSpec = bktimespec(RateSpec.ValuationDate, resetDates, resetVector);
BKT        = bktree(BKVolatilitySpec, RateSpec, BKTimeSpec);
Price      = floatbybk(BKT, Spread, RateSpec.ValuationDate, ...
                                Maturity, 'Reset', resetVector)

where 'ValuationDate', 'Maturity',' etc. were used to define the FRN parameters.

MATLAB: Does SWAPBYZERO include the principal in its computation of the Interest Rate Swaps in MATLAB (R2013b)

As mentioned in the documentation (R2013b), the "Principal" parameter is a "notional" amount used to determine the cash flows, although there is no actual exchange of principal. So you should not set this parameter to zero. Although the cash flow outputs "RecCF" and "PayCF" do include principal amounts, this should not affect the computation of the swap price since the principal amounts in the two legs cancel each other out.

If you have access to John Hull textbook "Options, futures, and other derivatives", it is mentioned that:

"If the principal were exchanged at the end of the life of the swap, the nature of the deal would not be changed in anyway. The principal is the same for both the fixed and the floating payments. Exchanging $100 million for $100 million at the end of the life of the swap is a transaction that would have no financial value...."

An enhancement request has been submitted so that the cash flow outputs, "RecCF" and "PayCF", not include the notional principal at the end of the swap to reflect the actual mechanics of the swap.

Best Answer

Related Solutions

MATLAB: Do I get an error of cash flow dates spanning across tree nodes using FLOATBYBK in the Financial Instruments Toolbox 1.0 (R2012b)

MATLAB: Does SWAPBYZERO include the principal in its computation of the Interest Rate Swaps in MATLAB (R2013b)

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