Interest Rate Swaps - LIBOR, LIBOR, LIBOR

[forumusernew]

Hi all,
I’ve read some conflicting accounts for plain vanilla interest rate swaps do we use LIBOR (T-1)? And for interst rate options use LIBOR (T)??? I think that’s it but to be honestly would’nt be suprised if I was wrong.

 

[S2000magician]

Both swaps and interest rate options pay in arrears, but the floating rate is set in advance.
If you have a quarterly pay, plain vanilla interest rate swap based on (90-day) LIBOR, the LIBOR rate at time zero (inception of the swap) will establish the payment at time one (90 days after inception). For example, on $10,000,000 notional with a fixed rate of 4% and a (time zero) LIBOR rate of 3.6%, the payment 90 days after inception will be $10,000 from the long (fixed rate payer) to the short (floating rate payer).
If you have an interest rate call on €20,000,000 that expires in 90 days, based on 180-day LIBOR with a 3% strike rate, the LIBOR rate 90 days from now will determine the payoff 270 days from now. If 180-day LIBOR is 2.8%, the option will expire worthless; if 180-day LIBOR rate is 3.6%, then the option will be exercised, and the payoff (180 days after expiration) will be €80,000.

 

[forumusernew]

Fantastic, thanks for the thorough, easy to understand explanation

 

[S2000magician]

You’re quite welcome