Swaps CMS: technical details

Quant Team, Banco Santander Central Hispano

1 CMS (SwapCMS → SwapCMS)

1.1 Swaps on CMS rates

By a CMS Swap Leg we mean a leg in a swap that uses a Constant Maturity Swap
rate as the underlying rate. The i-th cash flow of a CMS Swap Leg consists in paying
(or receiving1 ) the swap rate Ri , with a constant maturity specified in the contract and
determined at a fixing date Ti prior to the payment date Ui . Therefore, referring each
cash flow by the subscript variable i, the cash flow at time Ui is the swap rate times the
nominal Ni (that may vary from one flow to another), times the day count fraction mi
corresponding to the period (Ui−1 , Ui ), according to the convention specified for the leg.
Assuming the no-arbitrage condition in a complete market, the value of one cash flow at
time zero is obtained as the expectation under the risk neutral probability measure P of
the discounted payoff:
 R Ui   R Ui 
P − 0 rs ds P − 0 rs ds
Ci = E e Ri (Ti ))Ni mi = E e Ri (Ti ) Ni mi

The total value at time zero of the CMS Swap Leg is the sum of all these payments,
n
X n
X  R Ui 
P − rs ds
CM SSwapLegV alue = Ci = E e 0 Ri (Ti ) Ni mi
i=1 i=1

The CMS Swap rate paid in the CMS Swap Leg is given by

B(Ti , Vi0 ) − B(Ti , Viki )

( 1.1) Ri (Ti ) = Pki k k
,
k=1 B(T i , Vi )di

where

Ti is the fixing date of the CMS rate for the payment at Ui ,

Vi0 is the start date of the underlying swap
Vi1 , . . . , Viki is the payment schedule of the fixed leg of the underlying swap
dki is the day count fraction between the dates Vik−1 and Vik ,
1
In the sequel, we will always talk about paying the CMS rate, although, of course, the CMS Swap
Leg can also be received. 1
Preliminary version January 16, 2007

Fig. 1: CMS Flex Block

with the conventions defining these quantities as specified in the contract2 . See swapCMS
technical for a description of the technical details of the model.

1.2 Description of the Flex Block

Actually, the model described here needs to be activated. It appears in the list as
SwapCMS. The product is now available from the IRS window in Murex. The model
can be selected by ticking the option Flex in the tab Characteristics. Click then in
Flex Details, and Insert the Flex Block CMS. This flex block is quite simple: there
only appears a menu that allows us to choose between a valuation with an analytic
proxy (choice Yes, see figure 1) or with a MonteCarlo simulation (choice No). The
option appearing by default is Yes.
It is necessary to append the Flex Block CALIBRATOR to the CMS Flex Block.
The second position for the CALIBRATOR is obligatory. As usual,in this block the
following fields must be filled:

• Model: necessarily HJM if we choose the option Yes in the menu (1), or HW,
HJM, HJM-2F if we choose a MonteCarlo simulation for the valuation.

• Calibration Key: the corresponding one for the product and model chosen (see
SQuALID User Guide)

• Engine: MonteCarlo

• N Packs-Monte: number of packs in the MonteCarlo simulation

2
Actually, in the implementation of the model this quantities are calculated according to the standard
conventions.

CMS technical Quant Team, BSCH 2

Preliminary version January 16, 2007

• Path/Pack-Monte: number of paths for each pack. The total number of simulations
is the product of these two last fields.

• It is not necessary to fill the fields N TimeStep Tree, and Time Inc - Tree (they
are only necessary for a tree valuation)

CMS technical Quant Team, BSCH 3