Formula Method

DEFINITION of 'Formula Method '

A technique for calculating termination payments on a prematurely ended swap. Termination payments are used to compensate the party who did not cause the swap to end early for its financial loss. Because they are not very liquid, currency swaps tend to use the formula method, but it is one of the less common methods for calculating damages.

BREAKING DOWN 'Formula Method '

Of the three official methods for calculating termination payments as established by the International Swaps and Derivatives Association, the agreement value method, which is based on the terms available for a replacement swap, is most common. The third method, the indemnification method, is not often used. A swap may be terminated early if a termination event such as an illegality, tax event, tax event upon merger or credit event occurs. An event of default, such as bankruptcy or failure to pay, can also cause early termination.



RELATED TERMS
  1. Agreement Value Method

    The most common of three official methods established by the ...
  2. Indemnification Method

    A technique for calculating termination payments when a swap ...
  3. Replacement Swap

    A substitute for a swap arrangement that is terminated before ...
  4. Termination Clause

    A section of a swap contract that describes what will happen ...
  5. Termination Date

    The day on which a swap contract becomes invalid and no further ...
  6. Termination Event

    An occurrence that will cause all or part of a swap agreement ...
Related Articles
  1. Trading

    An In-Depth Look At The Swap Market

    The swap market plays an important role in the global financial marketplace; find out what you need to know about it.
  2. Trading

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  3. Investing

    What Warren Buffet Calls "Weapons of Mass Destruction": Understanding the Swap Industry

    A full analysis of how the swap industry works.
  4. Investing

    How Are Interest Rate Swaps Valued?

    When trading in financial markets, higher returns are generally associated with higher risk. Hedge your risk with interest rate swaps.
  5. Trading

    Currency Swap Basics

    Find out what makes currency swaps unique and slightly more complicated than other types of swaps.
  6. Investing

    Different Types of Swaps

    Investopedia explores the most common types of swap contracts.
  7. Markets

    What's an Interest Rate Swap?

    An interest rate swap is an exchange of future interest receipts. Essentially, one stream of future interest payments is exchanged for another, based on a specified principal amount.
  8. Managing Wealth

    How To Read Interest Rate Swap Quotes

    Puzzled by interest rate swap quotes terminology? Investopedia explains how to read the interest rate swap quotes
  9. Managing Wealth

    The Advantages Of Bond Swapping

    This technique can add diversity to your portfolio and lower your taxes. Find out how.
  10. Investing

    Interest Rate Swaps Explained

    Plain interest rate swaps that enable the parties involved to exchange fixed and floating cash flows.
RELATED FAQS
  1. How can an investor terminate a derivative contract?

    Read a brief overview about some of the different ways that derivatives traders can terminate their contracts early, including ... Read Answer >>
  2. Which of the following statements least accurately describes the ways in which a ...

    The correct answer is: a) If the winning party simply terminates the swap, then he'll get zero for it. If a swap has value, ... Read Answer >>
  3. What would motivate an entity to enter into a swap agreement?

    Learn why parties enter into swap agreements to hedge their risks, and understand how the different legs of a swap agreement ... Read Answer >>
  4. What are some risks a company takes when entering a currency swap?

    Read about the risks associated with performing a currency swap, including counterparty credit risk in the event that one ... Read Answer >>
  5. When was the first swap agreement and why were swaps created?

    Learn about the history of swap agreements, the first swap agreement between IBM and the World Bank, and how swaps have evolved ... Read Answer >>
  6. How are swap agreements financed?

    Learn how swap agreements are now cleared by swap execution facilities and require the use of collateral margin to hold, ... Read Answer >>
Hot Definitions
  1. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  2. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  3. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  4. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
  5. Weighted Average Life - WAL

    The average number of years for which each dollar of unpaid principal on a loan or mortgage remains outstanding. Once calculated, ...
  6. Real Rate Of Return

    The annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other ...
Trading Center