Formula Method

AAA

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.

INVESTOPEDIA EXPLAINS '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. Reverse Swap

    An exchange of cash flow streams that undoes the effects of an ...
  2. Debt For Bond Swap

    A debt swap involving the exchange of a new bond issue for similar ...
  3. Interest Rate Swap

    An agreement between two parties (known as counterparties) where ...
  4. Forward Swap

    A swap agreement created through the synthesis of two swaps differing ...
  5. Currency Swap

    A swap that involves the exchange of principal and interest in ...
  6. Quanto Swap

    A swap with varying combinations of interest rate, currency and ...
RELATED FAQS
  1. Why would a company issue a rights offering?

    Companies most commonly issue a rights offering to raise additional capital. A company may need extra capital to meet its ... Read Full Answer >>
  2. What is the difference between share purchase rights and options?

    There is a big difference between share purchase rights and options. With share purchase rights, the holder may or may not ... Read Full Answer >>
  3. What is the difference between an option-adjusted spread and a Z-spread in reference ...

    Unlike the Z-spread calculation, the option-adjusted spread takes into account how the embedded option in a bond can change ... Read Full Answer >>
  4. In what ways can a sinking fund affect bond returns?

    The effective yield of a bond sinking fund to an investor should not be considered similar to a bond nonsinking fund. Both ... Read Full Answer >>
  5. Can delta be used to calculate price volatility of an option?

    The delta of an option is a component of the Black-Scholes option pricing formula, which provides the implied volatility ... Read Full Answer >>
  6. How is fair value calculated in the futures market?

    The fair value is the theoretical calculation of how a futures stock index contract should be valued considering the current ... Read Full Answer >>
Related Articles
  1. Insurance

    Credit Default Swaps: What Happens In A Credit Event?

    The credit crisis of 2008 prompted important changes to the settlement of credit default swaps.
  2. Options & Futures

    An Introduction To Structured Products

    Learn a simple way to bring the benefits of derivatives into your portfolio.
  3. Options & Futures

    Careers In The Derivatives Market

    The growing interest in and complexity of these securities means opportunities for job seekers.
  4. Investing Basics

    The Barnyard Basics Of Derivatives

    This tale of a fictional chicken farm is a great way to learn how derivatives work in the market.
  5. Options & Futures

    Are Derivatives Safe For Retail Investors?

    These vehicles have gotten a bad rap in the press. Find out whether they deserve it.
  6. Options & Futures

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  7. Active Trading

    How Companies Use Derivatives To Hedge Risk

    Derivatives can reduce the risks associated with changes in foreign exchange rates, interest rates and commodity prices.
  8. Investing Basics

    Understanding Non-Deliverable Forward (NDF)

    A foreign exchange hedging strategy where the parties agree to settle the profit or loss in a foreign currency futures contract before the expiration date.
  9. Investing

    What More Volatility Means For Momentum Stocks

    One byproduct of the recent tick higher in bond yields: a meaningful rise in volatility for both stocks and bonds.
  10. Options & Futures

    How & Why Interest Rates Affect Options

    The Fed is expected to change interest rates soon. We explain how a change in interest rates impacts option valuations.

You May Also Like

Hot Definitions
  1. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
  2. Moving Average - MA

    A widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Productivity

    An economic measure of output per unit of input. Inputs include labor and capital, while output is typically measured in ...
  5. Variance

    The spread between numbers in a data set, measuring Variance is calculated by taking the differences between each number ...
  6. Terminal Value - TV

    The value of a bond at maturity, or of an asset at a specified, future valuation date, taking into account factors such as ...
Trading Center