DEFINITION of 'Indemnification Method '

A technique for calculating termination payments when a swap is ended early. The indemnification method requires the responsible counterparty to compensate the nonresponsible counterparty for all losses and damages caused by the early termination. This method was common when swaps were first developed, but was considered inefficient because it did not actually quantify, or describe how to quantify, the losses and damages from a prematurely terminated swap.

BREAKING DOWN 'Indemnification Method '

Today, the agreement value method, which is based on the terms and interest rates available for a replacement swap, is the most widely used method for calculating termination payments. Another, less-common alternative is the formula method. A swap may be terminated early if either counterparty experiences an event of default, such as bankruptcy or failure to pay, or a termination event, such as an illegality, tax event, tax event upon merger or credit event.

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