with an IR Swap that is a compounding interest rate swap on the variable interest side. The IR swap referenced changes its interest rate every 3 months but only pays out every 6 months. Because it is compounding the notional amount needs to reflect the calculated interest for the previous 3 months. SAP does not do this with updated values during the NPV (TPM60) process.
Example:
· Notional Amount: $1000
· Variable Rates (from yield curve):
o Start of Period 0 = 5%
o Start of Period 4 = 2%
· Interest payment frequency is every 6 months.
· Interest compound frequency is every 3 months and starts at Period 0.
· Period 0 = position date
· Assume each period consists of 30 days and that a year is 360 (for illustration purposes)
· Notional amount in FTR_EDIT for the start of period 4 is $1020 (before any NPV calculation is completed – it reflects this value because the most recent rate in the system was 8%)
Calculation of interest payment at the end of period 3.
1000 * .05 *(90/360) = $12.50
This is interest that has been calculated and because of compounding will be included in the calculation of interest for the next period from the start of period 4 to the end of period 6. Assuming that the 5% rate is a rate determined on the yield curve during NPV calculation the new interest amount calculated as part of that process should update the subsequent notional amount to 1012.50.
However, currently the NPV calculation (TPM60) takes the notional amount bases from the instrument structure information using only those rates that are fixed or the most recent rate available. So in the case above I would expect the notional amount for the start of period 4 to be 1012.50 but instead SAP directly populates the notional value of 1020 from the FTR_EDIT for this future date. And it uses 1020 to calculate the interest amount verses 1012.50 resulting in our frustration.
We would expect the calculation of interest payment at the end of period 6 to be done as follows.
- 1012.50 * .02 * (90/360) = $ 5.06 (correct)
VERSES what SAP currently is doing,
1020 * .02 * (90/360) = $ 5.10 (wrong)
Total interest payment calculated for the end of 6 months on the variable side as part of the valuation should be in my example: 12.50 + 5.06 = $17.56
This would continue throughout the valuation, with the notional amount resetting to $ 1000 at the start of period 7, calculating interest in the first 3 months on the variable rate determined from the yield curve for period 7, etc.
So again, to help clarify, the problem we have encountered and believe to be a bug in the SAP code perhaps is how notional values are calculated for the variable side of a compounding interest rate swap where the interest fixing occurs more frequently then when payment occurs.
Thanks ahead to any help we can recieve on this issue.