Method, system, and computer program product for trading interest rate swaps

Abstract

A method, system, computer program product, and data structure for trading in which a standardized contract is traded. The contract obligates a buyer and a seller to settle the contract based on a price of the contract at a first effective date. The contract is traded through an exchange that guarantees payment to the buyer of any amount owed to the buyer from the seller as a result of the contract and that guarantees payment to the seller of any amount owed to the seller from the buyer as a result of the contract. The price of the contract is determined based on preselected notional cash flows discounted by at least one point on an interest rate swap curve obtained from a preselected swap rate source.

Description

[0001] This application is a continuation of U.S. Application Ser. No. 09 / 209,746, filed Dec. 11, 1998, which is incorporated herein by reference. This application claims priority from U.S. Provisional Application Ser. No. 0 / 074,588, filed Feb. 13, 1998, U.S. Provisional Application Ser. No.0 / 101,419, filed Sep. 22, 1998, and U.S. Provisional Application Ser. No. 0 / 104,400, filed Oct. 15, 1998, each of which is incorporated herein by reference.BACKGROUND OF INVENTION[0002] 1. Field of the Invention[0003] This invention relates to a method, a system, and a computer program product for trading and settling a product. More particularly, the present invention relates to a method, a system, and a computer program product for trading and settling a contract having a price based on any preselected interest rate swap curve.[0004] 2. Discussion of the Background[0005] An interest rate swap (IRS) is a well known financial transaction which usually occurs between two parties. In a swap, the tw...

AI Technical Summary

Benefits of technology

[0023] It is a further object of the present invention to provide a novel method, system, and computer program product that reduces the overhead costs associated with conventional interest rate hedging.

[0089] Since the inputs (notional cash flow, IRS curve, etc.) to the inventive contract cause the price of the contract to behave similar to an IRS, the invention effectively puts an IRS in commodity form. As discussed above, the inputs can be varied to suit the tastes of existing and potential traders of the inventive contract. For example, by using a relatively long notional maturity (e.g., 5 years and 10 years) and a relatively short period between settlement dates (e.g., 3 months), the inventive contract provides a short term instrument that emulates a long term IRS and that can be freely traded on an exchange in commodity form.

Problems solved by technology

However, such an insulation or protection from changing interest rates results in an added cost to the party seeking protection from the potential change.

However, this practice also involves two major disadvantages.

First, both market segments are based on different credits and therefore an unexpected change in the yield differential of the two markets could result in heavy losses.

Second, conventional techniques require efficient access to the bond and repo market.

Specifically, repo transactions can be problematic since these transactions have to be renegotiated on a regular basis and market conditions can be very volatile.

Despite the enormous size of the IRS market, barriers to entry exist for new, and sometimes existing, participants.

Thus, each transaction is a separately negotiated contract with little standardization of financial terms.

The contracts are lengthy and complex, and legal review is required for each transaction.

Hence any large and sophisticated users must endure the overhead burdens associated with the conventional, inefficient operating environment of the IRS market.

Within the IRS market, bilateral netting agreements facilitate netting of positions between specific counterparties by reducing credit exposure and freeing up capital; however, it is difficult, if not impossible, for participants to freely net deals across multiple counterparties.

Further, it is time consuming and cumbersome to settle each agreement separately, and there is no guarantee that the cancellation or assignment of a particular contract provides the best price.

The various barriers to entry into the IRS market have resulted in a heavy concentration of business among a handful of the largest global banks.

This oligopolistic environment has led to an artificial lack of market transparency (since each transaction is unique and propriety to the counterparties) and the discrimination of many market participants who would benefit from more direct access to the IRS market.

Large and sophisticated users of IRSs (for example, large corporations) must often operate at a pricing disadvantage to the large global banks with whom they must conduct their business.

However, the CBOT product exhibited considerable design problems and received little customer support.

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