Pricing a Brazilian PRE/DI Swap

D. L. Chertok November 8, 2012

Summary
A Brazilian swap is an exchange-guaranteed contract between two counterparties where at maturity both sides exchange netted payments accrued according to different schedules.

Mathematical formulation

At inception, counterparties of a Brazilian PRE/DI swap agree to exchange payments at maturity [1]. The xed, or PRE side, pays the contract notional amount: = N (t0 )AF (t0 , t; rP RE (t0 , T )) , n AF (t0 , t; rP RE (t0 , T )) = [1 + rP RE (t0 , T )] 252 , N (T, T ; rP RE (t0 , T )) = Ncontract , where: t T t0 rP RE (t0 , T ) N (t, T ; rP RE (t0 , T )) N (t0 ) AF (t0 , t; rP RE (t0 , T )) n Ncontract current time; t [t0 ; T ], swap maturity ( in days ), effective date, futures-based rate ( on the PRE side ) quoted from t0 to T , notional at t, notional at inception, accrual factor from t0 to t determined by the contract rate rP RE (t0 , T ), number of business days between t0 and t ( accrual days ), contract notional payable at T . N (t, T ; rP RE (t0 , T )) (1.1) (1.2) (1.3)

D. L. Chertok, Ph. D., CFA, (daniel chertok@hotmail.com) is a quantitative investment professional in Chicago, IL.

The oating, or DI, side pays the accrued amount based on the notional amount on effective date and the daily average overnight interest rate: N t, T ; {rDI (ti )}K i=0 AF t0 , t; {rDI (ti )}K i=0 where: K rDI (ti ) number of business days between t0 and T , average daily overnight rate at ti [t0 ; tK = T ] , i = 0, K. = = N (t0 )AF t0 , t; {rDI (ti )}K i=0 ,
n

(1.4) (1.5)

[1 + rDI (ti )] 252 ,

i=1

The present value of the PRE side is the current notional accrued at the contract PRE rate to maturity and then discounted back to the valuation date: P VP RE (t) = N (t, T ; rP RE (t0 , T )) AF (t, T ; rP RE (t0 , T )) . AF (t, T ; rP RE (t, T )) (1.6) (1.7) The present value of the DI side is simply the current notional ( accrued at the actual realized DI rate from effective date to today ): P VDI (t) = N (t, T ; rDI (t0 , T )) . (1.8)

The current present value of the swap is the difference between the two sides: P Vswap (t) = (P VDI (t) P VP RE (t)) IP ayP RE , (1.9)

where IP ayP RE is the pay xed indicator, i.e., IP ayP RE = 1, 1, if the swap pays PRE, if the swap pays DI. (1.10)

Example

We consider a pay-PRE Brazilian swap tied to the ODF7 future maturing on 1/2/2017 on the PRE side. The swap was entered into at the PRE rate of 11.85% effective on 3/20/2007, rst accrued interest on 3/21/2007, and was priced on 3/27/2007. The results are presented in Table 2. Table 1 reects the PRE and DI rate histories respectively.

References
[1] Brazilian Mercantile and Futures Exchange. Swap contract specications, 2007. http://www.bmf.com.br/portal/pages/frame.asp? idioma=2&area=contratos&link_char=Swaps1. 2

Table 1: PRE and DI rate histories. Date 3/21/2007 3/22/2007 3/23/2007 3/26/2007 ODF quote 11.7% 11.682% 11.71% 11.695% Overnight rate 12.65% 12.63% 12.61% 12.6%

Table 2: Brazilian swap price calculation.

Parameter Underlying futures Effective date Valuation date Last history date Rate Accrual factor Current ODF quote Days to ODF maturity Nominal notional, BRL Strike Days to mat. at trade # of accrual days ODF Accrual factor discount factor at val date Trade notional, BRL Pay PRE? Price per notional, PRE Accrual, PRE Price per notional, DI Accrual, DI Total

Value ODF7 3/20/2007 3/27/2007 3/26/2007 1.001888628 11.695 2457 1,000,000 11.85 2461 4 1.001779176 0.334986352 334,986.35 1 340,150.50 5,164.14 335,619.02 632.66 4,531.48

Computation

[1.1265 1.1263 1.1261 1.126] 252

1.1185 252 2461 1.1185 252 2461 1, 000, 000 1.1185 252 334, 986.35 1.001779176 340, 150.50 334, 986.35 334, 986.35 1.001888628 335, 619.02 334, 986.35 5, 164.14 632.66
1.185 1.1695
2457 252