I have 2 questions on Basis Swap compounding and market conventions. These obviously apply where the reset period is shorter than the payment period

  1. Where both fixings have shorter reset period than payment period and there is a spread, and it is not a "compound without spread", does this, by convention, apply only to the first mentioned fixing rate? (The only one of which I know is SOFR vs Fed Funds which uses compound without spread so it doesn't apply yet, but as one who is programming pricing for these I need to know in a more general manner)

  2. Where this is an IOS compounding and the reset period is more than 1 day, are the days compounded? That is the difference between (1+rd)^n and 1+rdn or using log1p, n(log1p(rd)) or log1p(rdn) where 'd' is the daycount fraction (or yearFraction) for a single day, r is the interest rate that is reset n days later (sometimes more than 1 due to weekends or holidays)

  • $\begingroup$ Thank you for the upvotes but I'm really looking for answers, not reputation. I'd prefer my reputation to grow at work by writing things to the correct specification. $\endgroup$ – CashCow Oct 10 '19 at 10:08

From what I have now read I can partially answer 2: It is normally (conventionally) 1+rdn or log1p(rdn) except on Brazilian reset rates which use (1+rd)^n or n(log1p(rd)).

FED funds conventionally don't compound but use a weighted average rate over the period (weighted by daycount), and that is how they compound in Libor vs FED funds swaps. For SOFR vs FED Funds it appears both compound the same way, i.e. regular compounding.

With regards spread, even if compounding without spread it is necessary to know to which side to apply the spread so which is mentioned first will have a big significance in that.


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