Callable Swap

ORE defines the product as follows:

A Callable Swap can be terminated by one of the parties on specific dates and thus can be decomposed into a swap and a physically settled swaption, the latter representing the call right. The underlying swap must be fixed versus float and may have varying notional, rates, and spreads during its lifetime.

Source: ORE User Guide, Products catalogue, callableswap.tex.

The CallableSwapData node is the trade data container for the CallableSwap trade type. A callable swap is a swap that can be cancelled at predefined dates by one of the counterparties.

A callable swap is a normal swap with a kill switch. One party holds the switch. That party can end the swap on the call dates. If the right is never used, the swap runs to maturity like any other. The party holding the right pays for it through the terms of the trade.

A callable swap must have at least one leg. Multiple legs are allowed. The leg types can be Floating, Fixed, or Cashflow. Cross-currency underlyings are supported. The OptionData node describes the exercise dates. Its LongShort flag names the party holding the call right. The settlement must always be Physical. Leg directions follow the Payer flag, as for a swap, from the perspective of the party to the trade. This differs from a swaption, where leg directions follow the party that is long. If exercise triggers an exchange of notionals in a cross-currency callable swap, the exchange is captured as two exercise fees in the respective currencies. Unless MidCouponExercise is true, at least one full coupon period must follow the exercise date for a European callable swap. The same holds after the last exercise date for Bermudan and American callable swaps. An exercised callable swap is marked via the ExerciseData node within OptionData.

A callable swap is a swap plus an embedded option. The option is a physically settled swaption on the remaining swap. The party holding the call right terminates when the swap has become unfavourable to receive. ORE values the callable swap with the same machinery as a swaption. The exercise dates drive the optionality. Between the dates, the swap legs accrue and pay as usual.

• The swap rate levels that set the value of the fixed and floating legs.
• The volatility of the swap rates, through the embedded option.
• The exercise dates and the notice conventions.
• The discount curve.
• The terms of the legs, including notional amortisation.

The fixed payer benefits when rates fall and the swap runs. The party holding the call right benefits when terminating removes an unfavourable swap.

The swap runs coupon by coupon between call dates. On each call date the holder decides to terminate or to continue. A date that passes without exercise consumes that right. After termination no further payments occur. If no call date is used, the swap runs to maturity and ages like a plain vanilla swap.

A customer that may want to exit a swap buys the right to do so. The right allows a refinancing when rates move in the customer's favour. A bank structures the product for customers with uncertain swap needs. In ORE Studio a customer books callable swaps to value them and run sensitivities on the ORE engine.

ORE's catalogue shows a callable swap with a Bermudan call right on annual dates from 2031 to 2033:

<CallableSwapData>
    <OptionData>
      <LongShort>Short</LongShort>
      <Style>Bermudan</Style>
      <Settlement>Physical</Settlement>
      <MidCouponExercise>true</MidCouponExercise>
      <ExerciseDates>
        <ExerciseDate>2031-10-01</ExerciseDate>
        <ExerciseDate>2032-10-01</ExerciseDate>
        <ExerciseDate>2033-10-01</ExerciseDate>
      </ExerciseDates>
      ...
    </OptionData>
  <LegData>
    <LegType>Fixed</LegType>
    <Payer>false</Payer>
    <Currency>USD</Currency>
    ...
  </LegData>
  <LegData>
    <LegType>Floating</LegType>
    <Payer>true</Payer>
    <Currency>USD</Currency>
    ...
  </LegData>
</CallableSwapData>

Source: ORE User Guide, Products catalogue, callableswap.tex, listing Callable Swap data. The source listing repeats the opening tag of MidCouponExercise; the closing tag is normalised here.

The embedded right is a physically settled swaption, see the Swaption note.