Flexi Swap

ORE defines the product as follows:

A Flexi Swap is an amortizing swap in which one party has the option to further reduce the notional in each period to each value between the current notional and a specified lower bound for that period.

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

ORE states the pricing approach as follows:

Flexi Swaps are priced in ORE following the Replication Approach described in (F. Jamshidian, 2005). The replicating basket of Bermudan Swaptions is priced using the method as described under Product Type "Bermudan Swaption". Flexi Swaps can be single or cross currency.

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

ORE notes that flexi swaps are typically used for swaps linked to Asset Backed Securities with flexible amortisation.

A flexi swap lets the notional breathe. The schedule amortises in the usual way. On top of that, one party may cut the notional further in each period. The cut can land anywhere between the current notional and a stated lower bound. The right matters when the underlying collateral prepays at an uncertain speed.

The FlexiSwapData node is the trade data container for the flexi swap. The swap legs carry an amortising notional and are represented by LegData sub-nodes. The node also contains an OptionLongShort element. It names the holder of the prepayment option. A further sub-node describes the optional prepayments. In ORE's example the sub-node is LowerNotionalBounds. It means the notional can be reduced to any value between the given lower bound and the original notional in each fixed leg period.

A flexi swap is an amortising swap plus a strip of reduction rights. Each right allows the holder to cut the notional down to a lower bound in one period. ORE prices the rights by the Replication Approach. The approach replicates the reduction rights with a basket of Bermudan Swaptions. Each Bermudan Swaption in the basket prices with the method described under Product Type "Bermudan Swaption". The holder exercises a right only when the cut improves the swap value.

• The swap rate levels against the fixed coupon.
• The volatility of the swap rates, through the swaption basket.
• The amortisation schedule and the lower notional bounds.
• The identity of the option holder.
• The discount curve and the index spreads.

The reduction right is worth more when the swap has moved against the party that must keep receiving it. The fixed legs and the lower bounds define how much notional each right can release.

Period by period the holder decides whether to cut. A period that passes without exercise consumes that period's right. Actual cuts shrink the remaining notional. Later exposure shrinks with it. Late in life few rights remain. The swap then runs on the reduced schedule to maturity.

A customer in an Asset Backed Security trade needs a swap that follows flexible amortisation. The collateral prepays at an uncertain speed. A fixed amortisation schedule would mismatch the security. The flexi swap lets the notional track the collateral. In ORE Studio a customer books flexi swaps to value them and run sensitivities on the ORE engine.

ORE's catalogue shows a flexi swap whose optional prepayments are given by LowerNotionalBounds:

<FlexiSwapData>
  <LowerNotionalBounds>
        <Notional>451389557.145667</Notional>
        <Notional>427876791.621303</Notional>
        <Notional>404435982.369285</Notional>
        <Notional>379353200.32956</Notional>
        ...
  </LowerNotionalBounds>
  <OptionLongShort>Short</OptionLongShort>
  <LegData>
    <LegType>Fixed</LegType>
    ...
  </LegData>
  <LegData>
    <LegType>Floating</LegType>
    ...
  </LegData>
</FlexiSwapData>

Source: ORE User Guide, Products catalogue, flexiswap.tex, listing Flexi Swap data.

A Balance Guaranteed Swap is priced through an auxiliary flexi swap, see the Balance Guaranteed Swap note.