The Bootstrap Algorithm, Par Swaps, and the FRN Method

Abstract

One of the major developments in interest rate modeling has been the requirement that a viable theoretical model needs to be “arbitrage-free.” It is therefore unsettling when the same quantity, e.g., the theoretical value of a given swap, calculated in two different ways from the same data yields slightly different answers. Novak demonstrates that alternative standard procedures for pricing a swap can produce that result, due to a slight inconsistency between them in how the day-count conventions are handled in the calculation.