Target accrual redemption notes: models & valuation

Abstract

The market for exotic interest rate derivatives has primarily been dominated by callable Libor exotics. New flavors of such instruments have been introduced in the interest rate markets over the years. However, a new class of interest rate exotics, Targeted Redemption Notes (TARNS), has now attracted the attention of these financial markets. These instruments are completely different from the perspective of financial modeling. TARNS are instruments where structured coupons are paid to investors. It is basically a callable inverse floater with a Bermudan option. This report explores various aspects of payoffs, pricing and risks associated with TARN instruments.