Snowballs

"Path-dependent" derivative instruments related to Libor. Rates can set in advance or in arrears and early exercise is possible (i.e., there are multiple call/put dates). The path-dependent feature means that one must know about past coupons in order to determine the current coupon. The current coupon is given by the previous coupon plus a spread minus a floating interest rate, floored at 0%. In this way, the coupon builds upon previous coupons, much like a snowball that accumulates snow and grows as it rolls along the ground. For example, the first 2 coupons in a 10-year semi-annual snowball might be fixed at an above-market rate of 6.5%. The remaining coupons, i = 3 to 20, are given by Ci = Ci-1 + 2% - 6-month Libor setting in arrears. If 6-month LIBOR consistently fixes at a small value (e.g., < 2%), then the snowball coupons grow over time. If 6-month LIBOR consistently fixes at a larger value (e.g., > 2%), then the snowball coupons decrease over time. For a very large fixing of 6-month LIBOR (e.g., 9%), the snowball can immediately melt all the way down to the floor of 0%.Valuation is usually accomplished using a (forward-looking) Monte Carlo method. The LIBOR Market Model (LMM) is a popular model as the modelled quantities are the market-observed forward rates, and the LMM is consistent with the market-standard approach for valuing caps using Black´s formula. Also reffered to as callable snowballs or callable inverse snowballs.