A zero coupon swap (ZCS) in which the zero coupon leg has the right, without the obligation, to call off the underlying zero coupon swap on any coupon date after a specific lockout period. On calling off the structure, the zero coupon rate payer will be required to pay the other counterparty the fixed-rate amount compounded over the period preceding the call exercise date. Adding callability to a zero coupon swap allows an investor (literally, the zero coupon receiver) to enhance yield thanks to the higher interest rate that can be earned from the zero coupon payer in compensation for the risk of early termination. In turn, the zero coupon payer would have at his disposal the right to opt out if the trade is no more in his interest.
Derivatives
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