Modified Following Definition How It Works
Modified following is a date rolling method used when a contractual transaction day coincides with a holiday. In such cases, the date is adjusted to align with a business day. If parties in different regions sign contracts with varying banking days, modified following is based on the payment party’s holidays and their need for banking services to initiate the transaction.
Key Takeaways:
– Modified following modifies the date stated in a contract to account for holidays or bank holidays.
– The effective date of the contract is typically adjusted to the nearest business day to resolve such conflicts.
– Modified following also facilitates transaction settlement when national or bank holidays do not align with stock exchange holidays.
Modified following is exemplified by the business day convention. This rule states that if a swap or other contractual transaction’s payment date does not fall on a banking day, the modified following date will be the next banking day. An exception to this rule is when the banking day spans into a new month, in which case the banking day preceding the payment date is used.
Swaps are contractual agreements where modified following can alter the payment date. Swaps involve the exchange of financial instruments, typically cash flows based on a notional principal amount. One cash flow is fixed, while the other is variable, often based on a benchmark interest rate. Swaps are not traded on exchanges but instead arranged over-the-counter between businesses or financial institutions. Payment dates are agreed upon as part of the contract, and if a payment date coincides with a holiday, modified following adjusts it to align with a business day.
Modified following may be required if a transaction is scheduled for a bank holiday. Bank holidays and stock market holidays do not always align, creating obstacles to completing payments. By using modified following, contractual payments for derivatives can be managed more easily without explicitly listing each payment date and its exceptions within the contract.
