TRM Instruments: Processing And Calculations Instrument Guide
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www.wallstreetsystems.com Wall Street Systems – Empowering Treasury Trade and Settlement Wallstreet Suite Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations Version 7.3.14 Information in this document is subject to change without notice and does not represent a commitment on the part of Wall Street Systems. The software and documentation, which includes information contained in any databases, described in this document is furnished under a license agreement or nondisclosure agreement and may only be used or copied in accordance with the terms of the agreement. It is against the law to copy the software or documentation except as specially allowed in the license or nondisclosure agreement. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of Wall Street Systems. Although Wall Street Systems has tested the software and reviewed the documentation, Wall Street Systems makes herein no warranty or representation, either expressed or implied, with respect to software or documentation, its quality, performance, marketability, or fitness for a particular purpose. As a result, this software is provided "as is", and in no event will Wall Street Systems be liable for direct, indirect, special, incidental, or consequential damages from any defect in the software or by virtue of providing this documentation, even if advised of the possibility of such damages. The documentation may contain technical inaccuracies and omissions. The mention of an activity or instrument in this publication does not imply that all matters relating to that activity or instrument are supported by Wallstreet Suite, nor does it imply that processing of or by that activity or instrument is carried out in any particular way, even if such processing is customary in some or all parts of the industry. The windows and screen images shown herein were obtained from prototypes during software development. The actual windows and screen images in the software may differ. © Copyright 2011 Wall Street Systems IPH AB. All rights reserved. Second Edition (May 2011) This edition applies to Wallstreet Suite version 7.3.14 and to all later releases and versions until indicated in new editions or Wall Street Systems communications. Make sure you are using the latest edition for the release level of the Wall Street Systems product. Wall Street Systems, WSS, WALLSTREET, WALLSTREET SUITE and the Wall Street Systems logos are trademarks of Wall Street Systems Delaware, Inc. Finance KIT, Trema and Trema logo are trademarks of Wall Street Systems Sweden AB. Microsoft and Windows are either registered trademarks or trademarks of Microsoft Corporation in the United States and/or other countries. Adobe, Acrobat, and Acrobat Reader are either registered trademarks or trademarks of Adobe Systems Incorporated in the United States and/or other countries. All other products mentioned in this book may be trademarks or service marks of their respective companies or organizations. Company names, people names, and data used in examples are fictitious unless otherwise noted. 2 Contents Preface ...........................................................................................................................19 Intended audience ........................................................................................................................ 19 Associated documents ................................................................................................................ 19 Change history ............................................................................................................................. 20 1 Concepts ....................................................................................................................21 1.1 Instruments ............................................................................................................................ 21 1.2 Classes and types ................................................................................................................. 21 1.2.1 Creating types ................................................................................................................. 22 1.2.2 Customizing types ........................................................................................................... 22 1.3 Instrument templates ............................................................................................................ 23 1.4 Groups ................................................................................................................................... 23 1.5 Features ................................................................................................................................. 24 1.5.1 Primary and trading features ........................................................................................... 25 1.5.2 Action features ................................................................................................................ 25 1.5.3 Valuation approach and valuation setup features ........................................................... 25 1.6 Schedules .............................................................................................................................. 25 1.7 Deal capture ........................................................................................................................... 27 1.7.1 Input data ........................................................................................................................ 27 1.7.2 Generated data ............................................................................................................... 27 1.8 Processing ............................................................................................................................. 28 1.8.1 Setup ............................................................................................................................... 28 1.8.2 Execution ........................................................................................................................ 29 1.8.3 Cancellation .................................................................................................................... 29 1.9 Valuation and results ............................................................................................................ 29 1.9.1 Market value ................................................................................................................... 29 1.9.2 Profits and results ........................................................................................................... 29 1.9.3 Valuation modes ............................................................................................................. 30 2 Market standards and calculations .........................................................................33 2.1 Market standards .................................................................................................................. 33 2.1.1 Date basis ....................................................................................................................... 33 2.1.2 Interest types .................................................................................................................. 37 2.1.3 Price types ...................................................................................................................... 38 2.1.4 Yield/price conversions ................................................................................................... 38 2.1.5 Discount Margin .............................................................................................................. 66 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 3 2.1.6 Calculation methods ....................................................................................................... 67 2.2 Yield curves ........................................................................................................................... 81 2.2.1 Yield curve ...................................................................................................................... 81 2.2.2 Basis swaps .................................................................................................................... 91 2.2.3 Yield Curve interpolation ................................................................................................. 98 2.2.4 FX rate interpolation ...................................................................................................... 110 2.3 Key-figures .......................................................................................................................... 112 2.3.1 Valuation ....................................................................................................................... 112 2.3.2 Profit and Loss .............................................................................................................. 113 2.3.3 Option figures ................................................................................................................ 115 2.3.4 Risk ............................................................................................................................... 119 2.3.5 Dual currency ................................................................................................................ 147 2.4 Performance calculations .................................................................................................. 149 2.4.1 Actual basis and all cash basis ..................................................................................... 150 2.4.2 Trade date and value date based performance ............................................................ 150 2.4.3 Time-weighted rate of return (TWR) ............................................................................. 151 2.4.4 Money-weighted return ................................................................................................. 154 2.4.5 Instrument market values for third currency .................................................................. 155 2.4.6 Instrument market values and cashflows ...................................................................... 160 2.4.7 Example portfolio .......................................................................................................... 163 2.4.8 Risk-adjusted returns .................................................................................................... 166 2.4.9 Risk-adjusted return measures ..................................................................................... 175 2.4.10 Performance attribution ............................................................................................... 180 2.4.11 Performance measurement key-figures ...................................................................... 189 2.5 Value-at-Risk calculations .................................................................................................. 200 2.5.1 TRM approach to VaR calculations .............................................................................. 201 2.5.2 RiskMetrics data ........................................................................................................... 201 2.5.3 Market variables ............................................................................................................ 202 2.5.4 Transforming RiskMetrics data ..................................................................................... 204 2.5.5 VaR calculations ........................................................................................................... 207 2.5.6 Incremental VaR ........................................................................................................... 212 3 Debt instruments .....................................................................................................215 3.1 Bond ..................................................................................................................................... 215 3.1.1 Fixed-rate bond ............................................................................................................. 215 3.1.2 Floating rate note .......................................................................................................... 228 3.1.3 Australian floating rate note .......................................................................................... 236 3.1.4 Zero-coupon bond ......................................................................................................... 239 3.1.5 Amortizing bond ............................................................................................................ 241 3.1.6 Step-up bond ................................................................................................................ 243 3.2 Structured bonds ................................................................................................................ 244 3.2.1 Callable bond ................................................................................................................ 244 3.2.2 Dual-currency bond ....................................................................................................... 246 3.2.3 Credit step-up bond ...................................................................................................... 249 3.3 Schuldscheindarlehen ........................................................................................................ 250 3.3.1 Instrument setup ........................................................................................................... 250 4 © Wall Street Systems IPH AB - Confidential 3.3.2 Deal capture .................................................................................................................. 251 3.3.3 Processing .................................................................................................................... 251 3.3.4 Position monitoring ....................................................................................................... 251 3.4 Denominated bond .............................................................................................................. 254 3.4.1 Instrument setup ........................................................................................................... 254 3.4.2 Deal capture .................................................................................................................. 255 3.4.3 Processing .................................................................................................................... 256 3.4.4 Position monitoring ....................................................................................................... 256 3.5 Convertible bond ................................................................................................................. 258 3.5.1 Instrument setup ........................................................................................................... 258 3.5.2 Deal capture .................................................................................................................. 259 3.5.3 Processing .................................................................................................................... 259 3.6 Index-linked bond ............................................................................................................... 260 3.6.1 Instrument setup ........................................................................................................... 260 3.6.2 Deal capture .................................................................................................................. 262 3.6.3 Processing .................................................................................................................... 262 3.6.4 Australian index-linked annuity bond ............................................................................ 263 3.6.5 Australian index-linked bond ......................................................................................... 267 3.6.6 Brazilian (LFT) selic-linked security .............................................................................. 270 3.6.7 Brazilian FX-linked NBC-E/NTN-D ................................................................................ 271 3.6.8 Brazilian inflation-linked NTN ........................................................................................ 272 3.6.9 Canadian real return bond ............................................................................................ 273 3.6.10 French OAT€i .............................................................................................................. 274 3.6.11 Greek index-linked bond ............................................................................................. 277 3.6.12 Israeli index-linked bond ............................................................................................. 279 3.6.13 Italian BTP €i ............................................................................................................... 281 3.6.14 Japanese index-linked bond ....................................................................................... 282 3.6.15 Swedish index-linked bond ......................................................................................... 283 3.6.16 UK index-linked gilt ..................................................................................................... 287 3.6.17 US Tips ....................................................................................................................... 292 3.7 Asset backed security ........................................................................................................ 297 3.7.1 Instrument setup ........................................................................................................... 297 3.7.2 Deal capture .................................................................................................................. 299 3.7.3 Processing .................................................................................................................... 300 3.7.4 Position monitoring ....................................................................................................... 302 3.7.5 Australian MBS ............................................................................................................. 302 3.8 Short term loan .................................................................................................................... 305 3.8.1 Instrument setup ........................................................................................................... 306 3.8.2 Deal capture .................................................................................................................. 307 3.8.3 Processing .................................................................................................................... 308 3.8.4 Position monitoring ....................................................................................................... 311 3.9 Discount paper .................................................................................................................... 316 3.9.1 Instrument setup ........................................................................................................... 316 3.9.2 Deal capture .................................................................................................................. 317 3.9.3 Processing .................................................................................................................... 319 3.9.4 Position monitoring ....................................................................................................... 320 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 5 3.10 Loan .................................................................................................................................... 326 3.10.1 Fixed-rate loan ............................................................................................................ 326 3.10.2 Floating-rate loan ........................................................................................................ 337 3.10.3 Other loan structures .................................................................................................. 340 4 Equities ....................................................................................................................345 4.1 Equity ................................................................................................................................... 345 4.1.1 Instrument setup ........................................................................................................... 345 4.1.2 Deal capture .................................................................................................................. 346 4.1.3 Processing .................................................................................................................... 347 4.1.4 Position monitoring ....................................................................................................... 352 5 Security lending ......................................................................................................355 5.1 Repurchase agreement ...................................................................................................... 355 5.1.1 Repo (classic) ............................................................................................................... 355 5.1.2 Buy/sell back and sell/buy back .................................................................................... 362 5.1.3 Floating Repo ................................................................................................................ 363 5.1.4 Collateral ....................................................................................................................... 365 5.1.5 Substitution ................................................................................................................... 366 5.1.6 Margin movement ......................................................................................................... 370 5.1.7 Cash Collateral ............................................................................................................. 376 5.2 Security loan ........................................................................................................................ 380 5.2.1 Instrument setup ........................................................................................................... 380 5.2.2 Deal capture .................................................................................................................. 380 5.2.3 Processing .................................................................................................................... 381 6 Forex ........................................................................................................................383 6.1 FX spot and FX forward ...................................................................................................... 383 6.1.1 Instrument setup ........................................................................................................... 383 6.1.2 Market information ........................................................................................................ 384 6.1.3 Deal capture .................................................................................................................. 384 6.1.4 Processing .................................................................................................................... 387 6.1.5 Position monitoring ....................................................................................................... 393 6.2 Average FX rate forward ..................................................................................................... 406 6.2.1 Instrument setup ........................................................................................................... 406 6.2.2 Deal capture .................................................................................................................. 406 6.2.3 Processing .................................................................................................................... 408 6.2.4 Position monitoring ....................................................................................................... 409 6.3 Open Window FX Forward (FX Time Option) ................................................................... 409 6.3.1 Instrument setup ........................................................................................................... 410 6.3.2 Deal capture .................................................................................................................. 410 6.3.3 Processing .................................................................................................................... 411 6.3.4 Position monitoring ....................................................................................................... 411 6.4 FX swap ................................................................................................................................ 416 6.4.1 Instrument setup ........................................................................................................... 416 6 © Wall Street Systems IPH AB - Confidential 6.4.2 Market information ........................................................................................................ 418 6.4.3 Deal capture .................................................................................................................. 418 6.4.4 Processing .................................................................................................................... 420 6.4.5 Position monitoring ....................................................................................................... 422 6.5 Cost-of-funding FX swap .................................................................................................... 422 6.5.1 Instrument setup ........................................................................................................... 423 6.5.2 Deal capture .................................................................................................................. 423 6.5.3 Processing .................................................................................................................... 424 6.5.4 Position monitoring ....................................................................................................... 424 7 Index .........................................................................................................................425 7.1 Index types .......................................................................................................................... 425 7.2 Instrument setup ................................................................................................................. 426 7.2.1 Simple Index ................................................................................................................. 426 7.2.2 Composite Index ........................................................................................................... 427 7.2.3 Derived Index ................................................................................................................ 430 7.2.4 Performance averaging index ....................................................................................... 433 7.2.5 Performance totaling index ........................................................................................... 436 7.3 Market information .............................................................................................................. 440 7.4 Processing ........................................................................................................................... 440 7.4.1 Revision ........................................................................................................................ 440 7.4.2 Freezing Index Values .................................................................................................. 440 7.4.3 Updating Factors and Cash .......................................................................................... 441 7.4.4 Rebalancing .................................................................................................................. 441 8 Cash .........................................................................................................................443 8.1 Bank account ....................................................................................................................... 443 8.1.1 Instrument setup ........................................................................................................... 443 8.1.2 Deal capture .................................................................................................................. 444 8.1.3 Processing .................................................................................................................... 445 8.2 Call account ......................................................................................................................... 446 8.2.1 Instrument setup ........................................................................................................... 446 8.2.2 Deal capture .................................................................................................................. 447 8.2.3 Processing .................................................................................................................... 447 8.3 Call money ........................................................................................................................... 450 8.3.1 Instrument setup ........................................................................................................... 450 8.3.2 Deal capture .................................................................................................................. 451 8.3.3 Processing .................................................................................................................... 451 8.3.4 Position monitoring ....................................................................................................... 454 8.4 Cash ..................................................................................................................................... 454 8.4.1 Payment ........................................................................................................................ 454 8.4.2 Transfer ......................................................................................................................... 455 8.4.3 Complex payment ......................................................................................................... 457 8.5 Forecast ............................................................................................................................... 459 8.5.1 Instrument setup ........................................................................................................... 459 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 7 8.5.2 Deal capture .................................................................................................................. 459 8.5.3 Processing .................................................................................................................... 459 8.6 Cost-of-carry ........................................................................................................................ 460 8.6.1 Instrument setup ........................................................................................................... 461 8.6.2 Deal capture .................................................................................................................. 462 8.6.3 Processing .................................................................................................................... 462 9 Futures .....................................................................................................................465 9.1 Forward rate agreement ..................................................................................................... 465 9.1.1 FRA deposit and FRA discount ..................................................................................... 465 9.1.2 Australian FRA .............................................................................................................. 476 9.1.3 Swedish FRA ................................................................................................................ 477 9.2 Bond forward ....................................................................................................................... 479 9.2.1 Bond forward ................................................................................................................. 479 9.2.2 Swedish Bond forward .................................................................................................. 482 9.3 Money market future ........................................................................................................... 485 9.3.1 Money market future (single contract) .......................................................................... 485 9.3.2 Money market future chain ........................................................................................... 503 9.4 Bond future .......................................................................................................................... 506 9.4.1 Bond future ................................................................................................................... 506 9.4.2 CTD future .................................................................................................................... 509 9.4.3 Australian bond future ................................................................................................... 518 9.5 Equity future ........................................................................................................................ 519 9.5.1 Instrument setup ........................................................................................................... 519 9.5.2 Deal capture .................................................................................................................. 521 9.5.3 Processing .................................................................................................................... 521 9.6 FX future .............................................................................................................................. 523 9.6.1 Instrument setup ........................................................................................................... 523 9.6.2 Deal capture .................................................................................................................. 525 9.6.3 Processing .................................................................................................................... 525 9.6.4 Position monitoring ....................................................................................................... 527 9.7 Index future .......................................................................................................................... 529 9.7.1 Instrument setup ........................................................................................................... 530 9.7.2 Deal capture .................................................................................................................. 531 9.7.3 Processing .................................................................................................................... 531 10 Options ...................................................................................................................533 10.1 Cap/floor/collar .................................................................................................................. 533 10.1.1 Vanilla cap/floor/collar ................................................................................................. 533 10.1.2 Exotic cap/floor/collar .................................................................................................. 544 10.2 Swaption ............................................................................................................................ 546 10.2.1 Instrument setup ......................................................................................................... 547 10.2.2 Deal capture ................................................................................................................ 548 10.2.3 Processing .................................................................................................................. 549 10.2.4 Position monitoring ..................................................................................................... 550 8 © Wall Street Systems IPH AB - Confidential 10.3 Option on MM future ......................................................................................................... 559 10.3.1 Instrument setup ......................................................................................................... 560 10.3.2 Market information ...................................................................................................... 562 10.3.3 Deal capture ................................................................................................................ 562 10.3.4 Processing .................................................................................................................. 563 10.3.5 Position monitoring ..................................................................................................... 564 10.3.6 Australian MM Future option ....................................................................................... 568 10.4 Bond option ....................................................................................................................... 569 10.4.1 Instrument setup ......................................................................................................... 570 10.4.2 Deal capture ................................................................................................................ 572 10.4.3 Processing .................................................................................................................. 573 10.5 Bond Future Option .......................................................................................................... 574 10.5.1 Instrument setup ......................................................................................................... 574 10.5.2 Australian Bond Future Option .................................................................................... 574 10.6 Equity option ..................................................................................................................... 575 10.6.1 Instrument setup ......................................................................................................... 576 10.6.2 Deal capture ................................................................................................................ 577 10.6.3 Processing .................................................................................................................. 578 10.6.4 Position monitoring ..................................................................................................... 579 10.7 Index option ....................................................................................................................... 582 10.7.1 Instrument setup ......................................................................................................... 582 10.7.2 Deal capture ................................................................................................................ 583 10.7.3 Processing .................................................................................................................. 584 10.8 FX option ............................................................................................................................ 585 10.8.1 Vanilla FX option ......................................................................................................... 585 10.8.2 Digital FX option .......................................................................................................... 593 10.8.3 Barrier FX option ......................................................................................................... 596 10.8.4 Compound FX option .................................................................................................. 601 10.8.5 Average FX rate option ............................................................................................... 605 10.8.6 Position monitoring ..................................................................................................... 610 10.9 Exchange traded FX option .............................................................................................. 628 11 Swaps .....................................................................................................................629 11.1 Interest rate swap .............................................................................................................. 629 11.1.1 Single-currency IR swap ............................................................................................. 629 11.1.2 Asset swap .................................................................................................................. 656 11.1.3 Cross-currency swap .................................................................................................. 656 11.1.4 Brazilian IDxUSD Swap .............................................................................................. 677 11.1.5 Overnight index swap ................................................................................................. 677 11.1.6 Other swap structures ................................................................................................. 682 11.2 Total return swap .............................................................................................................. 682 11.2.1 Instrument setup ......................................................................................................... 683 11.2.2 Deal capture ................................................................................................................ 684 11.2.3 Processing .................................................................................................................. 685 11.3 Credit default swap ........................................................................................................... 688 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 9 11.3.1 11.3.2 11.3.3 11.3.4 11.3.5 Instrument setup ......................................................................................................... 688 Market information ...................................................................................................... 690 Deal capture ................................................................................................................ 690 Processing .................................................................................................................. 692 Position monitoring ..................................................................................................... 694 12 Commodities .........................................................................................................699 12.1 Gold .................................................................................................................................... 699 12.1.1 Gold deposit ................................................................................................................ 699 12.1.2 Gold IR swap .............................................................................................................. 702 12.2 Setting up commodities as currencies ........................................................................... 702 12.3 Commodity futures ........................................................................................................... 703 12.3.1 Setting up instruments ................................................................................................ 703 12.4 Commodity swaps and forwards ..................................................................................... 703 12.4.1 Schedule structure ...................................................................................................... 703 12.4.2 Setting up instruments ................................................................................................ 704 12.4.3 Deal capture ................................................................................................................ 705 13 Funds .....................................................................................................................707 13.1 Fund shares ....................................................................................................................... 707 13.1.1 Instrument setup ......................................................................................................... 707 13.1.2 Deal capture ................................................................................................................ 708 13.2 Fund fees ........................................................................................................................... 708 13.2.1 Instrument setup ......................................................................................................... 708 13.2.2 Deal capture ................................................................................................................ 710 13.2.3 Processing .................................................................................................................. 710 Appendix A: Features ............................................................................................................713 A.1 Categories of features ........................................................................................................ 713 A.2 List of features .................................................................................................................... 713 A.2.1 ABS - Asset Backed Security ....................................................................................... 713 A.2.2 ABS Valuation .............................................................................................................. 714 A.2.3 Accrual Yield Setup ...................................................................................................... 714 A.2.4 Allow Ad-Hoc Instructions ............................................................................................. 715 A.2.5 Allow Ad-Hoc Clients/Instructions ................................................................................. 715 A.2.6 Allow Forcing Type to Spot ........................................................................................... 715 A.2.7 Allow FX Currency Pair Shift ........................................................................................ 716 A.2.8 Allow Manual Classification .......................................................................................... 716 A.2.9 Allow Roll Over ............................................................................................................. 716 A.2.10 Allow Roll Over (Dual Currency) ................................................................................. 717 A.2.11 Allow Roll Over (FX) ................................................................................................... 717 A.2.12 Allow Roll Over (FX - Margin Result) .......................................................................... 718 A.2.13 Allow Roll Over (repo) ................................................................................................ 719 A.2.14 Allow Roll Over (Short Loan) ...................................................................................... 719 A.2.15 Allow Roll Over (Short Loan - Margin Result) ............................................................. 719 10 © Wall Street Systems IPH AB - Confidential A.2.16 A.2.17 A.2.18 A.2.19 A.2.20 A.2.21 A.2.22 A.2.23 A.2.24 A.2.25 A.2.26 A.2.27 A.2.28 A.2.29 A.2.30 A.2.31 A.2.32 A.2.33 A.2.34 A.2.35 A.2.36 A.2.37 A.2.38 A.2.39 A.2.40 A.2.41 A.2.42 A.2.43 A.2.44 A.2.45 A.2.46 A.2.47 A.2.48 A.2.49 A.2.50 A.2.51 A.2.52 A.2.53 A.2.54 A.2.55 A.2.56 A.2.57 A.2.58 A.2.59 A.2.60 A.2.61 A.2.62 A.2.63 Allow Roll Over (FX - Swap Style) .............................................................................. 720 Allow Roll Over (FX - Swap Style - Margin Result) .................................................... 720 Allow Roll Over (Guarantee) ....................................................................................... 720 Allow Security Loan .................................................................................................... 721 Allow Sight Account Transfer ..................................................................................... 721 Allow Signature Date .................................................................................................. 721 Allow Spread Curves .................................................................................................. 721 Allow Swap ................................................................................................................. 722 Allow Transaction Transfer ......................................................................................... 722 Allow Weight Difference ............................................................................................. 722 Allow Valuation Curves ............................................................................................... 723 Alternative Repayment Estimates .............................................................................. 723 Australian Bond Future Option ................................................................................... 724 Australian CIB ............................................................................................................. 724 Australian FRN ........................................................................................................... 724 Australian FRN Method .............................................................................................. 725 Australian IAB ............................................................................................................. 725 Australian IAB Valuation ............................................................................................. 725 Australian IAB (Round to 3) ........................................................................................ 725 Australian IAB Valuation (Round to 3) ........................................................................ 726 Australian IAB Par Curve Valuation ............................................................................ 726 Australian IAB Par Curve Valuation (Round to 3) ....................................................... 727 Australian Index-Linked Bond Valuation ..................................................................... 727 Australian MBS ........................................................................................................... 727 Australian MBS Valuation ........................................................................................... 728 Average FX Rate Forward .......................................................................................... 728 Average FX Rate Valuation ........................................................................................ 728 Average FX Rate Option ............................................................................................ 729 Average FX Rate Option Valuation ............................................................................ 729 Bank Account Balance ............................................................................................... 729 Bank Account Interest ................................................................................................ 730 Bank Account Valuation ............................................................................................. 732 Base IR Exposure Setup ............................................................................................ 732 Base IR Setup ............................................................................................................ 733 Base Valuation Setup ................................................................................................. 734 Bond ........................................................................................................................... 734 Bond - Brazilian LFT ................................................................................................... 737 Bond - Brazilian LFT Valuation ................................................................................... 737 Bond - Brazilian FX-Linked NBC ................................................................................ 737 Bond - Brazilian FX-Linked NBC Valuation ................................................................ 737 Bond - Brazilian Inflation-Linked NTN ........................................................................ 738 Bond - Brazilian Inflation-Linked NTN Valuation ........................................................ 738 Bond - Canadian RRB ................................................................................................ 738 Bond - Canadian Index-Linked Bond Valuation .......................................................... 738 Bond Denominations Setup ........................................................................................ 739 Bond Forward ............................................................................................................. 739 Bond Forward (Swedish) ............................................................................................ 740 Bond Forward Dates ................................................................................................... 741 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 11 A.2.64 Bond Forward Valuation ............................................................................................. 741 A.2.65 Bond - French OAT€i .................................................................................................. 741 A.2.66 Bond - French Index-Linked Bond Valuation .............................................................. 742 A.2.67 Bond Future ................................................................................................................ 742 A.2.68 Bond Future - Australian ............................................................................................. 743 A.2.69 Bond Future Valuation ................................................................................................ 743 A.2.70 Bond Future Option Valuation .................................................................................... 743 A.2.71 Bond - Greek Index-Linked Bond ............................................................................... 744 A.2.72 Bond - Greek Index-linked Bond Valuation ................................................................ 744 A.2.73 Bond - Israeli Index-Linked Bond ............................................................................... 744 A.2.74 Bond - Israeli Index-Linked Bond Valuation ............................................................... 745 A.2.75 Bond - Italian BTP€i .................................................................................................... 745 A.2.76 Bond - Italian Index-Linked Bond Valuation ............................................................... 745 A.2.77 Bond Option ................................................................................................................ 745 A.2.78 Bond Option Valuation ................................................................................................ 746 A.2.79 Bond Pricing ............................................................................................................... 746 A.2.80 Branch Codes ............................................................................................................. 747 A.2.81 Bootstrap Instrument .................................................................................................. 747 A.2.82 Call Account ............................................................................................................... 747 A.2.83 Call Account Valuation ............................................................................................... 749 A.2.84 Call Money .................................................................................................................. 750 A.2.85 Call Money Valuation .................................................................................................. 750 A.2.86 Cancel Provisional Settlements .................................................................................. 750 A.2.87 Cap/Floor/Collar ......................................................................................................... 751 A.2.88 Cap/Floor/Collar Valuation ......................................................................................... 751 A.2.89 Cashflow Charges ...................................................................................................... 751 A.2.90 Cash Collateral Account ............................................................................................. 752 A.2.91 Cash Payment ............................................................................................................ 754 A.2.92 Choose Coupon .......................................................................................................... 755 A.2.93 Collateral .................................................................................................................... 755 A.2.94 Collateral Delivery ...................................................................................................... 755 A.2.95 Collateral Setup .......................................................................................................... 756 A.2.96 Collateral Transfer ...................................................................................................... 756 A.2.97 Collateral Valuation .................................................................................................... 756 A.2.98 Competitive Premiums ............................................................................................... 756 A.2.99 Competitive Prices ...................................................................................................... 757 A.2.100 Competitive Rates .................................................................................................... 757 A.2.101 Competitive Rates (FX Swap) .................................................................................. 757 A.2.102 Complex Payment (cash) ......................................................................................... 757 A.2.103 Convertible Bond ...................................................................................................... 759 A.2.104 Convertible Bond Valuation ...................................................................................... 759 A.2.105 Convertible Bond Setup ............................................................................................ 759 A.2.106 Cost of Carry Balance .............................................................................................. 760 A.2.107 Cost of Carry Interest ............................................................................................... 760 A.2.108 Cost of Carry Valuation ............................................................................................ 761 A.2.109 Credit Client Setup ................................................................................................... 761 A.2.110 Credit Default Swap .................................................................................................. 762 A.2.111 Credit Default Swap Valuation .................................................................................. 763 12 © Wall Street Systems IPH AB - Confidential A.2.112 A.2.113 A.2.114 A.2.115 A.2.116 A.2.117 A.2.118 A.2.119 A.2.120 A.2.121 A.2.122 A.2.123 A.2.124 A.2.125 A.2.126 A.2.127 A.2.128 A.2.129 A.2.130 A.2.131 A.2.132 A.2.133 A.2.134 A.2.135 A.2.136 A.2.137 A.2.138 A.2.139 A.2.140 A.2.141 A.2.142 A.2.143 A.2.144 A.2.145 A.2.146 A.2.147 A.2.148 A.2.149 A.2.150 A.2.151 A.2.152 A.2.153 A.2.154 A.2.155 A.2.156 A.2.157 A.2.158 A.2.159 CreditManager position template .............................................................................. 764 Credit Rating ............................................................................................................. 764 Credit Default Swap Curve Setup ............................................................................. 764 Credit-Step-Up .......................................................................................................... 765 CTD Future ............................................................................................................... 765 Currency Conversion ................................................................................................ 767 Debt Flows Valuation (payment amount extraction) ................................................. 767 Delivery ..................................................................................................................... 767 Denominated Bond ................................................................................................... 767 Discount Paper ......................................................................................................... 768 Discount Paper OTC ................................................................................................ 770 Discount Valuation .................................................................................................... 770 Dividend Estimate ..................................................................................................... 771 Dual Currency ........................................................................................................... 771 Dual Currency Forecast ............................................................................................ 772 Equity ........................................................................................................................ 772 Equity Cash Dividend ............................................................................................... 773 Equity Conversion .................................................................................................... 773 Equity Detachment ................................................................................................... 774 Equity Future ............................................................................................................ 775 Equity Info ................................................................................................................. 776 Equity Option ............................................................................................................ 776 Equity Option Pricing ................................................................................................ 777 Equity Option Setup .................................................................................................. 777 Equity Option Valuation ............................................................................................ 778 Equity Return of Capital ............................................................................................ 778 Equity Split ................................................................................................................ 779 Estimation Curve Setup ............................................................................................ 780 Exotic Structure (Option) .......................................................................................... 780 Expiry Date Setup ..................................................................................................... 781 External Valuation .................................................................................................... 781 Fed Fund Future Chain ............................................................................................ 781 Fed Fund Future Dates ............................................................................................ 782 Fed Fund Future Par Valuation ................................................................................ 782 Fed Fund Future Valuation ....................................................................................... 783 Filtered Valuation ...................................................................................................... 783 Fixed Bond Valuation ............................................................................................... 783 Fixed IR Quote Valuation ......................................................................................... 783 Fixed IR Valuation .................................................................................................... 784 Fixed Quoted Valuation ............................................................................................ 784 Force Trade Date Performance ................................................................................ 784 Forecast .................................................................................................................... 784 Forecast Valuation .................................................................................................... 785 Forward Price Setup ................................................................................................. 785 FRA Dates ................................................................................................................ 785 Forward Rate Agreement (Deposit) .......................................................................... 786 Forward Rate Agreement (Discount) ........................................................................ 787 Forward Rate Agreement (Swedish) ........................................................................ 788 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 13 A.2.160 A.2.161 A.2.162 A.2.163 A.2.164 A.2.165 A.2.166 A.2.167 A.2.168 A.2.169 A.2.170 A.2.171 A.2.172 A.2.173 A.2.174 A.2.175 A.2.176 A.2.177 A.2.178 A.2.179 A.2.180 A.2.181 A.2.182 A.2.183 A.2.184 A.2.185 A.2.186 A.2.187 A.2.188 A.2.189 A.2.190 A.2.191 A.2.192 A.2.193 A.2.194 A.2.195 A.2.196 A.2.197 A.2.198 A.2.199 A.2.200 A.2.201 A.2.202 A.2.203 A.2.204 A.2.205 A.2.206 A.2.207 14 FRA Valuation .......................................................................................................... 789 FRA Option ............................................................................................................... 790 FRA Option Valuation ............................................................................................... 790 FRA Periods ............................................................................................................. 790 FRN Valuation .......................................................................................................... 791 Fund ......................................................................................................................... 791 Fund Fee Accrual and Realization .......................................................................... 792 Fund Fee Valuation .................................................................................................. 794 Future Dates ............................................................................................................. 795 Future Valuation ....................................................................................................... 795 FX ............................................................................................................................. 795 FX Cross Method ...................................................................................................... 796 FX Estimate (Forward) ............................................................................................. 797 FX Estimate (IR Difference) ...................................................................................... 797 FX Fixing .................................................................................................................. 797 FX Forward ............................................................................................................... 797 FX Future .................................................................................................................. 798 FX Future Netting ..................................................................................................... 798 FX Future Valuation .................................................................................................. 799 FX - Lagged FX Function ......................................................................................... 799 FX Margin Result ...................................................................................................... 800 FX Valuation ............................................................................................................. 800 FX Option ................................................................................................................. 800 FX Option Compound ............................................................................................... 801 FX Option Digital ...................................................................................................... 801 FX Option Listed ....................................................................................................... 802 FX Option Premium .................................................................................................. 803 FX Option Pricing ..................................................................................................... 803 FX Option Setup ....................................................................................................... 804 FX Option Valuation ................................................................................................. 805 FX Pricer (Forward) .................................................................................................. 805 FX Pricer (Option) ..................................................................................................... 806 FX Setup ................................................................................................................... 806 FX Swap ................................................................................................................... 807 FX Swap Cost-of-Funding ........................................................................................ 807 FX Swap Margin Result ............................................................................................ 808 FX Swap Quote Default ............................................................................................ 808 FX Swap Split ........................................................................................................... 810 FX Time Option ........................................................................................................ 810 FX Time Option Valuation ........................................................................................ 811 FX Trading Platform ................................................................................................. 811 Generic IR Valuation ................................................................................................ 811 Generic Loan ............................................................................................................ 812 Index ......................................................................................................................... 813 Index Averaging ........................................................................................................ 813 Index Composite ....................................................................................................... 814 Index Derived ........................................................................................................... 816 Index Estimate .......................................................................................................... 817 © Wall Street Systems IPH AB - Confidential A.2.208 A.2.209 A.2.210 A.2.211 A.2.212 A.2.213 A.2.214 A.2.215 A.2.216 A.2.217 A.2.218 A.2.219 A.2.220 A.2.221 A.2.222 A.2.223 A.2.224 A.2.225 A.2.226 A.2.227 A.2.228 A.2.229 A.2.230 A.2.231 A.2.232 A.2.233 A.2.234 A.2.235 A.2.236 A.2.237 A.2.238 A.2.239 A.2.240 A.2.241 A.2.242 A.2.243 A.2.244 A.2.245 A.2.246 A.2.247 A.2.248 A.2.249 A.2.250 A.2.251 A.2.252 A.2.253 A.2.254 A.2.255 Index Future ............................................................................................................. 818 Index - Lagged Index Function ................................................................................. 818 Index-Linked Bond .................................................................................................... 818 Index Option ............................................................................................................. 818 Index Option Setup ................................................................................................... 819 Index Option Valuation ............................................................................................. 820 Index Rebase (Index-Linked Bond) .......................................................................... 820 Index Totaling ........................................................................................................... 821 Index - UK Index Function ........................................................................................ 822 Index Valuation ......................................................................................................... 822 Instrument Quote Estimate ....................................................................................... 822 Internal Deal Mirroring .............................................................................................. 823 IR Derivative Valuation ............................................................................................. 823 IR Derivative Valuation Setup ................................................................................... 823 IR Pricer (Swap) ....................................................................................................... 824 IR Pricer (Swaption) ................................................................................................. 824 Issue ......................................................................................................................... 825 Japanese JGBi ......................................................................................................... 825 Japanese Index-Linked Bond Valuation ................................................................... 826 Loan Structure .......................................................................................................... 826 Manual Charges ....................................................................................................... 826 Margin Movement ..................................................................................................... 827 Maturity Date Setup .................................................................................................. 827 MM Future ................................................................................................................ 827 MM Future - Australian Bank Bill Future ................................................................... 828 MM Future - Australian 90-Day Bank Bill Future Chain ............................................ 829 MM Future - Money Market Future Chain ................................................................ 830 MM Future - Money Market 1M Future Chain .......................................................... 831 MM Future - Money Market 3M Future Chain .......................................................... 831 MM Future Method - Australian ................................................................................ 832 MM Future Dates ...................................................................................................... 832 MM Future Option ..................................................................................................... 833 MM Future Option - Australian Bank Bill Future Option ........................................... 834 MM Future Option Valuation ..................................................................................... 834 Money Market Future Par Valuation ......................................................................... 834 Money Market Future Valuation ............................................................................... 834 Mode Specific Method .............................................................................................. 835 Mode/Transaction Specific Method .......................................................................... 836 MtoM Instrument Setup ............................................................................................ 836 Netted Instrument ..................................................................................................... 837 Non Deliverable Forward FX Instrument .................................................................. 837 NumeriX Asset Swap Setup ..................................................................................... 838 NumeriX Setup ......................................................................................................... 839 NumeriX Single-Swap Valuation .............................................................................. 840 NumeriX Swap Valuation .......................................................................................... 841 NumeriX Valuation .................................................................................................... 841 Option Dates ............................................................................................................. 841 Option Premium ........................................................................................................ 842 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 15 A.2.256 A.2.257 A.2.258 A.2.259 A.2.260 A.2.261 A.2.262 A.2.263 A.2.264 A.2.265 A.2.266 A.2.267 A.2.268 A.2.269 A.2.270 A.2.271 A.2.272 A.2.273 A.2.274 A.2.275 A.2.276 A.2.277 A.2.278 A.2.279 A.2.280 A.2.281 A.2.282 A.2.283 A.2.284 A.2.285 A.2.286 A.2.287 A.2.288 A.2.289 A.2.290 A.2.291 A.2.292 A.2.293 A.2.294 A.2.295 A.2.296 A.2.297 A.2.298 A.2.299 A.2.300 A.2.301 A.2.302 A.2.303 16 Option Template Setup ............................................................................................. 842 Payment Agent ......................................................................................................... 842 Performance, Cash In/Out ........................................................................................ 843 Performance, FX Hedge ........................................................................................... 843 Performance, Index .................................................................................................. 843 Per-Leg Cashflow Valuation ..................................................................................... 844 Premium ................................................................................................................... 844 Premium Date Setup ................................................................................................ 844 Price Exposure Setup ............................................................................................... 845 Price Valuation ......................................................................................................... 845 Quote Default ........................................................................................................... 845 Quote Default (Australian FRN) ................................................................................ 846 Quote Default (Australian MBS) ............................................................................... 846 Quote Default (Chain) ............................................................................................... 847 Quote Default (Collateral) ......................................................................................... 847 Quote Default (Discount Paper OTC) ....................................................................... 847 Quote Default (FX) ................................................................................................... 848 Quote Default (Short Loan) ...................................................................................... 849 Quoted ...................................................................................................................... 849 Quoted Chain ........................................................................................................... 851 Range Accrual .......................................................................................................... 852 Repo Cash Delivery .................................................................................................. 853 Repo Cash Delivery (Floating) ................................................................................. 853 Repo Cash Delivery (Substitution) ........................................................................... 853 Repo Rounding ......................................................................................................... 854 Repo Valuation ......................................................................................................... 854 Repo Valuation (Floating) ......................................................................................... 854 Repurchase Agreement ............................................................................................ 854 Repurchase Agreement (Floating) ........................................................................... 856 Result ....................................................................................................................... 856 Result with Classification .......................................................................................... 857 RiskManager position template ................................................................................ 857 Risk Setup (BOND) .................................................................................................. 858 Risk Setup (FRN) ..................................................................................................... 858 Risk Venture Capital ................................................................................................. 859 Risk Yield .................................................................................................................. 859 Schedule Data .......................................................................................................... 859 Schedule Template Setup ........................................................................................ 859 Schuldschein ............................................................................................................ 860 Security Identifiers .................................................................................................... 860 Security Info .............................................................................................................. 861 Security Loan ............................................................................................................ 861 Settlement Setup ...................................................................................................... 861 Short Term Loan ....................................................................................................... 862 Short Term Loan Margin Result ............................................................................... 863 Short Term Loan Valuation ....................................................................................... 863 Single Swap Valuation .............................................................................................. 863 Special Issue ............................................................................................................ 864 © Wall Street Systems IPH AB - Confidential A.2.304 A.2.305 A.2.306 A.2.307 A.2.308 A.2.309 A.2.310 A.2.311 A.2.312 A.2.313 A.2.314 A.2.315 A.2.316 A.2.317 A.2.318 A.2.319 A.2.320 A.2.321 A.2.322 A.2.323 A.2.324 A.2.325 A.2.326 A.2.327 A.2.328 A.2.329 A.2.330 A.2.331 A.2.332 A.2.333 A.2.334 A.2.335 A.2.336 A.2.337 A.2.338 A.2.339 A.2.340 A.2.341 A.2.342 A.2.343 Spot Date Setup ....................................................................................................... 864 Spread Curve Setup ................................................................................................. 865 Substitution ............................................................................................................... 865 Swap ......................................................................................................................... 866 Swap (Book, FX Rate) .............................................................................................. 867 Swap (Deal, FX Rate) ............................................................................................... 867 Swap Valuation ......................................................................................................... 867 Swaption Valuation ................................................................................................... 868 Swaption Pricing ....................................................................................................... 868 Swap Per Leg Valuation ........................................................................................... 868 Swap Pricing ............................................................................................................. 868 Swaption ................................................................................................................... 869 Swap, Upfront ........................................................................................................... 869 Swedish Index-Linked Treasury Bond ...................................................................... 869 Swedish Index-Linked Bond Valuation ..................................................................... 870 Ticks Netting ............................................................................................................. 870 Trading Unit (Derivative) ........................................................................................... 871 Trading Unit (Equity) ................................................................................................. 871 Trading Unit (Index) .................................................................................................. 872 Trading Yield ............................................................................................................ 872 Transaction Charges ................................................................................................ 873 Transaction Conversion ............................................................................................ 873 Transfer (cash) ......................................................................................................... 874 TRS - Total Return Swap ......................................................................................... 875 TRS Deferred ........................................................................................................... 875 UK ILG (3M) ............................................................................................................. 876 UK ILG (8M) ............................................................................................................. 876 UK Index-Linked Bond (3M) Valuation ..................................................................... 876 UK Index-Linked Bond (8M) Valuation ..................................................................... 877 US Index-Linked Bond Valuation .............................................................................. 877 US TIPS .................................................................................................................... 877 US TIPS (with Rounding) ......................................................................................... 877 VaR Mapping Type ................................................................................................... 878 Valuation Curve Setup .............................................................................................. 878 Valuation Setup (Floating) ........................................................................................ 879 Value Date Setup ..................................................................................................... 879 Volatility Surface Setup ............................................................................................ 880 XAU Loan ................................................................................................................. 880 Yield .......................................................................................................................... 881 Z-DM/Spread Setup .................................................................................................. 882 Appendix B: Schedules .........................................................................................................883 B.1 Schedule parameters ......................................................................................................... 883 B.2 Templates ............................................................................................................................ 889 B.2.1 System-defined templates ............................................................................................ 889 B.2.2 User-defined templates ................................................................................................ 909 B.3 Schedule template groups ................................................................................................. 910 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 17 Appendix C: Option schedules .............................................................................................911 C.1 Option schedule parameters ............................................................................................. 911 C.2 Templates ............................................................................................................................ 913 C.2.1 System-defined templates ............................................................................................ 913 C.2.2 User-defined templates ................................................................................................ 915 C.3 Option schedule template groups .................................................................................... 915 Appendix D: Expressions......................................................................................................917 D.1 Expression syntax .............................................................................................................. 917 D.2 Market references in expressions ..................................................................................... 917 D.2.1 Using Fixing Quote ....................................................................................................... 917 D.2.2 Not using Fixing Quote ................................................................................................. 918 D.3 Constants in expressions .................................................................................................. 919 D.4 Functions in expressions .................................................................................................. 920 D.4.1 Basic functions ............................................................................................................. 920 D.4.2 Referring functions ....................................................................................................... 921 D.4.3 Special functions .......................................................................................................... 922 D.4.4 Special characters ........................................................................................................ 929 18 © Wall Street Systems IPH AB - Confidential Preface Welcome to the Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations guide. This guide describes the following for TRM: • The financial instruments that TRM supports and their required setup. • The calculations that TRM performs to produce the key-figures–market value, risk exposure, and profit/loss–used to analyze a position. Intended audience This guide is intended for TRM users who require information to support the following tasks: • Set up and customize instruments: For users with back office and middle office experience who have a good understanding of TRM. • Valuation: For experienced TRM users who need to understand how calculations are performed in TRM. Associated documents Associated documents can be accessed from the Help menu of the Wallstreet Suite’s applications. • TRM User Guide • TRM System Administration Guide • ACM User Guide • CLM User Guide • WebSuite User Guide. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 19 Change history Edition Date Changes Updated By 0.1 April 2011 Initial release 7.3.14. Features: Positive spread, Negative spread Bonds: Asset swap (minor changes) Dual currency: FX Fixing and Generic IR Valuation Risk profiles: Output (replaced the description) AI method: Australian Floater (3 decimals) Bond Futures: Position monitoring setup, Risk Setup (BOND) Yield/price conversion: Malaysian government bonds Bank Account, Cost of Carry, and Funds: Update Realization Date TRM Dev Team 0.2 May 2011 Israeli Index-Linked Bonds: time-dependent, Index Rebase TRM Dev Team 20 © Wall Street Systems IPH AB - Confidential Chapter 1 Concepts In the Wallstreet Suite Transaction & Risk Management Module (TRM), all instruments rely on the same key concepts. It is important to be familiar with these concepts to understand how the system works and to be able to use it effectively. TRM’s concepts are referred to frequently throughout this guide. Each one is explained in more detail in the relevant section. 1.1 Instruments In TRM, all instruments share several main characteristics: • Unique ID (and an optional Name) • Instrument Type (mandatory) (see 1.2 Classes and types on page 21 for more information) • Active From / Active To period (from/to dates inclusive) to restrict the period in which the • Instrument Group for use in rules, monitoring, and reporting • Labeling for Buy/Sell transactions (optional Buy Label and Sell Label naming) to override the default settings. instrument can be traded in TRM (optional) The following information is also available for each instrument: • History of all modifications made to an instrument since it was defined in the system • Links to documents or Web pages attached to the instrument which can be opened through the editor • User-defined properties that can be added to the instrument. Finally, an instrument is made up of features. Features are the most important of the key concepts. They are the building blocks of an instrument and are responsible for driving the processes in TRM. Features are explained in a later section of this chapter. First however, it is important to understand the concepts of instrument classes and types. 1.2 Classes and types The notion of instrument class is specific to TRM. Instrument classes denote the different categories of instruments which are supported by TRM. They are pre-defined in the system and cannot be changed by the user. An instrument class is only used as a basis on which to define an instrument type. Once the types have been defined, the instrument classes are no longer used. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 21 1 Concepts 1.2 Classes and types 1.2.1 Creating types The first step in defining instruments involves creating all the instrument types that are necessary to use the system. It is possible to create an infinite number of types with each class. However, it is not recommended to create instrument types that are based on an instrument class that you do not need. In contrast, you may wish to create more than one instrument type based on the same class to create more specific instrument definitions. For example, the Bond instrument class is used to define many different types of bonds instruments, such as fixed-rate bonds, floating-rate bonds, dual-currency bonds, and so on. Creating and customizing an instrument type for each type of bond makes it easier to define the instruments. Nevertheless, it is still possible to have only one instrument type, and differentiate the setup later, when the instrument is created. 1.2.2 Customizing types As mentioned in the earlier section, features are the most important of the key concepts. Features drive the behavior of an instrument in TRM. Each instrument class contains a set of available features: some features are mandatory, some are assigned by default, and others are optional. An instrument type is derived from an instrument class. The type inherits all the features contained in the instrument class automatically. Apart from mandatory features, which cannot be changed or removed, the default and optional features within the list can be modified as follows: • Default features can be made mandatory, optional, or be removed completely • Optional features can be made mandatory, default, or be removed completely. When the instrument type is assigned to an instrument, the instrument inherits the features as follows: • Mandatory features from the instrument type are assigned to the instrument and cannot be removed • Default features from the instrument type are assigned to the instrument but may be removed • Optional features from the instrument type can be manually applied to the instrument if required. For example, assume you need to define some fixed-rate bonds, some FRNs, and some dual-currency bonds in your system. You could simply create one Bond instrument type that exactly replicates the Bond instrument class. It will then be possible to set up any kind of bond instrument using this type. However, you may prefer to simplify the setup of bond instruments by creating three different instrument types based on the same instrument class. You could modify the set of features in the instrument class by selecting only the relevant features for each type of bond: • For the fixed-rate bond, you remove the features related to dual-currency, and everything related to floating-rates • For the FRN instrument, you assign as mandatory the FRN valuation method, and remove all features related to dual-currency, and anything else not related to an FRN • For the dual-currency bond, you assign as mandatory the Dual Currency feature, and remove anything else not related to the instrument you want to set up. By customizing an instrument type to correspond to a particular category of instrument, a significant part of the set up is done at type level making the task of setting up instruments much easier. It is important to keep in mind that the instrument type is a visible attribute of the instrument. Its definition is an important step in the process of instrument setup and therefore must be made with care. 22 © Wall Street Systems IPH AB - Confidential 1 Concepts 1.3 Instrument templates 1.3 Instrument templates Instrument templates use the framework of static data template editors. In the context of instrument setup, templates can be used to define more closely the characteristics of instruments that can be set up using a given instrument type, as follows: • The selected optional and default features of the given type can be modified to reflect more accurately the nature of instruments for which the template is designed. • Subentities and individual fields can be identified as mandatory or frozen in the instrument setup in a similar way to the features. Thus, you can control the instrument at the field level. • Values for default or frozen setup of the instrument can be already defined in the template. Thus, instruments based on a template, already inherits these configured values. As in with other static data templates, when you select a template in Instrument Editor, the template will automatically load all configured information, so that you only have to provide a limited set of values when you create the new instrument. For information about using the Instrument Template Editor, see TRM User Guide. 1.4 Groups Instrument groups facilitate reporting and monitoring of instruments and their subsequent transactions. They are also used in the setting up of rules as a means to identify individual cashflows in order to direct them to the correct place in the transaction flow. Each instrument is assigned to an instrument group during the setup process. Instrument groups are arranged into a simple hierarchy, where each group is assigned one parent. Instruments can only be assigned to a single instrument group in the hierarchy. Default instrument groups for the first level in the hierarchy are pre-defined in the system, but can be modified at implementation according to your organization’s requirements. You then create further instrument groups for the lower levels of the hierarchy to reflect the requirements of your organization. The first level of the hierarchy could typically represent the class of instruments in which you trade; such as Debt Instrument, Foreign Exchange, and Equity. Instrument groups in the second level could correspond to different types of instruments traded in these markets, and any lower levels would usually be created for instruments, which are derived from the same instrument type, but have different characteristics. Instrument groups from any level in the hierarchy can be used as a parameter when setting up reports or rules, and when monitoring instruments. The instrument group you use depends on how specific the rule, report, or position needs to be. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 23 1 Concepts 1.5 Features Consider the following example which illustrates how an instrument group hierarchy may be set up and used. Level 1 Level 2 Level 3 Level 4 In the example hierarchy, if the Government instrument group in level 4 is used as one of the parameters to run a report, the generated report will only contain data resulting from any Government Bonds assigned to this instrument group. Alternatively, if the Fixed-Rate Bond instrument group in level 3 is used as the start-up parameter, the resulting report will include data from both Corporate and Government Bonds. If an overview of all debt instruments is required in the report, the Debt Instrument group in level 1 should be selected. 1.5 Features The notion of the Instrument Class/Feature association is specific to TRM. Features are an integral part of setting up instruments. Features are system-defined entities used to give instruments their distinctive functionality and enable deal capture, transaction processing, and position monitoring. A feature is a combination of Setup and Process: • Setup refers to the number of database tables that are attached to a feature. It is only possible to populate the information related to these tables in the editor if the feature is attached to the instrument. • Process refers to the number of units of processing that are attached to a feature. The code that is linked to the feature is triggered only when the feature is attached to the instrument. The major benefits of this architecture are two-fold: • Setting up instruments becomes much easier because the system only proposes the necessary information according to the behavior required by the user for the instrument. • Processing is completely modular. This means that many independent units of code are triggered in sequence to handle the processing of the deals. This very low level dependency ensures an 24 © Wall Street Systems IPH AB - Confidential 1 Concepts 1.6 Schedules improved stability of the system should any modifications be made, and also an improved capacity for the addition of new processing features. Features are organized into the following categories: Primary, Trading, Action, Valuation, and Valuation Setup. These categories are pre-defined in the system and cannot be modified by the user. Features are frequently referred to throughout this guide. The combination of features associated with an instrument completely defines the instrument’s characteristics. Any parameters that need to be defined for the set up and processing of the features and their related actions are explained in more detail in the relevant section. Note: In Appendix A Features on page 713 you can find a list of the available features together with an explanation of how they are used. 1.5.1 Primary and trading features Primary features are responsible for the core deal generation (such as, transaction and cashflows), and core instrument setup. There can be only one primary feature associated with an instrument. Primary features contain the largest part of the business logic. They are used during instrument setup and throughout deal-entry. For example, the primary feature Bond enables the setup of the main characteristics of a bond and its associated cashflows. It also manages the creation and modification of a bond deal by calculating amounts and generating the cashflows. Trading features introduce additional setup possibilities and some additional rules for deal management. More than one trading feature can be applied to an instrument, and some trading features can be used for several different classes of instrument. For example, the trading feature Trading Unit enables the setup of a denomination size, a minimum bid size, and a minimum price unit for an instrument. It also ensures that this setup is verified when a deal is entered and will adjust the deal accordingly if the deal does not correspond to the setup. The processing units of primary and trading features are assigned with a priority number. This number ensures that the processes are executed in the correct order. 1.5.2 Action features Action features enable deal processing, some of which are also linked to a setup. The parameters defined in the setup are used when the action is performed. Action features are called each time the user wants to execute a business process. For example, the action feature Allow Roll Over (FX) enables roll over of FX forwards and FX swaps. 1.5.3 Valuation approach and valuation setup features Valuation Approach and Valuation Setup features work together: they determine which valuation approach is used for the instrument. With these features, it is possible to specify the market variables used in the valuation, such as yield curves, date basis, and discounting methods. Valuation can still be performed on an instrument even without any specific setup. In this case, the default settings for valuation are employed to find the market variables used to value the instrument. Note that, in TRM, as well as being responsible for calculating market value, the valuation approach is also responsible for calculating other figures, such as unrealized results and risk figures. 1.6 Schedules The concept of Schedules is used in several places in TRM. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 25 1 Concepts 1.6 Schedules There are two types of schedules; Schedules and Option Schedules: • Schedules are used for most debt instruments (and their derivatives): Asset Backed Securities, Bonds, Caps, Floors, and Collars, Loans, and Commercial Loans, Swaps, Total Return Swaps, and Swaptions. • Option Schedules are used for Exotic FX Options. Option schedules are a simplified version of schedules. They are used to enable the definition of option events, such as barriers or Bermudan exercise periods. In TRM, schedules and option schedules drive the generation of a set of cashflows. When the cashflow structure is frozen for an instrument, as is the case for Asset Backed Securities and Bonds, schedules are linked to the instrument itself, together with the generated cashflows. When the cashflow structure is not frozen (for example, with instruments such as Caps, Floors, and Collars, Loans, FX Options with Barriers, and so on), schedules can be associated with the deal instead of with the instrument. The cashflows are then generated at deal entry. Schedules contain a number of values that determine how a set of cashflows are generated. The information that can be defined in a schedule is explained in the appendices. TRM provides a number of Schedule Templates and Option Schedule Templates. A template groups together the prepackaged set of individual schedules that are necessary to set up a deal or type of instrument. Some of the characteristics of the deal or instrument are then used to automatically update many of the values in the schedule. When a template is applied, the schedules included in the template are simply copied onto the deal or instrument. Consequently, there is not a dynamic link between the deal or instrument and the schedule template. If any changes are subsequently made to a template, they are not reflected in the characteristics of the deal or instrument to which it had previously been applied. Many templates are provided by the system and users can use these as a basis on which to create their own. The following simple example illustrates the concept of schedules in TRM: • A 3-year fixed-rate loan paying 5% interest per annum with a bullet repayment of the principal amount A deal involving this instrument has two distinct types of cashflow: interest cashflows, and the principal payback cashflow. Two schedules need to be associated to the deal: one schedule to drive the creation of the interest cashflows, and another schedule to drive the creation of the principal payback cashflow. The following information is required for the interest schedule: 26 Type: Interest Category: Payback Start Date: Value date of the deal End Date: Maturity date of the deal Currency: Currency of the deal Method: Times/Year Frequency: 1 Rate Type: Interest Rate Rate: 5 © Wall Street Systems IPH AB - Confidential 1 Concepts 1.7 Deal capture The following information is required for the principal schedule: Type: Principal Category: Payback Start Date: Value date of the deal End Date: Maturity date of the deal Currency: Currency of the deal Method: Bullet TRM provides a system template (called Fixed, Bullet Repayment) which contains both these schedules. The template also contains some defaulting rules. As a result, when the schedule is applied to the instrument most of the information relating to the cashflow structure is defaulted automatically by TRM. Note: For more details about system templates and how they can be grouped or specialized into user templates, see Appendix B Schedules on page 883 and Appendix C Option schedules on page 911.) 1.7 Deal capture In TRM, dealing is carried out in Transaction Manager or in Enter Board. 1.7.1 Input data Some deal information that needs to be input is common to all transaction types, no matter what type of instrument is involved. This generic input data includes the following: • Instrument to be used in the deal • Opening Date of the deal when it is taken into account in the system • Portfolio that is impacted by the deal • Counterparty, that is, the other party involved in the deal. Other required input data is specific to an instrument type, for example, premium flow parameters for option transactions. Some input data can be defined either in the instrument definition or it can be specified at deal entry. 1.7.2 Generated data Some information is automatically set by the system on a new deal when the deal has been saved, such as: • Transaction Number which identifies the deal in the system • State which shows the transaction’s position in the workflow • Status, which gives additional information about the status of the deal. The deal’s associated cashflows, for example, interest flows, settlement or premium amounts, and position flows are generated, according to the instrument and its setup. Note: Deal capture information that is specific to an instrument type is explained in the relevant Deal capture section of this guide. For information about entering deals that is common to all instruments: see the TRM User Guide. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 27 1 Concepts 1.8 Processing 1.8 Processing Processing deals in TRM is mainly done through Transaction Manager; although some back office operations are performed using activities. There are a number of commands that can be performed on all deals. These commands are used to save, reject, or cancel a deal and move the deal through TRM’s process flow, and include: • Apply, Commit, Accept, Reject, Re-Open, and so on These commands are used to move a transaction to a different state in the workflow. The new state of the transaction when one of these actions is performed depends on how the transaction flow has been defined for the system. • Reset The Reset command resets all changes made to a deal since the last time it was saved in the system. If the reset command is performed on a new deal, the deal is removed. • Cancel Using this command, it is possible to cancel a deal which has been entered in error. Another of the concepts on which TRM is based is that of actions. An action is something you can execute on a deal (or several deals) in order to perform a business task. Some actions are available for all instruments, either by default, or through the addition of a feature: • Duplicate This action creates a new deal with the same characteristics as the initial transaction, apart from Transaction Number and State. After the deal has been duplicated, it is possible to change some of the characteristics of the new deal. This is a useful function when you need to create many deals with similar characteristics using the same instrument. • Package The Package action assigns a deal to a package. Packaging several deals together creates a link between them. Packages can be used as criteria in position monitoring or reports. • Add Transaction Charge or Cashflow Charge These actions allow you to add one or more charges to a deal. They are available when the respective feature is applied to the instrument. The charges are stored as separate cashflows. Many actions are specific to certain instruments, and details of these can be found in the relevant Processing section of this guide. Examples of instrument-specific actions in TRM are: Early Expiration of a loan; Exercise of an option; Fixing of a cashflow; and the Netting of a future. These actions are often only available once the deal has reached a certain stage in the process flow. Note: See the TRM User Guide for more information about executing actions on deals and processing deals through the transaction flow. 1.8.1 Setup The ability to execute certain actions on an instrument can either be linked to the presence of instrument-specific features applied to the instrument definition, or for other instruments, the execution is automatically included in the instrument setup. In all cases, the availability of an action can be made dependent on the state of the transaction. For example, it is possible to allow a tax to be added for newly entered transactions, but not for confirmed ones. 28 © Wall Street Systems IPH AB - Confidential 1 Concepts 1.9 Valuation and results 1.8.2 Execution The availability of the action is also often driven by certain conditions that are built into the action itself. The exercise of an option for example, recognizes that it can only be executed during the exercise period. The exercise action is unavailable outside the exercise period. Many frequently performed actions can be automated through batch activities. It is important to note that the batch activity executes exactly the same code as the user for the execution of the action. 1.8.3 Cancellation Sometimes, it is necessary to cancel the execution of an action. In TRM, all actions can be canceled or reversed. 1.9 Valuation and results 1.9.1 Market value In TRM, market value can be calculated using two different valuation methods: • Quoted valuation method which is a direct mark-to-market quote of an instrument • Theoretical valuation method which is a theoretical valuation model defined in the system. Generally, quotes can be obtained from the market for exchange-traded (listed) instruments and can be applied directly to establish the market value of a position, whereas over-the-counter (OTC) transactions need to be valued using a theoretical model. Theoretical models are set up in TRM and can range from models used for simple discounting of cashflows to complex multi-factor option valuation models. Regardless of the approach taken, users have two additional decisions to make that will have a minor impact on the market value of each position. More specifically, for each instrument, the following needs to be defined: • • Market value calculation period – If market value is calculated to the spot date (as of the valuation date) of the instrument – If market value is discounted from the spot date to the valuation date of the instrument. Market value calculation of foreign currency positions (into the base currency of the portfolio or another currency) – If market value is calculated using the spot rate between the two currencies – If the spot rate is further adjusted by O/N and T/N points – If the spot rate is adjusted by the interest rate differential between the two currencies from valuation date to spot date. 1.9.2 Profits and results The market value is used when calculating the total profit of a position. In TRM, the term profit refers to the profit/loss on a position at a given point in time since its inception or since a subsequent realization (for example, the payment of interest). The term result refers to the profit/loss over a specific period of time (for example, from January 1 to January 31). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 29 1 Concepts 1.9 Valuation and results In general terms, the market value of a position is compared to capital invested, and the difference is the total profit of the position. Total profit is further split into the following components (the exact description of each component may vary slightly according to the instrument): Profit Description Accrued Interest Interest accrued since the value date of the transaction or the previous coupon date until the valuation date. Accrued Profit Accrued/amortized discount/premium, accrued fees, or amortized option premiums since the value date of the transaction or the payment date of the premium/fee, until the valuation date. MtoM Profit Profit/loss resulting from the difference between market valuation (excluding accrued interest and accrued profit) and capital invested. For example, for instruments with a market quotation, MtoM profit is generally the difference between the market price and the deal price.However, when accruals and fees need to be taken into account, the calculation of MtoM Profit becomes more complex. MtoM profit is calculated to the spot date of the instrument, and not discounted to the valuation date. Note: For details of the MtoM Profit calculation for a particular type of instrument, see the relevant section of this guide. FX Profit Profit/loss resulting from the change in FX rates, between the value (or trade) date and the valuation date, calculated on the invested amount. Other Profit The residual profit/loss after the above components are separated from total profit. This residual is usually the end-product when total result is calculated correctly theoretically, but the other components are calculated according to general accounting practices. For example, the market value for a bond includes the accrued interest calculated until the spot date of the instrument (that is, the amount which would be received if the bond was sold today), while accrued interest includes the interest accrued until the valuation date. 1.9.3 Valuation modes Sometimes, it is necessary to calculate market value and results in different ways. For example, even if market value can be obtained from market quotes, occasionally it may be useful to run the valuation using a theoretical model. Furthermore, for accounting purposes, it may also be necessary to do the valuation using specific benchmark yield curves, and to apply specific accounting treatment for the difference between normal and benchmark valuation. Valuation modes allow users to define different valuation methods and models and to use different market parameters to value the same instrument. Every time valuation is requested by a user, the user specifies the valuation mode, and the system performs the valuation using the setup applicable to that mode. The standard system provides three different valuation modes: • Default • Theoretical • Benchmark. The valuation modes themselves are simply identifiers. Users need to specify the type of valuation that is to be carried out at instrument level. For example, if the Theoretical valuation mode is selected, the system will not switch automatically to a theoretical model. Rather, the user needs to link the appropriate valuation methods and models for each instrument, which are then called each time theoretical valuation is requested. Valuation Mode can be used as a start-up parameter for monitoring the treasury position, for running profit/loss reports, and for closing-the books. If no mode is specified, the system’s Default valuation mode is used. 30 © Wall Street Systems IPH AB - Confidential 1 Concepts 1.9 Valuation and results New valuation modes can be added during implementation according to your organization’s requirements. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 31 1 Concepts 1.9 Valuation and results 32 © Wall Street Systems IPH AB - Confidential Chapter 2 Market standards and calculations 2.1 Market standards 2.1.1 Date basis Date bases are used to calculate the length, in years, of the period between two dates. The formula for this calculation is t=d/B, where d is the number of days in the period, and B is the basis denominator. Both d and B depend on the date basis used. Different date bases may result in different values for d and B for the same period and, consequently, in different period lengths. TRM uses date bases when an interest rate is defined over a period. The definition of the rate must include how the length of the period is calculated. • 360 date bases In these date bases, the denominator B is always 360, but the calculation of the numerator varies. However, there is a difference in the way the 31st day at the beginning and at the end of the period under consideration is handled. The formulas used show how the period d between date1 (y1, m1, d1) and date2 (y2, m2, d2) is calculated: yi, mi, and di represent the year, month, and day, respectively; and min is the minimum value in the set. For example, min(d2, 30) means "use the lesser value of d2 and 30." • Actual date bases Actual date bases allow for different lengths of months and are, therefore, more accurate than the 360 date bases. The Actual date bases generally differ in the way that they handle leap years. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 33 2 Market standards and calculations 2.1 Market standards Example period 1991-06-30 to 1996-01-31 The period 1991-06-30 to 1996-01-31 is used in some of the following examples to show how the various date bases calculate the number of days between two dates. Name Description 30E/360 Any 31st day of the month is considered to be the 30th of the month. The formal definition is: d = min(d2,30) - min (d1,30) + 30(m2 - m1) + 360(y2 - y1) For the example period: d = min(31,30) - min(30,30) + 30*(1 - 6) + 360*(1996 -1991) = 1650 The length of the period in years is 1650/360 = 4.583 30E/360 EOM This is a variation of the 30E/360 basis, with the month of February having an invariable 30 days. Example: For the 2003-08-31 through 2004-02-29: d = min(30,30) min (31,30 + 30*(2 - 8 360*(2004 - 2003 = 180 The length of the period in years is 180/360 = 0.5 30/360 This is a variation of the 30E/360 basis. The difference occurs when d1 < 30. In this case, no rounding of the date occurs, and the above equation is replaced by: d = d2, - d1 + 30(m2 - m1) + 360(y2 - y1) For the example period: d1 = 30, so the 30E/360 formula is used and d = 1650 However, if the beginning of the period was the 29th instead of the 30th, the result would be: d = 31 - 29 + 30*(1 - 6) + 360*(1996 - 1991) = 1652 The length of the period in years would then be 1652/360 = 4.589. 30E+/360 This is a variation of the 30E/360 basis. The difference is that rounding is applied only to the earlier date. The equation is then: d = d2 - min(d1,30) + 30(m2 - m1) + 360(y2 - y1) For the example period: d = 31 - min(31,30) + 30*(1 - 6) + 360*(1996 -1991) = 1651 The length of the period in years is 1651/360 = 4.586 Actual/Actual ISDA If no leap year is involved in the calculation, then t = d/B where d = the actual number of days and B = 365. If there is a leap year, then t = d1/B1 + d2/B2, where d1 = the actual number of days in the leap year and B1 = 366 d2 = the actual number of days in the non-leap year and B2 = 365 Actual+/Actual ISDA Actual-/365 This is a variation on Actual/Actual ISDA, for which the first day is excluded for the day count. d = the actual number of days excluding all leap days (29th of February). B = 365 days. For the example period: The number of days between 1991-06-30 and 1996-01-31 is 1676, but since there is one leap day within that period, d = 1675. The length of the period in years, t, is 1675/365 = 4.589 Actual-/365+ d = the actual number of days excluding all leap days (29th of February). B = the number of days in the year in which the coupon value date falls. 34 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Name Description Actual-/365L d = the actual number of days excluding all leap days (29th of February). B = 366 if the last partial year of the period contains a leap day; otherwise, B = 365. The last partial year is the remaining period when the maximum number of full years have been counted off, starting from the beginning of the period. For the example period: The last partial year is the period from 1995-06-30 to 1996-01-31, which does not contain a leap day, so B = 365. The number of days between 1991-06-30 and 1996-01-31 is 1676, but since there is one leap day within that period, d = 1675. The length of the period in years, t, is 1675/365 = 4.589. If, instead, the end of the period were on 1996-02-29, the number of days would be 1675+29-1=1703 (the leap day is not counted), and the last partial year would contain a leap day, so that t would be 1703/366 = 4.653. Actual/360 d = the actual number of days. B = 360 days. For the example period: d = 1676 and B = 360, so t = 1676/360 = 4.656 Actual/365 d = the actual number of days. B = 365 days. For the example period: d = 1676 and B = 365 so t = 1676/365 = 4.592 Actual/365+ d = the actual number of days. B = 366 if the end of the period falls on a leap year; otherwise, B = 365. For the example period: The number of days between 1991-06-30 and 1996-01-31 is 1676. B = 366 since 1996 is a leap year. So t = 1675/366 = 4.577 Actual/365L d = the actual number of days. B = 366 if the last partial year of the period contains a leap day; otherwise B = 365. The last partial year is the remaining period when the maximum number of full years have been counted off, starting from the beginning of the period. For the example period: The last partial year is the period from 1995-06-30 to 1996-01-31, which does not contain a leap day, so B = 365 and t = 1676/365 = 4.592 Actual/Actual ISDA If no leap year is involved in the calculation, then t = d/B where d = the actual number of days and B = 365. If there is a leap year, then t = d1/B1 + d2/B2, where d1 = the actual number of days in the leap year and B1 = 366 d2 = the actual number of days in the non-leap year and B2 = 365. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 35 2 Market standards and calculations 2.1 Market standards Name Description Actual/Actual (n) The variable n is 1, 2, or 4, specifying the frequency of coupons. The corresponding coupon periods are 12, 6, and 3 months (= 12 / n), respectively. The time between the dates d1 and d2 is calculated by first calculating the number (p) of the whole periods that fit into the interval (d1, d2), from the date (d2) backwards, and then by adding the length of the first fractional period. The end and start dates of the periods are generated by repeatedly subtracting 12, 6, or 3 from the month number of d2. If the month thus generated has fewer days than the day of month of the end date (d2), the period end date is the end date of the month in question. That is, if d2 = 2008-05-31 and n = 4, then the start date of the last period is 2008-02-29. If the date (d1) is a start date of a whole period, then the time in years between d1 and d2 is simply the number of whole periods: Equation 2-1 Actual/Actual (n): number of whole periods t = p⁄n Otherwise, let ds and de be the start and end dates of the whole period wherein the date (d1) falls. Then the time in years between d1 and d2 is: Equation 2-2 Actual/Actual (n): time in years between d1 and d2 de – d1 t = p ⁄ n + -----------------------n ( de – ds ) Example Let the start and end dates be d1 = 2008-03-31 and d2 = 2009-09-30, and the frequency be n = 2. Then, the dates generated are as follows: • 2009-09-30 • 2009-03-30 • 2008-09-30 = de • 2008-03-30 = ds There are two (2) whole periods, and the time between d1 and d2 is: Equation 2-3 Actual/Actual (n): Example with 2 whole periods Actual/Actual (n) EOM Note: The Actual/Actual (n) EOM data basis is TRM-specific, i.e. non-market standard. This date basis is similar to Actual/Actual (n) except that the period end and start dates are moved to the last date of the month in question. That is, all the whole periods begin and end at the last day of the month. Example Let the start and end dates be d1 = 2008-03-31 and d2 = 2009-09-30, and frequency be n = 2. Then the dates generated are as follows: • 2009-09-30 • 2009-03-31 • 2008-09-30 = de • 2008-03-31 = ds That is, the dates in March have been moved to the end of March. There are three (3) whole periods, and no fractional part. Therefore, time in years is as follows: Equation 2-4 Actual/Actual (n) EOM: Example with 3 whole periods t = 3 ⁄ 2 = 1.5 36 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Name Description BRL/252 This date basis calculates time as business days according to the Brazilian (BRL) calendar divided by 252. Example Take the period between 2003/12/16 and 2004/02/02. For this period, the BRL calendar is set up with the following public holidays: 2003/12/25, 2003/12/26, and 2004/01/01, as well as 14 weekend days. Therefore, there are 31 business days in the period, and so, using this date basis, the resulting time is: 31/252 = 0.123015873 (instead of 48/365 = 0.131506849 if the Actual/365 date basis was used). 2.1.2 Interest types Name Discount factor in terms of interest rate Annually Compounded Rate Semi-Annually Compounded Rate Quarterly Compounded Rate Monthly Compounded Rate Daily Compounded Yield (B = denominator of date basis) r –t D = ⎛ 1 + ---------⎞ ⎝ 100⎠ r = 100 ( D r – 2t D = ⎛ 1 + ---------⎞ ⎝ 200⎠ r = 200 ( D – 1 ⁄ ( 2t ) – 1) r – 4t D = ⎛ 1 + ---------⎞ ⎝ 400⎠ r = 400 ( D – 1 ⁄ ( 4t ) – 1) r –12t D = ⎛ 1 + ------------⎞ ⎝ 1200⎠ r = 1200 ( D r –Bt D = ⎛ 1 + -------------⎞ ⎝ 100B⎠ r = 100B ( D Continuous Yield D = e Discount Rate Interest Rate Periodic Rate Interest rate in terms of discount factor r – --------- t 100 r D = 1 – --------- t 100 –1 ⁄ t – 1) – 1 ⁄ ( 12t ) – 1) – 1 ⁄ ( Bt ) – 1) 100 r = – --------- log D t 1–D r = 100 ------------t Depending on time: • Periodic Rate for maturities less than one year • Continuous Yield for maturities equal to or over one year. 1 D = -------------------r 1 + --------- t 100 100 1 r = --------- ⎛ ---- – 1⎞ t ⎝D ⎠ Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 37 2 Market standards and calculations 2.1 Market standards Name Discount factor in terms of interest rate Semi-Annual/Periodic Rate These interest types work in a similar way to interest type Interest Rate: Quarterly/Periodic Rate • If time is shorter than six months/three months/month, then the discount factor is periodic: • If time is longer than six months/three months/month, then the discount factor is compounded with frequency of 2, 4, or 12: Monthly/Periodic Rate Interest rate in terms of discount factor 1 / (1 + rate/100 * time) (1 + rate / (frequency * 100))^(-frequency * time) ("^" means to the power) Note: The number of months is calculated as calendar months. For example, from 15 February to 15 March is one month, regardless of date basis. This interest type works in a similar way to interest type Periodic Rate except that the last coupon period is one day longer, i.e. it includes both first and last date. ISDA CDS 2.1.3 Price types 2.1.3.1 Trading Margin The conversion of the quotation (trading margin) into the price is handled by specific quote handlers for Australian FRNs and MBS. The formula used to convert the trading margin (market quote) to the instruments price is described in 3.1.3 Australian floating rate note on page 236 and 3.7.5 Australian MBS on page 302 respectively. 2.1.4 Yield/price conversions Bonds are traded on either yield or price depending on the market conventions. At deal entry, the user can enter either the yield or the price of the bond, the missing value is then calculated from the entered one. For example, if you enter the price then the yield is calculated, and vice versa. The yield/price conversion of a bond is set by including the Trading Yield feature and associating the relevant yield convention with the instrument in the Instrument Editor. The convention determines which price and yield method are used for the conversion. When no convention is selected at the instrument level, the default convention for calculating the yield (deal rate) is ISMA with Actual/Actual date basis and Annually Compounded yield. The following information is provided in this section for each convention: Field Description Name The name of the convention as it appears in TRM. Description General description of the method and standard calculations. Usage Describes with which instrument this method is typically used. 2.1.4.1 Price/yield conversion The yield y is in most cases converted from the clean price Pc of a fixed rate bond by using either the ISMA or the Simple Yield formula. This section describes these two calculations. 38 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards 2.1.4.1.1 ISMA (financial/instrument/isma@yield) Information Description Name ISMA Description The ISMA yield uses a goal seeker method id in the system seeks for the yield which gives the input price. The algorithm iterates the yield y until the equation equals zero: Equation 2-5 ISMA method where Usage • p c is the clean market price • c i and d i represent the ith cashflow and its date (coupon date) • D • I a is the accrued interest is the discount factor for that cashflow This method applies to all bonds except Japanese government bonds, which use the simple yield. See 2.1.4.2 Yield/price conversion on page 40. 2.1.4.1.2 Simple Yield (financial/instrument/simple-yield@yield) Information Description Name Simple Yield Description The simple yield calculates the yield from the clean market price as follows: Equation 2-6 Simple Yield where • r is the coupon rate • p c is the clean market price • t m is the time in years from the valuation date to maturity From this, the conversion equation for simple yield is: Equation 2-7 Simple Yield: conversion equation Usage This method applies only to Japanese government bonds (GOVT-JP). See 2.1.4.2.29 GOVT-JP (financial/instrument/simple-yield@price) on page 59. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 39 2 Market standards and calculations 2.1 Market standards 2.1.4.2 Yield/price conversion The clean price Pc of a fixed rate bond is in most cases converted from the yield y by the formula: Equation 2-8 Yield/price conversion: clean price where • p c is the clean market price • c i and d i represent the ith cashflow and its date (coupon date) • D • I a is the accrued interest. is the discount factor for that cashflow If the dirty price is used, then accrued interest in the above equation is dropped. The methods of calculating the discount factor and the accrued interest may depend on market conventions as explained in the following sections. Hint: For the following bond conventions, when the yield is not specifically mentioned then the convention uses ISMA. 2.1.4.2.1 *ISMA-30/360-BIMONTHLY (financial/instrument/isma@price) Field Description Name *ISMA-30/360-BIMONTHLY Description *ISMA-30/360-BIMONTHLY bonds are regular fixed coupon securities with bi-monthly coupons and 30/360 date basis. With *ISMA-30/360-BIMONTHLY, the coupons for the ith cashflow on date di are discounted using the following formula: Equation 2-9 European bonds before the Euro t D ( y, d i ) = ( 1 + y ⁄ 6 ) i where • Usage t i is the time in years between the value date and the coupon date di . Convention used for australian bonds. 2.1.4.2.2 *ISMA-30E360-ANNUAL (financial/instrument/isma@price) Field Description Name *ISMA-30E360-ANNUAL Description *ISMA-30E360-ANNUAL bonds are regular fixed coupon securities with annual coupons and 30E/360 date basis. With *ISMA-30E360-ANNUAL, the coupons for the ith cashflow on date di are discounted using the following formula: Equation 2-10 European bonds before the Euro t D ( y, d i ) = ( 1 + y ) i where • 40 t i is the time in years between the value date and the coupon date di . © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Field Description Usage Convention used for European bonds (Belgium, Finland, and Germany) issued before the introduction of the Euro. 2.1.4.2.3 *ISMA-30E360-SEMI-ANNUAL (financial/instrument/isma@price) Field Description Name *ISMA-30E360-SEMI-ANNUAL Description *ISMA-30E360-SEMI-ANNUAL bonds are regular fixed coupon securities with semi-annual coupons and 30E/360 date basis. With *ISMA-30E360-SEMI-ANNUAL, the coupons for the ith cashflow on date di are discounted using the following formula: Equation 2-11 Sovereign and corporate bonds t D ( y, d i ) = ( 1 + y ⁄ 2 ) i where • Usage t i is the time in years between the value date and the coupon date di . Convention used for some sovereign or corporate bonds. 2.1.4.2.4 *ISMA-30E360-QUARTERLY (financial/instrument/isma@price) Field Description Name *ISMA-30E360-QUARTERLY Description *ISMA-30E360-QUARTERLY bonds are regular fixed coupon securities with quarterly coupons and 30E/360 date basis. With *ISMA-30E360-QUARTERLY, the coupons for the ith cashflow on date di are discounted using the following formula: Equation 2-12 ISMA 30E360 Quarterly bonds y ti D ( y, d i ) = ⎛ 1 + ---⎞ ⎝ 4⎠ where • Usage t i is the time in years between the value date and the coupon date d . i Supranational or regional bond issuer, for example, German Landesbank. 2.1.4.2.5 *ISMA-ACTACT-ANNUAL (financial/instrument/isma@price) Field Description Name *ISMA-ACTACT-ANNUAL Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 41 2 Market standards and calculations 2.1 Market standards Field Description Description This yield convention is used according to the Eurozone. With *ISMA-ACTACT-ANNUAL, the coupons for the ith cashflow on date di are discounted using the following formula: • If t m > 1 Equation 2-13 Standard Eurozone: when time in years is more than 1 • If t m ≤ 1 Equation 2-14 Standard Eurozone: when time in years is less than or equal to 1 where Usage • t i is the time in years between the value date and the coupon date d i • t m is the time in years from the valuation date to the maturity of the bond. Standard Euro Zone convention that can be applied to other corporate bonds. 2.1.4.2.6 *ISMA-ACTACT-QUARTERLY (financial/instrument/isma@price) Field Description Name *ISMA-ACTACT-QUARTERLY Description *ISMA-ACTACT-QUARTERLY bonds are regular fixed coupon securities with quarterly coupons and Act/Act date basis. With *ISMA-ACTACT-QUARTERLY the coupons for the ith cashflow on date di are discounted using the following formula: Equation 2-15 ISMA Act/Act Quarterly bonds y ti D ( y, d i ) = ⎛⎝ 1 + ---⎞⎠ 4 where • Usage t i is the time in years between the value date and the coupon date d . i Supranational or regional bond issuer, for example, EIB. 2.1.4.2.7 *ISMA-ACTACT-SEMI-ANNUAL (financial/instrument/isma@price) Field Description Name *ISMA-ACTACT-SEMI-ANNUAL 42 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Field Description Description ISMA-ACTACT-SEMI-ANNUAL bonds are regular fixed coupon securities with semi-annual coupons and Act/Act date basis. With *ISMA-ACTACT-SEMI-ANNUAL, the coupons for the ith cashflow on date di are discounted using the following formula: Equation 2-16 Standard UK government bondS where • Usage t i is the time in years between the value date and the coupon date d i Standard UK government bond convention that can be applied by other corporate bonds. 2.1.4.2.8 *ISMA-ACT360-ANNUAL (financial/instrument/isma@price) Field Description Name *ISMA-ACT360-ANNUAL Description ISMA-ACT360-ANNUAL bonds are regular fixed coupon securities with annual coupons and Act/360 date basis. ISMA-ACT360-ANNUAL bonds are calculated using the same formula as ISMA-30E360-ANNUAL, see 2.1.4.2.2 *ISMA-30E360-ANNUAL (financial/instrument/isma@price) on page 40. Usage This convention is used for bond instruments bonds (Interest FIXBIS) issued by sovereign issuers such as the Bank for International Settlement (BIS). 2.1.4.2.9 *ISMA-ACT365-ANNUAL (financial/instrument/isma@price) Field Description Name *ISMA-ACT365-ANNUAL Description *ISMA-ACT365-ANNUAL bonds are regular fixed coupon securities with annual coupons and Act/365 date basis. ISMA-ACT360-ANNUAL bonds are calculated using the same formula as ISMA-30E360-ANNUAL, see 2.1.4.2.2 *ISMA-30E360-ANNUAL (financial/instrument/isma@price) on page 40. Usage This convention is used for some sovereign bond instruments. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 43 2 Market standards and calculations 2.1 Market standards 2.1.4.2.10 *U.S.STREET-ACT365-SEMIANNUAL (financial/instrument/us-street@price) Field Description Name *U.S.STREET-ACT365-SEMIANNUAL Description U.S.STREET-ACT365-SEMIANNUAL bonds are regular or irregular securities with Act/365 date basis. With *U.S.STREET-ACT365-SEMIANNUAL, the coupons for the ith cashflow on date di are discounted using the following formula: Equation 2-17 U.S. Treasury Notes where • k is the compounding frequency of the yield. For example, k = 2 for semi-annual yield) • t0 is the time in years from the value date to d 0 the first coupon date. t 0 is calculated using the following formula: Equation 2-18 U.S. Treasury Notes: time in years where - t v, 0 is the period in years between the valuation date and the first coupon date t p, 0 is the period in years between the previous and the next coupon date, calculated using the date basis Act/365. • n is the number of coupon periods between d 0 and d i , the ith coupon date. n is calculated using: Equation 2-19 U.S. Treasury Notes: number of coupon periods n = round ( k × t i ) where Usage 44 t i is the time (in years) between d 0 and d i . U.S. Treasury Notes market convention on the secondary market. © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards 2.1.4.2.11 *U.S.STREET-ACTACT-SEMIANNUAL (financial/instrument/us-street@price) Field Description Name *U.S.STREET-ACTACT-SEMIANNUAL Description U.S.STREET-ACTACT-SEMIANNUAL bonds are based on the same formula as U.S.STREET-ACT365-SEMIANNUAL, but have Act/Act date basis. See 2.1.4.2.10 *U.S.STREET-ACT365-SEMIANNUAL (financial/instrument/us-street@price) on page 44. Usage Zero-coupon markets, such as, the U.S. and the UK strips. 2.1.4.2.12 *U.S.STREET-ACTACT-ANNUAL (financial/instrument/us-street@price-1) Field Description Name *U.S.STREET-ACTACT-ANNUAL Description U.S.STREET-ACTACT-ANNUAL bonds are based on the same formula as U.S.STREET-ACT365-SEMIANNUAL, but have annual coupon and Act/Act date basis. See 2.1.4.2.10 *U.S.STREET-ACT365-SEMIANNUAL (financial/instrument/us-street@price) on page 44. Usage Some sovereign bonds, for example, on the Euro Dollar market. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 45 2 Market standards and calculations 2.1 Market standards 2.1.4.2.13 *U.S. Treasury (financial/instrument/us-treasury@price) Field Description Name *U.S.TREASURY Description U.S.TREASURY bonds are regular and irregular fixed coupon securities with semi-annual coupons and Act/365 date basis. With *U.S.TREASURY, a periodic rather than compound rate is used for discounting over the partial period from the value date to the next coupon date di : Equation 2-20 U.S. Treasury notes and bonds where • t 0 is the time in years from the value date to the next coupon date (calculated as in *U.S.STREET-ACT365-SEMIANNUAL, see 2.1.4.2.10 on page 44) • t i is time in years from the value date to the coupon date. U.S. Treasury notes and bonds may have an odd first coupon, that is, the length of the first coupon period may be longer or shorter than the normal coupon period: • If the first coupon period is shorter, the coupon amount is calculated as: Equation 2-21 U.S. Treasury notes and bonds: shorter first coupon period c 1 = rt 1 where • - r is the nominal interest rate as a percentage of the par value - t 1 is the time (in years) between the value date of the interest accrual (i.e. beginning of interest accrual) and the first coupon date. If first coupon periods longer than the regular coupon period, the first coupon amount is given by: Equation 2-22 U.S. Treasury notes and bonds: longer first coupon period where - r is the nominal interest rate as a percentage of the par value - t 0 is time (in years) between the value date of the interest accrual and the date six months before the first coupon date. Note: If the first coupon period is exactly half a year, both equations give the same result. Usage 46 Standard U.S. Treasury Notes and bonds convention that can be applied to other corporate bonds. © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards 2.1.4.2.14 BOND-BR-LFT (financial/instrument/isma@price) Information Description ID BOND-BR-LFT Name Brazilian LFT Description BOND-BR-LFT bonds are Brazilian Zero Coupon Bonds linked to the O/N-SELIC-interest rate. The maturities can be over 2 years. They are traded and quoted in 1000's (Dirty Price, Date basis: Business Days/252) and have a unique security ID (ISIN number), issue date and maturity date. The price is derived from the traded yield according to the following equation: Equation 2-23 Brazilian zero coupon bond where Usage • P is the price (as a percentage of the par value) • y is the annual yield-to-maturity (as a percentage) • d denotes the number of business dates from settlement date to maturity date. Brazilian Zero Coupon Bonds Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 47 2 Market standards and calculations 2.1 Market standards 2.1.4.2.15 BOND-BR-NBC (financial/instrument/isma@price) Information Description ID BOND-BR-NBC Name Brazilian NBC Description BOND-BR-NBC bonds are fixed rate bonds linked to the PTAX-index (FX-rate). The maturities are 2Y, 3Y and 5Y. The fixed rate is 12% p.a. They are traded and quoted in 1000’s and have a unique security ID (ISIN number), issue date and maturity date. The price is calculated as a dirty price and is derived from the traded market rate quoted as a semiannual yield according to the following equation: Equation 2-24 Brazilian NBC bonds where Usage • P is the price (as a percentage of the par value) • y is the annual yield-to-maturity (as a percentage) • d360(k) is the number of days between settlement date and cashflow value date according to 30/360 date basis • c is the coupon rate (12%) • L is the number of future coupons • PTAX(t-1) is the PTAX-index rate valid at time t-1, and ID is the issue date • PTAX(ID-1) is the PTAX-index rate valid at Issue Date-1. Brazilian NBC Bonds 2.1.4.2.16 BOND-BR-NTN (financial/instrument/isma@price) Information Description ID BOND-BR-NTN Name Brazilian NTN 48 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Information Description Description BOND-BR-NTN bonds are bonds linked to the IGPM-index (NTN-C) and the ICPA-index (NTN-B). The maturities are 2Y, 3Y and 5Y. The fixed rate is 12% p.a. or 6% p.a. They are traded and quoted in 1000’s and have a unique security ID (ISIN number), issue date and maturity date. The price is calculated as a dirty price and is derived from the traded market rate quoted as a compound yield according to the following equation: Equation 2-25 Brazilian NTN bonds where • P is the price (as a percentage of the par value) • y is the annual yield-to-maturity (as a percentage) • bd(k) is the number of business days between settlement date and cashflow value date • L is the number of future coupons. • c is the coupon rate (12% or 6%) The nominal value is 1 000 at issue date for both NTN-B and NTN-C instruments. The nominal value is then adjusted by the IGPM-rates (NTN-C) and IPCA-rates (NTN-B) respectively. These rates are inflation rates published every month as a monthly (p.m.) rate. Usage Brazilian NTN Bonds Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 49 2 Market standards and calculations 2.1 Market standards 2.1.4.2.17 GOVT-AU (financial/instrument/australian@price) Information Description ID GOVT-AU Name Australian Government bond Description GOVT-AU bonds are medium to long-term debt securities with a fixed coupon paid semi-annually in arrears, redeemable at face value on the maturity date. Treasury Bonds are traded on a yield to maturity basis with the price per $100 face value calculated using the following pricing formulae: • Basic formula Equation 2-26 Australian government bond: Basic formula • Ex interest bonds Equation 2-27 Australian government bond: Ex interest bonds • Near-maturity bonds: Specifically, those entitling a purchaser to only the final coupon payment and repayment of principal. Equation 2-28 Australian government bond: Near-maturity bonds where • P is the price per $100 face value (the computed price is rounded to 3 decimal spaces) • v is 1 + i • i is the annual percentage yield to maturity divided by 200 in Equation 2-26 on page 50 and Equation 2-27 on page 50, or the annual percentage yield to maturity divided by 100 in Equation 2-28 on page 50 • f is the number of days from the date of settlement to the next interest payment date in Equation 2-26 on page 50 and Equation 2-27 on page 50 or to the maturity date in Equation 2-28 on page 50. • If the next interest payment date or maturity date falls on a non-business day, the next good business day (a day on which banks are open for business in Melbourne or Sydney, i.e. not a Saturday or Sunday) is used in the calculation of f. • d is the number of days in the half year ending on the next interest payment date • g is the half-yearly rate of coupon payment per $100 face value • n is the term in half years from the next interest-payment date to maturity 1 ----------- Settlement amounts are rounded to the nearest cent (0.50 cent is rounded up). That is, the pricing formula used for computing the price from the yield is the ISMA method. But in the case of near maturing bonds, i.e. when the bond is settled six months plus seven days before maturity, it is treated as a special case, using the pricing of Treasury Notes. Equation 2-29 Treasury Notes equation 50 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Information Description Usage Australian government bond 2.1.4.2.18 GOVT-CA (financial/instrument/canadian@price) Information Description ID GOVT-CA Name Canadian Government bond Description GOVT-CA bonds are regular, fixed-coupon securities with equal, semi-annual coupon payments and Act/365 date basis. These bonds are traded on a clean price basis. Although Canadian government bonds share similarities with U.S. Treasury bonds, they differ in the accrued interest calculation. The accrued interest on Canadian Government bonds is calculated as follows: Equation 2-30 Canadian government bonds where • AI is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • PAI is the number of accrued interest days computed in the following way: where - coupon days (pc) is the actual number of days in the current coupon period, calculated as coupon value date minus the start of the current coupon period - p AI is the actual number of days in the period over which the accrued interest is act calculated (calculated as accrued interest date minus the start of the current coupon period). Then: Usage act act - if p AI is less than or equal to 182, then p AI = p AI , or - if p AI is greater than 182, then p AI = ( 182.5 – ( p c – p AI ) ) act act Canadian government bond Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 51 2 Market standards and calculations 2.1 Market standards Information Description Yield The following algorithm is used to calculate the yield (Y) based on the price of Canadian Government bonds: • If one coupon payment remains, then the following algorithm is used to calculate the yield (Y) based on the price of Canadian Government bonds: Equation 2-31 Canadian government bonds: one coupon payment remains where • y is the annual yield-to-maturity (as a percentage) r is the nominal interest rate (to be paid at time i) as a percentage of the par value P is the clean price (as a percentage of the par value) DSM is the days from settlement date to maturity date AI is the accrued interest calculated as described in Equation 2-30 on page 51. If the first coupon is a short coupon, then the Yield formula of Canadian Bond (yield convention GOVT-CA) takes into account the first coupon as follows: Equation 2-32 Canadian government bonds: if first coupon is a short coupon Where - r is the nominal interest rate - t1 is the time (in years) between the beginning of the interest accrual and the first coupon date and then applies to the following Yield/Price formula: Equation 2-33 Canadian government bonds: Yield/Price formula Where - P is the clean price (as a percentage) of the Par value - y is the annual Yield-to-Maturity (as a percentage) - p1 is the number of days from the settlement date to the first coupon date - is the number of days in the quasi-coupon period ending on the first coupon payment date r is the nominal interest rate - n is the number of coupon payments remaining • 52 is the number of days from interest accrual date to first payment date is the number of days from the interest accrual date to the settlement date. If more than one coupon payment remains, the US Treasury bond market conventions (i.e. US Street calculation method) are used for the price/yield calculations. See 2.1.4.2.10 *U.S.STREET-ACT365-SEMIANNUAL (financial/instrument/us-street@price) on page 44. © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards 2.1.4.2.19 GOVT-CH (financial/instrument/isma@price) Information Description ID GOVT-CH Name Swiss Government bond Description GOVT-CH bonds are regular, fixed-coupon securities with equal, annual coupon payments and 30E/360 date basis (the date basis where the 31st of the month is treated as the 30th.) With GOVT-CH, the coupons for the ith cashflow on date d i are discounted using the following formula: Equation 2-34 Swiss government bonds where • Usage t i is the time in years between the value date and the coupon date d i Swiss government bond. 2.1.4.2.20 GOVT-DK-OLD-30E360 (financial/instrument/isma@price) Information Description ID GOVT-DK-OLD-30E360 Name Danish Government 30E360 before 8 February 2001 Description GOVT-DK-OLD-30E360 bonds are regular, fixed-coupon securities with annual coupon payments and 30E/360 date basis (the date basis where the 31st of the month is treated as the 30th). With GOVT-DK-OLD-30E360, the coupons for the ith cashflow on date d i are discounted using the following formula: Equation 2-35 Danish government bond issued before 8 February 2001 where • t i is the time in years between the value date and the coupon date With GOVT-DK-OLD-30E360, the Accrued Interest calculation is calculated using a 30E/360 date basis: Equation 2-36 where • I a is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • t a is the number of calendar days between the previous coupon payment (inclusive) and the settlement date (exclusive). • t i equals 360. It represents the number of days between the last and next coupon dates. 360 is also used for leap years. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 53 2 Market standards and calculations 2.1 Market standards Information Description Usage Danish government bond issued before 8 February 2001. 2.1.4.2.21 GOVT-DK (financial/instrument/isma@price) Information Description ID GOVT-DK Name Danish Government bond issued after 8 February 2001. Description GOVT-DK bonds are regular, fixed-coupon securities with equal, annual coupon payments and Act/Act date basis. With GOVT-DK, the coupons for the ith cashflow on date d i are discounted using the following formula: • If t m > 1 , then Equation 2-37 • If t m ≤ 1 , then Equation 2-38 where Usage 54 • t i is the time in years between the value date and the coupon date d i • t m is the time in years from the valuation date to maturity of the bond. Danish government bond. This corresponds to the standard Euro Zone convention. From 8 February 2001 the Danish Government bonds follow the Euro Zone convention. See 2.1.4.2.22 GOVT-EUROZONE (financial/instrument/isma@price) on page 55 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards 2.1.4.2.22 GOVT-EUROZONE (financial/instrument/isma@price) Field Description Name GOVT-EUROZONE Description Euro Zone government bonds are regular, fixed-coupon securities with equal, annual coupon payments and a bullet redemption using Act/Act date basis. These bonds are traded on a clean-price basis. With GOVT-EUROZONE, the coupons for the ith cashflow on date di are discounted using the following formula: • If t m > 1 Equation 2-39 GOVT-EUROZONE: time in years is more than 1 • If t m ≤ 1 Equation 2-40 EGOVT-EUROZONE: time in years is less than or equal to 1 where - t i is the time in years between the value date and the coupon date d i - t m is the time in years from the valuation date to the maturity of the bond. With GOVT-EUROZONE, the Accrued Interest is calculated as follows according to ISMA Rule 251: Equation 2-41 GOVT-EUROZONE: Accrued Interest where • I a is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • t a is the actual number of days between the last coupon payment date (inclusive) and the current value date (exclusive) • t i is the actual number of days in the coupon period between the last (inclusive) and next (exclusive) coupon dates multiplied by the number of coupon periods in the year. However, the denominator calculation is subject to exceptions in relation to irregular coupon periods (see below) • Usage n c is the number of coupon periods in the year. This is the standard Euro Zone convention. This convention applies to the following government bonds: Austria, Belgium, Cyprus, Finland, France (BTAN), German, Greece, Ireland, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, Spain. Note: France (OAT) and Italy also belong to the Eurozone, but apply small variants to the Euro Zone convention. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 55 2 Market standards and calculations 2.1 Market standards 2.1.4.2.23 GOVT-FR-OAT-OLD-AIR3 (financial/instrument/isma@price) Information Description ID GOVT-FR-OAT-OLD-AIR3 Name French Government OAT Old. Description GOVT-FR-OAT-OLD-AIR3 bonds are regular, fixed-coupon securities with equal, annual coupon payments, and Act/Act date basis. These bonds are traded on a clean price basis. With GOVT-FR-OAT-OLD-AIR3, the accrued interest calculation is rounded to 3 decimals using an Actual/Actual date basis: Equation 2-42 Old French OAT convention where • I a is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • t a is the time in years between the last coupon date (inclusive) and the value date (exclusive), calculated using the accrual date basis, • Usage t i is the time in years between the last (inclusive) and next (exclusive) coupon dates, calculated using the appropriate Actual/Actual date basis. Old French OAT convention for bonds issued before 18 April 2005, where the convention required an Accrued Interest calculation rounded to 3 decimals using an Actual/Actual date basis. This convention has been replaced by a rounding to 7 decimals. The old 3-decimal rounding is still accepted. 2.1.4.2.24 GOVT-FR-OAT (financial/instrument/isma@price) Information Description ID GOVT-FR-OAT Name French Government OAT Description French government OATs follow the Euro Zone standard convention. However, in the GOVT-FR-OAT method the accrued interest calculation is rounded to 7 decimals using an Actual/Actual date basis: Equation 2-43 French government OAT where • I a is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • t a is the time in years between the last coupon date (inclusive) and the value date (exclusive), calculated using the accrual date basis • Usage 56 t i is the time in years between the last (inclusive) and next (exclusive) coupon dates, calculated using the appropriate Actual/Actual date basis. French OAT convention for bonds issued after 18 April 2005 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards 2.1.4.2.25 GOVT-GR-OLD-30E360 (financial/instrument/isma@price) Information Description ID GOVT-GR-OLD-30E360 Name Greek Government 30E360 before 1 January 2001 Description GOVT-GR-OLD-30E360 bonds are fixed-coupon securities with annual coupon payments, and 30E/360 date basis (the date basis where the 31st of the month is treated as the 30th). These bonds are traded on a clean price basis. With GOVT-GR-OLD-30E360, the coupons for the ith cashflow on date d i are discounted using the following formula: Equation 2-44 Greek government bond where • Usage t i is the time in years between the value date and the coupon date d i . Greek government bond issued before 1 January 2001. 2.1.4.2.26 GOVT-HU (financial/instrument/isma@price) Field Description ID GOVT-HU Name Hungarian Government Description With this yield convention, the coupons for the ith cashflow on date di are discounted using the following formula: • If t m > 1 Equation 2-45 Hungarian government bonds: when time in years is more than 1 • If t m ≤ 1 Equation 2-46 Hungarian government bonds: when time in years is less than or equal to 1 where Usage • t i is the time in years between the value date and the coupon date d i • t m is the time in years from the valuation date to the maturity of the bond. Hungarian government bonds. This convention uses the accrued interest method Hungarian (4 decimals), see Hungarian (4 decimals) on page 75. 2.1.4.2.27 GOVT-IT (financial/instrument/isma@price) Information Description ID GOVT-IT Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 57 2 Market standards and calculations 2.1 Market standards Information Description Name Italian Government Description GOVT-IT bonds are regular, fixed-coupon securities with equal, semi-annual coupon payments, and Actual/Actual date basis. With GOVT-IT, the coupons for the ith cashflow on date d i are discounted using the following formula: Equation 2-47 Italian government bonds where • t i is the time in years between the value date and the coupon date d i Equation 2-48 Italian government bonds: time in years - d i is the number of days between the value date and the coupon date d - n is the number of coupons i.e. 2. - d c is the number of days during the coupon period With GOVT-IT, the accrued interest calculation is rounded to 5 decimals using an Actual/Actual date basis: Equation 2-49 Italian government bonds: accrued interest calculation • I a is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • t a is the time in years between the last coupon date (inclusive) and the value date (exclusive), calculated using the accrual date basis • Usage t i is the time in years between the last (inclusive) and next (exclusive) coupon dates, calculated using the appropriate Actual/Actual date basis. Italian government bonds. 2.1.4.2.28 GOVT-IT-ZC (financial/instrument/isma@price) Field Description ID GOVT-IT-ZC Name Italian Government Zero Coupon 58 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Field Description Description This yield convention is used for the Italian Government Bond with Zero Coupon. The date basis is Actual-/365 and the discount factor is calculated according to the following formula: • If t m > 1 Equation 2-50 Italian ZC government bonds: when time in years is more than 1 • If t m ≤ 1 Equation 2-51 Italian ZC government bonds: when time in years is less than or equal to 1 where Usage • t i is the time in years between the value date and the coupon date d i • t m is the time in years from the valuation date to the maturity of the bond. Italian Government Bond with Zero Coupon 2.1.4.2.29 GOVT-JP (financial/instrument/simple-yield@price) Information Description ID GOVT-JP Name Japanese Government Description GOVT-JP bonds are regular, fixed-coupon securities with equal, annual coupon payments, and Actual-/365 date basis. These bonds are traded on a clean price basis. With GOVT-JP, the Accrued Interest calculation is truncated to 7 decimals using Actual/365 date basis: Equation 2-52 Japanese government bonds • I a is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • t a is the time in years between the last coupon date (inclusive) and the value date (exclusive), calculated using the accrual date basis • t i is the time in years between the last (inclusive) and next (exclusive) coupon dates, calculated using the appropriate Actual/365 date basis. Usage Japanese government bonds Yield Simple Yield Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 59 2 Market standards and calculations 2.1 Market standards 2.1.4.2.30 GOVT-MALAYSIA (financial/instrument/isma@price) Information Description Name GOVT-MALAYSIA Usage Used to support Malaysian Government bonds. These bonds have semi-annual coupon payments with Act/2Act date basis. 2.1.4.2.31 GOVT-NO (financial/instrument/norwegian@price) Information Description Name GOVT-NO Description Norwegian government bonds are regular, fixed-coupon securities with equal, annual coupon payments and a bullet redemption on an Act/365 date basis. These bonds are traded on a clean-price basis. With GOVT-NO, the coupons for the ith cashflow on date di are discounted using the following formula: Equation 2-53 Norwegian government bonds where • t i is the time in years between the value date and the coupon date calculated using the date basis Actual/365 With GOVT-NO, the Accrued Interest calculation is calculated using date basis Actual/365: Equation 2-54 Norwegian government bonds: Accrued Interest where • I a is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • t a is the actual number of calendar days between the previous coupon payment and the settlement date. The actual number of calendar days include leap years • t i is equal to 365 and represents the number of days between the last and next coupon dates. Note: 365 is also used for leap years. Usage Norwegian government bonds 2.1.4.2.32 GOVT-NZ (financial/instrument/isma@price) Information Description ID GOVT-NZ Name New Zealand Government Bond 60 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Information Description Description GOVT-NZ bonds are regular, fixed-coupon securities with semi-annual coupon payments, and Actual/Actual date basis. These bonds are traded on a clean price basis. With GOVT-NZ, the coupons for the ith cashflow on date d i are discounted using the following formula: Equation 2-55 New Zealand government bonds where • Usage t i is the time in years between the value date and the coupon date d i calculated using the date basis Actual/Actual. New Zealand government bonds 2.1.4.2.33 GOVT-SE (financial/instrument/isma@price) Information Description ID GOVT-SE Name Swedish Government Bond Description GOVT-SE bonds are regular, fixed-coupon securities with equal, annual coupon payments, and 30E/360 date basis (the date basis whereby the 31st of the month is treated as the 30th). These bonds are traded on a clean price basis. With GOVT-SE, the coupons for the ith cashflow on date d i are discounted using the following formula: Equation 2-56 Swedish government bonds where • t i is the time in years between the value date and the coupon date d i With GOVT-SE, the accrued interest calculation is calculated using an 30E/360 date basis: Equation 2-57 where Usage • I a is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • t a is the number of calendar days between the previous coupon payment (inclusive) and the settlement date (exclusive) • t i equals 360. It represents the number of days between the last and next coupon dates. 360 is also used for leap years. Swedish government bonds. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 61 2 Market standards and calculations 2.1 Market standards 2.1.4.2.34 GOVT-SG (financial/instrument/us-street@price) Field Description Name GOVT-SG Description Singaporean Government Bonds are based on the same formula as U.S.STREET-ACTACT-SEMIANNUAL. See 2.1.4.2.11 *U.S.STREET-ACTACT-SEMIANNUAL (financial/instrument/us-street@price) on page 45. Usage Singaporean government bond convention. This convention uses the accrued interest method Singaporean (8 decimals), see Singaporean (8 decimals) on page 77. 2.1.4.2.35 GOVT-UK (financial/instrument/isma@price) Information Description ID GOVT-UK Name UK Government Bond Description GOVT-UK bonds are regular, fixed-coupon securities with equal, semi-annual coupon payments, and Actual/Actual date basis. These bonds are traded on a clean price basis. With GOVT-UK, the coupons for the ith cashflow on date d i are discounted using the following formula: Equation 2-58 where • t i is the time in years between the value date and the coupon date d i Equation 2-59 where Usage - d i is the number of days between the value date and the coupon date d - n is the number of coupons i.e. 2. - d c is the number of days during the coupon period UK government bond convention. 2.1.4.2.36 GOVT-US (financial/instrument/us-street@price) Information Description ID GOVT-US Name United States Government 62 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Information Description Description U.S. Treasury government bonds are regular and irregular fixed-coupon securities with semi-annual coupon payments and Actual/365 date basis. These bonds are traded on a clean price basis. With GOVT-US, a periodic rather than compound rate is used for discounting over the partial period from the value date to the next coupon date d i : Equation 2-60 U.S Treasury government bonds where • t 0 is the time in years from the value date to the next coupon date (calculated as in the U.S. Street method) • t i is the time in years from the value date to d i . U.S. Treasury notes and bonds may have a first coupon of an unequal length. That is, the length of the first coupon period may be longer or shorter than the normal coupon period. • If the first coupon period is shorter, the coupon amount is calculated as follows: Equation 2-61 First coupon period shorter c 1 = rt 1 where - r is the nominal interest rate - t 1 is the time (in years) between the dated date (the beginning of interest accrual) and the first coupon date. • If the first coupon period is longer, the first coupon amount is calculated as follows: Equation 2-62 First coupon period longer c 1 = r ⁄ 2 + rt 0 where - t 0 is time (in years) between the dated date and the date six months before the first coupon date. • Usage If the first coupon period is exactly half a year, both equations give the same result. This is the US government bond convention based on U.S. Street Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 63 2 Market standards and calculations 2.1 Market standards 2.1.4.2.37 GOVT-USAGENCY (financial/instrument/isma@price) Information Description ID GOVT-USAGENCY Name United States Government Agency Description GOVT- USAGENCY bonds are fixed-coupon securities with annual coupon payments, and 30/360 date basis. These bonds are traded on a clean price basis. With GOVT-USAGENCY, the accrued interest is calculated as follows using a 30/360 date basis: Equation 2-63 United States Government Agency where • I a is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • t i is the length of the coupon period calculated using the accrual date basis of 30/360 (or coupon date basis if the former is missing) • Usage 64 t r is the length of the remaining accrual period (i.e. the time between the accrual date and the end date of the coupon). US government Agencies bond convention © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards 2.1.4.2.38 GOVT-ZA (financial/instrument/south-african@price) Information Description ID GOVT-ZA Name South African Government bond Description GOVT-ZA bonds are regular, fixed-coupon securities with semi-annual coupon payments, and Actual/365 date basis. These bonds are traded on a clean price basis. With GOVT-ZA, the Accrued Interest calculation is rounded to 5 decimals using an Actual/365 date basis: Equation 2-64 South African Government bond where • I a is the accrued interest • r is the nominal interest rate (to be paid at time i) as a percentage of the par value • t a is the time in years between the last coupon date (inclusive) and the value date (exclusive), calculated using the accrual date basis • t i is the time in years between the last (inclusive) and next (exclusive) coupon dates, calculated using the appropriate Actual/365 date basis. With GOVT-ZA, the coupons for the ith cashflow on date d i are discounted using the following formula: Equation 2-65 where • k is the compounding frequency of the yield (for example, k=2 for semi-annual yield) • t 0 is time in years from the value date to d 0 , the first coupon date. t 0 is calculated using the following formula: Equation 2-66 Time in years from value date to first coupon date t v, 0 t 0 = --------t p, 0 where - t v, 0 and t p, 0 are the periods in years between the valuation date and the first coupon date, and between the previous and the next coupon date, respectively, calculated using the date basis Act/365 - n is the number of coupon periods between d 0 and d i , the ith coupon date. The number of coupon periods is calculated using: n = round ( kxt i ) where t i is the time (in years) from the next coupon date to the maturity of the bond, and round rounds the number to the nearest integer. Usage South African Government bond convention Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 65 2 Market standards and calculations 2.1 Market standards 2.1.4.2.39 INDEX-UK (function/index-uk@price) ID INDEX-UK Name Index-linked UK Government bond Description The prevailing market conventions for price/yield calculations in the UK index-linked market are different from the conventions used for the Swedish and US index-linked markets. The market practice is to assume that all future semi-annual coupon periods have the same length as the present accrued period. Therefore, the overall period T si between settlement and the ith coupon, in the date basis actual/365, is given by: Equation 2-67 Index-linked UK Government bond The market quoted clean price and the semi-annual nominal yield to maturity Y nominal are calculated by the following price/yield formula: Equation 2-68 Price/yield equation where • C IndexAdj is the index adjusted coupons • R IndexAdj (prolonged RPI index figures) is the redemption. Given the price, the nominal yield is obtained by numerical methods. The real yield to maturity y Real is derived from the nominal yield and the assumed inflation rate using the Fisher equation: Equation 2-69 Fisher equation Usage Index-linked UK Government bonds 2.1.5 Discount Margin Discount margin is the spread that, when added to the discounting zero curve, will equate the theoretical value of a floating rate note (see 3.1.2 Floating rate note on page 228) to the quoted price. Discount Margin is calculated at instrument level and shown in Rate Monitor or in Transaction Manager (Figure Discount Margin). In this calculation, the day count method and yield type specified in Discount Margin page are used, and the spread is added to the discounting curve defined in this page. When discount margin is used in the valuation, it is added to the valuation curve specified for the instrument, and the day count method and yield type used are taken from the interpolation method of this valuation curve. For the results to be consistent, the day count method and yield type specified in Discount Margin page should match these. Also, the instrument's valuation curve should 66 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards be used for discount margin calculation. Discount margin valuation is enabled by the feature FRN Valuation, see A.2.164 FRN Valuation on page 791. At instrument level, discount margin m is calculated by solving the equation: Equation 2-70 Discount margin Where: – Pd The dirty price (at spot) of the bond, based on the market quote. – d i The coupon dates. – ci The fixed or estimated coupons. y D i The discount factors (from spot) from the discounting curve on dates d i . – Note: Coupons have to be fixed in Instrument Editor for the fixing to have an effect on the discount margin calculation. – and are the rate-to-discount-factor and discount-factor-to-rate conversions (from spot date) using the day count method and yield type specified in the discount margin setup. 2.1.6 Calculation methods 2.1.6.1 Accrued interest calculations The generic formula for accrued interest AI is: Equation 2-71 Accrued interest (generic formula) t AI = --- × C T where C is the coupon amount, T is the length of the coupon period (in years, calculated with the appropriate date basis), and t is the length of the accrual period (in years). There are many variations of this basic formula. Note: For bonds, the method used for the accrued interest calculation is specified in the AI Method field in Instrument Editor’s Bond page. The date basis used for period length calculations is specified in the Cashflow page (Accrual Date Basis field). If the accrual date basis is not defined, then the date basis of the cashflow is used. Both these pages are available in the editor when the Bond feature is present in the instrument definition (see A.2.51 Bond on page 734). Some AI methods use neither the accrual nor the cashflow’s date basis. This is because the day count method is built in the method. The following table lists the symbols used in the accrued interest calculations: Symbol Description P Principal on which the coupon amount and accrued interest are calculated. C Coupon amount. r Coupon interest rate (as a decimal number). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 67 2 Market standards and calculations 2.1 Market standards Symbol Description T Coupon period in years. t Accrual period in years. D Coupon period in days. d Accrual period in days. 2.1.6.1.1 Generic methods The following sections describe the generic methods for calculating accrued interest in TRM. Linear Equation 2-72 Accrued Interest: Linear t AI = --- × C T Linear 30/360 EOM The Linear 30/360 EOM method ensures that the calculation of accrued interest follows the same month-end behavior as accrued interest used in the calculation of accrued profit. This method is used when defining the Result IR setup for a result treatment (in Result Editor). It achieves a constant yield when a 30E/360 EOM date basis is selected (in Result Editor’s Accrual Yield page). See the TRM User Guide for more information about setting up result treatments. Linear (Closing) The Linear (Closing) method ensures that in closing the books, February is considered as having 30 days when 30-day date bases (such as, the 30/360 and 30E/360 date bases) are used. This means that in accounting, these date bases result in equal interest accrual amount postings in each month. Actual/Actual Equation 2-73 Accrued Interest: Actual/Actual d AI = ---- × C D where D is the interest period length in actual days, and d is the length of the accrual period in actual days. This method will ignore any date basis conventions associated with the coupon. Actual/Actual (Inclusive) This method accrues interest linearly over the interest period, including the first day and excluding the last day of the period. Actual/Actual Annually In the following methods, Actual/Actual Annually, Actual/Actual Semi-Annually, and Actual/Actual Quarterly, the basic formula is used, but the period length calculation is more complicated, as follows: • 68 The coupon period is divided into 12/N -month segments, starting from the end of the coupon period. © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards • The number of months in each segment, 12/N, may be 12, 6, or 3, depending on the method chosen (respectively, Annually, Semi-Annually, or Quarterly). • The segments are created by moving the coupon end date back in 12/N -month steps. • If a date created by such a move does not exist (that is, it falls after the end of month), the end-of-the-month date is substituted for it. Let ith such segment span dis days, and the part of the period within the segment contain dip days; then the total period length in years is: Equation 2-74 Accrued Interest: Actual/Actual Annually - total period length i dp t = ∑ -------i d N i s Note: If the period extends over an entire segment, then dip = dis and the contribution to the total period length of that segment is simply 1/N years. This calculation is repeated for the coupon period (T) and for the accrual period (t), and finally the accrued interest is: Equation 2-75 Accrued Interest: Actual/Actual Annually t AI = --- × C T These methods will ignore any date basis conventions associated with the coupon. Actual/Actual Annually (5 decimals) Non-government Italian bonds are based on annual coupon and Actual/Actual accrual date basis with a rounding to the fifth decimal. This method can be used for more generic purposes as well as for non-government Italian bonds. Accrued Interest is calculated as follows: Equation 2-76 Actual/Actual Annually (5 decimals): accrued interest AI = R 7 [ r × d ⁄ D ] × P Where AI Accrued interest r Nominal interest rate (to be paid at time i) as a real number. d Time in years between the last coupon date (inclusive) and the value date (exclusive), calculated using the accrual date basis. D Time in years between the last (inclusive) and next (exclusive) coupon dates, calculated using the appropriate Actual/Actual date basis. P Principal Index ratio: Equation 2-77 Actual/Actual Annually (5 decimals): index ratio Index IndexRatio = R 5 ⎛⎝ -----------------------------⎞⎠ IssueIndex Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 69 2 Market standards and calculations 2.1 Market standards Index Accrued Interest: Equation 2-78 Actual/Actual Annually (5 decimals): index accrued interest IndexAI = IndexRatio × AI Coupon % methods With the Coupon % methods, the accrued interest is calculated directly from the principal (P) and the coupon rate (r). It may happen that the accrued interest thus calculated is larger than the actual coupon amount (for example, if the date basis used in the AI calculation is different from the date basis used for the calculation of the coupon amount). In this case, accrued interest is capped at the coupon amount, and the daily accrual towards the end of the coupon period may be zero. • Coupon % Equation 2-79 Accrued Interest: Coupon % AI = min [ r × t × P ,C ] • Coupon % Relative Semi-Annually Equation 2-80 Accrued Interest: Coupon % Relative Semi-Annually r×t×P AI = min ------------------- ,C 2T Here T is calculated using the date basis of the cashflow, not the accrual date basis. • Coupon % Relative Quarterly Equation 2-81 Accrued interest: Coupon % Relative Quarterly r×t×P AI = min ------------------- ,C 4T Here T is calculated using the date basis of the cashflow, not the accrual date basis. • Coupon % Compound Annually Equation 2-82 Accrued interest: Coupon % Compound Annually t AI = min [ ( 1 + r ) – 1 ,C ] • Coupon % Compound Semi-Annually Equation 2-83 Accrued interest: Coupon % Compound Semi-Annually 2t AI = min [ ( 1 + r ⁄ 2 ) – 1 ,C ] • Coupon % Compound Quarterly Equation 2-84 Accrued interest: Coupon % Compound Quarterly 4t AI = min [ ( 1 + r ⁄ 4 ) – 1 ,C ] Expression If the coupon is fixed in arrears, the fixing rate is not known when figure accrued interest is calculated. As an estimate, the system uses the current market rate for the fixing period. 70 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards The formula for accrued interest is then: Equation 2-85 Accrued interest: Coupon % Expression t AI = A × --T where: – t is the time in years between the start of the coupon period and the valuation date – T is the length in years of the coupon period – A is the coupon amount calculated using the expression defined for the coupon cashflow. Dual currency • Dual-Currency Estimated The settlement amount is calculated using the forward FX rates. • Dual-Currency Last The settlement amount is calculated using the FX rate of the previous FX fixing. Note: Both methods round the figure value in the cashflow currency before converting it into the settlement currency. Range For range accrual transactions, several specific accrued interest calculation methods exist. They are all based on the principle that the interest (coupon) rate has to be scaled down by a factor depending on the number of days the market variable being observed has been within the range. Once the interest rate has been scaled down, the accrued interest is calculated linearly based on the time spent until valuation date, the total interest period and the date basis of the cashflow. The accrued interest methods and the corresponding factors are: • Range Proportional Days In Range / Observation Days until valuation date • Range So Far In Days In Range / Total Interest Period • Range So Far Out (Total Interest Period - Days Out of Range) / Total Interest Period • Range Fixing Assumes the variable observed will remain in the same state as on valuation date, i.e. So Far In if it is out of range and So Far Out otherwise. Note that the default observation period includes the first date of the interest period and excludes the last date (i.e payment date) of the interest period. For example: Let us consider the interest period from 01/06/2003 until 01/12/2003 with the interest calculation expression as: max[0, 4.85 * range(Euribor/6M, 0, 4.00, up-in/down-in, 2, EUR, ACT/365)] Valuation date is 30/06/2003, i.e. there have been 30 observation days, and 29 days on interest accrual. The total interest period is 183 days. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 71 2 Market standards and calculations 2.1 Market standards Assume that the 6M Euribor rate was in the range 20 times. The accrued interest would be (using date basis Act/365): • Range Proportional method: 4.85% * 20/30 * 29/365 * Nominal Amount • So-Far-In method: 4.85% * 20/183 * 29/365 * Nominal Amount • So-Far-Out method: 4.85% * (183 - 10)/183 * 29/365 * Nominal Amount, i.e. 4.85% * 173/183 * 29/365 * Nominal Amount Yield Accrued Interest This yield based method is used only for the yield accrual of discount/premium – it is not to be used for actual accrued interest calculation. It converts the coupon rate to the same basis as with which yield to maturity is calculated (in a manner that the total coupon remains the same, but the rate of accrual changes). Yield accrual is then based on the coupon accruing with this rate. ISDA CDS The ISDA CDS method is used with credit default swap. This AI method is based on the Linear AI method except that the last period coupon is one day longer, i.e. it includes both the first and last dates in the AI calculation. 2.1.6.1.2 Market-specific methods The following sections describe the market-specific methods for calculating accrued interest in TRM. Note: With regards to rounding, we use the symbol Rn to indicate the rounding to n decimal places. In the applications the interest rate r is given as a % (e.g. r = 3.85 is treated as 3.85% = 0.0385). In the calculation, the system uses the real number. This means that an AI Method (3 decimals) corresponds to a rounding (R5) of the real number to 5 decimals. Australian (3 decimals) This is the AI method rounded to 3 decimals using the Actual/Actual date basis: Equation 2-86 Accrued interest: Australian (3 decimals) AI = R 5 [ ( r ⁄ 2 ) × d ⁄ D ] × P where d is the length of the accrual period in actual days and D is the interest period length in actual days. Australian Floater (3 decimals) This is the method used for australian domestic floating rate note, rounded to 3 decimals using instrument date basis. Equation 2-87 Accrued interest: Australian Floater (3 decimals) AI = R 5 [ r × t ] × P where 72 – r is the fixing rate of the current coupon – P is the Principal © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards – t is the length of the accrual period in years, calculated using the coupon date basis. Moreover, during the ex coupon period, accrued interest is based directly on the number of remaining days to the next coupon using the following equation: Equation 2-88 Accrued interest: Australian Floater (3 decimals): ex coupon period AI = R 5 [ r × t ] × P Where – P is the principal – t is the length of the remaining period (to the next coupon) in years, calculated using the coupon date basis. Australian Index Linked These are the Australian Index Linked (IAB) or Australian Index Linked (CIB) AI methods used for Australian index-linked bonds or Australian capital indexed bonds respectively. Note: For three decimal places rounding, use AI method Australian Index Linked (IAB) (3 dec). Belgian The following calculation applies for all coupon lengths (except short coupons); see Equation 2-74 on page 69 for more details: For short coupons, the calculation is the following; see Equation 2-79 on page 70 for more details: Canadian The Actual/365 (Canadian Bond) date basis considers a year to have 365 days, whereas the length of a coupon period is represented by 365 divided by the number of coupon periods in a year. For the most common Canadian domestic bond structures, which pay a semi-annual coupon, this implies the length of a coupon period is 365/2 = 182.5 days. Where f is the annual payment frequency (or number of coupon periods per year), the Actual/365 Canadian Bond measures the fraction of a coupon period represented by a given number of days as follows: • If the number of days of interest accrual is less than the actual number of days in the coupon period: Equation 2-89 Accrued Interest: Canadian { frac } pc d×f = ----------365 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 73 2 Market standards and calculations 2.1 Market standards Which, for semi-annual pay bonds where f = 2 , reduces to: Equation 2-90 Accrued Interest: Canadian semi annual pay bonds { frac } pc d = ------------182.5 Then Equation 2-91 Canadian AI calculation { frac } AI = A c × p c • If the number of days of interest accrual exceeds 365/f, or 182.5 days for a semi-annual pay bond: Equation 2-92 Accrued Interest: Canadian when interest accrual exceeds 365/f or 182.5 days { frac } pc df × f = 1 – ------------365 Where – d f is the actual number of days from the valuation date to the next coupon date. Then Equation 2-93 Canadian AI calculation when interest accrual exceeds 365/f or 182.5 days { frac } AI = A c × p c French (3 decimals) Equation 2-94 Accrued interest: French (3 decimals) AI = max [ ( R 5 [ 1 + rt ] – 1 ) × P ,C ] where t is the length of the accrual period in years, calculated using the accrual date basis, operator R5 signifies the rounding, and Tc and t are the length of the coupon period calculated using the coupon date basis and the accrual date basis, respectively. French (4 decimals) This method is the same as French (3 decimals) except that the rounding operator = R6. French (7 decimals) This method is the same as French (3 decimals) except that the rounding operator = R9. Greek (3 decimals) Greek index-linked bonds are based on the annual coupon and Actual/Actual Accrual date basis with a rounding to the third decimal. This method is used for Greek index-linked bonds. Accrued Interest is calculated as follows: Equation 2-95 Accrued interest: Greeks (3 decimals) AI = R 5 [ r × d ⁄ D ] × P 74 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Where AI Accrued interest r Nominal interest rate (to be paid at time i) as a real number. d Time in years between the last coupon date (inclusive) and the value date (exclusive), calculated using the accrual date basis. D Time in years between the last (inclusive) and next (exclusive) coupon dates, calculated using the appropriate Actual/Actual date basis. P Principal Index ratio: Equation 2-96 Accrued interest: Greeks (3 decimals) - index ratio Index IndexRatio = R 3 ⎛⎝ -----------------------------⎞⎠ IssueIndex Index Accrued Interest: Equation 2-97 Accrued interest: Greeks (3 decimals) - index accrued interest IndexAI = IndexRatio × AI Hungarian (4 decimals) This is the AI method rounded to 4 decimals using the Actual/Actual accrual date basis: Equation 2-98 Accrued interest: Hungarian (4 decimals) AI = max [ ( R 6 [ 1 + rt ] – 1 ) × P ,C ] where t is the length of the accrual period in years, calculated using the accrual date basis, the operator R6 signifies the rounding, and Tc and t are the length of the coupon period calculated using the coupon date basis and the accrual date basis, respectively. Israeli (Annual Compound, 5 decimals) • Bond Bond coupon rate r (in %) is converted to the annual compound rate as follows: Equation 2-99 Accrued Interest: Israeli (Annual Compound, 5 decimals) Bond Where: t = Time in years between the last (inclusive) and next (exclusive) coupon dates, calculated using the appropriate Actual/365 date basis. r = nominal interest rate Then, the AI is computed as follows: Equation 2-100 Israeli (Annual Compound, 5 decimals) Bond - AI calculation Where P is the principal. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 75 2 Market standards and calculations 2.1 Market standards • Index Linked Bond Coupon rate r (in %) is converted to the annual compound rate as follows: Equation 2-101 Israeli (Annual Compound, 5 decimals) Index Linked Bond Then, the Index AI is computed as follows: Equation 2-102 Israeli (Annual Compound, 5 decimals) Index Linked Bond - AI calculation Where P is the principal. Israeli (Linear, 5 decimals) This is the AI method rounded to 5 decimals using the Actual/365 date basis: Equation 2-103 Accrued Interest: Israeli (Linear, 5 decimals) AI = R 7 [ r × d ⁄ D ] × P where AI Accrued interest r Nominal interest rate (to be paid at time i) as a real number. d Time in years between the last coupon date (inclusive) and the value date (exclusive) calculated using the accrual date basis. D Time in years between the last (inclusive) and next (exclusive) coupon dates, calculated using the appropriate Actual/365 date basis. P Principal The index (inflation-adjusted) Accrued Interest is rounded to 5 decimals using Actual/365 date basis: • Index Ratio Equation 2-104 Accrued Interest: Israeli (Linear, 5 decimals) - index ratio Index IndexRatio = R 9 ⎛ -----------------------------⎞ ⎝ IssueIndex⎠ • Index Accrued Interest % Equation 2-105 Accrued Interest: Israeli (Linear, 5 decimals) - index accrued interest % IndexAI = IndexRatio × AI 76 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards Italian (5 decimals) This is the Actual/Actual AI method rounded to 5 decimals: Equation 2-106 Accrued interest: Italian (5 decimals) AI = R 7 [ ( r ⁄ 2 ) × d ⁄ D ] × P where d is the length of the accrual period in actual days and D is the interest period length in actual days. Japanese Yield (7 decimals) This is the Coupon % AI method ( Coupon % methods on page 70) truncated to 7 decimals: Equation 2-107 Accrued Interest: Japanese Yield AI = min [ ( R 9 ( 1 + r t ) × P – P ), C ] where t is the length of the accrual period in years. Norwegian The Norwegian accrued interest method is calculated during ex-coupon and based directly on the number of remaining days next to the coupon using the following equation: Equation 2-108 Accrued Interest: Norwegian t AI = C × --------365 Where C The coupon interest percent per annum. t-------365 The actual number of calendar days from the settlement date (transaction value date) to the next coupon payment date divided by 365. Singaporean (8 decimals) This is the Actual/Actual AI method rounded to 8 decimals: Equation 2-109 Accrued interest: Singaporean (8 decimals) AI = R 10 [ ( r ⁄ 2 ) × d ⁄ D ] × P where – d is the time in years between the last coupon date (inclusive) and the value date (exclusive), calculated using the accrual date basis. – D is the time in years between the last (inclusive) and next (exclusive) coupon dates, calculated using the appropriate Actual/Actual date basis. South African (5 decimals) This is the Coupon % AI method truncated to 5 decimals: Equation 2-110 Accrued interest: South African (5 decimals) AI = min [ ( R 7 ( 1 + r t ) – 1 )P ,C ] Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 77 2 Market standards and calculations 2.1 Market standards where t is the length of the accrual period in years. US Agency Equation 2-111 Accrued interest: US Agency AI = r × ( T – t r ) × P where T is the length of the coupon period calculated using the accrual date basis (or coupon’s date basis if the former is missing), and tr is the length of the remaining accrual period (that is, the time between the accrual date and the end date of the coupon). 2.1.6.2 Annuity calculations Annuity calculations are based on all interest cashflows having Kind = Annuity Component and a matching value date, with the amortization cashflows also having Kind = Annuity Component. This allows cashflows from several interest schedules to be included in the calculation. Grace periods can be handled by setting up a forward starting amortization schedule: the coupon dates before will not match the amortization dates and will therefore behave outside any annuity calculation. The later ones will be part of the annuity calculation. In practical terms, this means one of the following: • Instrument setup can start from a normal fixed rate loan and be defined so that interest and amortization share the value dates, or create a reference interest schedule from the amortization schedule • Select the calculation methods (either Annuity or Fixed Annuity), on both schedules (P stands for Principal, Ri for the repayment as i-th value date, Ci for the coupon amount, n the number of dates). See the following sections for more information. 2.1.6.2.1 General annuity calculation This works for any date basis, irregular dates, varying interest rate, and so on, when Interest and Amortization Calculation Method = Annuity. Ri + Ci = Ri-1 + Ci-1 whenever i and sum(Ri) = -P Ci is calculated as usual from the outstanding nominal (that is, P+sum(Ri) where i from 1 to i-1) Ri and Ci are rounded according to the Leg Amount Precision Rn is adjusted so that Rn = P + sum(rounded(Ri)) where i from 1 to n-1 – If the 1st coupon period is short, then you get a "big" amortization and a small coupon amount – Rounded(Ri) + rounded(Ci) are not always equal because of the rounding effect (couple of rounding units difference maximum) Note that the cashflow part of the calculation is given the attribute Kind = Annuity Component. For an irregular annuity, if a rate is specified in the principal schedule, the annuity is computed equally across all flows, except for the last one. The last payment is adjusted according to the outstanding principal amount (100 - r). 2.1.6.2.2 Fixed annuity calculation This works only when the same discount factor is used for all periods, that is, the same interest rate and date bases, so all periods are worth the same (for example, 30/360 for semi-annual or quarterly, Actual/Actual for yearly, and so on), when Interest and Amortization Calculation Method = Fixed Annuity. 78 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.1 Market standards The calculation always uses the last interest period to calculate the annuity amount. It calculates the repayment amount from a direct formula that assumes that you have the same discount factor for all periods. The calculation will not work if there are different periods or uneven date bases. The simplified formula is: Ri = P * (D-1) * D^(i-1) / (1 – D^n) D being the discount factor for 1 period, that is (1+rate*180/360), for a semi-annual 30/360 interest. Therefore, the annuity amount is calculated from: Cn+Rn = Rn*(D-1) + Rn = Rn * D = P * (D-1) * D^(n-1) / (1 – D^n) * D = P * (D-1) * D^n / (1 – D^n) This accumulated annuity is used as the reference annuity amount for all value dates in the rest of the calculation. Once amortizations are calculated (using the direct formula), for each date, the remaining amount from the reference annuity is distributed between interest flows that have Kind = Fixed Annuity, in relation to their Amount % value (in the case where there are many interest amounts for the same date). To handle the short 1st coupon, the attribute 1st Coupon Excluded must be set on the interest schedule: this removes the Fixed Annuity kind so that the interest amount is calculated as usual, based on the principal. Note that the cashflows part of the calculation is given the Fixed Annuity kind as well as the Annuity Component kind. 2.1.6.2.3 Annuity calculation with rounded repayment factors This works when Interest Calculation Method = Annuity, and Amortization Calculation Method = Fixed Annuity. The calculation precision is set to the number of decimals for the repayment/principal ratio %. The amortization calculation is similar to the fixed annuity calculation, except that the Ri/P calculation is rounded to the specified precision. The interest amounts have to be calculated from the outstanding nominal (requires the Annuity calculation method) and the sum of repayment and interest varies significantly because of the repayment ratio% rounding effect. The same attribute is used to handle the short 1st coupon. 2.1.6.3 FX rate calculation The following three methods are available for the calculation of valuation date's FX rate (Sv) from FX Spot rate (S): • Spot Rate: This method uses the FX Spot Rate to convert the cashflow currency to the valuation currency, i.e. the rate is unchanged from the default method. Equation 2-112 FX method: Spot Rate calculation Sv = S • Today's Rate (Forward Points): This method modifies the FX Spot rate with forward points between the valuation date and the spot date. Equation 2-113 FX method: Today’s Rate (Forward Points) calculation S v = S – p × 0.0001 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 79 2 Market standards and calculations 2.1 Market standards where p is the forward points. Typically there are O/N and T/N quotes between the valuation date and the spot date, in which case: Equation 2-114 FX method: Today’s Rate (Forward Points) calculation a b a b p = ( p1 + p1 ) ⁄ 2 + ( p2 + p2 ) ⁄ 2 where the superscripts refer to O/N and T/N. • a and b refer to Ask and Bid quotes respectively, and subscripts 1 and 2 Today's Rate (IR Differential): This method modifies the FX Spot rate with the ratio of the two currencies' discount factors. Equation 2-115 Today's Rate (IR Differential) calculation v S v = SD ⁄ D c where – Dv is the valuation currency discount factor between the valuation date and the spot date – Dc is the cashflow currency discount factor between the valuation date and the spot date. 2.1.6.3.1 Example of FX rate calculation The following example shows the calculations using the following market date (Rate Monitor): • • FX Rate Spot S = 1.5 O/N points • p 1 = 0.02 T/N points • p 2 = – 0.03 b b a Bid • p 1 = 0.06 Bid • p 2 = – 0.01 a Ask Discount Factors O/N • Ask T/N c • D 2 = 0.999985555764 v • D 2 = 0.999948197128 Cashflow Currency • D 1 = 0.999992955609 Valuation Currency • D 1 = 0.999964445709 c v Forward Points Equation 2-116 Example - FX method: Today’s Rate (Forward Points) calculation a b a b p = ( p 1 + p 1 ) ⁄ 2 + ( p 2 + p 2 ) ⁄ 2 = 0.02 S v = S – p × 0.0001 = 1.499998 80 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves • IR Differential Equation 2-117 Example - FX method: Today's Rate (IR Differential) calculation c c c v v v D = D 1 D 2 = 0.999977500389355 D = D 1 D 2 = 0.999912644678814 v c S v = SD ⁄ D = 1.49990271424530 2.2 Yield curves TRM boot straps zero coupon yield curves in order to carry out valuations that are based on discounting future cashflows and/or estimating the amounts of unfixed future cashflows. Three types of bootstrapped zero coupon yield curves exist in TRM: • Yield Curves, i.e. zero coupon yield curves calculated from IR quotes (e.g. deposit, swap and FRA quotes) MM futures and/or bonds. These curves are generally used for discounting (and estimating) any arbitrary set of cashflow. • Tenor Basis Swap Curve, i.e. zero coupon yield curves calculated from tenor basis swap quotes and a base yield curve. These curves are used as estimation curves in tenor basis swap valuation (of the leg for which the spread is quoted) in order to capture the affect of the tenor basis spread quotes. • Cross Currency Basis Swap Curve, i.e. zero coupon yield curves calculated from cross currency basis swap quotes and a base yield curve. These curves are used as valuation curves in cross currency basis swap valuation (of the leg for which the spread is quoted) in order to capture the affect of the cross currency basis spread quotes. The bootstrapping logic for all these yield curves is explained below. Note: See the TRM User Guide for general information about setting up yield curves. 2.2.1 Yield curve A yield curve is a curve that gives the prices of discount bonds maturing in the future as a function of time. Since any cashflow maturing in the future can be regarded as a discount bond, a yield curve can be used to value any instrument that can be represented as a collection of cashflows. In principle, it is also possible to price linear derivatives which have a price that only depends on forward interest rates (for example, short futures, ignoring convexity adjustment) using forward rates derived from the zero curve. In practice, however, this should be treated with caution since the derived forward rate will depend on the method used in the construction of the zero curve much more than the spot rates depend on it. The information on interest rates that can be observed in the market comes in various forms. There are deposit rates that give the discount bond prices directly, but these are mainly available only for Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 81 2 Market standards and calculations 2.2 Yield curves maturities shorter than one year. Longer interest rates are embedded in the swap rates, FRA and short future rates, and bond prices. The objective of yield curve construction is to recover the discount bond price information from the market information. The guiding principle is that when the quoted instruments are priced against the zero coupon curve, the original quotes should be reproduced. Since this requirement does not uniquely define the zero curve, some additional conditions on the functional form and the smoothness of the curve have to be imposed. Discount factors are the fundamental elements on which most valuation calculations are based. If valuation needs for example an interest rate over a period in order to calculate the market value of a caplet, it is the discount factors for the start and end dates of that period that are given as input to valuation, and the desired interest rate is derived from these. 2.2.1.1 Input The starting point of a bootstrap curve is a given set of interest rate related market information. This information may consist of deposit prices, bond prices, or swap prices, for example. In general, any instrument for which a liquid quote exists, and the theoretical price can be calculated using only zero-coupon information, can be used. Normally, it is assumed that all the instruments have the same risk offset. That is, the bootstrap calculation produces a zero curve that is the sum of the risk-free rate and the spread. Each price quote creates a set of cashflows, which are used as input for the bootstrap algorithm (see 2.2.1.3 Bootstrap algorithm on page 83). 2.2.1.1.1 Deposit quotes A deposit quote generates a negative unit cashflow at spot, and a positive unit plus interest cashflow at the maturity of the deposit. The interest amount corresponds to the interest type defined for the deposit quote. The maturity date of the deposit follows the definition of the tenor of the deposit. 2.2.1.1.2 Swap quotes A swap quote creates a negative unit cashflow at spot, and a positive unit cashflow at the maturity of the swap. In addition, the fixed coupons (yearly, semi-annual, and so on) of the swap are created, and their amounts calculated using the date basis and interest type of the quote. 2.2.1.1.3 FRA quotes Each FRA creates a node point at its maturity. The bootstrap curve will have the property that the discount factor over the FRA period is equal to the discount factor implied by the FRA quote. The market quote of an FRA provides an estimate of the interest rate between two dates in the future: the value date and the maturity date of the FRA. This can be converted into the forward price on the value date of a zero-coupon bond on the maturity date of the FRA. Given the market quote of the FRA (r) and the length of the FRA period (t) (calculated using the appropriate date basis), the price on the value date (dv) of a discount bond that matures on the maturity date (dm) of the FRA is given by: Equation 2-118 FRA quotes 1 P ( d v ,d m ) = ------------1 + rt 2.2.1.1.4 Money market future quotes Each MM future creates a node point at its maturity. The bootstrap curve will have the property that the discount factor over the future period is equal to the discount factor implied by the future quote. The market quote of the price of the future provides an estimate of the forward interest rate over the period of the future. This can be converted into a discount factor between the start and the end of the future period. 82 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves Given the MM future quote (F), the corresponding interest rate over the period of the future is r =100 - F, from which the discount price over the period can be calculated, either using the equation for FRA quotes, or if the quote is of the discount type using: P ( d v, d m ) = 1 – rt Equation 2-119 Money market figure quotes 2.2.1.2 Bootstrap date basis and interest type If a cashflow of a bootstrapping instrument (swap, bond, FRA, or MM future) does not fall on a node point of the bootstrap curve, interpolation is needed to find the discount factor for the date in question. Note: The base date for interpolation is the spot date corresponding to the figure date of the calculation. 2.2.1.3 Bootstrap algorithm The bootstrap curve has the following properties: • The (zero coupon) market prices derived from the bootstrap curve will be equal to the given market prices. • The bootstrap curve follows a given functional format and satisfies a smoothness condition (bootstrap curve is continuous). Within each interval, the chosen bootstrap rate is given by: y ( t ) = ai + bi ( t – ti ) Equation 2-120 Bootstrap algorithm where: – ai and bi are parameters calculated by the bootstrap process, and ti is the starting point of the interval in question. – The default interest type is Continuous Yield. 2.2.1.3.1 Node points The maturities of the input instruments are always used as node points. 2.2.1.4 Example: Bootstrapping zero-coupon curve In this example, the zero-coupon curve is based on deposit quotes for the short end (for maturity periods of up to one year) and swap quotes for the long end (for maturity periods of two years and longer). Note: The number of periods in the curves has been kept to a minimum in order to simplify the illustration of the method. In reality, the curves would have many more periods defined. • Depo Quotes For the deposit quotes, the following periods have been defined: Tenor Date Basis Interest Type Interest Structure O/N Actual/360 Periodic Rate At Maturity T/N Actual/360 Periodic Rate At Maturity 6M Actual/360 Periodic Rate At Maturity 1Y Actual/360 Periodic Rate At Maturity Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 83 2 Market standards and calculations 2.2 Yield curves • Swap Quotes For the swap quotes, the following periods have been defined: • Period Date Basis Interest Type Interest Structure 2Y 30/360 Periodic Rate Annual 3Y 30/360 Periodic Rate Annual Parameters Interpolation method is Linear (with flat rate extrapolation), based on Continuous Yield, date basis 30/360. The deposit and swap quotes are as follows: Period Deposit Swap Bid Ask Bid Ask O/N 4.8 4.88 T/N 4.78 4.84 6M 5.1 5.1 1Y 5.161 5.161 2Y 5.257 5.257 3Y 5.32 5.32 The yield curve uses the average of the bid and ask quotes as input. The deposit quotes are already zero-coupon quotes, thus the resulting yield curve is simply the average of the deposit bid and ask quotes: Period Deposit Swap Bid Yield Curve Bid Ask Ask O/N 4.8 4.88 4.84 T/N 4.78 4.84 4.81 6M 5.1 5.1 5.1 1Y 5.161 5.161 5.161 2Y 5.257 5.257 3Y 5.32 5.32 Average The remaining rates for the yield curve, for the 2Y and 3Y periods, have to be solved from the existing rates using bootstrapping. 2.2.1.4.1 Finding the 2-year rate The object of the zero-coupon curve calculation is to derive a set of rates that, when used to price the fixed leg of the swap specified in the underlying swap curve, will price all the fixed-leg payments at par on the spot date. 84 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves To calculate the market value at spot MVspot of the fixed leg of a 2-year swap, the following equation is used: Equation 2-121 2-year swap: market value at spot MVspot A × r 2s × cp 1 A × ( 1 + r 2s × cp 2 ) MV spot = -------------------------------- + ----------------------------------------------D 1Y D 2Y where: – A = nominal amount – r2s = 2-year swap rate – cp1 = period from the spot date to the first coupon date – cp2 = period from the first coupon date to the second coupon date – D1Y = discount factor for the period between the spot date and the 1 year date – D2Y = discount factor for the period between the spot date and the 2 year date. If the swap is priced at par, then the market value at par is equal to the nominal amount: Equation 2-122 Swap priced at par A × r 2s × cp 1 A × ( 1 + r 2s ) × cp 2 A = -------------------------------- + ----------------------------------------------D 1Y D 2Y r 2s × cp 1 ( 1 + r 2s × cp 2 ) therefore: 1 = --------------------- + -----------------------------------D 1Y D 2Y Since the 1 year zero-coupon rate is already known (it is taken directly from the underlying deposit quotes), the 1 year discount factor can be calculated. This equation can be rearranged to solve D 2Y as follows: Equation 2-123 ( 1 + r 2s × cp 2 ) D 2Y = -------------------------------------------------------( 1 – ( r 2s × cp 1 ⁄ D 1Y ) ) The coupon periods cp1 and cp2 are calculated from the spot date and the swap coupon dates using the date basis of the swap quote (30/360). The date counts for the swap coupons are as follows: Period Date Days from spot (30/360 date basis) Days from spot (Actual/360 date basis) Spot 24-11-2000 0 0 1Y coupon 26-11-2001 362 367 2Y coupon 25-11-2002 721 731 Since the 30/360 date basis is used for the interpolation, the period lengths are: cp 1 = 362 / 360 cp 2 = (721 - 362) / 360 = 359 / 360 The 2-year swap rate (from the swap quotes) r 2s = 5.257%. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 85 2 Market standards and calculations 2.2 Yield curves The discount factor for the 1 year rate, D1Y, can be calculated from the 1 year rate (5.161%), using the date basis (Actual/360) and interest type (Periodic Rate) defined for that tenor: 5.161 367 D 1Y = ⎛ 1 + ------------- × --------- ⎞ = 1.05261353 ⎝ 100 360 ⎠ The discount factor D2Y then becomes: ( 1 + 0.05257 × 359 ⁄ 360 ) D 2Y = --------------------------------------------------------------------- = 1.1080711 × 362 ⁄ 360 ⎞ ⎞ ⎛ 1 – ⎛ 0.05257 ----------------------------------------------⎝ ⎝ ⎠⎠ 1.0526135 From this the 2-year zero-coupon rate r2Y can be calculated, using the date basis (30/360) and interest type (Compound Yield) defined for that tenor: ( 1 + r 2Y ) ( 721 ⁄ 360 ) = D 2Y therefore: r 2y = 1.1080711 ( 360 ⁄ 721 ) – 1 = 0.05257465 2.2.1.4.2 Finding the 3-year rate The zero-coupon curve must also price the 3-year swap at par, and so the 3 year discount factor D3Y for the period from the spot date to the 3-year date must satisfy the following condition: r 3s × cp 1 r 3s × cp 2 ( 1 + r 3s × cp 3 ) 1 = --------------------- + --------------------- + -----------------------------------D 1Y D 2Y D 3Y where: – r3s = the 3-year swap rate – cp1 = the period from the spot date to the first coupon date – cp2 = the period from the first coupon date to the second coupon date – cp3 = the period from the second coupon date to the third coupon date – D1Y = the discount factor for the period between the spot date and the 1 year date: – D2Y = the discount factor for the period between the spot date and the 2 year date: This equation can be rearranged to solve D3Y as follows: ( 1 + r 3s × cp 3 ) D 3Y = -------------------------------------------------------------------------------------------------------( 1 – ( r 3s × cp 1 ⁄ D 1Y ) – ( r 3s × cp 2 ⁄ D 2Y ) ) The coupon periods cp1, cp2, and cp3 are calculated from the spot date and the swap coupon dates using the date basis defined for the bootstrapping (30/360). The following date counts for the swap instrument coupons are as follows: Period Date Days from spot (30/360 date basis) Days from spot (Actual/360 date basis) Spot 24-11-2000 0 0 1Y coupon 26-11-2001 362 367 2Y coupon 25-11-2002 721 731 3Y coupon 24-11-2003 1080 1095 Since the 30/360 date basis is used for the interpolation, the period lengths are: cp1 = 362 / 360 86 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves cp2 = (721 - 362) / 360 = 359 / 360 cp3 = (1080 -721) / 360 = 359 / 360 The 3-year swap rate (from the swap quotes) r3s = 5.32%. The discount factors for the 1 year and 2 year rates (D1Y and D2Y) have already been calculated: D1Y = 1.0526135 D2Y = 1.1080711 So the discount factor D3Y becomes: ( 1 + 0.0532 × 359 ⁄ 360 ) D 3Y = ---------------------------------------------------------------------------------------------------------------------------- = 1.1683699 0.0532 × 362 ⁄ 360 ⎞ ⎛ 0.0532 × 359 ⁄ 360 ⎞ ⎞ ⎛ 1 – ⎛ --------------------------------------------------------------------------------------⎝ ⎝ ⎠ –⎝ ⎠⎠ 1.0526135 1.1080711 From this the 3-year zero-coupon rate r3Y, can be calculated using the date basis 30/360 and the interest type Continuous Yield defined for that tenor: ( 1 + r 3Y ) ( 1080 ⁄ 360 ) = D 3Y therefore: r 3Y = 1.1683699 ( 360 ⁄ 1080 ) – 1 = 0.05323865 The complete zero-coupon curve is shown in the table below: Period Deposit Swap Bid Yield Curve Bid Ask Ask Average O/N 4.8 4.88 4.84 T/N 4.78 4.84 4.81 6M 5.1 5.1 5.1 1Y 5.161 5.161 5.161 2Y 5.257 5.257 5.257465 3Y 5.32 5.32 5.323865 2.2.1.4.3 Finding the 3-year rate The zero-coupon yield curve must also price the 3-year swap at par, and so the 3 year discount factor D3Y for the period from the spot date to the 3-year date must satisfy the following condition: r 3s × cp 1 r 3s × cp 2 ( 1 + r 3s × cp 3 ) 1 = --------------------- + --------------------- + -----------------------------------D 1Y D 2Y D 3Y where: – r3s = the 3-year swap rate – cp1 = the period from the spot date to the first coupon date – cp2 = the period from the first coupon date to the second coupon date – cp3 = the period from the second coupon date to the third coupon date – D1Y = the discount factor for the period between the spot date and the 1 year date: – D2Y = the discount factor for the period between the spot date and the 2 year date: Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 87 2 Market standards and calculations 2.2 Yield curves This equation can be rearranged to solve D3Y as follows: ( 1 + r 3s × cp 3 ) D 3Y = -------------------------------------------------------------------------------------------------------( 1 – ( r 3s × cp 1 ⁄ D 1Y ) – ( r 3s × cp 2 ⁄ D 2Y ) ) The coupon periods cp1, cp2, and cp3 are calculated from the spot date and the swap coupon dates using the date basis defined for the bootstrapping (30/360). The following date counts for the swap instrument coupons are as follows: Period Date Days from spot (30/360 date basis) Days from spot (Actual/360 date basis) Spot 24-11-2000 0 0 1Y coupon 26-11-2001 362 367 2Y coupon 25-11-2002 721 731 3Y coupon 24-11-2003 1080 1095 Since the 30/360 date basis is used for the bootstrapping, the period lengths are: cp1 = 362 / 360 cp2 = (721 - 362) / 360 = 359 / 360 cp3 = (1080 -721) / 360 = 359 / 360 The 3-year swap rate (from the swap quotes) r3s = 5.32%. The discount factors for the 1 year and 2 year rates (D1Y and D2Y) have already been calculated: D1Y = 1.0526135 D2Y = 1.1080711 So the discount factor D3Y becomes: ( 1 + 0.0532 × 359 ⁄ 360 ) D 3Y = ---------------------------------------------------------------------------------------------------------------------------- = 1.1683699 × 362 ⁄ 360 ⎞ ⎛ 0.0532 × 359 ⁄ 360 ⎛ 1 – ⎛ 0.0532 -------------------------------------------– -------------------------------------------- ⎞ ⎞ ⎝ ⎝ ⎠ ⎝ ⎠⎠ 1.0526135 1.1080711 From this the 3-year zero-coupon rate r3Y, can be calculated using the date basis 30/360 and the interest type Continuous Yield defined for that tenor: ( 1 + r 3Y ) ( 1080 ⁄ 360 ) = D 3Y therefore: r 3Y = 1.1683699 ( 360 ⁄ 1080 ) – 1 = 0.05323865 The complete zero-coupon curve is shown in the table below: Period Deposit Swap Bid Ask O/N 4.8 4.88 4.84 T/N 4.78 4.84 4.81 6M 5.1 5.1 5.1 1Y 5.161 5.161 5.161 2Y 88 Bid Yield Curve 5.257 Ask 5.257 Average 5.257465 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves Period Deposit Bid Swap Ask 3Y Yield Curve Bid Ask Average 5.32 5.32 5.323865 2.2.1.5 Example: Yield Curve calculated using bonds Consider this example of a bootstrap yield curve calculated using bond prices, with the following definition: Data Value Spot Days 2 Calculation Date 18-07-2005 Effective Date 20-07-2005 For the deposit, there is the following data: Periods Dates Date Basis Rate Discount Factor 0/N 19-07-2005 Actual/360 4 0.9998889012 T/N 20-07-2005 Actual/360 4.1 0.9998861241 1W 27-07-2005 Actual/360 4.12 0.9989747482 1M 22-08-2005 Actual/360 4.14 0.9959952360 2M 20-09-2005 Actual/360 4.15 0.9926801325 3M 20-10-2005 Actual/360 4.16 0.9892581249 6M 20-01-2006 Actual/360 4.17 0.9789111777 9M 20-04-2006 Actual/360 4.18 0.9689484804 1Y 20-07-2006 Actual/360 4.19 0.9590334329 In addition, two bond instruments are used as input for the curve. • The cashflow structure of the first bond is: Amount Value Date Time -99.014305 20-07-2005 0.005479452 5.0694444 08-04-2006 0.723287671 5.069444 08-04-2007 1.723287671 100 08-04-2007 1.723287671 The first cashflow is the dirty price of the bond at the effective date. • The cashflow structure of the second bond is: Amount Value Date Time -98.01367611 20-07-2005 0.005479452 4.84639 08-04-2006 0.723287671 4.84639 08-04-2007 1.723287671 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 89 2 Market standards and calculations 2.2 Yield curves Amount Value Date Time 4.85967 08-04-2008 2.726027397 4.84639 08-04-2009 3.726027397 100 08-04-2009 3.726027397 The first cashflow is the bond dirty price at the effective date. The assumption is that the zero curve is piecewise linear between two node points. In this specific case, it is assumed that the zero rate is continuously compounding and the date basis is Actual/365. The maturity of the instrument is used as node points in the bootstrap algorithm: see 2.2.1.5.1 Scenario 1 - Maturity of bonds as node points on page 90. 2.2.1.5.1 Scenario 1 - Maturity of bonds as node points For the period [20/07/2006,08/04/2007] For the first bond, the coupon date 08-04-2006 falls between the 6M and the 9M periods. The discount factor is converted into continuous compound rate and the rate is interpolated to derive the discount factor at 08-04-2006: Date Discount Factor Time Rate 20-01-2006 0.50958904 0.041826583 0.9789111777 08-04-2006 0.72328767 0.041730381 0.9702678903 20-04-2006 0.75616438 0.041715581 0.9689484804 Since the zero rate is piecewise linear between the node points, that is, between one year and bond maturity [20/07/2006,08/04/2007], the one year discount factor needs to be converted into a continuous compound rate: Date Discount Factor Time Rate 20-07-2006 0.959033433 1.005479452 0.041601389586 Let us denote the slope by b, so the Pricing equation for the first bond can be written as: – 99.0143 × 0.99977504 = 5.069444 × 0.97026789 + 105.069444 × exp ( – ( 0.04160139 + b × ( 1.72328 – 1.0054794 ) ) × 1.72328 ) From this we can deduce that b = 0.031411691 The rate and the discount factor at the first bond maturity are as follows: 0.04160139 + b × ( 1.7232877 – 1.0054794 ) = 0.06414896 exp ( – ( 0.04160139 + b × ( 1.7232877 – 1.0054794 ) ) × 1.7232877 ) = 0.89534415 For the period [08/04/2007,08/04/2009] At the beginning of the period, we have: Date Discount Factor Time Rate 08-04-2007 0.895344149 1.723287671 0.064148959214 90 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves Again, since the zero rate is a piecewise linear function, the slope of the line needs to be found so that the Pricing equation for the second bond is satisfied: – 98.01368 × 0.99977504 = 4.84639 × 0.97026789 + 4.84639 × 0.89534415 + 4.85967 × exp ( ( – ( 0.06414896 + b × ( 2.7260274 – 1.7232877 ) ) × 2.7260274 ) ) + 104.84639 × exp ( ( – ( 0.06414896 + b × 3.7260274 – 1.7232877 ) ) × 3.7260274 ) ) The slope b is then calculated as -0.00364043. The time between the effective date 18-07-2005 and the 2Y node point 20-07-2007 is 2.005479452. The 2Y rate and discount factor at the value date 20-07-2007 can be calculated as: 0.06414896 + b × ( 2.0054795 – 1.7232877 ) = 0.06312166 exp ( – ( 0.06414896 + b × ( 2.0054795 – 1.7232877 ) ) × 2.0054795 ) = 0.88109556 The time between the 18-07-2005 and the maturity of the second bond (08-04-2009) is 3.726027397. The rate and the discount factor are then: 0.06414896 + b × ( 3.7260274 – 1.7232877 ) = 0.05685813 exp ( – ( 0.06414896 + b × ( 3.7260274 – 1.7232877 ) ) × 3.7260274 ) = 0.80908206 For the period [08/04/2009, ∞ +[ 08-04-2009 is the last node point. The algorithm makes a flat extrapolation based on the continuous compound rate (that is, 0.056858126). Therefore, the 5Y discount factor corresponding to 20-07-2010 (that is, for time 5.008219178), is: exp ( – ( 0.05685813 ) × 5.0082192 ) = 0.75219629 2.2.2 Basis swaps 2.2.2.1 Tenor Basis Swap Curve This section describes the algorithm used in converting tenor basis swap spreads into discount factors. The input to the algorithm consists of a base yield curve and a series of tenor basis spread quotes, resulting in a tenor basis swap curve. We search for a series of discount factors such that the value of the tenor basis swap is at par. The estimation curve method is used in tenor basis swaps, i.e. the underlying curve is used for discounting, and the derived tenor basis swap curve for the estimation of the swap coupon amounts (for the leg for which the spread is quoted). 2.2.2.1.1 Input • Spot date • Basis swap quotes: These are tuples (start date, maturity, spread, coupon frequency), with some implicit rules for the generation of coupons. Discount curve: A fixed curve that provides discount factors ( Dd ) for required dates. • • Coupon estimation: This is a function E [ D 1, D 2, s, ϒ ] that returns a coupon estimate, given two discount factors, coupon period, and a spread. The bootstrap algorithm input is generated from this data. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 91 2 Market standards and calculations 2.2 Yield curves For each swap quote we generate the coupon date data (see Equation 2-124 on page 92), corresponding to the start, end, and payment dates, and the length of the coupon period of the ith coupon of the jth quote. Equation 2-124 Coupon date data We shall also need the discount factors derived from the discount curve for all payment dates: Equation 2-125 Discount factors for all payment dates Given the interpolation date basis, all dates are transformed into times from spot date, so that we have coupon time triplets (Equation 2-126 on page 92) and swap maturity times (Equation 2-127 on page 92). Equation 2-126 Coupon time triplets Equation 2-127 Swap maturity times 2.2.2.1.2 Algorithm Initially, set T, the last known node point, to zero (i.e. spot). 1. Choose the smallest maturity greater than the last known node point T, i.e. choose J: Equation 2-128 Smallest maturity There could, in principle be more than one, but start by assuming that J is unique. 2. For all i such that t ei ≤ T , calculate the coupon estimate based on the known part of the J bootstrap curve: Equation 2-129 Coupon estimate Where some interpolation may be needed, use the interpolation method specified for the derived curve. 3. Calculate the stub price of the swap as the sum of the known coupons of each leg: Equation 2-130 Stub price of the swap Note: For discounting, we use the discount curve that was given as input. The term Dd [ TJ ] can be interpreted as the discounted value of the redemption payment, in which case the other 92 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves leg has value 1. Likewise, we may interpret the term 1 – Dd [ T J ] as the value of the other leg in case there is no principal exchange. 4. Initialize iteration: Create a new node point for the bootstrap curve at T J , with initial value Dn = 0.00001 5. For each coupon with t ei J > T , calculate the estimate based on D e [ T ] (known) and Dn , see Equation 2-129 on page 92. where the discount factors may have to be interpolated from D e [ T ] and Dn , using the interpolation method specified for the derived curve. Calculate the value of the swap: Equation 2-131 Swap value If P n is positive, let D p = D n , and P p = P n . If P n is negative, stop. 6. Repeat step 5. on page 93 using Dn = 1 . If P n is negative let D l = D n and P l = P n . If P n is positive, stop. 7. Generic step: Use a goal seek algorithm and the method described in step 5. on page 93 to find D n so that the value of the Jth swap is zero. 8. Set T = T J and create new node D e [ T J ] = D n . If T < max j [ T j ] , then go to step 1. on page 92, otherwise stop. 2.2.2.2 Cross Currency Basis Swap Curve This section describes the algorithm used in converting cross currency basis swap spreads into discount factors. The input to the algorithm consists of a base yield curve and a series of cross currency basis spread quotes, resulting in a cross currency basis swap curve. We search for a series of discount factors such that the value of the cross currency basis swap is at par. The discount curve method is used in cross currency basis swaps, i.e. the underlying curve is used for estimating the swap coupon amounts, and the derived cross currency basis swap curve for discounting (the leg for which the spread is quoted). 2.2.2.2.1 Input • Spot date • Cross currency basis swap quotes: These are tuples (start date, maturity, spread, coupon frequency), with some implicit rules for the generation of coupons. • Estimation curve: A fixed curve that provides discount factors ( D e ) for the required dates. Coupon estimation: This is a function E [ D 1, D 2, s, ϒ ] that returns a coupon estimate, given two discount factors, coupon period, and a spread. • The bootstrap algorithm input is generated from this data. For each swap quote, we generate the coupon date data (see Equation 2-124 on page 92), corresponding to the start, end, and payment dates; and the length of the coupon period of the ith coupon of the jth quote. Then, using the estimation method, together with the estimation curve discount factors for the start and end dates of the coupon, and , we can create the corresponding coupons using Equation 2-129 on page 92. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 93 2 Market standards and calculations 2.2 Yield curves Given the interpolation date basis, all dates are transformed into times from spot date, so that we have coupon payment times and swap maturity times (Equation 2-127 on page 92). 2.2.2.2.2 Algorithm Initially, set T, the last known node point, to zero (i.e. spot). 1. Choose the smallest maturity greater than the last node point: That is, choose J so that T J = minj [ T j > T ] . There could, in principle be more than one, but start by assuming that J is unique. 2. Calculate the stub price of the swap as the sum of the known discounted coupons minus the known price of the other leg (assumed at par, i.e. principals are exchanged). Equation 2-132 Discount curve: stub price 3. Initialize iteration: Create a new node point for the bootstrap curve at T J , with initial value D n = 1.0 . 4. Calculate the value of swap: Equation 2-133 Discount curve: swap value where the discount factors may have to be interpolated from D d [ T ] and D n , using the interpolation method specified for the derived curve. The last term is the principal payment: in this method, we always assume that principals are exchanged. If P n is positive, let D p = D n and P p = P n . If P n is negative, stop. 5. Repeat step 4. on page 94 using D n = 0.0000001 . If P n is negative, let let D l = D n and P l = P n . If P n is positive, stop. 6. Generic step: Use a goal seek algorithm and the method described in step 4. on page 94 to find D n so that the value of the Jth swap is zero. 7. Set T = T J and create new node D d [ T J ] = D n . If T < maxj [ Tj ] go to step 1. on page 94, otherwise stop. 2.2.2.3 Basis swap bootstrapping This section describes the algorithm used in converting basis swap spreads into discount factors. Two different approaches are presented: estimation curve bootstrapping and discount curve bootstrapping. In both approaches, the input to the algorithm consists of an underlying zero curve and a series of basis spread quotes. In both algorithms, we search for a series of discount factors such that the value of the calculated spread leg is at par. (Section 2.2.2.3.3 Non-par market value on page 97 addresses the case when the other leg is not at par.) The estimation curve method is used in tenor basis swaps, while the discount curve method is used in cross currency basis swaps. 94 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves 2.2.2.3.1 Estimation curve bootstrapping This section describes the bootstrap algorithm for estimation curve bootstrapping. In estimation curve bootstrapping, we use the underlying curve for discounting, and the bootstrapped curve for the estimation of the swap coupon amounts. This method is used in tenor basis swaps. Input data generation • Spot date • Basis swap quotes: These are tuples (start date, maturity, spread, coupon frequency), with some implicit rules for the generation of coupons. • Discount curve: A fixed curve that provides discount factors (Dd) for the required dates. • Coupon estimation: This function discount factors, coupon period, and a spread. returns a coupon estimate, given two The bootstrap algorithm input is generated from this data. For each swap quote, we generate the coupon date data ( ), corresponding to the start, end, and payment dates and the length of the coupon period of the ith coupon of the Jth quote. We shall also need the discount factors derived from the discount curve for all payment dates: . Given the interpolation date basis, all dates are transformed into times from the spot date, so that we have coupon time triplets ( ), and swap maturity times ( ). The algorithm Initially, set T, the last known node point, to zero (i.e. spot). 1. Choose the smallest maturity greater than the last known node point T. That is, choose J so that TJ=minj[Tj > T]. There could, in principle, be more than one, but start by assuming that J is unique. 2. For all i such that bootstrapped curve: , calculate coupon estimate based on the known part of the Equation 2-134 Estimation curve bootstrapping: coupon estimate – If interpolation is needed, use the interpolation method specified for the bootstrapped curve. 3. Calculate the stub price of the swap as the sum of the known coupons of each leg: Equation 2-135 Estimation curve bootstrapping: calculated stub price of the swap Note: For discounting, we use the discount curve given as input. The term can be interpreted as the discounted value of the redemption payment, in which case the other leg has value Dd[TJ]. Similarly, we may interpret the term as the value of the other leg in case there is no principal exchange. 4. Initialize iteration: Create a new node point for the bootstrap curve at TJ, with initial value Dn=0.00001 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 95 2 Market standards and calculations 2.2 Yield curves 5. For each coupon with , calculate the estimate based on De[T] (known) and Dn: Equation 2-136 Estimation curve bootstrapping: calculate the estimate – Where the discount factors may have to be interpolated from De[T] and Dn, using the interpolation method specified for the bootstrapped curve, calculate the value of swap: Equation 2-137 Estimation curve bootstrapping: calculate the value of the swap – If the value is negative, stop. Otherwise, let Dp=Dn and Pp=Pn 6. Repeat step 5. on page 96 using Dn=1. If the resulting price is positive, stop. Otherwise, let and Dl=Dn and Pl=Pn 7. Generic step: Use a goal seeker algorithm and the method described in step 5. on page 96 to find Dn so that the value of the Jth swap is zero. 8. Set T = TJ and create the new node De[TJ]=Dn. If T < maxj[Tj] go to step 1. on page 95, otherwise stop. 2.2.2.3.2 Discount curve bootstrapping This section describes the bootstrap algorithm for discount curve bootstrapping. In discount curve bootstrapping these roles are exchanged: the underlying curve generates the coupon estimates, and the bootstrapped curve is used in discounting. The discount curve method is used in cross currency basis swaps. Input data generation • Spot date • Basis swap quotes: These are tuples (start date, maturity, spread, coupon frequency), with some implicit rules for the generation of coupons. • Estimation curve: A fixed curve that provides discount factors (De) for required dates. • Coupon estimation: This is a function two discount factors, coupon period, and a spread. that returns a coupon estimate, given The bootstrap algorithm input is generated from this data. For each swap quote, we first generate the coupon date data ( ), corresponding to the start, end, and payment dates, and the length of the coupon period ith of the coupon jth of the quote (sj). Then, using the estimation method with the estimation curve discount factors for the start and end dates of the coupon, and , we can create the corresponding coupons using the following equation: Equation 2-138 Discount curve bootstrapping: creating the coupons Given the interpolation date basis, all dates are transformed into times from spot date, so that we have coupon payment times ( 96 ) and swap maturity times ( ) © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves The algorithm Initially, set T, the last known node point, to zero (i.e. spot). 1. Choose the smallest maturity greater than the last node point: That is, choose J so that TJ=minj[Tj>T]. There could, in principle be more than one, but start by assuming that J is unique. 2. Calculate the stub price of the swap as the sum of the known discounted coupons minus the known price of the other leg (assumed at par, i.e. the principals are exchanged). Equation 2-139 Discount curve bootstrapping: stub price 3. Initialize iteration: Create a new node point for the bootstrap curve at Tj, with initial value Dn=1.0. 4. Calculate the value of swap: Equation 2-140 Discount curve bootstrapping: value of the swap – Where the discount factors may have to be interpolated from Dd[T] and Dn, using the interpolation method specified for the bootstrapped curve. The last term is the principal payment: in this method, we always assume that the principals are exchanged. – If the value is negative, stop. Otherwise, let Dp=Dn and Pp=Pn. 5. Repeat step 4. on page 97 using Dn=0.0000001. If the resulting price is positive, stop. Otherwise, let Dl=Dn and Pl=Pn. 6. Generic step: Use a goal seeker algorithm and the method described in step 4. on page 97 to find Dn so that the value of the swap is zero. 7. Set T=TJ and create the new node Dd[TJ]=Dn. If T < maxj[Tj]. If go to step 1. on page 97, otherwise stop. 2.2.2.3.3 Non-par market value The bootstrapping algorithm described in section 2.2.2.3 Basis swap bootstrapping on page 94 applies to the basic setup, where we want to bootstrap a new curve (estimation or discounting) for the spread leg, and assume that the other leg (i.e the leg whose value is taken as an input to the bootstrapping algorithm) of the swap is valued at par. There are cases when this assumption is no longer valid: • Case 1. Instead of spread leg, we calculate the new curve for the flat leg. In this case the other leg is the spread leg, which is not at par. • Case 2. We want to use two different curves for estimation and discounting of the other leg, which will then have a non-par value. In these cases the value of the other leg needs to be calculated: We have to generate its cashflows (using the estimation curve defined for the other leg) and discount them (using the discount curve defined for the other leg). The coupon structure of the other leg may differ from the structure of the calculated leg and is given in IR Quote and Yield Curve Editor's Tenor page. The estimation and calculation curves are given in IR Quote and Yield Curve Editor's Other Leg Yield Curves page once the optional feature Other Leg Yield Curves is selected. For more information about this editor, see TRM User Guide. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 97 2 Market standards and calculations 2.2 Yield curves Using the same notation as above, but with bars above the symbols to indicate that they refer to the other leg and are known in advance, the value of the other leg becomes: Equation 2-141 Non-par market value This value has to replace the value in Equation 2-135 on page 95, which becomes: Equation 2-142 Non-par market value Otherwise, bootstrapping follows the same steps as described previously. 2.2.2.4 Interpolation before first swap quote The first calculated node of a basis swap curve is usually at one year. Without any additional information, one would use the interest rate of the bootstrapped curve at the first node for all dates before it. However, it is reasonable to assume that instead of being flat, the bootstrapped curve should follow the underlying curve. To achieve this, the yield creation algorithm creates an additional virtual quote for each gap of the underlying curve that is no closer than 14 days before the first actual quote. Each virtual quote has the same value as the first actual quote, but they are treated as deposits instead of swaps. The virtual quotes are included in the bootstrapping process, and their presence causes the bootstrapped curve to follow the shape of the underlying curve also before the first spread quote. 2.2.3 Yield Curve interpolation An interpolation method is a way of estimating the shape of a yield curve between points for which quotes exist. TRM performs interpolation to calculate these rates from the closest known quotes according to the variables specified in the interpolation method. The default interpolation method of yield curves is Linear, Flat Rate Extrapolation with date basis Actual/365 and interest type Continuous Yield. 2.2.3.1 Interpolation periods The starting point of yield curve interpolation is a set of known yields for a number of periods (the node points), all having the same start date (spot date). The objective is to find the discount factor between the spot date and another date for which there is no direct data. All input quotes are first converted into discount factors between the spot date and the end date of the quote period (or start date, if the quote is for a period before the spot). Quotes that do not start or end at the spot date can be used if there is also a series of quotes starting from or ending at the spot date (for example, T/N and S/N in markets where the spot date is today). By combining the discount factors from the spot to the end dates of the forward quotes, a synthetic quote from the spot can be obtained. This can then be used in the same way as regular quotes from the spot. Before the first input period and after the last, extrapolation is required. The methods required are specified in the interpolation method definition. 98 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves 2.2.3.2 Interpolation date basis The interpolation algorithm uses the period lengths, between the common starting point of all periods and the end point of each period, as input data. When the interpolation result is requested for a target date, the period length between the common start date and the target date is needed. To calculate these period lengths, a date basis is required. The same date basis is used for all periods, regardless of the date basis used for the discount factor. The date basis specified in the interpolation method definition is used both for the calculation of the interpolation period lengths and to convert discount factors into the interpolation rate (except, of course, if the interpolation rate is a discount factor, in which case, conversion is not needed). 2.2.3.3 Interpolation over spot date When we seek a discount factor for a date after spot and before the first forward quote (most often the one week quote), the nearest known discount factor before the target date is for spot (D=1). However, that discount factor cannot be converted into rate, since the period length is zero. Therefore, the previous existing quote (usually, O/N) is used as if it were the quote for the zero-length period from spot to spot. 2.2.3.4 Type of interpolation 2.2.3.4.1 Linear To calculate the interest rate for a date for which no direct quote exists, linear interpolation is used to calculate the interest rate rm for the period tm (to spot date) between the closest quoted periods t1 and t2 such that t1 < tm < t2. Interest % r2 rm r1 Period t1 tm t2 1. The rates r1 and r2 need to be converted to the correct interest type before they can be used in the linear interpolation. To do this, two calculations need to be done: a. Calculate the discount factors D1 and D2 for the periods t1 and t2. For example, if the interest type is Annually Compounded Rate and the date basis is Actual/365, then the discount factors D1 and D2 are calculated as follows: Equation 2-143 Linear interpolation: Discount factor D1 –d --------1- r 1 365 D 1 = ⎛ 1 + ---------⎞ ⎝ 100⎠ Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 99 2 Market standards and calculations 2.2 Yield curves and Equation 2-144 Linear interpolation: Discount factor D2 –d --------2- r 2 365 D 2 = ⎛⎝ 1 + ---------⎞⎠ 100 where d1 and d2 are the actual number of days between the spot date and the period end dates for the periods t1 and t2. b. From these discount factors D1 and D2, the rates can be calculated with the correct interest type (r1C and r2C). The interest type and date basis that you selected for the interpolation of the yield curve will be used. Here, we use the interest type Continuous Yield date basis Actual/365: Equation 2-145 Linear interpolation: interest type r1C – 100 r 1C = ------------ 1nD 1 t1 and Equation 2-146 Linear interpolation: interest type r1C – 100 r 2C = ------------ 1nD 2 t2 2. Linear interpolation is then used to calculate the rate rmc. The date basis used is the one selected in the interpolation setup. The interpolation setup is described in the TRM User Guide. This rate will have the same interest type as r1C and r2C: Equation 2-147 Linear interpolation: calculated rate rmc ( t 2 – t m )r 1C + ( t m – t 1 )r 2C r mc = ---------------------------------------------------------------t2 – t1 3. The discount factor Dm, from the cashflow value date to the spot date, is calculated from the linearly interpolated rate rmc. The form of the equation is based on the date basis and interest type of the linear interpolation method. For continuous yield: Equation 2-148 Linear interpolation: Continuous Yield Dm = e – r mc -----------t m 100 4. The discount factor Dm derived from the linearly interpolated rate rmc is multiplied by the discount factors for the period from the spot date to the valuation date, using market quotes. For example, if the number of spot days is 2, we would use DO/N and DT/N: D = DO/NDT/NDm 100 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves Example: Interest rate interpolation In this example, the interest rate for a cashflow at 1.5 years is calculated using two IR quotes at 1 and 2 years. Note: In this example, all calculated amounts are rounded. Data Symbol Value Value Date 22-11-2000 Spot Days 2 Spot Date 24-11-2000 IR quote (1Y) r1 5.161% Date basis of 1Y quote d/B Actual/360 Number of days from spot date to 1Y cashflow on 26-11-2001 367 Interest type of 1Y quote Periodic IR quote (2Y) r2 5.2575% Date basis of 2Y quote d/B 30/360 Number of days from spot date to 2Y cashflow on 25-11-2002 721 Interest type of 2Y quote Annually Compounded Rate O/N quote rO/N 4.84% T/N quote rT/N 4.81% Date basis of O/N and T/N quotes d/B Actual/360 Instrument date basis d/B Actual/360 Number of days from spot date to 1.5Y on 24-05-2002 using instrument date basis 546 For this example, it is assumed that a linear interpolation method has been defined with the date basis Actual/365 and interest type of Continuous Yield. • Step 1 - Convert the reference rates to continuous yield rates To convert the reference rates r1 and r2 to continuous yield rates, first the discount factors for these rates is calculated, using the date bases and interest types defined for these two quotes. – The 1Y quote has an Actual/360 date basis and Periodic Rate interest type. This gives the following formula: Equation 2-149 Example: Interest Rate Interpolation r1 d1 D 1 = ⎛ 1 + --------- × ---------⎞ ⎝ 100 360⎠ – –1 5.161 367 –1 = ⎛ 1 + ------------- × ---------⎞ = 0.950016 ⎝ 100 360⎠ The 2Y quote has a 30/360 date basis and Annually Compounded Rate interest type. This gives the following formula: Equation 2-150 Example: Interest Rate Interpolation –d --------2- r 2 360 5.2575 D 2 = ⎛⎝ 1 + ---------⎞⎠ = ⎛⎝ 1 + ----------------⎞⎠ 100 100 – 721----------360 = 0.902469 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 101 2 Market standards and calculations 2.2 Yield curves – Next, the continuous yield rates r1C and r2C are calculated from these discount factors, using the interpolation method date basis Actual/365 and interest type Continuous Yield): Equation 2-151 Example: Interest Rate Interpolation – 100 – 100 r 1C = ------------ 1nD 1 = ---------------------- 1n ( 0.950016 ) = 5.0997 t1 367 ⁄ 365 Equation 2-152 Example: Interest Rate Interpolation – 100 – 100 r 2C = ------------ 1nD 2 = -------------------------- 1n ( 0.902469 ) = 5.124 t2 ( 731 ) ⁄ 365 • Step 2 - Linear interpolation Linear interpolation with the recalculated reference rates from the first step is used to calculate the continuous yield rate rmc. Note: tm is recalculated using the interpolation method date basis Actual/365. Equation 2-153 Linearly interpolated rate rmc r mc • – 546 546 – 367 ⎛ 731 ------------------------⎞ 5.0997 + ⎛ ------------------------⎞ 5.124 ⎝ 365 ⎠ ⎝ 365 ⎠ ( t 2 – t m )r 1C + ( t m – t 1 )r 2C = ---------------------------------------------------------------- = ------------------------------------------------------------------------------------------------ = 5.11165 t2 – t1 – 367-⎞ ⎛ 731 ----------------------⎝ 365 ⎠ Step 3 - Discount factor to spot date (Dm) The discount factor Dm, from the cashflow value date to the spot date, is calculated from the linearly interpolated rate rmc from the previous step (Equation 2-153 on page 102). The equation in this example is based on the interpolation interest type Continuous Yield and date basis Actual/365: Equation 2-154 Discount factor to spot date Dm = e • r mc ⎞ - t – ⎛ -------⎝ 100⎠ m = e 5.11165 – ⎛⎝ -------------------⎞⎠ ( 546 ⁄ 365 ) 100 = 0.926386 Step 4 - Discount factor to valuation date (D) To get the discount factor to the valuation date, the discount factor Dm to the spot date is multiplied by the discount factors for the period from the spot date to the valuation date, DO/N and DT/N. The number of spot days is 2. This gives the following equation: D = DO/NDT/NDm The discount factors DO/N and DT/N are calculated from the O/N and T/N rates, using the date basis and interest type defined for the quotes. In this case, they have both been defined with date basis Actual/360 and interest type Periodic Rate. Equation 2-155 Discount factors DO/N 4.84 1 –1 D O ⁄ N = ⎛ 1 + ---------- × ---------⎞ = 0.9998656 ⎝ 100 360⎠ 102 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves and Equation 2-156 Discount factors DT/N 4.81 1 –1 D T ⁄ N = ⎛⎝ 1 + ---------- × ---------⎞⎠ = 0.9998664 100 360 D = DO/NDT/NDm = 0.926386 * 0.9998656 * 0.9998664 = 0.926137 If a discount factor between two dates is needed, neither of which is the spot, the two discount factors between the spot and the two days in question are calculated, and divided one by the other. 2.2.3.4.2 Cubic splines interpolation The interpolation method is defined by choosing the optional feature Yield Curve Interpolation Setup, and then, in the Interpolation page, by selecting one of the interpolation methods. Choices for cubic spline are: Hermite Spline (Two Points), Hermite Spline (Three Points) or Cubic Spline. The first two refer to Hermite Spline ( Hermite spline on page 105) with slopes at node points (mi) defined by either a two-point difference or a three-point difference, as explained in section Setting the slopes at node points on page 106. The third option (Cubic Spline) corresponds to classic spline described in section Classic spline on page 104. For more information about setting up yield curves, see TRM User Guide. The input to the interpolation module is a set of points, usually giving the value of interest rate at a set of times. The task of the interpolator is to provide the value of the dependent variable (e.g. interest rate) at an arbitrary point, i.e. to extend a function defined at a restricted number of points to a function defined everywhere (or more typically, for non-negative numbers when we are dealing with time as an independent variable). The interpolation function will go through the points given as input. In the quasi-cubic spline interpolation, we also require that the interpolation function be continuous and differentiable at all points. Furthermore, a classic spline will have a continuous second derivative at all points. The yield curve interpolation is used in two different settings: where the input points are known in advance and when the shorter end of the curve is needed to construct new points in the longer end. The latter situation takes place in bootstrapping when there are coupons falling on dates, which are not maturity dates of the input quotes. (That is, we need to interpolate from the existing curve to discount such coupons.) The classic spline has the property that when any input point is changed, the whole curve moves. On the other hand, Hermite splines depend only on two or four points around the interval to be interpolated, and are therefore easier to use in bootstrapping. Technical definition Given a set of points (with and , a cubic spline is a continuous function that goes through the points in I, and is a cubic polynomial within each interval intervals altogether), and is either continuously differentiable (quasi-cubic spline) or has a continuous second derivative (classic cubic spline). Boundary conditions Let us call Pi the cubic polynomial forming the spline within interval Ii. Then, a quasi-cubic spline satisfies the following conditions: Equation 2-157 Cubic spline: conditions Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 103 2 Market standards and calculations 2.2 Yield curves This gives us 3N - 4 conditions. For classic splines, the continuity of the second derivative provides another N - 2 conditions: Equation 2-158 Cubic spline: classic splines To determine all N - 1 cubic polynomials, 4N - 4 parameters need to be set. This means that for classic spline, two additional conditions are needed, while for quasi-cubic splines N additional conditions are necessary. With classic spline, the additional two conditions are usually set at either boundary, for example: Equation 2-159 Cubic spline: natural condition and clamped spline where λ 1 and λ N are the slope of the curve at either end. For the bootstrapping algorithm, it is convenient to be able to set the two additional conditions at the short end of the curve: Equation 2-160 Cubic spline: bootstrapping algorithm conditions Classic spline The value of the spline at a point is given in terms of the second derivatives at node points (zi) as shown in Equation 2-161 on page 104: Equation 2-161 Classic spline: value of spline where 104 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves The parameters zi can be solved by requiring that the derivatives at interior nodes ( ) be continuous: Equation 2-162 Classic spline: continuous derivatives at interior nodes and that the boundary conditions are satisfied, which in case of clamped boundary conditions means: Equation 2-163 Classic spline: clamped boundary conditions In matrix form, Equation 2-162 on page 105 and Equation 2-163 on page 105 can be written as follows: Equation 2-164 Classic spline: matrix Hermite spline In each sub interval Ii, we can normalize the argument t by mapping it to the interval [0, 1] Equation 2-165 Classic spline: normalize t where Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 105 2 Market standards and calculations 2.2 Yield curves Then, we may represent the cubic polynomial as a linear combination of the third order Hermite polynomials over the normalized interval [0, 1]: Equation 2-166 Classic spline: third order Hermite polynomials where mi is the derivative at point ti. It is the setting of these N derivatives at the node points that uniquely determines the quasi-cubic spline. From Equation 2-166 on page 106 we can find the value of the second derivative of the curve at each node. The left hand-side derivative is: Equation 2-167 Classic spline: Left hand side derivative • Setting the slopes at node points There are various methods for determining mi, and we shall consider the following four: – Three-point difference Equation 2-168 Cubic spline: three-point difference method If we use clamped initial and final conditions, then: Equation 2-169 Cubic spline: three-point difference method, clamped 106 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves – Two-point difference Equation 2-170 Two-point difference If we use clamped initial and final conditions, then: Equation 2-171 Two-point difference: clamped initial and final conditions For the classic (continuous second derivative) case, we have the additional N - 2 conditions that the second derivative at each interior node point is continuous: Equation 2-172 Two-point difference: Classic – With clamped boundary conditions following set of equations: , mi can be solved from the Equation 2-173 Clamped boundary conditions: equations Note: Equation 2-173 on page 107 is equivalent to Equation 2-162 on page 105 and Equation 2-163 on page 105, except that here we use the slopes as parameters, while in the classic formulation second derivatives are used. – Replacing the long end boundary condition (mN = 2) with an initial condition on the second derivative () we have the following set of equations, which can be solved sequentially: Equation 2-174 Clamped boundary conditions: initial condition on the second derivative Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 107 2 Market standards and calculations 2.2 Yield curves Extrapolation For values t < t1 and t > tN we have to use extrapolation. For yield curve interpolation it makes sense to use linear interpolation, typically with zero slope. In this case, to maintain continuity of the first derivative, clamped boundary conditions are appropriate for the spline itself. If we apply two initial conditions for a classic spline, we have no control over the slope at the long end of the curve, and the first derivative will be discontinuous. 2.2.3.4.3 Spline building algorithm The structure of the spline building algorithm depends on whether the node points (ti, fi) are all known in advance, or whether we have to solve the values if as we go along (as in bootstrapping). There are three cases: • All node points are known: In case the values at the node points are known, we can use the methods described in Setting the slopes at node points on page 106 directly. • Bootstrapping is required to construct the curve, but interpolation is not necessary during curve construction. • Bootstrapping uses interpolation. If interpolation is needed during bootstrapping, there are two possibilities: – If the information up to a given point fully defines the interpolation curve up to that point, then we can use sequential bootstrapping ( Sequential bootstrapping on page 108). – If the information beyond the current node is necessary for the interpolator, we need an iterative algorithm ( Iterative algorithm on page 109). Sequential bootstrapping If we have to boot strap the values at node points, or if we use classic spline, a sequential algorithm is needed. We only consider classic case with initial conditions ( ) and quasi-cubic case with the two-point difference, since these are the cases amenable to the bootstrapping type of algorithm. Classic spline with boundary conditions and quasi-cubic spline with three-point difference are described in section Iterative algorithm on page 109. Set Equation 2-175 Spline building algorithm: sequential bootstrapping Equation 2-176 Spline building algorithm: sequential bootstrapping - Classic case only For the ith interval, given the value fi+1 at the right-hand end of the interval, we set for the classic case: Equation 2-177 Spline building algorithm: sequential bootstrapping - ith interval where for i > 1: Equation 2-178 Spline building algorithm: sequential bootstrapping (i > 1) 108 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves And for the quasi-cubic case: Equation 2-179 Spline building algorithm: sequential bootstrapping (quasi-cubic case) In either case, the ith spline is now given in terms fi+1. If fi+1 is known, then the sequential bootstrapping is finished. Otherwise, this function can now be used iteratively to solve the bootstrapping step, yielding a value fi+1 that provides the market price for the ith bootstrapping instrument. Iterative algorithm The sequential algorithm for classic spline, while well adapted to the solving of the bootstrap problem, cannot be made to satisfy the boundary condition at the long end of the curve. On the other hand, for quasi-cubic spline with three-point differences the sequential algorithm cannot be applied at all. For these cases we need an iterative approach. • Quasi-cubic spline In this algorithm, we solve the problem of missing node values by using the values from the previous iteration round. To initialize the values, we use sequential bootstrapping with two-point differences. – Bootstrap using the sequential algorithm with two-point differences. – Bootstrap using the sequential algorithm with three-point differences. Takes the values for nodes beyond the current one from the previous iteration round. Repeat until slopes no longer change. In practice, only one iteration is needed. • Classic spline The objective here is to use the sequential algorithm iteratively to find a classic spline with the proper slope at the long end of the curve. The idea is to apply sequential bootstrapping with the given initial slope and to adjust the initial second derivative so that the final slope, which is determined by the initial conditions and the sequential bootstrapping process, will be equal to the requested value. To ensure a good initial guess, we first carry out bootstrapping using linear interpolation and create a cubic spline through its node points. We then use the second derivative at the first node point as the initial value ( η ) for the iteration algorithm. Iteration algorithm 1. Initialize: Set the initial slope and second derivative: Equation 2-180 Cubic spline interpolation: Iteration algorithm 2. Sequential bootstrapping: Using the initial conditions and sequential bootstrapping (see Sequential bootstrapping on page 108), find the interpolation curve. 3. Iteration k: Find the error in the end condition slope: Equation 2-181 Cubic spline interpolation: Iteration algorithm Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 109 2 Market standards and calculations 2.2 Yield curves k where λ 1 is the target value, and m N is the slope at the kth iteration. If |ek| is small enough, stop, otherwise adjust the free initial variable: Equation 2-182 Cubic spline interpolation: Iteration algorithm Slope to a change in the initial second derivative. Go to 2. on page 109. 2.2.3.4.4 Reference time In interpolating a yield curve, the value to be interpolated is either the discount factor between two dates or the corresponding interest rate. One of these dates has to be common to all interpolated values, and the interpolation results depend on the choice of the common date. Since usually most of the market quotes used in the construction of the curve are from the spot, TRM uses the spot date as the common reference point for all interpolated values. This leads to a two-phased bootstrapping process: • Before spot: In the first phase, we use the valuation date as reference and apply bootstrapping only to the input quotes with maturity on or before the spot date, thus creating a stub yield curve between the valuation date and spot date. • After spot: In the second phase, we move the reference date to spot, and apply bootstrapping to all input quotes with maturity after the spot date. To these quotes, we add the discount factors between the spot date and each date from the valuation date to the spot date (including the former and excluding the latter) derived from the stub curve constructed in the first phase. Whenever a discount factor between two dates (d1 and d2) is needed, the following steps are taken: 1. Find the discount factor (D1) between the spot date (ds) and d1. To do this, calculate the length of period between ds and d1 in year using the interpolation date basis defined for the curve, and find the value of the interpolation variable at that point of time. If the interpolation variable is not a discount factor but a rate, convert the rate into discount factor by using the rate type and date basis defined for the curve. 2. Similarly, find the discount factor (D2) between ds and d2. 3. Finally, the discount factor between dates d1 and d2 is D12 = D2/D1. 2.2.3.4.5 Exponential splines If scaling is set to Logarithmic (interpolation setup), then the interpolation is carried out on the logarithms of the original values. The interpolation curve then has the form: Equation 2-183 Exponential splines: interpolation curve y(x) = e 2 a + bx + cx + dx 3 where: • The parameters a, b, c, d vary from interval to interval. 2.2.4 FX rate interpolation Forward FX rates are the result of interest rate differences. When a market FX exchange rate is needed on a date for which no direct quote is available, the exchange rate needs to be interpolated from other quotes. In FX markets, all market rates except S (spot) are quoted in terms of 110 Δ F (forward points) that are to be added to S. © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.2 Yield curves To find out, on valuation date dr, a market rate F on a future date d, one of the following methods is used: • If d is before the next banking day, then: Equation 2-184 FX rate interpolation: market rate ( d – dr ) F = S – ΔF T/N – ΔF O/N -----------------d O/N where: – dO/N is the number of days from the valuation date to the next business day. Note: For FX rates before the spot date, the forward points are taken from the opposite side of the spread. That is, the bid rate is calculated from the bid spot rate and ask points and the ask rate is calculated from the ask spot rate and bid points. • If d is before the spot date but after the next business day, then: Equation 2-185 FX rate interpolation: before spot date. after business day ( d – dT ) F = S – Δ F T/N --------------------d T/N where: – • dT is the next business day and dT/N is the number of days from the next business day to the spot. If d is the spot date, then: F=S • If there is an exact quote Δ Fd (number of forward points) for date d, then: Equation 2-186 FX rate interpolation: exact number of forward points F = S + Δ Fd • If there are two market quotes Δ Fd1 and Δ Fd2 such that d1 < d < d2 then: Equation 2-187 FX rate interpolation: two market quotes Δ F d2 – Δ F d1 - ( d – d1 ) F = S + Δ F d 1 + -------------------------d2 – d1 This is illustrated in the following figure. Forward points % ΔFd2 ΔFd ΔFd1 Period • d1 d d2 If the quote for d1 is S, then ΔF d1 = 0 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 111 2 Market standards and calculations 2.3 Key-figures If the date d is after the last quoted rate, then we extrapolate linearly using the slope between the two last quotes: • Equation 2-188 FX rate interpolation: after last quoted rate where dN is the last quote date and d N– 1 is the penultimate quote date. 2.2.4.1 Example: FX rate interpolation In this example, the USD/JPY exchange rate is calculated at a date 121 days after spot, with spot date 11-01-1999. We have the following data: Data Symbol Value Maturity d 121 days USD/JPY spot rate S 137.9 Quote for 3 months in forward points ΔF d1 -190 Quote for 6 months in forward points ΔF d2 -380 Date basis for currency Actual/360 d1 = 31 + 28 + 31 = 90 d2 = 31 + 28 + 31 + 30 + 31 + 30 = 181 Therefore, using the following equation: Equation 2-189 FX rate interpolation: interpolated forward rate Δ Fd2 – Δ Fd1 - ( d – d1 ) F = S + Δ F d 1 + -------------------------d2 – d1 The interpolated forward rate for 121 days = 137.65: Equation 2-190 FX rate interpolation: example interpolated forward rate – 0.380 – ( – 0.190 ) F = 137.9 + ( – 0.190 ) + ----------------------------------------- ( 121 – 90 ) = 137.9 – 0.254 = 137.65 181 – 90 2.3 Key-figures The following section describes the available key-figures for basic fixed cashflows. For key figures for dual currency cashflows, see 2.3.5 Dual currency on page 147. 2.3.1 Valuation Detailed calculations are available in the instrument-specific sections. 112 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures 2.3.1.1 Interest Rate The interest rate is the rate that is used in the calculation of IR exposure for the period between the cashflow's risk date and spot date. The interest rate is based on the Present Value Discount Factor (Dv) and Present Value Spot Discount Factor (Ds): where R[] is the rate type defined in the Instrument Editor's IR Exposure page (Base IR Exposure Setup feature), and t is the time between the spot date and risk date, calculated using the Date Basis defined in the Instrument Editor's IR Exposure page. Note: If the risk calculation is based on the risk yield, the yield type and date basis are derived from the setup in the Risk Yield page (Risk Yield feature) of the Instrument Editor. Depending on the setup, the Interest Rate key figure displays: • The zero coupon rates of the valuation curve (by default) • The same rate (yield-to-maturity), when the instrument's risk yield is set with Method = Yield-to-Maturity in the Risk Setup page (the Risk Setup page is available when the Feature Risk Setup (Bond) is selected). 2.3.1.2 Market Value The market value of the transaction (cashflow) calculated using the valuation method specified for the instrument, given in the figure currency. 2.3.1.3 Market Value Local The market value of the transaction (cashflow) calculated using the valuation method specified for the instrument, given in the currency of the transaction (cashflow). 2.3.2 Profit and Loss 2.3.2.1 Accrued Interest Accrued interest of the coupon converted into figure currency. 2.3.2.2 Accrued Interest Local Accrued interest in the coupon/cashflow currency. 2.3.2.3 Accrued Profit Non-interest accrued profit, for example, accrued discount premium for bonds, or amortized fees and option premiums, converted into figure currency. 2.3.2.3.1 Accrued Profit (BVC) The Accrued Profit (BVC) component of accrued profit is a Closing the Books figure which is calculated separately for each BVC adjustment, as follows: Accrued Profit (BVC) = BVC Amount (D_left - D_total) / (1 - D_total) Where: – D_total = discount factor for the period from adjustment to maturity using all-in yield as of the adjustment date. – D_left = discount factor for the period from valuation to maturity using all-in yield as of the adjustment date. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 113 2 Market standards and calculations 2.3 Key-figures 2.3.2.3.2 Accrued Profit (Costs) This is a Closing the Books figure and is the part of Accrued Profit directly related to costs (for example, fees), which is calculated separately for each fee, as follows: Accrued Fee Profit = Fee Amount (D_left - D_total) / (1 - D_total) Where: – D_total = discount factor for the period from adjustment to maturity using all-in yield as of the adjustment date. – D_left = discount factor for the period from valuation to maturity using all-in yield as of the adjustment date. 2.3.2.3.3 Accrued Profit (Discount) This is a Closing the Books figure and is the part of Accrued Profit directly related to Discount Premium (for example, fees), which is calculated for the Discount (Premium) of a Bond, as follows: Accrued Discount Profit = Discount/Premium Amount (D_left - D_total) / (1 - D_total) Where: – D_total = discount factor for the period from adjustment to maturity using all-in yield as of the adjustment date. – D_left = discount factor for the period from valuation to maturity using all-in yield as of the adjustment date. 2.3.2.3.4 Accrued Profit (Residual) The Accrued Profit (Residual) figure (that is, the discount/premium component) is then the difference between the total Accrued Profit figure and the Accrued Profit (Costs) and Accrued Profit (BVC) figures. 2.3.2.4 Accrued Profit Local Non-interest accrued profit, for example, accrued discount premium for bonds, or amortized fees and option premiums, in the currency of the transaction (cashflow). 2.3.2.5 FX Profit The part of the difference between the market value and the book value of the transaction (cashflow) due to changes in FX Spot rates. 2.3.2.6 Accrued Margin Profit Accrued Margin Profit Local converted to figure currency. 2.3.2.7 Accrued Margin Profit Local Accrued part of the margin amount. The margin profit is calculated by accruing the margin amount calculated linearly throughout the life of the transaction. 2.3.2.8 Margin Profit Margin Profit Local converted to figure currency. 2.3.2.9 Margin Profit Local The residual margin profit, i.e. Total Margin Profit Local - Accrued Margin Profit Local. 2.3.2.10 Total Margin Profit Margin Profit Local converted to figure currency. 114 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures 2.3.2.11 Total Margin Profit Local Profit resulting from transaction margins, i.e. the discounted margin amount, expressed in the currency of the transaction/margin. Margins are currently supported for short-term loans (3.8 Short term loan on page 305) and FX spots and FX forwards (6.1 FX spot and FX forward on page 383 and FX swaps (6.4 FX swap on page 416.) 2.3.2.12 MtoM Profit The part of the Profit due to changes in market variables other than FX rates, converted into figure currency. 2.3.2.13 MtoM Profit Local The part of the Local Profit due to changes in market variables other than FX rates, expressed in the currency of the transaction (cashflow). 2.3.2.14 Other Profit The part of the Profit not attributable to the other profit types (MtoM, FX, or Accrued), converted into the figure currency. 2.3.2.15 Other Profit Local The part of the Local Profit not attributable to the other profit types (MtoM, FX, or Accrued), expressed in the currency of the transaction (cashflow). 2.3.2.16 Total Profit The difference between the market value and the book value of the transaction (cashflow), converted into figure currency. 2.3.2.17 Total Profit Local The difference between the market value and the book value of the transaction (cashflow), expressed in the currency of the transaction (cashflow). 2.3.3 Option figures FX option key figures are calculated using the valuation model set up by the user: Note: For more information about option valuation models, see section 10.8.6.2.2 on page 611. Equation 2-191 where – S is the FX Spot Rate – X is the FX Strike Rate – Γa is the Asset currency continuous rate – Γc is the Cash currency continuous rate – τe is the time to expiry date – dρ is the time delay between expiry and payment date – σ is the volatility Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 115 2 Market standards and calculations 2.3 Key-figures The valuation formula may use other transaction parameters, such as gap, barrier, or exercise schedule, or model parameters, such as Quality, but these will be considered implied and not shown in the formulas. 2.3.3.1 Asset and cash currencies The values of some key figures will depend on the choice of asset and cash currencies. The asset currency is by default the currency with the higher priority (as defined in Currency Priority Editor), or the base currency in case the traded currencies have no priorities defined. For more information about setting currency priorities, see TRM User Guide, Client Priorities. You can change the (defaulted) asset currency in Transaction Manager. This impacts the option figures displayed in Transaction Manager. 2.3.3.2 Greeks Greeks are sensitivities of option price to changes in the variables determining the price. These are calculated numerically using: Equation 2-192 Greeks - sensitivities of option price where ε is a small number. TRM calculates the Greeks described in the following sections: Basic sensitivities Formula Cross sensitivities Delta Asset Rho Speed Gamma Cash Rho Speed Strike Delta Vega Speed (Vanna, Wega) Strike Gamma Theta Speed Asset Rho Delta Bleed Asset Yield Gamma Gamma Bleed 116 Formula © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures Basic sensitivities Formula Cross sensitivities Cash Rho Asset Rho Bleed Cash Yield Gamma Cash Rho Bleed Vega Vega Bleed Formula Sigma Gamma (Volga) Theta Time Gamma For barrier options, TRM offers some additional key figures, which describe the behavior of the option’s value near the barrier. These figures replicate the standard sensitivity calculations, except that the valuation is done at the barrier, without crossing it. Upper barrier sensitivities Formula Lower barrier sensitivities Upper Barrier Delta Gap Lower Barrier Delta Gap Upper Barrier Gamma Gap Lower Barrier Gamma Gap Upper Barrier Strike Delta Gap Lower Barrier Strike Delta Gap Upper Barrier Strike Gamma Gap Lower Barrier Strike Gamma Gap Upper Barrier Asset Rho Gap Lower Barrier Asset Rho Gap Upper Barrier Asset Yield Gamma Gap Lower Barrier Asset Yield Gamma Gap Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations Formula 117 2 Market standards and calculations 2.3 Key-figures Upper barrier sensitivities Formula Lower barrier sensitivities Upper Barrier Cash Rho Gap Lower Barrier Cash Rho Gap Upper Barrier Cash Yield Gamma Gap Lower Barrier Cash Yield Gamma Gap Upper Barrier Vega Gap Lower Barrier Vega Gap Upper Barrier Sigma Gamma Gap Lower Barrier Sigma Gamma Gap Upper Barrier Theta Gap Lower Barrier Theta Gap Formula 2.3.3.3 Intrinsic and time value There are three methods for intrinsic value calculation: Method Formula Description Zero Volatility Calculate option price assuming volatility zero. Forward Calculate option price assuming volatility zero, and substituting zero for cash rate and IR difference for asset rate. Spot Calculate option price assuming volatility zero, and substituting zero for cash and asset rates. For barrier options intrinsic value calculated at upper and lower barriers is called Upper Barrier Digital and Lower Barrier Digital respectively. 2.3.3.4 Risk figures Sensitivity figures are calculated for one unit of asset currency and expressed in cash currency. To convert them into risk key figures they are multiplied by cash amount (including the sign of the transaction) and FX rate between the cash currency and the figure currency. In addition, theta figures, which are originally calculated for one unit of time (year), are divided by 365 so that they will correspond to a daily change in option value. Similarly, volatility figures (vega, vanna, wega) are calculated for one unit change in volatility (100%). They are divided by 100 so that they will correspond to a change of one percentage unit in volatility. 118 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures 2.3.4 Risk Note: For Theoretical valuation, present value is equal to market value in all cases except for bond futures in IR risk figures calculation. 2.3.4.1 Exposures Exposures in general measure sensitivity of the present value to a change in a market rate. 2.3.4.1.1 FX Exposure The sensitivity of the present value of the cashflow to a change in the FX Spot rate. The magnitude of the change is defined for each currency in Currency Editor (as a percentage). FX exposures are netted within each currency (in Currency Editor), as well as within each class currency (in Currency Class Editor), see TRM User Guide. Totals that include different currencies or different currency classes are taken from the absolute values of the currency or the total exposures of the currency class. 2.3.4.1.2 IR Exposure 1 The sensitivity of the present value of the cashflow to a parallel shift of 1 basis point (1bp) in the yield curve. The value of a position can be seen as a function of a number of discount factors for different maturities: V = V [ D1, D2, ... , Dn] where other dependencies, such as FX rates, have been suppressed since they are immaterial to the issue under consideration. Alternatively, since each discount factor depends on the interest rate for the period in question, it is possible to write: V = Vr [ r1, r2, ... , rn] However, the interest rates in the second formula depend on the definition of the date basis as well as on the type of interest rate (periodic, compounded, and so on). Therefore, the first formula is more fundamental, and IR exposure calculations are based on that one. Based on the first equation, the sensitivities on discount factors can be calculated as: ∂V V i = --------∂D i For fixed cashflows, Vi is simply the amount of the cashflow, while for floating-rate instruments and derivatives, the formula will be more complex. Once the sensitivity with respect to the discount factor is found, the corresponding sensitivity with respect to an interest rate can be derived, given the type of interest rate and date basis. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 119 2 Market standards and calculations 2.3 Key-figures For example, for a yearly compounded rate: D [ t ,r ] = ( 1 + r ) –t ∂D ------- = – t ( 1 + r ) – t – 1 = – tD ( t + 1 ) ⁄ t ∂r Di ∂V ∂V- ∂------∂V- ( ti + 1 ) ⁄ ti ------- = ------- = – ------tD ∂r i ∂D i ∂r i ∂D i i i ( t + 1 ) ⁄ ti ∂V ∂V E 1bp = ------- × 0.0001 = – -------- t i D i i × 0.0001 ∂r i ∂D i where: – ti is the length of period calculated according to the chosen date basis. For other interest rate types, we get similar formulae. ∂V However, the term V r = --------- does not change with the choice of risk yield type and date basis. ∂D i The value of V r is shown in Transaction Manager as the Figure Risk Value. Note: The date basis and yield type that is used for IR exposure calculations can be defined at instrument level using the feature Base IR Exposure Setup: see A.2.48 Base IR Exposure Setup on page 732. If the instrument uses the feature Risk Yield, the date basis and yield type defined for the risk yield override the IR exposure setup for the period from spot date to risk date: see A.2.291 Risk Yield on page 859. 2.3.4.1.3 Discounting via spot date Often, discounting to the valuation date is done via spot date, with two different yield curves used for the part between the risk date and spot date (Valuation Curve), and the spot date and the valuation date (Discount Curve). In this case, we calculate the discount factor sensitivity separately for each discount factor ( D 2 [ r 2 ] from the risk date to the spot date, D 1 [ r 1 ] from the spot date to the valuation date where interest rate r 2 and discount rate r 1 are the rates over the corresponding periods). The total sensitivity to change in discount factors is then: Equation 2-193 IR exposure 1: total sensitivity of DF 2.3.4.1.4 To spot If the switch To Spot in IR Exposure page of the Instrument Editor is set (see A.2.48 Base IR Exposure Setup on page 732), IR exposure calculation is based on discounting to spot instead of to valuation 120 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures date. That is, D 1 [ r 1 ] ,the discount factor between the spot date and the valuation date is set to 1 (and the corresponding sensitivity to zero): Equation 2-194 IR exposure 1: with To Spot switch 2.3.4.2 Spot IR Exposure 1 Spot IR Exposure 1 only takes into account the part of IR exposure due to a movement of the interest rate between the spot date and the risk date: Equation 2-195 Spot IR Exposure 1 where • D 2 is the discount factor between the spot date and the risk date, • r 2 is the corresponding interest rate, converted from D 2 using the date basis and rate type defined in the IR Exposure page of Instrument Editor. r 2 is shown as Figure Interest Rate. Note: The switch To Spot in IR Exposure page of the Instrument Editor has no effect on Spot IR Exposure 1bp. 2.3.4.3 Present Value The market value of the transaction (cashflow) calculated using the risk method specified for the instrument, given in the figure currency. 2.3.4.4 Present Value Local The market value of the transaction (cashflow) calculated using the risk method specified for the instrument, given in the currency of the transaction (cashflow). 2.3.4.5 Basis Point Value Basis point value is used in the risk calculations of bond instruments and represents the value of 1 basis point. The figure is scaled so that it corresponds to a unit of the instrument, not to the position size, and is calculated as follows: (10,000.0 * (- ir_exp_down + ir_exp_up) / 2.0 / (nominal_amount * fx_convert) Where: – IR Exposure Down and IR Exposure Up are calculated with an offset equal to 0.0001 – The offset returns a value of 10,000.0 (1 / 0.0001) – 2.0 reflects the approximation used for the calculation of the numerical derivative. The individual figures can be found in Transaction Manager (that is, the sum of Figure IR Exposure Down / Up from cashflows, Nominal Amount of the transaction, and Figure FX Convert from the cashflows). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 121 2 Market standards and calculations 2.3 Key-figures 2.3.4.6 Yield Yield is shown at transaction and position levels. It is defined as: Equation 2-196 Yield key figure i y = ri Vp ∑ ----------------i ∑ Vp where • r i is the interest rate used for discounting the i th cashflow in the position • V p is the present value of the cashflow. i If an instrument is set up with the Risk Yield feature (A.2.291 Risk Yield on page 859), the same interest rate (yield to maturity) is used for the discounting of all cashflows and key figure Yield shows the yield to maturity: Equation 2-197 Yield key figure: Yield to Maturity i y = r Vp ∑ ---------------i ∑ Vp i = ∑ Vp r -------------i ∑ Vp = r 2.3.4.7 Spread 2.3.4.7.1 Z-DM (Discount Margin) Z-DM is the (constant) spread that has to be added to the risk-free rate used to discount the future (fixed or estimated) cashflows of a bond in order to have the total of the discounted cashflows equal to the market value of the bond (at spot date). The date basis and interest type used in the Z-DM calculation can be set up by adding feature Z-DM/Spread Setup to the instrument: see A.2.343 Z-DM/Spread Setup on page 882. If there is no setup, then the default values are used: Date Basis: Actual/Actual ISDA, Interest Type: Continuous. Z-DM ( μ ) is calculated by solving: Equation 2-198 Key figures: Spread = Z-DM calculation P = ∑ ci D [ R [ Di ,ti ] + μ ,ti ] + D [ R [ Dmat ,tmat ] + μ ,tmat ] where P is the (dirty) price of the instrument at spot, Di and Dmat are discount factors from the risk free curve between spot and payment dates of cashflows, ti and tmat are the times between spot date and payment dates, and ci are the coupon amounts (fixed or estimated) per unit nominal amount. Functions D[] and R[] convert the interest rate into the discount factor, and vice versa, according to the interest type setup. 2.3.4.7.2 Z-Spread Z-spread is the ratio between the Present Value Discount Factor and the Risk Free Discount Factor, converted into the rate using the date basis and interest type defined for risk free curve's interpolation. The risk free curve can be defined in the Currency Editor: see TRM User Guide. If it is not defined, the default curve of the currency is used. 122 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures The calculation for Z-Spread ( μ z ) is: Equation 2-199 Key figures: Spread: Z-Spread calculation μ z = R [ D p ⁄ D rf ,t ] Where Dp and Drf are Present Value Discount Factor and Risk Free Discount Factor, respectively, and t is time between risk base date and cashflow risk date, and is the function that converts discount factor into rate. Risk method Z-Spread In the risk method Z-Spread, the Present Value Discount Factor is calculated by adding Z-DM to the risk free rate (for the period from the spot to the risk date). Discounting from the spot to the valuation date uses the discount curve defined for the instrument as usual. When Z-DM is added to the risk free rate (rrf), it will be used according to the date basis and interest type defined for the risk free rate. For consistency, the Z-DM/Spread Setup has to use the same date basis and interest type as the risk free rate. The key figures Z-DM and Z-Spread are very similar, but not necessarily the same. Even if Z-DM and risk free curve setups match, there is the difference that Z-DM is calculated for the period between the spot and the payment date, while Z-Spread is calculated for the period between the risk base date and the payment date. If IR Exposure Setup (A.2.48 Base IR Exposure Setup on page 732) uses the To Spot switch, Z-DM and Z-spread will be calculated using the same time period. There is still another difference: While Z-DM is added to the risk free rate, Z-Spread is based on the ratio of discount factors. If the time period used (To Spot), the date basis, and the interest type setups match, we have: Equation 2-200 Key figures: Spread discount factors μ z = R [ D [ r rf + μ ,t ] ⁄ D [ r rf + t ] , t ] If we use Continuous Yield, i.e. D [ r, t ] = exp [ – r × t ] and D [ D, t ] = – log [ D ] ⁄ t then we get: μ z = – log [ exp [ – ( r rf + μ ) × t ] ⁄ exp [ – r rf × t ] ] ⁄ t μ z = – log [ exp [ – μ × t ] ] ⁄ t = μ So, in this case, Z-DM is equal to Z-Spread. If the other interest types are used, there may be some minor differences. 2.3.4.7.3 Spread IR Exposure 1 bp The Spread IR Exposure 1 bp is the sensitivity of the present value of the cashflow to a shift in the yield used for discounting from risk date to risk base date. It is defined for fixed cashflows as: Equation 2-201 Key figures: Spread IR Exposure 1 bp ∂D 2 ∂D 1 E μ = V r ⎛ D 1 --------- + D 2 ---------⎞ × 0.0001 ⎝ ∂r 2 ∂r 1 ⎠ Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 123 2 Market standards and calculations 2.3 Key-figures ∂D 2 ∂D 1 E μ = V r ⎛ D 1 --------- + D 2 ---------⎞ × 0.0001 ⎝ ∂r 2 ∂r 1 ⎠ That is, the formula is the same as for IR Exposure 1 bp: see 2.3.4.1.2 IR Exposure 1 on page 119. For floating cashflows, there is a new (not displayed) key figure, Spread Risk Value, which is equal to Figure Payment Amount for the interest cash flow, and zero for the pseudo risk cash flows. In terms of spread risk value, spread IR exposure 1bp is: Equation 2-202 Key figures: Spread IR Exposure 1 bp ∂D 2 ∂D 1 E μ = V μ ⎛ D 1 --------- + D 2 ---------⎞ × 0.0001 ⎝ ∂r 2 ∂r 1 ⎠ Where is V μ the spread risk value. That is, the exposure formula is the same for both floating and fixed cashflows, the only difference being how the risk value is obtained. The date basis and interest type used in these calculations are determined either by the IR exposure setup (feature Base IR Exposure Setup), if given, or by the interpolation method specified in the curve in the discounting (the valuation curve specified in the risk method Zero-Coupon, and the risk-free curve in the risk method Z-Spread). See A.2.289 Risk Setup (FRN) on page 858 or A.2.288 Risk Setup (BOND) on page 858. For fixed bonds, if the risk method Yield to Maturity is used, then the date basis and interest rate defined for the risk yield are applied, even if there is an IR exposure setup (feature Base IR Exposure Setup). See A.2.48 Base IR Exposure Setup on page 732. 2.3.4.7.4 Beta exposure The beta exposure is simply the Spread IR Exposure 1bp scaled with risk method Z-Spread: Equation 2-203 Key figure: beta exposure Eβ = Eμ × μz Where μ z is the Z-Spread. 2.3.4.8 Risk profiles This section describes each risk profile by explaining which risk dates are created, what market and cashflow data are used, and how calculations are carried out. A risk profile is a method to carry out interest rate risk calculations that are specific to a certain type of instrument. Risk profiles are set up at the instrument level by attaching the feature Floating Valuation Setup (A.2.338 Valuation Setup (Floating) on page 879). Each risk profile generates risk cashflows for the cashflows of the transaction, calculating risk values and convexity matrix in the prescribed manner. Risk values can be viewed in the Cashflow / Event Figure view of Transaction Manager. For more information on how IR exposure is calculated from risk values, see 2.3.4 Risk on page 119. Input A risk profile calculation uses two types of input data: market data and cashflow data. Market data includes estimation curve, valuation curve and discount curve. These are set up in the Instrument Editor, Yield Curves page. Additionally, certain risk profiles use volatility and past quotes for the fixing rate. 124 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures All risk profile calculations are carried out at the cashflow level. Different risk profiles use different properties of the cashflow in the calculations. The following sections provide detailed information about these profiles. Output Each risk profile creates a list of risk dates and a corresponding list of risk values, which together characterize the interest rate exposure of the specific cashflow. In addition, for each cashflow the risk profile estimates the fixing rate and the amount of the coupon. 2.3.4.8.1 Plain Vanilla Plain vanilla risk profile corresponds to the standard floating cashflow, where the coupon period is the same as the fixing period. Risk dates are: payment date, coupon start date (since when), and coupon end date (until when). Input data used in calculations: tc s Dp D1 Dn Coupon period length Spread Discount factor for the payment date (from valuation and discount curves) Discount factor for the start of the coupon period (from estimation curve) Discount factor for the end of the coupon period (from estimation curve) Coupon estimate Equation 2-204 Risk profile: Plain vanilla: Estimated amount A e = D 1 ⁄ D n – 1 + st c Valuation Risk values: Equation 2-205 Plain vanilla: Risk values D1 V p = ------ – 1 + st c Dn Dp V 1 = -----Dn Dp D1 V n = ------------2 Dn Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 125 2 Market standards and calculations 2.3 Key-figures Convexity matrix: Equation 2-206 Plain vanilla: Convexity matrix V pp = 0 1 V p1 = -----Dn D1 V pn = – ------2 Dn V 11 = 0 Dp V 1n = ------2 Dn Dp D1 V nn = 2 ------------3 Dn 2.3.4.8.2 Generic Risk dates are: payment date, fixing period start date, and fixing period end date. Input data used in calculations: t tf tc σ σc s Xc Xf Time to fixing date f D p , D1 , Dn Factor (=-1 for inverse floater) Fixing period length Coupon period length Volatility Convexity adjustment volatility Spread Cap rate Floor rate Discount factors Calculated variables: F R aa ac af Forward rate d1 , d2 Black76 factors Adjusted rate Convexity adjustment Cap adjustment Floor adjustment Normal distribution 126 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures where Equation 2-207 Generic V = t c ( R f + s + a c + a f )D p 2 ⎛ e tσc – 1⎞ t F 2 ⎝ ⎠ f a a = --------------------------------tf F + 1 R = F + aa ⎛ D1 ⎞ – 1⎟ ⎜ -----Dn F = ⎜ ---------------⎟ ⎜ t ⎟ ⎝ f ⎠ ac = N ( d1 ) R – N ( d2 ) X af = N ( –d2 ) X – N ( –d1 ) R 2 R σ t log ⎛ ------------⎞ + -------⎝ X – s⎠ 2 d 1 = ----------------------------------------σ t 2 R σ t log ⎛ ------------⎞ – -------⎝ X – s⎠ 2 d 2 = ----------------------------------------σ t The risk values are calculated numerically. 2.3.4.8.3 Constant Maturity Risk dates are: Payment date, start dates, and coupon dates of the underlying swap. We shall consider an individual constant maturity swap (CMS) coupon, since all unfixed coupons are handled in the same way. A fixed coupon becomes a fixed cashflow and is handled likewise. Input data: tp t1 t2 ts Time to payment date Start date of the coupon period End date of the coupon period Start date of the underlying swap Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 127 2 Market standards and calculations 2.3 Key-figures si ei σ s D p, D 1, D i , Start dates of the underlying swap coupons End dates of the underlying swap coupons Volatility e Di Discount factors corresponding to the previously mentioned dates Calculated variables: y yc ac Forward rate Convexity-adjusted rate Convexity adjustment The fair value of CMS coupon is: Equation 2-208 fair value of CMS coupon V = yc ( t2 – t1 ) where yc, the convexity adjusted forward swap rate, is calculated as shown below. For risk values and convexity matrix, we regard the adjusted swap rate as a function of discount factors, and calculate numerically the following derivatives: Equation 2-209 Constant maturity: derivative calculations ∂y c ∂V V x = ---------- = ( t 2 – t 1 ) ---------∂D x ∂D x 2 V xy 2 ∂ yc ∂ V = -------------------- = ( t 2 – t 1 ) -------------------∂D x ∂D y ∂D x ∂D y Convexity adjusted swap rate First, we calculate the forward swap yield from the underlying discount factors: Equation 2-210 Constant maturity: Forward swap yield D1 – D1 y = ------------------∑ τi Di where D1 and D2 are discount factors at the start and end of the swap, respectively, and τi = ti – t i–1 are the swap coupons’ period lengths (where we set t0 = ts). The convexity adjustment applied to the forward yield y for a swap, starting at time T is given by: Equation 2-211 Constant maturity: convexity adjustment 128 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures where σ is the yield volatility and p[yd;y] is the price of the fixed leg of the swap as function of the yield yd. The price function is given by: Equation 2-212 Constant maturity: price function p [ y d ;y ] = D [ y d, t n ] + y c ∑ τi D [ yd, ti ] i where t i are the payment dates of the fixed leg , τi are the length of the coupon periods and the discount factor D[yd;ti] are calculated using compounding with the swap frequency. The adjusted swap yield is then: Equation 2-213 Constant maturity: adjusted swap yield 2.3.4.8.4 Compound (O/N) The Compound (O/N) risk profile corresponds to a coupon determined by compounding overnight rates over the coupon period. Within the compounding period, the result of the compounding up to the valuation date is known, and the rate compounded over the remaining period is estimated from discount factors at the beginning and end of the remaining period. Therefore, the risk dates are: payment date, valuation date, and the coupon end date (until when). Before the start of the coupon period, valuation date is replaced by coupon start date (since when). Input data used in calculations: Dp D1 Discount factor for the payment date (from valuation and discount curves) Dn Discount factor for the end of the coupon period (from estimation curve) During the coupon period = 1, before coupon period discount factor for the start of the coupon period (from estimation curve) The coupon amount is compounded over the period from d s to d e , typically including only business days: Equation 2-214 Compound (O/N) coupon amount where r d is the overnight rate for day d and l d is the length of the period between two consecutive days using the appropriate day count method. The coupon amount can be estimated by: Equation 2-215 Compound (O/N) estimated coupon amount Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 129 2 Market standards and calculations 2.3 Key-figures where A f is the known part of the compound factor: Equation 2-216 Compound (O/N) compound factor and we use as the estimate for the compounding factor for the rest of the period. Risk values: Equation 2-217 Compound (O/N) risk values Convexity matrix is: Equation 2-218 Compound (O/N) convexity matrix 2.3.4.8.5 Generic Compound (O/N) The Generic Compound risk profile is a generalization of Compound (O/N) risk profile, allowing multiplicative spread as well as an additive one. In addition, the daily rate may be capped. Input data: s Spread h Multiplicative spread c Cap for the daily rate (spread-adjusted). Dp Discount factor for the payment date (from valuation and discount curves) 130 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures D1 During the coupon period = 1, before coupon period discount factor for the start of the coupon period (from estimation curve) Dn Discount factor for the end of the coupon period (from estimation curve) The payment amount of a compound floater with additive and multiplicative spreads and a cap is: Equation 2-219 Generic Compound (O/N) where the product is taken over the compounding period, A is the nominal amount of the transaction (from now on we use A = 1.0, and leave it out from subsequent formulas), s (additive spread), h (multiplicative spread), and c (cap) are constants, d is the length of a day (e.g 1/360 or 1/252, depending on the date basis, and r i is the compounding rate for day i (expressed as annually compounded rate). Valuation On a given valuation day k, we know the historical part of the compounding: Equation 2-220 Generic Compound (O/N) valuation day and in terms of the known part the estimated payment amount becomes: Equation 2-221 Generic Compound (O/N) estimated payment amount Writing A f = A k + 1 , and D p for the discount factor between valuation day k and the payment date, the fair value of the payment becomes: Equation 2-222 Generic Compound (O/N) fair value of payment where E[] is the expectation operator. The fair value (Equation 2-222 on page 131) can be calculated numerically given an interest rate model. However, for practical purposes the non-linearity of this instrument is negligible, and it will be more efficient to ignore the optional features embedded in the min operator, and carry out the valuation in a deterministic world. Also, we shall not consider the effect of rounding, since rounding renders the fair value function non-differentiable, and its effect on valuation is small anyway. Furthermore, in order to get rid of the dependence on the O/N discount factors, we shall apply the following approximation: Assume that either r i ≤ c for all i > k or r i > c for all i > k Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 131 2 Market standards and calculations 2.3 Key-figures That is, if , we shall use the estimate Equation 2-223 Generic Compound (O/N) estimate A 1 Otherwise, Equation 2-224 Generic Compound (O/N) estimate A • Fixed estimate In the first case, the cashflow can be treated as fixed, for which standard cashflow valuation and risk analysis will suffice. That is, let n be the number of days left in the fixing period. Then the estimated amount is: Equation 2-225 Generic Compound (O/N) fixed estimate As we now consider this cashflow fixed, risk values are: Generic Compound (O/N) fixed estimate risk values and the convexity matrix is empty. • Variable estimate In the second case, we shall use the following approximation: Let n be the number of days left in the fixing period and let D 1 and D n be the discount factors for the start and end of the (remaining) fixing period respectively. 132 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures Then we make the approximation: Equation 2-226 Generic Compound (O/N) variable estimate where we have set . That is, we assume that the overnight rates during the remaining fixing period are equal. Finally, let us write: Equation 2-227 Then, the estimated fixing amount becomes: Equation 2-228 The risk profile calculates the following key figures: – Estimated Amount Equation 2-229 Generic Compound (O/N) variable estimate: estimated amount – Present Value Equation 2-230 Generic Compound (O/N) variable estimate: present value Risk Values (Discount Factor Sensitivities): For risk values, it is useful to define the following differentials: Equation 2-231 Generic Compound (O/N) variable estimate: risk value differentials Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 133 2 Market standards and calculations 2.3 Key-figures Then, risk factors become: Equation 2-232 Generic Compound (O/N) variable estimate: risk factors 134 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures – Fixing Period Start Equation 2-233 Generic Compound (O/N) variable estimate: fixing period start – Fixing Period End Equation 2-234 Generic Compound (O/N) variable estimate: fixing period end – Convexity Matrix Equation 2-235 Generic Compound (O/N) variable estimate: convexity matrix Notice that if the multiplicative spread h is zero, we get: Equation 2-236 Generic Compound (O/N) variable estimate: multiplicative spread is zero and if the additive spread s is zero, we get: Equation 2-237 Generic Compound (O/N) variable estimate: additive spread is zero Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 135 2 Market standards and calculations 2.3 Key-figures 2.3.4.8.6 Compound (Simple) The Compound (Simple) risk profile is applicable to coupons based on compounded average interest rate. The actual compounding expression is only used for the estimation of the current coupon amount. Future coupons and risk are calculated using a simple generic approximation. Input data used in calculations: tc Coupon period length tf Fixing period length s Spread r Compounded rate up to the valuation day Dp D1 Discount factor for the payment date (from valuation and discount curves) Dn Discount factor for the end of the coupon period (from estimation curve) 136 During the coupon period = 1, before coupon period discount factor for the start of the coupon period (from estimation curve) © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures Coupon estimation Before the start of the coupon period, the estimated coupon is: Equation 2-238 Compound (Simple) estimated coupon During the coupon period, we use an estimate that combines the currently known compounded rate up to the valuation day (r) with a simple estimate of the discount factor for the rest of the period: Equation 2-239 Compound (Simple) during coupon period: estimate where D[] and R[] are rate to discount and discount to rate conversion functions, respectively, and t r is the length of the remaining fixing period. Valuation Risk values per unit nominal amount are calculated as: Equation 2-240 Compound (Simple) risk values Convexity matrix is: Equation 2-241 Compound (Simple) convexity matrix Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 137 2 Market standards and calculations 2.3 Key-figures 2.3.4.8.7 Average (Simple) The Average (Simple) risk profile is applicable to coupons based on interest rate averaged over a period. The actual averaging expression is only used for the estimation of the current coupon amount. Future coupons and risk are calculated using a simple generic approximation. Input data used in calculations: tc Coupon period length tf Fixing period length s Spread r Compounded rate up to the valuation day Dp D1 Discount factor for the payment date (from valuation and discount curves) Dn Discount factor for the end of the coupon period (from estimation curve) During the coupon period = 1, before coupon period discount factor for the start of the coupon period (from estimation curve) Coupon estimate First, we calculate the estimated forward rate (f) for the remaining fixing period: Equation 2-242 Average (Simple) estimated forward rate where t r is the length of the remaining fixing period, and R[] is the function that converts the discount factor into interest rate according to fixing type. Next, we calculate the expected fixing rate, based on the rate known up to the valuation date (r) and the estimated forward rate f: Equation 2-243 Average (Simple) fixing rate Finally, the estimated amount is: Equation 2-244 Average (Simple) estimated amount where D[] is the function that converts interest rate into discount factor according to fixing type. 138 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures Valuation Risk values per unit nominal amount are calculated as: Equation 2-245 Average (Simple) risk values Convexity matrix is: Equation 2-246 Average (Simple) convexity matrix 2.3.4.8.8 Fed Fund The Fed Fund risk profile corresponds to the coupon calculated from the average overnight rate over the coupon period. This average is estimated by assuming that the overnight discount factor stays constant over the coupon period, in which case, this rate can be calculated as follows: Equation 2-247 Fed funds: Average overnight rate where D 1 and D n are the discount factors for the start and end of the coupon period, and d is the number of days in the period. For the coupon with start date after the valuation date, the risk dates are payment date, coupon start date (Since When), and coupon end date (Until When). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 139 2 Market standards and calculations 2.3 Key-figures Risk values: Equation 2-248 Fed funds: Risk values Convexity matrix Equation 2-249 Fed funds: Convexity matrix Estimated amount: Equation 2-250 Fed Funds: estimated amount where tc Coupon period length Dp D1 Dn Discount factor for the coupon payment (from valuation and discount curves) 140 Discount factor for the start of the coupon period (from estimation curve) Discount factor for the end of the coupon period (from estimation curve) © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures s Spread d Number of days in the coupon period. Running coupon For the running coupon, we already know the average rate up to the valuation date. Let r be that rate, and t0 the length of the known period, te the length of the remaining period, and de the number of days in the remaining coupon period. Risk values: Equation 2-251 Fed Funds - running coupons: risk values Convexity matrix: Equation 2-252 Fed funds - running coupon: Convexity matrix Estimated amount: Equation 2-253 Fed Funds - running coupons: estimated amount Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 141 2 Market standards and calculations 2.3 Key-figures 2.3.4.9 Duration figures 2.3.4.9.1 Duration Duration is the mean maturity of money in a transaction. For a simple cashflow, the duration is simply the maturity t of the cashflow. For transactions containing several cashflows, the duration is considered as the weighted average maturity of each cashflow, with the weights, the present values of the cashflows. Equation 2-254 Key figures: Duration Σt i V i U = ------------ΣV i Where Vi Present value of the cashflow i with t i > 0 . ti Time to maturity of the cashflow i with t i > 0 . 2.3.4.9.2 Duration (Days) Duration (Days) is the Duration expressed in days. The Duration (Days) key figure is calculated as follows: Equation 2-255 Key figures: Duration (Days) calculation U ( Days ) = U × B Where U Duration B The date basis defined at the instrument level, for example, 365, 360, and so on, 2.3.4.9.3 Effective Duration Effective duration is the relative change of the present value of a position with respect to a change to the interest rate. Thus, it can be represented as a relative figure of IR Exposure, based on the IR exposure calculated with 1 bp (basis point): Equation 2-256 Key figures: Effective Duration 10000 × E { i1 } U eff = – ----------------------------------Vp Note: For a single bond evaluated with the par method and continuously compounded yield, the effective duration is the same as the Macauley duration; for yearly compounded yield, the effective duration is the same as the modified duration (see 2.3.4.9.5 Modified Duration on page 145). 142 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures For a position with present value close to zero, the effective duration, as well as Duration and Duration (Days), may be unstable (present value in the denominator). For example, if the present value of the position changes from a small positive number to a small negative number, the effective duration will change from a large positive number to a large negative number. (This happens particularly when a bond has been bought but is still in the pending state: the settlement amount belongs to the position and has a present value very close to the bond's present value.) In fact, when present value is zero, effective duration would be infinite, and will therefore not be shown. 2.3.4.9.4 Effective Convexity Convexity is related to the second order term in the Taylor expansion of the value of an asset as a function of yield: Equation 2-257 Convexity In this case, convexity is defined as C = V''/V If instead of yield, we consider zero coupon valuation, there are several variables, and the second order derivative becomes a matrix: Equation 2-258 where ri are the zero rates taken into account in the valuation of the asset. We want to use derivatives with respect to the discount factors D i [ r i ] , in which case Equation 2-259 for off diagonal elements, and Equation 2-260 Here we have written: Equation 2-261 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 143 2 Market standards and calculations 2.3 Key-figures for the part that is independent of the type of the interest rate and can therefore be calculated just by knowing the discount factors. Once we know the risk values and convexity matrix, we can estimate the change in the market value due to a small change Δ r in the valuation curve by: Equation 2-262 Duration figures - Effective Convexity: change in market value Usually, we are interested only in the parallel shift, in which case Equation 2-263 Duration figures - Effective Convexity: parallel shift where Equation 2-264 Duration figures - Effective Convexity: parallel shift and Equation 2-265 Duration figures - Effective Convexity: parallel shift Effective convexity can now be defined as: Equation 2-266 Duration figures - Effective Convexity and the convexity term corresponding to an individual risk date is: Equation 2-267 Duration figures - Effective Convexity: risk date where Vi is the present value of the ith cashflow. Note that for an asset with fixed cashflows, the cross-derivatives H ij are equal to zero when i ≠ j . 144 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures In this case we get: Equation 2-268 Duration figures - Effective Convexity: asset with fixed cashflows In particular, if the present value is calculated using yield-to-maturity method, i.e. if every cashflow is discounted with the same yield y m , we obtain: Equation 2-269 Duration figures - Effective Convexity: YTM method 2.3.4.9.5 Modified Duration For on-balance instruments modified duration is a relative figure of the IR exposure (1 bp) of the transaction based on the present value of the transaction. For off-balance instruments (as well as for on-balance instruments during the settlement period), where the present value is close to zero and not a good measure of risk taken, we substitute an estimate of the size of the underlying position. This estimate depends on the instrument type: • FRA and MM future: Average of the absolute value of the present values of the risk values at each end of the underlying contract period. • Bond future: Average of the absolute values of the present value of the position cashflows and the settlement cashflows of the underlying CTD bond. • IR Swap: Average of the present values of the legs. Example: Bond - Transaction/instrument grouping If you group by transaction or by instrument in Treasury Monitor, modified duration is calculated as follows: Equation 2-270 Grouping by transaction: modified duration calculation 10000 × E { i1 } U mod = -----------------------------------------------sett pos φ × ( Vp + Vp ) Where E { il } sett The present value of the settlement cashflows after the figure Spot Date. The value date of the settlement cashflows is the same as the transaction’s value date. pos The present value of the position cashflows after the figure Spot Date. Position cashflows correspond to all other cashflows, i.e. not settlement. Vp Vp φ The IR exposure to 1 bp change in the interest rate for the cashflows after the figure Spot Date (i.e. excluding cashflows before or on the figure Spot Date). The average of the present value components. φ = 0.5 or 1 depending on the number of present value components. Note: For example, if you have a spot position, the only component is the present value of the position cashflows and in this case φ = 1. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 145 2 Market standards and calculations 2.3 Key-figures Note: Settlement cashflows are cashflows with the same date as the value; position cashflows are all other cashflows. The IR Exposure 1bp and the Present Value figures are calculated to Valuation Date. Note: In the case of a partial forward sell or purchase of a position, you should group Instrument and Liquidity Type (extended), and monitor the 'Committed' part. This excludes the pending settlement that causes a jump in the present value weight at the instrument level. Example: Bond - Total grouping if you group by total in Treasury Monitor, modified duration is calculated as follows: Equation 2-271 Grouping by total: modified duration calculation – E { i1 } U mod = U eff = ⎛ ---------------⎞ × 10000 ⎝ Vp ⎠ where Vp The present value. E { i1 } The IR exposure to 1 basis point (bp) change in the interest rate. Example: IR Swap - Transaction/instrument grouping If you group by transaction or by instrument in Treasury Monitor, modified duration is calculated as follows: Equation 2-272 Modified Duration: IR Swap 10000 × E { i1 } U mod = --------------------------------------------------leg1 leg2 φ × ( Vp + Vp ) Where E { il } The IR exposure to 1 bp change in the interest rate for the cashflows after the figure Spot Date (i.e. excluding cashflows before or on the figure Spot Date). leg1 The present value of the cashflows of the first leg after the figure Spot Date. Vp leg2 The present value of the cashflows of the second leg after the figure Spot Date. φ The average of the present value components. Vp Note: φ = 0.5, in the case of IR Swap as we have two present value components (one per leg). 2.3.4.9.6 Effective Spread Duration Equation 2-273 Key figures: Effective Spread Duration Eμ U μ = ----------------------------V p × 0.0001 where E μ is the total spread IR exposure of the position and Vp is the total present value of the position. 146 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.3 Key-figures 2.3.4.9.7 Effective Beta Duration Effective beta duration (duration times spread or DTS) is effective spread duration scaled by Z-spread. It gives the sensitivity to a relative change in spread, where spread duration is the sensitivity to an absolute change in spread: Equation 2-274 Key figures: Effective Beta Duration Uβ = Uμ × μz See Risk method Z-Spread on page 123. 2.3.5 Dual currency A dual currency cashflow is a cashflow where the actual payment is in a different currency to the cashflow currency. The FX rate used in calculating the settlement amount may be fixed or floating. The cashflow currency amount may also be fixed or floating. TRM supports the following three cases: • Fixed amount, fixed FX rate, see 2.3.5.1 Fixed amount, fixed FX rate on page 147. • Fixed amount, floating FX rate, see 2.3.5.2 Fixed amount, floating FX rate on page 148. • Floating amount, fixed FX rate, see 2.3.5.3 Floating amount, fixed FX rate on page 148. The following sections describe how dual currency cashflows are valuated. 2.3.5.1 Fixed amount, fixed FX rate In this case the payment amount is known, so that it can be treated the same way as any fixed cashflow. The essential figures are: • Settlement Amount As As = ASs where A is Amount, and Ss is Settlement FX Rate • Figure Market Value V = AsD/(SxS) where Sx is the FX rate between cashflow currency and the settlement currency, S is Figure FX Convert (between the cashflow currency and the figure currency) and D is the Figure Market Value Discount Factor. 2.3.5.1.1 Example: Fixed amount, fixed FX rate Let us consider the following cashflow and market data: Name Symbol Value Amount A 7500.0 Settlement FX Rate Ss 10.0 FX Rate Sx 9.799 Figure FX Convert S 1.2 Figure Market Value Discount Factor D 0.9948283718493263 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 147 2 Market standards and calculations 2.3 Key-figures Key figures are: Name Symbol Value Settlement Amount Market Value As 7500.0 × 10.0 = 75000.0 Market Value V 75000.0 x 0.9948 / (9.799 x 1.2) = 6345:22 2.3.5.2 Fixed amount, floating FX rate This case is a risk-wise equivalent to an ordinary single currency cashflow, except that Figure Payment Amount has to be estimated: Payment Amount Apay • Apay = ASx where A is Amount, and Sx is FX Rate between cashflow and settlement currencies (not shown in Transaction Admin). Figure Market Value • Since the FX rate is floating, the market value (and risks) are the same as for a fixed cashflow in the cashflow currency. V = AD/S where D is Figure Market Value Discount Factor (in the cashflow currency). 2.3.5.2.1 Example: Fixed amount, floating FX rate Market data: Name Symbol Value Amount A 1000000.0 FX Rate Sx 9.799 Figure FX Convert S 1.2 Figure Market Value Discount Factor D 0.993433829648000 Name Symbol Value Payment Amount Apay 1000000.0 × 9.799 = 9799000.0 Market Value V 1000000.0 x 0.9934 / 1.2 = 827861.52 Key figures are: 2.3.5.3 Floating amount, fixed FX rate In this case IR exposure is divided between the settlement and cashflow currencies, while FX exxposure is in the cashflow currency. • Payment Amount Ap is estimated using the risk profile defined for the instrument: Ap = A[D1,D2,s]Ss where D1 and D2 are the discount factors (in cashflow currency) for the start and end dates of the interest period, s is the spread, and Ss is the Settlement FX Rate. Function A[] is the payment amount estimation method provided by the risk profile. • 148 Figure Market Value is the estimated payment amount discounted and converted to the figure currency. © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations V = ApayDpay/(SxS) where Dp is the discount factor for payment date (in settlement currency). 2.3.5.3.1 Example: Floating amount, fixed FX rate This example shows calculations with plain vanilla risk profile without spread. Name Symbol Value Amount A 1000000.0 FX Rate Sx 9.799 Settlement FX Rate Ss 10.0 Figure FX Convert S 1.2 Figure Market Value Discount Factor D 0.996858127940000 Figure Present Value Discount Factor (1) D1 0.999053805572000 Figure Present Value Discount Factor (2) D2 0.996858127940000 Figure Present Value Discount Factor (p) Dp 0.996858127940000 Name Symbol Value Payment Amount Apay 1000000.0 x (0.9991 / 0.9969 - 1) x 10.0 = 22025.98 Market Value V 22025.98 x 0.9969 / (9.799 x 1.2) = 1867.26 Key figures are: 2.4 Performance calculations Performance measurement is an area that has become increasingly important as clients of asset managers have become more sophisticated and demanding. Portfolio managers are expected to meet or beat a specified benchmark on a regular basis. In order to facilitate calculations and comparisons of traded and benchmark portfolios, common standards have evolved, such as the Performance Presentation Standards set up by the Association of Investment Management and Research (AIMR-PPS). The performance measurement implemented in TRM in Performance Monitor is based on these standards. One objective of the performance measurement process is to calculate the performance of traded portfolios and then compare it to the performance of selected benchmarks. In principle it is possible to outperform the benchmark by (i) stock (bond) picking, in other words being over or under exposed in a specific security relative to the benchmark and (ii) using leveraged instruments that have different payoff profiles than the underlying cash (spot) instruments. Examples of leveraged instruments include forwards, futures, and options. The benchmark portfolios used for comparison against the traded portfolios consist of transactions created from index compositions which represent the target performance for a portfolio. Risk, for performance measurement, is the amount of deviation from the benchmark rather than absolute changes in the portfolio market value. Treasury Monitor can be used to produce a key-figure level analysis of the traded portfolio versus the benchmark. Performance is measured by the time-weighted rate of return (TWR). TWR measures the change in the value of a portfolio as a percentage of the capital that has actually been invested. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 149 2 Market standards and calculations 2.4 Performance calculations 2.4.1 Actual basis and all cash basis The AIMR-PPS standards require that performance is measured on both an actual basis and an all cash basis. Actual basis and all cash basis can be defined as follows: • Actual basis measures the growth of the actual invested capital, in other words it is a combination of both stock picking and leverage. • All cash basis attempts to eliminate the effects of leverage by restating the position into an equivalent cash position having the same market exposure (the spot equivalent position, SEP). The all cash basis performance is then the performance measured on the restated cash equivalent position. If a fund is using leverage, the AIMR-PPS standards require the presentation of both actual and all cash basis performance. Since the benchmark is normally non-levered, the comparison between the benchmark and all cash basis show the stock picking ability of the fund manager whereas the difference between the actual and the all cash basis performance indicate timely and efficient use of leverage in managing the fund. 2.4.2 Trade date and value date based performance Typically a cash (spot) transaction is committed on the trade date but physically delivered and paid some days later on the value date. Clearly, a bought position is exposed to the market from trade date but the market value during the period until value date depends on whether the trade or value date approach is adopted. The two methods are defined as follows: • With the trade date method, the market value on the trade date is equal to the value of the position side of the transaction, and consequently, the cashflow term on the trade date is equal to the settlement payment. Thus, the trade date method can be seen as trading with immediately delivery and payment. • With the value date method, the market value during the period between trade and value date is the net value of the position and the settlement payment. On the value day the cashflow term is equal to the settlement payment and the market value is equal to the value of the position side. Traditional investment management has adopted the trade date approach, whereas the value date approach is more prevalent among corporate treasuries. TRM supports both approaches. The default is the trade date method. The AIMR-PPS standards stated that trade date valuation was required after 1/1/2005. 2.4.2.1 Bank accounts If the position includes bank accounts then buying a cash (spot) instrument is just a reallocation of the needed cash from the bank account into the bought instrument. This should of course not cause any jumps in the total market value of the position, neither should there be any cashflows in or out of the aggregated position. In value date based performance, the total market value does not show any jumps since the money is physically drawn on the bank account the same day as the bought instrument takes on the full un-netted market value. The cashflow into the instrument is balanced by the negative cashflow at the bank account and thus on the aggregated level there are no cashflows in or out of the position. Using trade date based performance the cashflows do not cancel each other out since the flow into the instrument happens on the trade date whereas the physical out flow on the bank account is at value date. Also the total market value jumps as an effect of the trade; at trade date the total value increases due to the mismatch between the un-netted market value of the bought instrument and the fact that the money is still in the bank account balance (and will earn interest) until the value date. The observed problem can be solved by including a fictitious bank account in the position. On the calculated fictive account the settlements of bought (sold) instruments are drawn (deposited) at trade date and subsequently reversed at value date. In this way, when buying (selling) an instrument we get a negative (positive) cashflow at trade date in the fictitious bank account balancing the cashflow into (out of) the instrument, and one positive (negative) cashflow at value date in the fictitious account balancing the flow out of (into) the real bank account. The increase (decrease) in the market value at instrument level is balanced by the negative (positive) balance in 150 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations the fictitious account. On the aggregated position level, there are no cashflows and no jumps in the market value, either at the trade date or the value date. 2.4.3 Time-weighted rate of return (TWR) The ideal TWR index for the period 0 to T, with valuation whenever cashflows occur, is given by: Equation 2-275 MV 1 MV l + 1 MV L MV T P TWRT, 0 = ------------------------- × .... × ----------------------- × .... × --------------------------------------- × -------------------------MV 0 + C 0 MV l + C l MV L – 1 + C L – 1 MV L + C L where – l = {0, ..., L} is the time, in the period 0 to T, at which the cashflows occur – MVl is the market value including accrued income but before any deposits/withdrawals to/from the portfolio at time l – Cl represents the cashflows (deposits, positive flow / withdrawals, negative flow) to/from the portfolio at time l. The definitions of the market values and the cashflow terms will depend on: (i) whether performance is measured on the actual basis or the all cash basis, (ii) whether the trade date or value date approach is used and (iii) the transaction type, for example whether it is a spot, forward/future, option or composite instruments such as a swap. The major drawback with the ideal TWR index is that it requires re-valuing the portfolio each time there is a cash inflow or outflow. If the portfolio does not include the cash position then every buy/sell creates a cashflow in/out of the portfolio. Thus, the portfolio has to be re-valued every time a transaction takes place. This is neither feasible nor practical and thus the ideal TWR index is normally approximated with the TWR daily sampled index: Equation 2-276 MV 1 MV t + 1 MV T P DailyT, 0 = ------------------------- × .... × ----------------------- × .... × --------------------------------------MV 0 + C 0 MV t + C t MV T – 1 + C T – 1 where – MVt is the market value including accrued income but before any deposits/withdrawals to/from the portfolio on day t, – Ct represents the sum of all cashflows (deposits, positive flow / withdrawals, negative flow) to/from the portfolio during day t: Ct = ∑ C l̃ l̃ ∈ {t – 1, t } The Dietz method overcomes the need to know the valuation of the portfolio on the date of each cashflow by assuming a constant rate of return on the portfolio during the period. The original Dietz method assumed that all cashflows occurred at the midpoint of the period. The modified Dietz Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 151 2 Market standards and calculations 2.4 Performance calculations method weights each cashflow by the amount of time it is held in the portfolio. The modified Dietz method for the period from 0 to T is given by: Equation 2-277 L MV T + ∑ ( Wl – 1 )Cl l=0 P Dietz T, 0 = ------------------------------------------------------L MV 0 + ∑ Wl Cl l=0 where the weight factor Wl is the proportion of the period (from 0 to T) that the cashflow Cl has been in/out of the portfolio: T–l W l = ----------T The original Dietz method is obtained by setting the weight Wl = 1/2, for all l. The AIMR-PPS standards currently require that portfolio performance is evaluated using TWR calculations at least quarterly and these interim returns are geometrically linked. From 1/1/2001 (periods from that date), monthly valuations are required. The AIMR accept approximation methods such as the modified Dietz method. 2.4.3.1 Percentage growth from the TWR index Assuming positive market values, the percentage growth (return) during day t is given by: Equation 2-278 % P TWRt, t – 1 = ( P TWRt, t – 1 – 1 ) × 100 Similarly for the whole period from 0 to T the percentage growth is: Equation 2-279 % P TWR T, 0 = ( P TWRT, 0 – 1 ) × 100 2.4.3.2 TWR calculations in TRM In order to calculate daily return in TRM, the intraday Dietz returns are first calculated. Then, the intraday Dietz returns are geometrically linked as a Time-Weighted Return Index: the product of the Dietz returns allows for transitions from a short/long position to a long/short position in period 0 to T. Finally, the daily return in TRM is derived as the growth from the TWR Index between time t and t-1. 152 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations 2.4.3.2.1 Intraday Dietz returns Due to the problems of determining the exact time of each intra-day cashflow to calculate the intra-day performance, we assume a constant cashflow weighted by factor W. The intraday Dietz return is then given by: Equation 2-280 ∑ MV t ( u ) + ∑ ( W – 1 )C t ( u ) u∈U u∈U P Dietzt, t – 1 = ---------------------------------------------------------------------------------∑ MVt – 1 ( u ) + ∑ WCt ( u ) u∈U u∈U where – U is the position and u an instrument in that position, – MVt(u) is the market value of the instrument u at time t including cashflows during the period t-1 to t (one day), – Ct(u) is the sum of all cashflows in (positive flow) / out (negative flow) to/from the instrument u during the period t-1 to t: Ct ( u ) = ∑ C (u) l̃ l̃ ∈ {t-1, t } – W is the constant weight factor applied to the sum of the cashflows (not the individual cashflows) giving the proportion of the day the intra-day cashflows are assumed to have been in or out of the position. With w = 1, 1/2, or 0, all cashflows are assumed to take place at the beginning, middle or end of the day, respectively. 2.4.3.2.2 Geometric linking of intraday Dietz returns These intraday returns can then be geometrically linked as a Time-Weighted Return Index to provide PDietzT,0 for the period from 0 to T. This method allows for transitions from a short/long position to a long/short position in the period 0 to T. With this method, each transition is assumed to occur at the end of a day. The M (end day) transition points are collected in the set A: Equation 2-281 ⎛ ⎞ ⎛ ⎞ A = {t: sign ⎜ ∑ MV t ( u ) + ∑ ( W – 1 )C t – 1 ( u )⎟ ≠ sign ⎜ ∑ MV t ( u ) + ∑ WC t ( u )⎟, t=1,..,T} ⎝u ∈ U ⎠ ⎝u ∈ U ⎠ u∈U u∈U where the variables are as described for Equation 2-280 on page 153 and A(m) is the mth transition from long/short to short/long (m=1,...,M). The return for a long sub-period [A(m), A(m+1)] is given by: Equation 2-282 A ( m+1 ) P FK_TWR [A ( m ),A ( m + 1 )] ( U ) = ∏ P Dietzt, t – 1 ( U ) t = A ( m )+1 and for a short sub-period: Equation 2-283 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 153 2 Market standards and calculations 2.4 Performance calculations A ( m+1 ) P shortFK_TWR [A ( m ),A ( m + 1 )] ( U ) = 2 – ∏ P Dietz t, t – 1 ( U ) t = A ( m )+1 The combined return index for the whole period from 0 to T, assuming A(0)=0 and A(M+1)=T, is given by the following: Equation 2-284 M P FK_TWR [T,0] ( U ) = ∏ P̃FK_TWR [A( m ),A( m + 1 )] ( U ) m=0 where P̃ FK_TWR [A ( m ),A ( m + 1 )] ( U ) is given by either P FK_TWR [A ( m ),A ( m + 1 )] ( U ) if ⎛ ⎞ sign ( P FK_TWR [A ( m ),0] ( U ) ) = sign ⎜ ∑ MV A ( m ) ( u ) + ∑ WC A ( m ) ( u )⎟ ⎝u ∈ U ⎠ u∈U or P shortFK_TWR [A ( m ),A ( m + 1 )] ( U ) if ⎛ ⎞ sign ( P FK_TWR [A ( m ),0] ( U ) ) ≠ sign ⎜ ∑ MV A ( m ) ( u ) + ∑ WC A ( m ) ( u )⎟ ⎝u ∈ U ⎠ u∈U 2.4.3.2.3 TRM Return as the percentage growth of the TWR Index Finally, the return during day t is given by: Equation 2-285 TRM Return as the percentage growth of the TWR Index % P TWRt, t – 1 = ( P TWRt, t – 1 – 1 ) × 100 2.4.4 Money-weighted return Given a portfolio with initial market value V0, cashflows ci on dates ti, and final market value VT at time T, money weighted return, or internal rate of return (y), is defined as the constant interest rate 154 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations such that the total of the initial value and all cashflows prolonged to time T with y is equal to the final value: Equation 2-286 ci V0 ----------------- + ∑ ------------------------- – VT = 0 D ( y ,T ) D (y,T – t i) i If the type of the interest rate is compounded (at any frequency), it is possible to choose to discount all cashflows to the start date, or any other date for that matter, and obtain the same result. Periodic rate and discount rate will usually provide different results depending on the valuation date. 2.4.4.1 Periodic Rate If we use interest type Periodic Rate and prolong to the end date of the observation period, the above equation can be solved without iteration: Equation 2-287 V 0 ( 1 + yT ) + ∑ c i ( 1 + y ( T – t i ) ) – V T = 0 i ⎛ ⎞ V T – V 0 – Σc i = y ⎜ V 0 T + ∑ c i ( T – t i ) ⎟ ⎝ ⎠ i V T – V 0 – Σc i y = --------------------------------------------V0 T + Σi ci ( T – ti ) 2.4.5 Instrument market values for third currency The saved Performance Data (Market Value) of a Portfolio is based on Treasury Monitor's market value calculation. This performance data is saved by running the Performance Data Calculation activity. The Performance Data Calculation activity saves the home currency market value and the local market value as they are calculated by Treasury Monitor. Equation 2-288 Home currency market value and local currency market value V HomeCCY = V LocalCCY × S v { LocalCCY ⁄ HomeCCY } where V HomeCCY The saved performance data (market value) Sv The FX conversion from the transaction's Trading Currency (for example GBP) into the chosen Figure Currency (for example, EUR or USD) depends on the FX method that is defined at the instrument level (Instrument Editor - Base Valuation page). See A.2.50 Base Valuation Setup on page 734. FX method calculations are described in section 2.1.6.3 FX rate calculation on page 79. LocalCCY The transaction currency HomeCCY The currency in which the Performance Data Calculation activity was run. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 155 2 Market standards and calculations 2.4 Performance calculations 2.4.5.1 Converting the portfolio home currency into figure currency By default, the Performance Monitor's market value is calculated and stored in the portfolio trading currency. Therefore, in order to display the market value in a third currency (i.e. in a figure currency other than the portfolio trading currency) the Performance Monitor converts the home currency market value into the third currency using the FX spot rate. Note: If you want to avoid the FX spot conversion and use the figure currency data that is calculated in the same way as in the Treasury Monitor, see 2.4.5.2 Figure currency based on Treasury Monitor's market value calculation on page 156. To convert the portfolio home currency into the figure currency you use the Performance Data Calculation activity as follows: Field Description Top Portfolio To Process Name of the top portfolio. The activity saves the home currency market value in the portfolio base currency. This is the default behavior if nothing is set in the Figure Currency field. Figure Currency Leave this field empty to save the home currency market value in the portfolio base currency. To display the market value in a third currency in the FX Spot Rate figure, the Performance Monitor converts the home currency market value to the third currency. Equation 2-289 Home currency market value and local currency market value V ThirdCCY = V HomeCCY × S { HomeCCY ⁄ ThirdCCY } where S The FX Spot. Note: Only one home currency market value is saved at a time. When you run the activity again, the previous market value is replaced with the new one. 2.4.5.2 Figure currency based on Treasury Monitor's market value calculation The Performance Monitor's market value can also be directly expressed (i.e. without an FX spot conversion as detailed in 2.4.5.1 Converting the portfolio home currency into figure currency on page 156) in a third currency i.e. in a figure currency other than the portfolio trading currency. In this case, like in the Treasury Monitor, the FX conversion of the transaction's cashflow currency (for example GBP) into the chosen figure currency (for example, EUR or USD) depends on the FX Method set up in the Instrument Editor in the Base Valuation page (Base Valuation Setup feature). The FX methods can be: • Spot Rate • Today's Rate (Forward points) • Today's Rate (IR Differential) See A.2.50 Base Valuation Setup on page 734 for more information. 156 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations To convert the portfolio home currency directly into the figure currency you use the Performance Data Calculation activity as follows: Field Description Top Portfolio To Process Name of the top portfolio. The activity saves the home currency market value in the portfolio base currency. This is the default behavior if nothing is set in the Figure Currency field. Figure Currency The activity saves the home currency market value in the selected figure currency. For example, if you run the Performance Data Calculation activity with a top portfolio base currency of USD and nothing in the Figure Currency field, and then you run the activity again with Figure Currency = EUR, the activity will store both the USD home currency market value and the EUR home currency market value in the database. 2.4.5.3 Examples The following the examples illustrate the different FX method calculations for a transaction of 100000000 GBP using the following data: Data Example Top Portfolio base currency USD Trading Portfolio base currency EUR Transaction currency GBP 2.4.5.3.1 FX Method = Spot Rate (Default) This example illustrates two scenarios, one with the Top Portfolio and one with the Portfolio using the Spot Rate method. The Today' s Rate (Forward Points) method is very similar to the Spot Rate method and is not described separately. Note: For the trading of futures, you need to specify a cost of carry instrument at the portfolio level. Scenario 1: The activity is run for the Top Portfolio in USD When the Performance Data Calculation activity is run on the Top Portfolio with a different base currency to the Trading Portfolio's, the Market Value is saved in the Top Portfolio currency and over the previously saved market value for the trading currency is overridden. Equation 2-290 Example - Spot Rate equation 1 V HomeCCY = V LocalCCY × -----------------------------------------------------S { LocalCCY ⁄ HomeCCY } Equation 2-291 Example - Spot Rate S { GBP ⁄ USD } = 1.50 Equation 2-292 Example - Spot Rate: Top Currency calculation V TopHomeCCY = 100000000 × 1.50 = USD150000000 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 157 2 Market standards and calculations 2.4 Performance calculations Furthermore, in Performance Monitor, when the user selects both the Top and the Trading Portfolios, the stored Market Value in the Top Portfolio currency (USD) is converted to the Trading Portfolio currency (EUR) using the FX Spot Rate. The third currency is calculated as follows: Equation 2-293 Example - Spot Rate: Third Currency equation 1 V ThirdCCY = V HomeCCY × -----------------------------------------------------S { ThirdCCY ⁄ HomeCCY } Equation 2-294 Example - Spot Rate S { EUR ⁄ USD } = 1.20 Equation 2-295 Example - Spot Rate: Third Currency conversion 1 V ThirdCCY = 150000000 × ---------- = EUR125000000 1.20 Scenario 2 The activity is run for the trading portfolio in EUR When the activity is run for the Trading Portfolio the following calculations are done: Equation 2-296 Example - Spot Rate: Trading Portfolio equation V HomeCCY = V LocalCCY × S v { LocalCCY ⁄ HomeCCY } Equation 2-297 Example - Spot Rate: Trading Portfolio FX Spot S { GBP ⁄ EUR } = 1.25 Equation 2-298 Example - Spot Rate: Trading Portfolio Currency conversion V TopHomeCCY = 100000000 × 1.25 = EUR125000000 Furthermore, in Performance Monitor, when the user selects both the Top and the Trading Portfolios, the stored Market Value in the Trading Portfolio currency (EUR) is converted to the Top Portfolio currency (USD) using the FX Spot Rate. The third currency is calculated as follows: Equation 2-299 Example - Spot Rate: Trading Portfolio Third Currency equation V ThirdCCY = V HomeCCY × S { HomeCCY ⁄ ThirdCCY } Equation 2-300 Example - Spot Rate: Trading Portfolio S { EUR ⁄ USD } = 1.20 Equation 2-301 Example - Spot Rate: Trading Portfolio Third Currency conversion V ThirdCCY = 125000000 × 1.20 = USD150000000 158 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations 2.4.5.3.2 FX Method = Today' s Rate (IR Differential) Scenario 1: The activity is run for the Top Portfolio in USD Equation 2-302 Example - Today' s Rate (IR Differential) Top Portfolio equation V HomeCCY = V LocalCCY × S v { LocalCCY ⁄ HomeCCY } Equation 2-303 Example - Today' s Rate (IR Differential) Top Portfolio currency conversion S v { GBP ⁄ USD } = 1.49983775759643 Equation 2-304 Example - Today' s Rate (IR Differential) Top Portfolio V TopHomeCCY = 100000000 × 1.49983775759 = USD149983775.76 Furthermore, in Performance Monitor, when the user selects both the Top and the Trading Portfolios, the stored Market Value in the Top Portfolio currency (USD) is converted to the Trading Portfolio currency (EUR) using the FX Spot Rate. The third currency is calculated as follows: Equation 2-305 Example - Today' s Rate (IR Differential) Top Portfolio: Third Currency equation 1 V ThirdCCY = V HomeCCY × -----------------------------------------------------S { ThirdCCY ⁄ HomeCCY } Equation 2-306 Example - Today' s Rate (IR Differential) Top Portfolio: FX Spot S { EUR ⁄ USD } = 1.20 Equation 2-307 Example - Today' s Rate (IR Differential) Top Portfolio: Third Currency conversion 1 V ThirdCCY = 149983775.76 × ------- = EUR124986479.80 1.2 Scenario 2: The activity is run for the Trading Portfolio in EUR Equation 2-308 Example - Today' s Rate (IR Differential): Trading Portfolio equation V HomeCCY = V LocalCCY × S v { LocalCCY ⁄ HomeCCY } Equation 2-309 Example - Today' s Rate (IR Differential): Trading Portfolio FX Spot S v { GBP ⁄ EUR } = 1.24988909927463 Equation 2-310 Example - Today' s Rate (IR Differential): Trading Portfolio Currency conversion V TradingCCY = 100000000 × 1.24988909927 = EUR124988909.93 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 159 2 Market standards and calculations 2.4 Performance calculations Furthermore, in Performance Monitor, when the user selects both the Top and the Trading Portfolios, the stored Market Value in the Trading Portfolio currency (EUR) is converted to the Top Portfolio currency (USD) using the FX Spot Rate. The third currency is calculated as follows: Equation 2-311 Example - Spot Rate: Trading Portfolio Third Currency equation V ThirdCCY = V HomeCCY × S { HomeCCY ⁄ ThirdCCY } Equation 2-312 Example - Spot Rate: Trading Portfolio S { EUR ⁄ USD } = 1.20 Equation 2-313 Example - Spot Rate: Trading Portfolio Third Currency conversion V ThirdCCY = 124988909.93 × 1.20 = USD149986691.91 2.4.6 Instrument market values and cashflows 2.4.6.1 Spot instruments Spot instruments are un-leveraged instruments and therefore performance measurement based on actual basis and all cash basis will be identical for those instruments. For the actual basis approach, the selected trade or value date method defined for the instrument will determine the market values and cashflows terms. For the all cash basis approach, the trade date values are used. 2.4.6.2 Forward/future instruments For forward and future instruments the delivery price is typically set such that the contract cost nothing to enter. The payoff function is linear since a 1 unit increase (decrease) in the unit forward price implies a 1 unit increase (decrease) in the market value of the (long) forward/future contract. However, since no initial investment is required the instrument has a leveraged percentage payoff compared with an equivalent spot position. As an example, consider a forward contract with delivery price 90, forward price 100 and thus a market value of 10. If the forward price increases by 1 unit to 101 then the market value of the forward also increases by 1 unit to 11 leading to a percentages return of (11/10 -1) 10%. The percentages return on the spot position is around (101/100 - 1) 1% and thus the forward position can be regarded as geared 10 times compared to the spot position. The market value at time t of a forward contract is given by: Equation 2-314 MV t = F t × #unit – K × #unit where Ft is the forward price at time t, K is the delivery price and #unit is the contract size. The sensitivity with respect to the spot rate St is given by: Equation 2-315 ∂MV t ∂( F t × # unit ) ∂( S t × D (t,T) × #unit ) -------------- = ------------------------------- = ------------------------------------------------------ = D (t,T) × #unit ∂S t ∂S t ∂S t where we have used the arbitrage free relation between the spot and forward rates expressed by the discount factor D(t,T) for the period between t and the maturity of the contract T. 160 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations The spot equivalent position, SEP (used for the all cash basis approach to performance measurement) should have the same market exposure as the forward. Therefore: Equation 2-316 ∂MV SEPt ----------------------- = D (t,T) × #unit → MV SEPt = S t × D (t,T) × #unit = F t × ( #unit ) ∂S t The market value of the spot equivalent position MVSEPt is given by the value of the position side of the forward/future transaction. The market values and cashflow terms for the two performance methods are: • Actual basis: The performance should measure the growth of the actual invested capital, in other words the market value is MVt given by Equation 2-314 on page 161. If the transaction has a cash settlement then the cashflow term at value date is equal to the settled cash amount. If the transaction results in delivery of the underlying, then this is handled as a spot transaction committed at the notification date. • All cash basis: The effect of the used leveraged should be eliminated by restating the position into a spot equivalent one, in other words the market value is given by MVSEPt in Equation 2-316 on page 161. The cashflow term at trade date should be equal to the cash needed to buy the spot equivalent position: Equation 2-317 C 0 = MV SEP0 = F 0 × # unit = K × # unit The periodical fixing of futures will cause the period market value change to be realized. From a performance perspective this is equivalent to selling/buying market value and thus the cashflow term will balance the change in market value such that the performance is unaffected by the mark-to-market process. 2.4.6.3 Option instruments There is a large variety of different option contracts in the market which have a non-linear payoff function with respect to the price of some underlying instrument. One option position and one spot position requiring the same initial investment will certainly have very different percentages returns. Typically, the return of the option position will have larger volatility than the return of the spot position. In this sense the option position is a leveraged position. First we assume an option valuation model, in TRM it is the Black-Scholes model, linking the theoretical unit value of the option f and the spot rate of the underlying instrument St: Equation 2-318 MV t = f ( S t, t, .... ) The sensitivity of the option position is then given by: Equation 2-319 ∂MV t ∂( f ( S t, t, .... ) ) -------------- = -------------------------------- × #unit = Δ ( S t, t, .... ) × #unit ∂S t ∂S t where the partial derivative using the Black-Scholes model is delta, a risk key-figure. The spot equivalent position (SEP) should have the same instantaneous market exposure as the option position. Therefore: Equation 2-320 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 161 2 Market standards and calculations 2.4 Performance calculations ∂MV SEPt ----------------------- = Δ ( S t, t, .... ) × #unit → MV SEPt = S t × Δ ( S t, t, .... ) × #unit ∂S t Thus, the SEP position is equal to: Δ ( S t, t, .... ) × #unit units of the underlying instrument. The delta typically varies over the life of the option and thus the unit size of the SEP position is not constant over time. From the above analysis the following definitions follow: • Actual basis: The performance should measure the growth of the actual invested capital, in other words the market value is MVt given by Equation 2-318 on page 162. If the transaction has a cash settlement then the cashflow term at value date is equal to the settled cash amount. If the transaction results in delivery of the underlying, then this is handled as a spot transaction committed at the exercise date. • All cash basis: The effect of the used leveraged should be eliminated by restating the position into a spot equivalent one, in other words the market value is given by MVSEPt in Equation 2-320 on page 162. The cashflow term at trade date should be equal to the cash needed to buy the spot equivalent position: Equation 2-321 C 0 = MV SEP0 = S 0 × Δ ( S 0, 0, .... ) × #unit where S0 and Δ ( S 0, 0, .... ) are the spot rate and delta, respectively, at the time the position was committed. The unit size of the SEP position may vary with time: increases can be regarded as more units being bought and decreases as some units being sold. Thus, from a performance perspective the result is a re-balancing cashflow of: Equation 2-322 C t = S t × ( Δ ( S t, t, .... ) – Δ ( S t – 1, t – 1, .... ) ) × #unit 2.4.6.4 Swaps and other composite instruments Swaps and composite instruments such as buy/sell back repos are essentially a combination of other instruments. In general the actual basis approach treats the composite as a separate instrument whereas the all cash basis approach handles the components of the composite as separate transactions. For example, when using the actual basis the market value of a regular interest rate swap is the net value of the receiving and the paying leg. For the all cash basis however the swap is regarded as one long spot position in the receiving leg and one short spot position in the paying leg. 2.4.7 Example portfolio As an example portfolio we will use a cash position together with a spot and forward position in the same instrument. The initial cash position is 100. On day 1 we first commit one spot transaction of 1 unit at the price 50 for delivery at day 3. Secondly we commit a one month forward transaction of 1 unit at the delivery price 50.5. The market rates used are given in the table below. The overnight balance on the bank account will earn the constant O/N interest rate of 0.1%. Day Spot Rate Forward Rate O/N Interest Rate 0 50 50.5 0.1% 1 51 51.5 0.1% 162 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations Day Spot Rate Forward Rate O/N Interest Rate 2 52 52.5 0.1% 3 53 53.5 0.1% 4 54 54.5 0.1% 5 55 55.5 0.1% 6 56 56.5 0.1% 7 57 57.5 0.1% 8 58 58.5 0.1% 9 59 59.5 0.1% 2.4.7.1 Actual basis performance with value date method The market values and the cashflow terms have been calculated according to the value date version of the actual basis performance method (see table below). Day 3 is the value date of the spot transaction and it can be seen that the instrument level cashflow of 50 is balanced by the bank account cashflow of -50 such that no cashflows occur at the aggregated (portfolio) level. Day Spot Forward Bank Account Portfolio Market Value Cash flow Market Value Cash flow Market Value Cash flow Market Value Cash flow 0 0 0 0 0 100 0 100 0 1 1 0 1 0 100.10 0 102.1 0 2 2 0 2 0 100.20 0 104.2 0 3 53 50 3 0 50.30 -50 106.3 0 4 54 0 4 0 50.35 0 108.35 0 5 55 0 5 0 50.40 0 110.40 0 6 56 0 6 0 50.45 0 112.45 0 7 57 0 7 0 50.50 0 114.50 0 8 58 0 8 0 50.55 0 116.55 0 9 59 0 9 0 50.60 0 118.60 0 On the portfolio level the performance (see Equation 2-280 on page 153 and Equation 2-279 on page 152) is given by: 102.1 104.2 106.3 108.35 110.40 112.45 114.50 116.55 118.60 P Dietz 9, 0 = ------------- × ------------- × ------------- × ---------------- × ---------------- × ---------------- × ---------------- × ---------------- × ---------------100 102.1 104.2 106.3 108.35 110.40 112.45 114.50 116.55 118.60 % = ---------------- = 1.1860 → P Dietz 9, 0 = ( P Dietz9, 0 – 1 ) × 100 = 18.60% 100 Thus the growth of the invested capital has been 18.60% over the period. The spot instrument level performance with the weight factor W set to 1 is given by: The high period performance is more or less due only to the 100% return of day 2 (the infinite performance of the first day is skipped by setting 1/0 = 1). The high return on day 2 is a consequence of using the value date method - the market value of the position side and the Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 163 2 Market standards and calculations 2.4 Performance calculations 1 2 53 54 55 56 57 58 59 P Dietz9, 0 = --- × --- × --------------- × ------ × ------ × ------ × ------ × ------ × ------ = 2.2692 0 1 2 + 50 53 54 55 56 57 58 % → P Dietz 9, 0 = ( P Dietz9, 0 – 1 ) × 100 = 126.92% payment side of the transaction is netted between trade date and value date. This gives a distorted instrument level performance that is not easily interpreted. 2.4.7.2 Actual Basis Performance with Trade Date Method The market values and the cashflow terms have been calculated according to the trade date version of the actual basis performance method (see table below). On day 1 the spot transaction is committed and thus we have a cashflow of 50 at the instrument level. In the table we can see that this cashflow is balanced by the negative cashflow of -50 in the calculated fictive bank account called Settlement. We also notice that the market value at spot instrument level from trade to value date is matched by the negative balance in the fictive bank account, such that the market value at portfolio level is the same as for the value date version of actual basis shown above. Day Spot Forward Bank Account Settlement Portfolio Market Value Cash flow Market Value Cash flow Market Value Cash flow Market Value Cash flow Market Value Cash flow 0 0 0 0 0 100 0 0 0 100 0 1 51 50 1 0 100.10 0 -50 -50 102.1 0 2 52 0 2 0 100.20 0 -50 0 104.2 0 3 53 0 3 0 50.30 -50 0 50 106.3 0 4 54 0 4 0 50.35 0 0 0 108.35 0 5 55 0 5 0 50.40 0 0 0 110.40 0 6 56 0 6 0 50.45 0 0 0 112.45 0 7 57 0 7 0 50.50 0 0 0 114.50 0 8 58 0 8 0 50.55 0 0 0 116.55 0 9 59 0 9 0 50.60 0 0 0 118.60 0 On the portfolio level the performance is the same as calculated for the value date method, 18.60%. The performance at the spot instrument level with the weight factor W set to 1 is now given by: 51 52 53 54 55 56 57 58 59 % P Dietz 9, 0 = --------------- × ------ × ------ × ------ × ------ × ------ × ------ × ------ × ------ = 1.18 → P Dietz9, 0 = 18% 0 + 50 51 52 53 54 55 56 57 58 showing that the instrument level performance is both stable and connected to the underlying rate change. In this example the spot rate percentages return is also 18% and thus the match is exact. With more buys and sells creating more cashflows in and out the match will not be 100%, still the connection is very strong. The performance attribution analysis of the selection effect have to be based on the trade date version and not on the value date version since the latter one is distorted by the trading in the instrument. The performance of the forward instrument is given by: 1 2 3 4 5 6 7 8 9 % P Dietz 9, 0 = --- × --- × --- × --- × --- × --- × --- × --- × --- = 9.00 → P Dietz9, 0 = 800% 0 1 2 3 4 5 6 7 8 164 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations Skipping day 0 (setting 1/0 = 1), the return of the forward was 800%. In comparison to the return on the spot position of 18%, the forward is clearly a leveraged instrument. 2.4.7.3 All cash basis performance (trade date only) The market values and the cashflow terms have been calculated according to the all cash basis performance method (see table below). With this method, all spot transactions are handled according to the trade date version. The figures for the spot transaction in the table below are therefore the same as for the actual basis performance with trade date method (previous page). The differences in the rest of the table are due to the fact that the forward position has been restated into the spot equivalent position (SEP) using the definition in 2.4.6.2 Forward/future instruments on page 160 (Equation 2-316 on page 161). Day Spot Forward Bank Account Settlement Portfolio Market Value Cash flow Market Value Cash flow Market Value Cash flow Market Value Cash flow Market Value Cash flow 0 0 0 0 0 100 0 0 0 100 0 1 51 50 51.50 50.5 100.10 0 -50 -50 152.60 50.5 2 52 0 52.50 0 100.20 0 -50 0 154.70 0 3 53 0 53.50 0 50.30 -50 0 50 156.80 0 4 54 0 54.50 0 50.35 0 0 0 158.85 0 5 55 0 55.50 0 50.40 0 0 0 160.90 0 6 56 0 56.50 0 50.45 0 0 0 162.95 0 7 57 0 57.50 0 50.50 0 0 0 165.00 0 8 58 0 58.50 0 50.55 0 0 0 167.05 0 9 59 0 59.50 0 50.60 0 0 0 169.10 0 On the forward instrument level the performance (W = 1) is now given by: · 51 52.5 53.5 54.5 55.5 56.5 57.5 58.5 59.5 P Dietz 9, 0 = ------------------- × ---------- × ---------- × ---------- × ---------- × ---------- × ---------- × ---------- × ---------- = 1.1782 0 + 50.5 51.5 52.5 53.5 54.5 55.5 56.5 57.5 58.5 % → P Dietz9, 0 = 17.82% It can be seen that the all cash basis performance for the forward instrument is very similar to the 18% return on the spot position. The use of forwards and futures gives the fund manager the possibility to gear the portfolio. In other words, they can take on more market exposure than there is cash in the portfolio to buy. In this sense the fund manager borrows money from the market. This implicit borrowing of the fund is represented at the aggregated portfolio level by a cashflow into the fund at the trade date of the forward / future. In the table above this can be seen as a cashflow of 50.5 on day 1 at the portfolio level. The all cash basis performance on the total portfolio level is given by: Note that the capital base of the fund was not fully invested; there was about 50 money that could have been invested in the spot instrument for example. If so, the all cash basis performance at the portfolio level would have been around 18%. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 165 2 Market standards and calculations 2.4 Performance calculations P Dietz9, 0 = 152.6 154.7 156.8 158.85 160.9 162.95 165 167.05 169.1 ------------------------× ------------- × ------------- × ---------------- × ---------------- × ---------------- × ---------------- × ---------------- × ---------------165 167.05 100 + 50.5 152.6 154.7 156.8 158.85 160.9 162.95 % = 1.1236 → P Dietz9, 0 = 12.36% 2.4.8 Risk-adjusted returns TRM produces risk-adjusted return figures in Performance Monitor. This allows you to measure the performance of your portfolio in relation to the amount of risk taken. Throughout this section a simplified notation for the time weighted rate of return (TWR) is used. The linked intraday Dietz returns used as TWR figures in TRM, defined in Equation 2-284 on page 154 as: P FK_TWR [T,0] ( U ) will here be denoted simply as: TWR T, 0 ( P ) 2.4.8.1 Sampling frequency As described in 2.4.3.2 TWR calculations in TRM on page 152, the time-weighted rate of return (TWR) in TRM is calculated from the intraday Dietz returns, based on daily market values and cashflows. These returns are then geometrically linked to calculate the TWR for longer periods. Due to the method of linking, it is generally not possible to calculate the TWR of a sub-period directly from the sub-period market values and cashflows. The sub-period (from b to a, b ≥ a) TWR of a portfolio P is instead given by the following equation: Equation 2-323 TWR b, 0 ( P ) TWR b, a ( P ) = ----------------------------TWR a, 0 ( P ) where TWRx,0(P) is the cumulative performance, from time 0 to x (a or b) of the portfolio P based on intraday Dietz returns. 2.4.8.1.1 Sub-period return The periodic return (%) of the sub-period is: Equation 2-324 R periodic ( b, a ) ( P ) = 100 × ( TWR b, a ( P ) – 1 ) The continuously compounded return (%) for the sub-period is: Equation 2-325 R cont ( b, a ) ( P ) = 100 × ln ( TWR b, a ( P ) ) 166 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations where ln() is the natural logarithm. Research has shown that the periodic return data tend to be skewed whereas the continuously compounded return data are more normally distributed. This is a tendency which becomes more pronounced with longer sub-periods. The measures of risk-adjusted return implemented in TRM assume normally distributed returns. The following sampling frequencies T, or sub-periods, expressed in calendar days are supported in TRM: T (sampling frequency) Calendar Days 1 1 day 1W 7 days 1M 30 days 3M 90 days During non-business days, the portfolio is assumed to have zero return and will therefore only accrue interest. For business days, the return for the sub-period, expressed in calendar days from d-T to d is therefore: Equation 2-326 TWR d, 0 ( P ) R d, d – T ( P ) = 100 × ln ⎛⎝ ------------------------------------⎞⎠ TWR d – T, 0 ( P ) (continuous yield) Equation 2-327 TWR d, 0 ( P ) R d, d – T ( P ) = 100 × ⎛ ------------------------------------ – 1⎞ ⎝ TWR d – T, 0 ( P ) ⎠ (periodic) 2.4.8.2 Aggregation periods Statistical measures (mean, variance and standard deviation) of the return given by Equation 2-326 on page 167 or Equation 2-327 on page 167 above can be calculated for either fixed or moving aggregation periods. Each measure will be associated with (and displayed at) the end date of the aggregation period. The aggregation period is expressed in terms of the sampling frequency, or T-periods (1 day, 1 week etc.). The total aggregation period length is given as N T-periods, where N is an integer. The return calculations, and hence the statistical measures, are based on the daily linked TWR series. If the length of the TWR series (which is in days) is not an integer multiple of N*T for fixed periods, or simply T for the moving periods, then the first period will be a short period. For example, assume that we have daily returns for one and a half years from 31/12/96 to 30/6/98, monthly sampling (T =1M) and a 12-month fixed aggregation period (N=12). The set of end dates would then be given by: Datesfixed = {30/6/98, 30/6/97} where the first period, to 30/6/97, would be a short period (only 6 months data available, from 31/12/96). For a 12-month moving aggregation period the set of end dates would be given by: Datesmoving = {30/6/98, 31/5/98, 30/4/98, 31/3/98, 28/2/98, 31/1/98, 31/12/97} and the first period, to 31/12/97, would be a full 12-month period. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 167 2 Market standards and calculations 2.4 Performance calculations 2.4.8.3 Portfolio returns The cumulative return of portfolio P for the aggregation period consisting of N T-periods and with an end date d is denoted by Rd,d-NT(P) and is calculated in the same way as for the sub-period return (Equation 2-326 on page 167 or Equation 2-327 on page 167): Equation 2-328 TWR d, 0 ( P ) R d, d – NT ( P ) = 100 × ln ⎛ ----------------------------------------⎞ ⎝ TWR d – NT, 0 ( P )⎠ (continuous yield) Equation 2-329 TWR d, 0 ( P ) R d, d – NT ( P ) = 100 × ⎛ ---------------------------------------- – 1⎞ ⎝ TWR d – NT, 0 ( P ) ⎠ (periodic) The annualized return is then given by: Equation 2-330 K(T) R annual, d, d – NT ( P ) = ⎛ -------------⎞ R (P) ⎝ N ⎠ d, d – NT (continuous yield) Equation 2-331 K(T) ------------⎛ ⎞ R d, d – NT ( P )⎞ N ⎛ ⎜ – 1⎟ R annual, d, d – NT ( P ) = 100 × 1 + -----------------------------⎜⎝ ⎠ ⎟ 100 ⎝ ⎠ (periodic) where K(T) is the number of T-periods making up a business year. The number of days, weeks and so on of a business year will differ from year to year. In order to simplify the calculations K(T) is fixed according to the sampling frequency T as follows: T (Sampling frequency) K(T) (no. of T-periods in business year) 1 (non-business days included) 365 1 (non-business days excluded) 260 1W 52 1M 12 3M 4 Annualizing the returns in this way makes the returns for different period lengths and sampling frequencies more comparable. Fund reports typically present return and risk adjusted return figures on an annualized basis. 168 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations 2.4.8.3.1 Statistics of the portfolio return The mean, variance and standard deviation of the portfolio return for portfolio P over the aggregation period are given as key-figures in Performance Monitor. Zero returns (from non-business days) are not included in these calculations and so these are estimates of the underlying market. A slightly different notation to that used for the return figures is employed for statistical figures. Mean Equation 2-332 T, N Rd ( P ) 1 = ---Ñ N–1 ∑ Rd – nT,d – ( n + 1 )T ( P ) n=0 Variance Equation 2-333 T, N Var ( R d ( P ) ) 1 = ------------Ñ – 1 N–1 T, N ∑ ( Rd – nT,d – ( n + 1 )T ( P ) – Rd (P)) 2 n=0 Standard Deviation Equation 2-334 T, N σ ( Rd (P)) = T, N Var ( R d (P)) where d is a period end date (as defined in 2.4.8.2 Aggregation periods on page 168), T is one of the supported sampling frequencies, N is the length of the period, expressed in T-periods and Ñ is the number of T-periodic returns that are non-null (business days). To clarify the notation used here for the statistical figures, we shall calculate the mean and variance for the last period ending 30/6/98 from the example given above in 2.4.8.2 Aggregation periods on page 168. (Daily returns for one and a half years from 31/12/96 to 30/6/98, monthly sampling (T =1M) and a 12-month aggregation period (N=12). The last period is the same for both the fixed and moving aggregation periods. Mean 11 1M,12 R 30/6/98 ( P ) 1 = ------ ∑ R 30/6/98-n × 1M, 30/6/98- ( n + 1 ) × 1M ( P ) 12 n=0 1 = ------ ( R 30/6/98, 31/5/98 ( P ) + ........ + R 31/7/97, 30/6/97 ( P ) ) 12 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 169 2 Market standards and calculations 2.4 Performance calculations Variance 11 1M,12 Var ( R 30/6/98 ( P ) ) 2 1M,12 1 = ------ ∑ ( R 30/6/98-n × 1M, 30/6/98- ( n + 1 ) × 1M ( P ) – R 30/6/98 ( P ) ) 11 n=0 2 2 1M,12 1M,12 1 = ------ ( ( R 30/6/98, 31/5/98 ( P ) – R 30/6/98 ( P ) ) + ( R 31/7/97, 30/6/97 ( P ) – R 30/6/98 ( P ) ) ) 11 The volatility is the annualized standard deviation of the cumulative return. Volatility Equation 2-335 T, N σ annual ( R d (P))= T, N K ( T ) × σ ( Rd (P)) where K(T) is the number of T-periods making up the business year. This scaling makes the volatility from one sampling frequency comparable with the volatility calculated from a different sampling frequency. The covariance between two portfolios describes the association between them. For example if a positive (negative) return in the portfolio P is associated with a positive (negative) return in the benchmark portfolio B, then the covariance between the portfolios will be positive. If a positive return in one of them is associated with a negative return in the other, then the covariance between them will be negative. Given that the returns are normally distributed then a covariance of zero implies that the returns are totally independent; if you observe the return of one portfolio it gives you no additional information about the likely return of the other portfolio. The covariance calculations in TRM exclude the null returns (the returns for non-business days) and so the covariance estimates are based on the underlying market. Covariance Equation 2-336 T, N Cov ( R d 1 -----------Ñ – 1 T, N ( P ), R d ( B ) )= N–1 T, N ∑ ( Rd – nT,d – ( n + 1)T ( P ) – Rd T, N ( P ) ) × ( R d – nT,d – ( n + 1 )T ( B ) – R d (B)) n=0 The standardized covariance is called the correlation coefficient and can have values ranging from -1 to +1. A correlation coefficient of +1 implies perfect positive correlation and -1 implies perfect negative correlation. Perfect positive (negative) correlation means that there is a positive (negative) linear relation between the returns of the two portfolios. For example if you observe a positive return in the benchmark portfolio B then you also know the positive (negative) return of the portfolio P. 170 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations Correlation Coefficient Equation 2-337 T, N ρ ( R d ( P ), T, N Rd ( B ) ) = T, N T, N Cov ( R d ( P ), R d ( B ) ) -------------------------------------------------------------------------------------T, N T, N Var ( R d ( P ) ) × Var ( R d ( B ) ) 2.4.8.3.2 TRM variables The following key-figures related to portfolio return are available in Performance Monitor. The statistics are provided for user analysis. Standard risk adjusted return measures (for example the Sharpe Ratio and the Treynor Ratio) are also provided, and are described in 2.4.9 Risk-adjusted return measures on page 175. • The return, cumulative return and annualized return figures: Return, Return (Cumulative) and Return (Annualized) key-figures, respectively. • The statistics of the portfolio (cumulative) return: Return Mean, Return Variance, Return Standard Deviation, Return Volatility, Covariance, Correlation Coefficient. 2.4.8.4 Excess returns In performance analysis the fund manager is more interested in the return relative to the benchmark portfolio than the return of the portfolio itself. The cumulative excess return of portfolio P relative to the benchmark portfolio B is the difference in returns: Equation 2-338 R d, d – NT ( P – B ) = R d, d – NT ( P ) – R d, d – NT ( B ) The annualized excess return is then calculated in a similar way to the annualized return as shown above: Equation 2-339 K(T) R annual, d, d – NT ( P – B ) = ⎛⎝ -------------⎞⎠ R (P – B) N d, d – NT (continuous yield) Equation 2-340 K(T) ------------⎛ ⎞ R d, d – NT ( P – B )⎞ N ⎜ ⎛ – 1⎟ R annual, d, d – NT ( P – B ) = 100 × 1 + ---------------------------------------⎜⎝ ⎠ ⎟ 100 ⎝ ⎠ (periodic) 2.4.8.4.1 Statistics of the excess return The mean, variance, and standard deviation of the excess return of the portfolio P relative to the benchmark B are given as key-figures in Performance Monitor. Tracking error is the same as the standard deviation. The annualized tracking error is calculated in the same way as the volatility figure above. Zero returns (from non-business days) are not included in these calculations. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 171 2 Market standards and calculations 2.4 Performance calculations Mean Equation 2-341 T, N Rd ( P 1 – B ) = ---Ñ N–1 ∑ Rd – nT,d – ( n + 1 )T ( P ) – Rd – nT,d – ( n + 1 )T ( B ) n=0 Variance Equation 2-342 T, N Var ( R d 1 -----------Ñ – 1 (P – B)) = N–1 T, N ∑ ( ( R d – nT,d – ( n + 1 )T ( P ) – R d – nT,d – ( n + 1 )T ( B ) ) – R d (P – B)) 2 n=0 Standard Deviation Equation 2-343 T, N σ ( Rd (P – B)) = T, N Var ( R d (P – B)) Tracking Error Equation 2-344 T, N TE ( R d T, N ( P – B ) ) = σ ( Rd (P – B)) Tracking Error (Annualized) Equation 2-345 T, N TE annual ( R d (P – B)) = T, N K ( T ) × TE ( R d (P – B)) where – d is a period end date (as defined in 2.4.8.2 Aggregation periods on page 168) – T is one of the supported sampling frequencies – N is the length of the period, expressed in T-periods – Ñ is the number of T-periodic returns that are non-null (business days) and – K(T) is the number of T-periods making up the business year. 2.4.8.4.2 TRM variables The following key-figures are available in Performance Monitor. The statistics are provided for user analysis. Standard risk adjusted return measures (for example Alpha, Beta, the Information Ratio) are also provided, and are described in 2.4.9 Risk-adjusted return measures on page 175. • 172 The excess return, cumulative excess return and annualized excess return: Excess Return, Excess Return (Cumulative) and Excess Return (Annualized) key-figures, respectively. © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations • The statistics of the excess return: Excess Return Mean, Excess Return Variance, Excess Return Standard Deviation, Tracking Error, Tracking Error (Annualized), Excess Return Volatility (same as Tracking Error (Annualized)). 2.4.8.5 Linear regression The figure below shows concurrent portfolio and benchmark returns together with the estimated best-fit linear regression (least squares method). If we assume that we have the following set of concurrent portfolio returns: { R d – nT,d – ( n + 1 )T ( P ), ( R d – nT,d – ( n + 1 )T ( B ) ), n = 0, ..... , N -1 } where n represents each ‘pair’ of concurrent portfolio R(P) and benchmark R(B) returns, then the linear regression function for each pair is then given by the following straight-line equation: Equation 2-346 R d – nT,d – ( n + 1 )T ( P ) = α + β × R d – nT,d – ( n + 1 )T ( B ) α (alpha) and β (beta) are selected such that the sum of the squared differences between each pair of concurrent returns (estimation error) is minimized. The estimation error is given by: Equation 2-347 N–1 T, N Err d ( α, β) = ∑ [ Rd – nT,d – ( n + 1 )T ( P ) – (α + β × Rd – nT,d – ( n + 1)T ( B )) ] 2 n=0 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 173 2 Market standards and calculations 2.4 Performance calculations Minimizing the estimation error gives the following relationships: Equation 2-348 T, N α* = R d T, N ( P ) – β* × R d (B) Equation 2-349 T, N T, N Cov ( R d ( P ), R d ( B ) ) β* = ------------------------------------------------------------T, N Var ( R d ( B ) ) Equation 2-350 T, N Err d T, N ( α*, β* ) = ( N – 1 ) × Var ( R d 2 (P)) × (1 – R ) where R2 is given by: Equation 2-351 T, N T, N ⎛ ⎞2 Cov ( R ( P ), R ( B ) ) 2 T, N T, N d d R ( R d ( P ), R d ( B ) ) = ⎜⎜ ---------------------------------------------------------------------------------------⎟⎟ T, N T, N ⎝ Var ( R d ( P ) ) × Var ( R d ( B ) )⎠ α* and β* are the best fit values of the alpha α and beta β. Alpha is the intercept on the y-axis and beta is the slope of the linear regression function. Alpha represents the part of the return from portfolio P which is independent of the benchmark movement and beta is the sensitivity of the return with respect to the benchmark. The variable R2, a least squares measure (the correlation coefficient given by Equation 2-337 on page 171 squared), is an indication of the goodness of fit of the linear regression to the data. The higher the value of R2, the better the fit of the linear function to the data - in other words, the more the portfolio returns are determined by the benchmark returns. 2.4.9 Risk-adjusted return measures In all risk-adjusted return measures the return is related to the risk taken. Therefore we need to quantify the risk. The most common measures are the portfolio return standard deviation, beta and the tracking error. The standard deviation can be seen as the risk from the perspective of the end investor in the fund whereas beta and the tracking error represent more the risk taken by the fund manager. Other risk figures, described below, are also provided for user risk analysis. 2.4.9.1 TRM variables The following risk adjusted return measures are provided. These are described in more detail below. General statistics (mean, variance, standard deviation) of the portfolio and excess returns are also provided (see 2.4.8.3 Portfolio returns on page 168 and 2.4.8.4 Excess returns on page 171). • 174 Risk adjusted return measures: Return Standard Deviation (standard deviation of the portfolio return), Return Volatility (annualized standard deviation of the portfolio return), Beta, Tracking Error, Tracking Error (Annualized), Alpha, Alpha (Annualized), Information Ratio, Sharpe Ratio, Modigliani-Modigliani, Treynor Ratio, Jensen’s Alpha. © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations 2.4.9.2 Return standard deviation The end investor’s main concern is typically the absolute level of the portfolio returns. For the investor the risk is therefore the uncertainty of the future portfolio returns. The historical risk is often measured as the N period standard deviation of the T-periodic returns of the portfolio P, as shown in Equation 2-334 on page 169 (square root of the variance). If we assume that the portfolio returns are normally distributed then we can calculate confidence intervals for the future returns, based on the historical standard deviation (SD) and mean. For example, we can say that the future returns will be in the interval mean +/- 1SD with 68% confidence and in the interval mean +/- 2SD with 95% confidence. 2.4.9.3 Return volatility The volatility is the annualized standard deviation of the cumulative portfolio return -standard deviation scaled by √K(T), where K(T) is, as shown above, the number of T-periods making up the business year (Equation 2-335 on page 170). This scaling makes the volatility from one sampling frequency comparable with the volatility calculated from a different sampling frequency. 2.4.9.4 Beta The risk for the fund manager is more the uncertainty of the future returns relative to the benchmark portfolio than the return of the portfolio itself; the risk-less portfolio for a fund manager is a portfolio that is guaranteed the same future returns as the benchmark. The historical risk relative to the benchmark can be measured by beta which, as shown in the previous section, is a measure of the sensitivity of the portfolio P with respect to changes in the benchmark portfolio B: Equation 2-352 T, N β ( R d ( P ), T, N Rd ( B ) ) = T, N T, N Cov ( R d ( P ), R d ( B ) ) ------------------------------------------------------------T, N Var ( R d ( B ) ) where the covariance is given by Equation 2-336 on page 171 and the variance by Equation 2-333 on page 169. A beta of 1 implies that the portfolio will tend to move with the benchmark, and thus the fund manager has zero risk relative to the benchmark. A beta greater (less) than 1 means that the portfolio will fluctuates more (less) than the benchmark and therefore the fund manager has taken a position relative to the benchmark. 2.4.9.5 Tracking error Tracking error is another benchmark related risk measure defined as the N period standard deviation of the T-periodic excess return of the portfolio P relative to the benchmark B (Equation 2-344 on page 172). The annualized tracking error for excess returns is calculated in the same way as the annualized volatility for portfolio returns above; tracking error scaled by √K(T), where K(T) is the number of T-periods making up the business year. This scaling, as before, means that annualized tracking errors calculated with different sampling frequencies (T-periods) can be compared. If we assume that the excess returns are normally distributed and that the historical tracking error is a good prediction of the future then, as for the portfolio return itself above, we can predict confidence intervals for the future excess returns (mean +/- 1SD with 68% confidence and mean +/- 2SD with 95% confidence). 2.4.9.6 Alpha This is the alpha term in the linear regression presented in 2.4.8.5 Linear regression on page 173. This figure can be written in terms of T-period return: Equation 2-353 where as before, the covariance is given by Equation 2-336 on page 171, the variance by Equation 2-333 on page 169, and the means by Equation 2-332 on page 169. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 175 2 Market standards and calculations 2.4 Performance calculations T, N α ( R d ( P ), T, N Rd ( B ) ) = T, N Rd ( P ) T, N T, N Cov ( R d ( P ), R d ( B ) ) T, N - × Rd ( B ) - ------------------------------------------------------------T, N Var ( R d ( B ) ) The annualized alpha is then given by: Equation 2-354 T, N α annual ( R d T, N ( P ), R d T, N ( B ) ) = K ( T ) × α ( Rd T, N ( P ), R d (B)) (continuous yield) Equation 2-355 T, N α annual ( R d ( P ), T, N Rd ( B ) ) T, N T, N α ( R d ( P ), R d ( B ) )⎞ ⎛⎛ = 100 × ⎜ ⎜ 1 + -------------------------------------------------------⎟ 100 ⎠ ⎝⎝ K(T) ⎞ – 1⎟ ⎠ (periodic) where K(T) is, as before, the number of T-periods making up a business year. The alpha is the part of the return from portfolio P that can’t be attributed to the risk taken in terms of beta. A positive alpha can be obtained by stock picking and/or market timing. With stock picking the fund manager tries to be overexposed or underexposed in securities having a mean return above or below the benchmark return, respectively. With market timing the manager tries to fine-tune the beta of the fund such that it is less or greater than 1 when the benchmark return is negative or positive, respectively. A fund tracking the benchmark will, by definition, have an alpha value of zero. The alpha value can therefore be seen as the contribution to the portfolio’s return coming from active fund management. 2.4.9.7 R squared The R2 figure is a measure of how much information alpha and beta provide about the portfolio. It is a least squares variable (see 2.4.8.5 Linear regression on page 173), an indication of the goodness of fit of the linear regression to the data. The higher the value of R2, the better the fit of the linear function to the data - in other words, the more the portfolio returns can be described in relation to the benchmark returns. Figures over 0.75 or under 0.25 are considered to indicate that the explanatory power is high or low, respectively. In other words, R2 provides an indication of how well the behavior of the portfolio returns is described by the alpha and beta values. 2.4.9.8 Information ratio The information ratio is the annualized period excess return of the portfolio P relative to the benchmark B, divided by the annualized tracking error: Equation 2-356 T, N IR d R annual, d, d – NT ( P – B ) ( P, B ) = -------------------------------------------------------T, N TE annual ( R d ( P – B ) ) where the annualized excess return is given by Equation 2-339 on page 171 (continuously compounded returns) or Equation 2-340 on page 172 (periodic returns), and the annualized tracking error by Equation 2-341 on page 172. 176 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations For example: 1M, 12 IR 30/6/98 ( P, B ) is the information ratio calculated from the monthly excess returns during the 12-month period starting at 970630 (980630 - 12*1M) and ending at 980630. A positive information ratio indicates that the investment decision to deviate from the benchmark was a good decision since it resulted in a higher return. The higher the information ratio the more excess return was obtained by the same risk taken. An information ratio of +0.5 is considered to be an acceptable result, a ratio of +0.75 a good result and a figure of +1.0 is typically seen as an excellent result. 2.4.9.9 Sharpe ratio The figure below shows the risks and returns of some portfolios - the benchmark B, example portfolios and a risk-free portfolio. The return is measured as the annualized period return, Rannual, and the risk as the annualized standard deviation of the T-periodic returns (the volatility σannual). 2.4.9.9.1 Risk-return characteristics (risk measured by volatility) It is clear that the benchmark B is preferable to portfolio P2 since the return is higher and the risk is less. The comparison against P1 is not so clear cut; the return of P1 is lower but so is the risk. In portfolio theory the existence of a risk-free portfolio is usually assumed. The return of the risk-free portfolio is fixed (in other words the volatility is zero) and known in advance. Furthermore the investor is allowed to buy the portfolio (invest money at the risk-free interest rate), or sell short the portfolio (borrow money at the risk-free interest rate, and invest the proceeds in the risky portfolio). All combinations of the risk-free portfolio and a risky portfolio lie along the straight line connecting them (line 1 for P1 and line 3 for P2) in the risk-return diagram above. By borrowing at the risk-free interest rate and investing the proceeds in portfolio P1, the investor can construct the portfolio P′1 that has the same risk as the benchmark B but a higher return. Given the existence of the risk-free portfolio a rational investor will prefer portfolio P1 to B and P2(and B to P2). The preferred portfolio is the one with the greatest slope, that is to say with the largest Sharpe ratio: Equation 2-357 T, N Sharpe d R annual, d, d – NT ( P ) – R annual, d, d – NT ( P riskfree ) ( P, P riskfree ) = ----------------------------------------------------------------------------------------------------------------T, N σ annual ( R d ( P ) ) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 177 2 Market standards and calculations 2.4 Performance calculations where the annualized returns are given by Equation 2-330 on page 168 (continuously compounded returns) or Equation 2-331 on page 169 (periodic returns), and the volatility by Equation 2-335 on page 170. A high Sharpe Ratio is therefore an indication of high returns relative to the risk taken. 2.4.9.10 Modigliani-Modigliani (M2) This is a version of the Sharpe ratio analysis that ranks portfolios in exactly the same order as the Sharpe analysis but gives the result in terms of return and not as a ratio. The risk-adjusted return measure is called Modigliani-Modigliani, or M2 for short. Given a portfolio P, M2 is the return of the combination of the risk-free portfolio and P that has the same risk (in terms of volatility) as the benchmark B. Thus, for portfolio P1 in the figure above (Risk-return characteristics (risk measured by volatility)), M2 is equal to the return of portfolio P′1. A high value of M2 is therefore an indication of high returns relative to the risk taken. Mathematically, M2 of portfolio P is given by: Equation 2-358 M 2 T, N d ( P, B, P riskfree ) T, N = R annual, d, d – NT ( P riskfree ) + σ annual ( R d T, N ( B ) ) × Sharpe d ( P, P riskfree ) = R annual, d, d – NT ( P riskfree ) + T, N σ annual ( R d ( B ) ) -------------------------------------------- × R annual, d, d – NT ( P ) – R annual, d, d – NT ( P riskfree ) T, N σ annual ( R d ( P ) ) The annualized returns are given by Equation 2-330 on page 168 (continuously compounded returns) or Equation 2-331 on page 169 (periodic returns), and the volatility by Equation 2-335 on page 170. 178 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations 2.4.9.11 Treynor ratio The Treynor ratio is similar to the Sharpe ratio but with beta as the risk measure. The figure below shows the risk and return characteristics for some portfolios where the risk measure is beta. Note that the benchmark B has a beta of 1 and the risk free portfolio is assumed to have a beta of zero. 2.4.9.11.1 Risk-return characteristics (risk measured by beta) The Treynor ratio measures the slope of the line connecting the risk-free portfolio and the risky portfolio: Equation 2-359 T, N Treynor d R annual, d, d – NT ( P ) – R annual, d, d – NT ( P riskfree ) ( P, B, P riskfree ) = ----------------------------------------------------------------------------------------------------------------T, N T, N β ( R d ( P ), R d ( B ) ) where the annualized returns are, as before, given by Equation 2-330 on page 168 (continuously compounded returns) or Equation 2-331 on page 169 (periodic returns), and the beta by Equation 2-352 on page 175. As for both the Sharpe Ratio and M2, a high value of this ratio is an indication of high returns relative to the risk taken. The fund manager has outperformed the benchmark if the fund has a higher Treynor ratio than the benchmark. In the figure above, portfolio P1 has outperformed the benchmark in terms of Treynor ratio (but not P2). 2.4.9.12 Jensen’s Alpha If the benchmark consists of all securities the fund can invest in (for example the issued equities in all listed companies besides the tobacco related ones), we make the assumption that the line connecting the risk-free portfolio and the benchmark (line 2) represents the set of risk-return effective portfolios. So for every risk level the largest expected return is obtained by investing in a combination of the risk-free portfolio and the benchmark that has the wanted risk level. If the wanted risk level in beta terms is β̃ then the expected annualized period return of the effective portfolio is given by: Equation 2-360 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 179 2 Market standards and calculations 2.4 Performance calculations R annual, d, d – NT ( P ( β̃ ) ) = R annual, d, d – NT ( P riskfree ) + β̃ × R annual, d, d – NT ( P ) – R annual, d, d – NT ( P riskfree ) Jensen’s Alpha is calculated as the actual return of the portfolio P less the return of the effective portfolio (Equation 2-360 on page 179) with identical beta: Equation 2-361 T, N Jensen d T, N – β ( Rd ( P, B, P riskfree ) = R annual, d, d – NT ( P ) – R annual, d, d – NT ( P riskfree ) T, N ( P ), R d ( B ) ) × ( R annual, d, d – NT ( P ) – R annual, d, d – NT ( P riskfree ) ) where the annualized returns are, as for the Treynor ratio, given by Equation 2-330 on page 168 (continuously compounded returns) or Equation 2-331 on page 169 (periodic returns), and the beta by Equation 2-352 on page 175. A positive value of Jensen’s Alpha indicates that the portfolio has a higher return than the effective portfolio (a benchmark with the same level of risk) and a negative value implies a lower return. In the figure above (Risk-return characteristics (risk measured by beta)), we have a positive value of Jensen’s alpha for portfolio P1 (the return is higher than for B′) and a negative value for portfolio P2 (the return is less than for B′′). Therefore portfolio P1 is a more risk-return effective portfolio than the benchmark (but not P2). 2.4.10 Performance attribution The goal of performance attribution is to quantify the contribution of the various investment decisions to the final overall portfolio (excess) return. The investment decision variables supported are the ones expressed via the Performance Monitor grouping dimensions, for example, Market, Currency, Branch Codes, Issuer, Maturity Period, and so on. The attribution models split the excess return into Allocation, Selection and Interaction effects: • Allocation is the investment decision between the selected grouping • Selection measures the investment decision within the selected grouping • Interaction is the interaction between the allocation and selection term The benchmark is represented as a portfolio with transactions. 2.4.10.1 Performance attribution methods The following attribution methods are used in TRM: • Single currency portfolios The Brinson framework. • Multi currency portfolios The Karnosky and Singer framework. • Combining attribution effects over time The Cariño method. The calculations used in each of these methods are described in the next section. 180 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations 2.4.10.1.1 Base currency performance attribution Here are the calculations used for the Brinson attribution of excess return: Equation 2-362 R – R = Σ wi Ri – Σ wi Ri = A + S + I i i Allocation Equation 2-363 A = Σ ( wi – wi ) ( Ri – R ) i Selection Equation 2-364 S = Σ wi ( Ri – Ri ) i Interaction Equation 2-365 I = Σ ( wi – wi ) ( Ri – Ri ) i where wi is the fraction of the market value invested in the i-th sector, and Ri is the return. The corresponding benchmark values are denoted by wi and Ri . 2.4.10.1.2 Multi- currency performance attribution The return of the multi-currency portfolio is given by: Equation 2-366 R base = Σ w i ( R i – C̃ ccy ( i ) ) + Σ ( w i ( ccy ) + h ccy ) ( C̃ ccy + ε base, ccy ) i ccy + Σ h ccy ( C ccy – C̃ ccy ) ccy where: – wi is the fraction of the market value invested in the i-th asset. – Ri is the return of the assets in the i-th segment expressed in the local currency. – Cccy is the local currency risk free return. – hccy is the currency weight of FX overlay hedge transactions. – εccy is the change in the spot FX rate (common to all investments in each currency). – Cccy is the local currency return of FX overlay hedge transactions. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 181 2 Market standards and calculations 2.4 Performance calculations 2.4.10.1.3 Asset-related performance attribution Brinson style factors: Equation 2-367 A asset = Σ ( w i – w i ) ( ( R i – C̃ ccy ( i ) ) – BRP ) i Equation 2-368 S asset = Σ w i ( R i – R i ) i Equation 2-369 I asset = Σ ( w i – w i ) ( R i – R i ) i where BRP is the benchmark local return premium: Equation 2-370 BRP = Σ w i ( R i – C̃ ccy ( i ) ) i Asset leverage: Equation 2-371 L asset = ( – BRP ) ( Σ w i – Σ w i ) i i Equation 2-372 ( Σ wi + Σ i ccy h ccy = 1 ) 2.4.10.1.4 Currency related performance attribution Brinson style factors: Equation 2-373 A hedge = Σ ccy ( ( w i ( ccy ) + h ccy ) – ( w i ( ccy ) + h ccy ) ) ( ( C̃ ccy + ε base, ccy ) – BCR ) Equation 2-374 S hedge = Σ ccy h ccy ( C ccy – C̃ ccy ) Equation 2-375 I hedge = Σ ccy ( h ccy – h ccy ) ( C ccy – C̃ ccy ) where CRP is the benchmark currency return: Equation 2-376 182 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations BCR = Σ ( w i ( ccy ) + h ccy ) ( C ccy + ε base, ccy ) ccy Assumed common FX return might imply a small unexplained residual: Equation 2-377 R base – R base = A asset + S asset + I asset + L asset + A hedge + S hedge + I hedge 2.4.10.1.5 Linking attribution factors over time Daily attribution is preferable as weight factors wi are time dependent. Excess return and arithmetical factors are not additive over time: Equation 2-378 R – R = ( 1 + R1 ) ( 1 + R 2 ) – ( 1 + R 1 ) ( 1 + R2 ) ≠ ( R1 – R1 ) + ( R2 – R2 ) The error can be distributed over time such that: Equation 2-379 1 R – R = ---- Σ k t ( R t – R t ) Kt where Equation 2-380 ln ( 1 + R ) – ln ( 1 + R ) K = ----------------------------------------------------R–R and Equation 2-381 ln ( 1 + R t ) – ln ( 1 + R t ) k t = -------------------------------------------------------Rt – Rt 2.4.10.2 Example of single currency performance attribution This example is based on four equities grouped into two sectors by branch code: Automobiles-sector (BMW and General Motors) and Telecom-sector (Motorola and Nokia). There are two portfolios: a managed trading portfolio and a benchmark portfolio. The performance of the managed trading portfolio is measured against the benchmark, where each stock has an equal 25% weight at the beginning of the period. For the sake of simplification, the performance measurement period is only one day, 23rd of April 2003. The market rates used in this example are fictitious and are set to illustrate the mechanism of performance attribution. In the managed trading portfolio, the Telecom-sector is over weighted and, respectively, the Automobiles-sector is under weighted in comparison to the benchmark with equal weights. The weights, amounts and returns for equities, sectors, managed portfolio and benchmark are presented in the Performance Monitor view below. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 183 2 Market standards and calculations 2.4 Performance calculations The benchmark portfolio has a return of 8.57 % and the managed portfolio has a return of 12.86 %. The investment decisions of the managed portfolio have created a 4.29% excess return, which can be further analyzed by Performance Attribution Key-Figures in Performance Monitor. The Key-Figures Allocation, Selection and Interaction for Automobiles and Telecom sector are calculated as shown in the following sections. 184 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations 2.4.10.2.1 Automobiles 2.4.10.2.2 Telecoms sector Allocation = (66.00% - 50.00%) * (27.21% - 8.57%) = 2.999677 %. Selection = 50.00% * (26.26% - 27.21%) = -0.471547 %. Interaction = (66.10% - 50.00%) * (26.26% - 27.21%) = -0.151837 %. The Allocation Figure expresses how successful the asset manager has been in allocating funds between sectors. In this example, it is the decision to overweight the Telecom sector and to underweight the Automobiles sector. The Telecom sector return is considerably higher than the negative one of the Automobiles sector. The positive Allocation Figure of the Telecom sector is intuitively straightforward, since the sector performed well and it was over weighted in the managed portfolio. The positive Allocation Figure of the Automobiles sector is due to the fact that this lower return sector was under weighted in the managed portfolio in comparison to the benchmark. The Selection Figure expresses how successful the asset manager has been in stock picking (to select equities within a certain group) here within a sector. The negative Figure Selection means that within the sector, higher return equity was underweighted and lower return equity was overweighted, in comparison to the benchmark portfolio. The Figure Intersection represents the part of the excess return that cannot be attributed either to allocation or selection decisions. The sum of the Allocation, Selection and Interaction figures equals the difference between managed portfolio and benchmark portfolio returns, that is, the excess return. 2.4.10.3 Example of multi-currency performance attribution The following example is based on four equities, which are grouped according to currency denomination; EUR for BMW and NOKIA and USD for GENERAL MOTORS and MOTOROLA. The benchmark portfolio consists of these four stocks which have an initial weight of 25 % each. Therefore, the benchmark portfolio has initially equivalent exposures in both currencies. The managed trading portfolio consists of the investments in these four stocks, but with different weights than in the benchmark portfolio. In comparison with the benchmark, USD assets are Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 185 2 Market standards and calculations 2.4 Performance calculations over-weighted: USD denominated stocks total 72% and EUR stocks 28% of the initial market value of the managed portfolio. In order to bring currency exposure of the managed portfolio in line with the benchmark, USD dollars are sold against EUR by FX-Forward transaction. As a result of the hedge, the managed portfolio has 49.60 % exposure in EUR and 50.40 % exposure in USD. For the sake of simplification, the performance measurement period is only one day, 23rd of April 2003. During the day, USD is set to depreciate 10 % against the EUR. The market rates used in this example are fictitious and are set to illustrate the mechanism of multi-currency attribution. All market values are expressed in EUR. The following image displays asset market values at the beginning and end of the period: This image illustrates the portfolio structure: 186 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations These are the intermediate results used to calculate attribution figures: The Key-Figures Asset Allocation, Asset Selection, Asset Interaction and Asset Leverage for EUR denominated investments is calculated as follows: 2.4.10.3.1 Asset allocation The value added by the decision to deviate from the benchmark’s asset allocation is indicated by the asset allocation key figure. For multicurrency investments, the relevant benchmark to be used to analyze the value added of local currency allocation decisions is the average local currency return premium, known as BRP. Equation 2-382 A asset where Wi Asset Weight of the ith group in the Portfolio Asset Weight of the ith group in the Benchmark Return of the ith group in the Benchmark local currency risk free rate of return BRP is the benchmark local return premium: Equation 2-383 BRP Asset Allocation = (27.62%-50.00%) * (12.97%-8.38%) = -1.028916306% Equation 2-384 S asset Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 187 2 Market standards and calculations 2.4 Performance calculations Asset Selection = 50.00% * (19.06% - 12.98%) = 3.0397352% Asset Interaction = (27.62% - 50.00%) * (19.06% - 12.98%) = -1.36075776% Equation 2-385 Asset Leverage = 8.38% * (99.99% - 100.00%) = -0.000836592% Equation 2-386 The Key-Figures Hedge Allocation, Hedge Selection and Hedge Interaction for EUR denominated investments are calculated as follows: 2.4.10.3.2 Hedge allocation The value added by the decision to deviate from the benchmark’s currency allocation is indicated by the hedge allocation key figure. When determining the amount allocated to a certain currency, both the underlying investments and currency overlays are taken into account. When determining currency returns, both the risk-free return of a currency and change in the FX rate against the portfolio's base currency are taken into account. Equation 2-387 A hedge where CRP is the benchmark currency return. It expresses the currency return (risk free rate + change in FX rate against the portfolio's base currency) of the benchmark. 188 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations Currency weight of portfolio FX overlay hedge transactions. Currency weight of Benchmark FX overlay hedge transactions. Change in the spot FX rate (common to all investments in a particular currency) Hedge Allocation = (49.60%-50.00%)*(0.01% - (-4.54%)) = -0.018016123% Hedge Selection Equation 2-388 Hedge selection where Local currency return of FX overlay hedge transactions. In this example, the hedge selection figure is zero, since there are no hedges in the benchmark portfolio. Hedge Interaction = (21.99% - 0.00%) * (0.01% - 0.009722%) = -0.000038688%. Equation 2-389 Hedge interaction 2.4.11 Performance measurement key-figures The key-figures available in Performance Monitor are described in the following table. These figures include the risk adjusted return measures, for example the Information Ratio and Modigliani-Modigliani (see 2.4.8 Risk-adjusted returns on page 166). More details about these key-figures and how they are calculated are given in the section 2.4 Performance calculations on page 149. Figure Definition Allocation The Brinson performance attribution factor measuring how well money has been allocated (relative benchmark) between the selected groups (such as Branch Code), given by: Allocation_i (T) = (w_it - W_it)*(R_it - R_i) where w_it is the Attribution Weight of the ith group in the portfolio W_it is the Attribution Weight of the ith group in the Benchmark R_it is the Return of the ith group in the Benchmark R_t is the Benchmark total return at time T Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 189 2 Market standards and calculations 2.4 Performance calculations Figure Definition Allocation (Cumulative) The allocation factor (A) that is additive over time: where R = cumulative total Portfolio Return R = cumulative total Benchmark Return and Rt = total Portfolio return on day t Rt = total Benchmark Return on day t Allocation (cumulative) T = sum t=1 to T Excess Return Factor (t) * Allocation (t) / Excess Return Factor (Cumulative) Alpha The part of the return on a portfolio that cannot be attributed to the risk taken (the risk taken in terms of beta). It is the intercept of the y-axis of the linear regression function between the portfolio and the benchmark portfolio. Alpha (Annualized) The alpha of the portfolio, converted into an annualized figure. Asset Allocation The multi-currency performance attribution is based on Karnosky and Singer framework. The Allocation, Selection, and Interaction terms follow Brinson et al. framework, similar to the single currency performance attribution. The Asset Allocation is the performance attribution factor measuring how successfully funds have been allocated relative to the benchmark between the selected groups (such as Branch Code) given by: where Asset Weight of the ith group in the Portfolio Asset Weight of the ith group in the Benchmark Return of the ith group in the Benchmark Local currency risk free rate of return BRP is the benchmark local return premium: 190 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations Figure Definition Asset Allocation (Cumulative) Since Excess Return and arithmetical factors are not directly additive over time, the following methodology ("Combining Attribution Effects over Time" by D.R . Carino) is applied to link attribution effects over time: where R = cumulative total Portfolio Return R = cumulative total Benchmark Return and R = cumulative total Portfolio Return Rt = cumulative total Benchmark Return AAsset is the portfolio's cumulative Asset Allocation AAssett is the portfolio's Asset Allocation effect at time point t. Asset Interaction Performance attribution factor measuring the interaction between Asset Allocation and Asset Selection. It is part of the Excess Return that cannot be divided to either Allocation or Selection. Asset Interaction (Cumulative) See Key-Figure Asset Allocation (Cumulative), where methodology to link effects over time is described. Asset Leverage The return contribution from leveraged market investment in respect to the total portfolio market value due to unrealized result of FX hedge transactions. For example, you buy US bonds worth 100 M Euro and hedge the currency exposure into Euro using FX forwards. If the dollar goes up 10% the bonds are worth around 110M Euro and you have an offsetting unrealized loss of 10M from the FX forwards. In this case your bond position is leveraged since you have 110M of a portfolio total of 100M invested into it. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 191 2 Market standards and calculations 2.4 Performance calculations Figure Definition Asset Leverage (Cumulative) See Key-Figure Asset Allocation (Cumulative), where methodology to link effects over time is described. Asset Selection Performance attribution factor measuring how successful you have been at selecting securities relative to the benchmark within the selected groups (such as Branch Code), given by: where Asset Weight of the ith group in the Benchmark Return of the ith group in the Portfolio Return of the ith group in the Benchmark Asset Selection (Cumulative) See Key-Figure Asset Allocation (Cumulative), where methodology to link effects over time is described. Asset Selection/Interaction The combined Asset Selection and Asset Interaction factors given by: Note: As a difference to the pure Asset Selection, Portfolio Weight is used here. Asset Selection/ Interaction (Cumulative) See Key-Figure Asset Allocation (Cumulative), where the methodology to link effects over time is described. Asset Weight Fraction of the market value invested in ith asset. Attribution Amount The market value allocated to the selected cell i at beginning of day t, given by: Attribution Amount (T) = Market Value Start (T) + Weight Factor * Cashflows (T) Attribution Weight The percentage of total Attribution Amount allocated into cell i at time t: Attribution Weight (T) = Attribution Amount (T) / Total Attribution Amount (T) (The Total level is defined by the user in the X,Y axis selection lists as in Treasury Monitor.) Beta The gradient of the linear regression function between the portfolio and the benchmark portfolio. This is a measure of the sensitivity of the portfolio with respect to changes in the benchmark portfolio. A value of beta greater than 1 means that the portfolio returns will be more than the benchmark returns (less than 1 means the returns will vary less). Correlation The correlation coefficient between the portfolio and the benchmark portfolio (standardized covariance). A positive (negative) value indicates that if there is a positive return for the benchmark portfolio, then there will also be a positive (negative) return for the portfolio. Covariance The covariance between the portfolio and the benchmark portfolio. A positive (negative) value indicates that if there is a positive return for the benchmark portfolio, then there will also be a positive (negative) return for the portfolio. 192 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations Figure Definition Difference Result The difference of the monetary returns between a trading portfolio and a benchmark portfolio, expressed as daily Monetary P/L Excess Return and calculated as follows: RE t = RE P, t – RE B, t where REt is the Monetary P/L Excess Return for day t REP,t is the Monetary Portfolio Return for day t REB,t is the Monetary Benchmark Return for day t This key-figure behaves like Excess Return, except that money amounts are used. Note: In Treasury Monitor, the key-figures Market Value and Market Value Start are used. Monetary P/L Excess Return is the difference between the trading portfolio’s Market Value Change and that of the benchmark portfolio. Difference Result (Cumulative) The sum of daily Monetary P/L Excess Returns during a period of n days. Difference Return Contribution Displayed under the benchmark, this figure is the line-by-line difference between the Return Contribution of the portfolio and the Return Contribution of the benchmark. Difference Return Contribution (Cumulative) measures the same difference over time. Excess Return This is the portfolio return relative to the benchmark return for the specified interval. Excess Return (Annualized) The difference between the Return (Cumulative) of the portfolio and the Return (Cumulative) of the benchmark portfolio, converted into an annual figure. Excess Return Asset Contribution This is the difference between local portfolio return premium and base currency benchmark return premium. Alternatively, this is the sum of the Asset attribution factors at time point t: Excess Return Asset Contribution (Cumulative) This is the sum of cumulative Asset attribution factors. Excess Return Contribution This is the sum of the attribution factors at time T: Excess Return Contribution (Cumulative) This is the sum of the cumulative attribution factors: Excess Return (Cumulative) The difference between the Return (Cumulative) of the portfolio and the Return (Cumulative) of the benchmark portfolio. Excess Return Factor Daily factor used for linking attribution effects over time. Excess Return Factor (Cumulative) Total period factor used for linking attribution effects over time. Excess Return Hedge Contribution Excess return contribution from the hedge strategy, which is the sum of the Hedge attribution factors at time t: Excess Return Contribution (T) = Allocation (T) + Selection (T) + Interaction (T) Excess Return Contribution (Cumulative) = Allocation (Cumulative) + Selection (Cumulative) + Interaction (Cumulative) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 193 2 Market standards and calculations 2.4 Performance calculations Figure Definition Excess Return Hedge Contribution (Cumulative) This is the sum of the cumulative Hedge attribution factors. See Key-Figure Asset Allocation (Cumulative), where the methodology to link effects over time is described. Excess Return (N Samples) This is the portfolio return relative to the benchmark return over N sub-periods (T-periods) of sampling frequency T. Excess Return (Sample) This is the portfolio return relative to the benchmark return over one sub-period (T-period) of sampling frequency T. Excess Return Mean The mean value of excess returns over the aggregation period (aggregation period length expressed as N T-periods). Excess Return Semideviation Key-figures: σ ep Excess Return Semideviation (Negative) σ en Excess Return Semideviation (Positive) measure the semideviation of excess return over a benchmark. If the sample returns of the benchmark are ri, then Excess Return Standard Deviation The standard deviation of excess returns over the aggregation period (aggregation period length expressed as N T-periods). Excess Return Variance The variance of excess returns over the aggregation period (aggregation period length expressed as N T-periods). Excess Return Volatility The standard deviation of excess returns over the aggregation period (aggregation period length expressed as N T-periods), converted into an annualized figure. Hedge Allocation The performance attribution factor measuring how successful we have been in our currency strategy in comparison to the benchmark given by: where CRP is the benchmark currency return currency weight of portfolio FX overlay hedge transactions currency weight of Benchmark FX overlay hedge transactions change in the spot FX rate (common to all investments in each currency) Hedge Allocation (Cumulative) 194 See Key-Figure Asset Allocation (Cumulative), where methodology to link effects over time is described. © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations Figure Definition Hedge Interaction The performance attribution factor measuring the interaction between Hedge Allocation and Hedge Selection is given by: Hedge Interaction (Cumulative) See Key-Figure Asset Allocation (Cumulative), where the methodology to link effects over time is described. Hedge Selection The performance attribution factor measuring how successful you have been in hedging the selection of optimal maturity of the hedge transactions is given by: Local currency return of FX overlay hedge transactions. Hedge Selection (Cumulative) See Key-Figure Asset Allocation (Cumulative), where the methodology to link effects over time is described. Hedge Selection/Interaction The combined Hedge Selection and Hedge Interaction factors are given by: Hedge Selection/Interaction (Cumulative) See Key-Figure Asset Allocation (Cumulative), where the methodology to link effects over time is described. Hedge Weight The currency weight of FX overlay hedge transaction. Information Ratio A measurement of the return of the portfolio in terms of the risk taken (risk adjusted return measure). The Excess Return (Annualized) divided by the Tracking Error (Annualized). A positive value indicates that the decision to deviate from the benchmark was a good one since it resulted in a higher return. The higher the value of the Information Ratio, the more excess return was obtained by the same risk taken. Interaction The Brinson performance attribution factor measuring the interaction between allocation and selection, given by: Interaction_i (T) = (w_it – W_it)*(r_it-R_it) where W_it is the Attribution Weight of the ith group in the Benchmark w_it is the Attribution Weight of the ith group in the portfolio r_it is the Return of the ith group in the Portfolio R_it is the Return of the ith group in the Benchmark Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 195 2 Market standards and calculations 2.4 Performance calculations Figure Definition Interaction (Cumulative) Interaction factors (I) that are additive over time. where R = cumulative total Portfolio Return R = cumulative total Benchmark Return and Rt = total Portfolio return on day t Rt = total Benchmark Return on day t Interaction (cumulative) T = sum t=1 to T Excess Return Factor (t) * Interaction (t) / Excess Return Factor (Cumulative) Jensen's Alpha A measurement of the return of the portfolio in terms of the risk taken (risk adjusted return measure). Jensen’s Alpha is defined as the difference between the return on the portfolio and the return on the ‘effective’ benchmark portfolio with the same beta. A positive (negative) value implies that the portfolio has a higher (lower) return than the effective benchmark with the same level of risk. Market Value Movements Movements between buckets/branches are considered to happen between the dates, that is, at midnight. Thus, for an instrument worth X moving from bucket B to A at date T, the market value start at date T will be equal to the market value end at day T-1 plus the amount X. The Market Value Movements key-figure is equal to X. In general: Market Value Start (T) = Market Value End (T-1) + Market Value Movements (T) ModiglianiModigliani A measurement of the return of the portfolio in terms of the risk taken (risk adjusted return measure). Defined as the return of a combination of the portfolio and the risk-free portfolio that has the same risk (volatility) as the benchmark portfolio. A high Modigliani-Modigliani value indicates high returns relative to the risk taken. R2 R squared, is the fit of the linear regression function between the portfolio and the benchmark portfolio. A measure of how well the behavior of the portfolio returns is described by the Alpha and Beta values. Figures over 0.75 or under 0.25 are considered to indicate that the explanatory power is high or low, respectively. Return The rate of return (percentage growth) of the portfolio over a specified interval. Return (Annualized) The return on the portfolio over the aggregation period (length of this period expressed as N T-periods), converted into an annualized figure. Return Contribution The contribution of the selected cell to the total absolute performance, given by: Return Contribution (T) = Attribution Weight (T) * Return (T) = Result (T) / Total Attribution Amount (T) 196 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations Figure Definition Return Contribution (Cumulative) The cumulative value of Return Contribution. Rt, Cumulative Return Contribution for cell i over period from 1 to T is: Here, R is the cumulative total performance, Rt is the total performance for period t, and is the performance of cell i for period t. Return (Cumulative) The return on the portfolio over the aggregation period (length of this period expressed as N T-periods). Return (N Samples) The portfolio return over N sub-periods (T-periods) of sampling frequency T. Return (Sample) The portfolio return over one sub-period (T-period) of sampling frequency T. Return Mean The mean of the cumulative returns over the aggregation period (length of this period expressed as N T-periods). Return Semideviation Displays the standard deviations of returns which are below (above) the average returns, respectively. Key-figures: Return Semideviation (Upside) ( σ u ) Return Semideviation (Downside) ( σ d ) Return Semideviation (Positive) ( σ p ) Return Semideviation (Negative) ( σ n ) are based an sample returns Ri. Let sample count (the number of consecutive samples used in averaging) be n. Then for the kth sample: where Ri is the sample mean return. Return Standard Deviation The standard deviation of the cumulative returns over the aggregation period (length of this period expressed as N T-periods). Return Variance The variance of the cumulative returns over the aggregation period (length of this period expressed as N T-periods). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 197 2 Market standards and calculations 2.4 Performance calculations Figure Definition Return Volatility The standard deviation of the cumulative returns over the aggregation period (length of this period expressed as N T-periods), converted into an annualized figure. Selection The Brinson performance attribution factor measuring how good you have been at selecting securities (relative benchmark) within the selected groups (such as Branch code), given by: Selection_i (T) = W_it*(r_it-R_it) where W_it is the Attribution Weight of the ith group in the Benchmark r_it is the Return of the ith group in the Portfolio R_it is the Return of the ith group in the Benchmark Selection (Cumulative) The selection factors (S) that are additive over time. where R = cumulative total Portfolio Return R = cumulative total Benchmark Return and Rt = total Portfolio return on day t Rt = total Benchmark Return on day t Selection (cumulative) T = sum t=1 to T Excess Return Factor (t) * Selection (t) / Excess Return Factor (Cumulative) Selection/ Interaction 198 The combined Selection and Interaction factors given by: © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.4 Performance calculations Figure Definition Selection/ Interaction (Cumulative) Since Excess Return and arithmetical factors are not directly additive over time, the following methodology is applied in order to link attribution effects over time: where R = cumulative total Portfolio Return R = cumulative total Benchmark Return and Rt = total Portfolio return on day t Rt = total Benchmark Return on day t Sharpe Ratio A measurement of the return of the portfolio in terms of the risk taken (risk adjusted return measure). Defined as the difference between the annualized return of the portfolio and the annualized return of a risk-free portfolio, expressed as a ratio of the annual standard deviation (volatility) of the portfolio. A high Sharpe Ratio indicates high returns relative to the risk taken. Tracking Error The standard deviation of excess returns over the aggregation period (length of this period expressed as N T-periods). Tracking Error (Annualized) The standard deviation of excess returns over the aggregation period (length of this period expressed as N T-periods), converted into an annualized figure. Treynor Ratio A measurement of the return of the portfolio in terms of the risk taken (risk adjusted return measure). Defined as the difference between the annualized return of the portfolio and the annualized return of a risk-free portfolio, expressed as a ratio of the beta between the portfolio and the benchmark portfolio. A high Treynor Ratio indicates high returns relative to the risk taken. 2.4.11.1 Performance measurement (debug) key-figures Debug key-figures in Performance Monitor are intermediate results for multi-currency performance attribution. The return for the multi-currency portfolio is given by the following equation: R base = ∑ wi ( Ri – Cccy( i ) ) + ∑ ( wi( ccy) + hccy ) ( Cccy + εbase, ccy ) + ∑ hccy ( Cccy – Cccy ) i ccy ccy Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 199 2 Market standards and calculations 2.5 Value-at-Risk calculations The following key-figures are found in the Debug key-figure folder: Figure Definition FX Rate FX rate between the base currency and the currency in question (for example, Instrument Currency). Multi-currency attribution uses an implied FX rate (from all transactions except FX) because, under the multi-currency framework, only one common FX rate for all transaction types is accepted. Combinations of, for example, O/N, T/N, and Spot rates, as they are applied elsewhere in TRM valuation depending on the cashflow value date, are not accepted. FX Return Return of the currency with respect to the base currency during the period. This is basically the return that is the result of the changes in the (implied) FX rate. In the return formula for multi-currency attribution, this term is marked with εbase,ccy. IR Return The currency risk-free rate of return for the period (the shortest maturity rate from the yield curve defined for the currency). This rate is taken from the risk-free curve defined for the currency. This yield curve should only have the O/N-period defined; the rate set for that period will define the risk-free return of the currency. In the return formula for multi-currency attribution, this term is marked with: C ccy ( i ) Adjusted Asset Return Local rate of return for the assets within the respective group. In the return formula for multi-currency attribution, this term is marked with Ri (or Ri if the key-figure is displayed under the Benchmark). Adjusted Hedge Return The currency return of the legs of the hedge transaction within the respective group. In the return formula for multi-currency attribution, this term is marked with hi (or hi if the key-figure is displayed under the Benchmark). Return Premium Local return premium BRP = ∑ wi ( Ri – Cccy( i ) ) i Deposit Return This is the currency exposure return: ( w i ( ccy ) + h ccy ) ( C ccy + ε base, ccy ) Note: The configuration of implicitly matched instruments in TRM should lead to identical FX valuations. Any differences will cause the sum of the attribution terms to not sum exactly to the portfolio excess return. Given the extensive instrument coverage and the flexibility in valuation techniques in TRM, it is likely that the user will have to accept same degree of mismatch between the attribution figures and the excess return. 2.5 Value-at-Risk calculations Value-at-risk (VaR) is a measure of the potential change in value of a portfolio or position with a defined level of confidence over a selected risk horizon (one day, one month, and so on). For example, you could measure your maximum potential loss with a 95% confidence level on an FX deal due to an unfavorable change in the FX rate over one day. (A 95% confidence level means that your maximum potential loss will not exceed the change in value predicted by this method 95% of the time, i.e. 5% of the time you risk losing more than this value.) 200 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.5 Value-at-Risk calculations The value-at-risk (VaR) calculations in TRM are performed in an integrated real-time module that allows the full functionality of Treasury Monitor to be used with the VaR key-figures produced. In order to perform these calculations, certain statistical data (volatility and correlation) of the market variables are required. These data can be imported from RiskMetrics or any other source with a similar file interface. The data source can be augmented with proprietary data on market variables which it doesn't cover. Mapping between TRM market variables and the imported statistical data is carried out in VaR Mapping Editor. The flexibility of this board allows instruments such as bonds to be mapped to their own volatility and correlation data instead of using a zero-coupon curve. VaR Data Board provides the possibility for extensive stress testing by simulating changes in the market conditions. User-defined scenarios can be created and the correlation and volatility data can be edited. The required confidence level and risk horizon can be defined for each portfolio. In order to do so, the properties VAR-CONFIDENCE-LEVEL and VAR-HORIZON-ID should be added to the Properties page in Portfolio Editor. See TRM User Guide for more information about TRM VaR related applications and portfolio properties. The rest of this section assumes that RiskMetrics is the source of the statistical data. 2.5.1 TRM approach to VaR calculations In order to calculate the VaR figures for a position, an estimate of the probability distribution for that position is required. This is created from the imported statistical data (the volatilities and correlations of the market variables) and the sensitivity of the position to changes in those market variables (deltas). To use the statistical data to assess the value-at-risk of a position, you need to first perform the following steps: • Import the statistical data into the system (see 2.5.3.1 RiskMetrics data on page 203). • Calculate any missing data (see 2.5.4 Transforming RiskMetrics data on page 204). • Map the cashflows of the position to the RiskMetrics maturity vertices (see 2.5.4.3 Cashflow mapping on page 205. • Calculate the VaR deltas of the position (see 2.5.5.1 Calculating VaR deltas on page 207). 2.5.2 RiskMetrics data In RiskMetrics, the basic underlying assumption is that the relative change in each market variable X, from one period to another, is normally distributed with a mean of zero and standard deviation σ: Xt – Xt – 1 ------------------------ ∼ N ( 0, σ x ) Xt – 1 Equation 2-390 VaR: RiskMetrics data Furthermore, the joint distribution of the relative changes in all market variables is assumed to follow a multivariate normal distribution with the correlations between the market variables given in the correlation matrix C. RiskMetrics provides the correlation matrix C and the volatilities of the different market variables. The volatility V of market variable X is defined as 1.65 σ x . A detailed description of the creation of these data and the format in which they are available is given in the RiskMetrics Technical Document. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 201 2 Market standards and calculations 2.5 Value-at-Risk calculations 2.5.2.1 Variance-covariance matrix It is simple to reconstruct the standard deviations of the market variables, σ x , from the volatility data supplied by RiskMetrics (volatility is defined as 1.65 times standard deviation). If other data sets are used (not RiskMetrics) then the measure of volatility may be different, in which case the multiplier I0, (1.65 in the case of RiskMetrics) will be given in the data file and stored with the volatility data. TRM works with the variance-covariance matrix Σ : Equation 2-391 variance-covariance matrix Σ = σCσ where C is the correlation matrix, σ is a diagonal matrix of the standard deviations of the market variables and the elements are given by Equation 2-392 VaR: Correlation-diagonal matrix Σ ij = σ i C ij σ j This matrix contains both the volatility and correlation information. Note that since the diagonal elements of the correlation matrix are equal to one (Cii = 1), the diagonal elements of Σ are the variances (standard deviations squared: Σ ii = σ i2 ). Also (Cji = Cij). 2.5.2.2 Risk horizons The range of values within which a market variable is likely to move depends on the time horizon used. RiskMetrics provide data for two horizons: one day and one month. The maximum potential loss is sometimes referred to as DEaR, Daily Earnings at Risk, for the one day time horizon whereas the risk measure for the one month horizon is referred to as VaR, Value at Risk. The data in the RiskMetrics files are given for the period in question, not as yearly rates. Theoretically, the volatilities for different time horizons should be obtained from the one day volatility by multiplying by the square root of time. For example, if σ 1 is the one day volatility and σ 5 the five day volatility, the following equation should hold: Equation 2-393 VaR: Risk horizons σ5 = 5σ 1 However, there is evidence that long term volatilities differ from the values obtained using this equation. Therefore the one month horizon is also needed for calculating long term risk measures. For risk horizons beyond one month we use the formula above, replacing the one day volatility with the one month volatility. Risk horizons between one day and one month are interpolated from these two figures as described in 2.5.4.2 Interpolating volatilities and correlations on page 204. 2.5.3 Market variables A market variable is any variable for which there is a market quote (for example rate, yield or price) which affects the value of a cashflow. The market variables recognized by RiskMetrics differ from those used by TRM. The RiskMetrics market variables are mapped to the correct TRM market variables in VaR Mapping Editor. The RiskMetrics data may also have to be transformed in one way or another before it can be used for calculations in TRM. 202 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.5 Value-at-Risk calculations This section describes these different types of data. The section 2.5.4 Transforming RiskMetrics data on page 204 describes how the RiskMetrics data are transformed into data suitable for TRM. 2.5.3.1 RiskMetrics data The RiskMetrics data provided are the volatilities and correlations for the market variables given below. The data are provided for certain periods, the RiskMetrics vertices (for example, 1 month, 2 months, and so on) since providing data for all periods would be unfeasible. Data for periods in-between these vertices are calculated using cashflow mapping (see 2.5.4.3 Cashflow mapping on page 205). • Foreign exchange (FX) spot rates for certain currencies. The data are always calculated with US dollar (USD) as the quote currency, for example SEK/USD. The volatility of an FX rate does not depend on the direction in which it is quoted (SEK/USD or USD/SEK), but the sign of the correlation between the two rates will change if the direction is changed. The symbol for spot quotes is XS (for example, the Swedish krona spot quote is SEK.XS). • Money market (MM) rates for the same set of currencies. These rates are for the periods (vertices) O/N, 1 week, and 1, 2, 3, 6, and 12 months. The symbols for these rates are of the form R001, R007, R030, and so on (for example, SEK.R001, SEK.R007). • Government bond zero rates for different currencies. Periods (vertices) included are 2, 3, 4, 5, 7, 9 10, 15, 20, and 30 years. The symbols for government zero rates are of the form Z02, Z03, Z04 and so on (for example, for Swedish bonds SEK.Z02, SEK.Z03, SEK.Z04). • Swap zero rates for different currencies. Periods (vertices) included are 2, 3, 4, 5, 7, and 10 years. The symbols for these rates are of the form S02,S03 and so on (for example, SEK.S02,SEK.S03). • Equity indexes. The symbol for a stock index is SE (for example Swedish stock index is SEK.SE). 2.5.3.2 TRM market data The market data for TRM falls into the following categories: • Foreign Exchange (FX) spot rates for any currency involved in trading. Since the present value of a position is expressed in the portfolio base currency or the monitoring currency selected in Treasury Monitor, the VaR key-figures should also be expressed in the same currency. The original data from RiskMetrics are always expressed in terms of US dollars and so they have to be converted into correlations and volatilities in terms of the base currency (see 2.5.4.1 Reference currency on page 204). • Interest rate (IR) reference rates In TRM, there are several ways to derive an IR reference rate (see 2.2 Yield curves on page 81). A reference rate is taken from a defined yield curve. The simplest way to define a yield curve is to use direct market quotes. It is also possible to derive a zero-coupon yield curve from a set of instruments or other reference rate yield curves, for example, by using a depo curve for the short end and a swap curve for the long end. Offsets can be added to previously defined rates in the yield curve to derive new rates. Due to the possible complexity of this rate derivation, it is not feasible to derive the correlations for the derived yield curve from the correlations of the underlying yield curve. Therefore, each IR reference curve has to be mapped separately to its correlation vertices on the Interest Rate Mapping page of VaR Mapping Editor. • IR instruments An IR instrument, such as a bond and a bond future can be either mapped to volatilities and correlations of a yield curve, or directly to its individual volatility and correlation data, if such is available. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 203 2 Market standards and calculations 2.5 Value-at-Risk calculations In the former case, the default is to use the VaR mapping specified for the instrument's currency, but it is also possible to choose a different mapping by bringing in the feature VaR Mapping Type, see A.2.336 VaR Mapping Type on page 878. To use instrument-specific volatility and correlation data, the instrument has to be given its own mapping in VaR Mapping Editor (Instrument Mapping page). • Equities Equities can either be mapped onto their individual volatility and correlation data or onto a common index. In the latter case, the beta of the equity is used to obtain the equity's volatility from the volatility of the index. The beta defined in Rate Monitor can be overridden for VaR calculations. 2.5.4 Transforming RiskMetrics data This section describes how the RiskMetrics data are transformed into data suitable for TRM. 2.5.4.1 Reference currency In RiskMetrics all currencies are quoted against the US dollar. This means that when value-at-risk is calculated in a different currency, typically the portfolio base currency, or the figure currency of Treasury Monitor, the variance-covariance matrix has to undergo a transformation. To get covariances for the cross rates X=A/B and Y=C/D we use the following equation: Equation 2-394 VaR: Covariances cross rates Cov ( X, Y ) = Σ AC + Σ BD – Σ AD – Σ BC If X and Y are the same rate, in other words A=C and B=D, then Equation 2-395 VaR: Covariances same rate 2 2 2 σ x = Cov ( X, X ) = σ A + σ B – 2Σ AB If one of the rates is not a cross rate, for example if Y=C, then Equation 2-396 VaR: Covariances one of the rates is not a cross rate Cov ( X, C ) = Σ AC – Σ BC 2.5.4.2 Interpolating volatilities and correlations RiskMetrics provide volatility and correlation data for risk horizons of one day and one month. Whenever risk horizons differing from these are used, the data have to be interpolated. 2.5.4.2.1 Volatility It is appropriate to use quadratic interpolation to calculate volatilities for risk horizons (maturities) other than one day and one month. • Case 1: Risk horizon t between t1 (one day) and t2 (one month). If t is the risk horizon for which the standard deviation is needed and t1 < t < t2, let Equation 2-397 VaR: Case 1 - Volatility t – t1 τ = -------------t2 – t1 204 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.5 Value-at-Risk calculations then the volatility σ is given by: Equation 2-398 VaR: Case 1 - Volatility calculation 2 σt = • 2 σ1 σ2 τt ------ + ( 1 – τ )t -----t2 t1 Case 2: For t outside the range [t1, t2], the volatility is scaled by the square root of time. – For t < t1: Equation 2-399 VaR: Case 2 - Volatility σt = – ( t ⁄ t 1 )σ 1 For t > t2: Equation 2-400 VaR: Case 2 - Volatility calculation σt = ( t ⁄ t 2 )σ 2 2.5.4.2.2 Correlation data For correlations, linear interpolation is used. That is, if the two known correlations for the risk horizons t1 (one day) and t2 (one month) are ρ 1 and ρ 2 , then the correlation ρ t for the risk horizon t can be calculated using one of the following methods: • Case 1: Risk horizon t between t1 and t2. Equation 2-401 VaR: Correlation data ρ t = τρ 2 + ( 1 – τ )ρ 1 • Case 2: Risk horizon t outside the range [t1, t2]. – For t < t1: ρ t = ρ 1 – For t > t2: ρ t = ρ 2 2.5.4.3 Cashflow mapping A financial position is made up of one or more cashflows which need to be marked-to-market (present value) using current market rates for the VaR calculations. The present value of most cashflows depends on two variables: • The spot rate of the cashflow currency • The interest rate for the maturity of the cashflow. This means that the number of market variables is of the same order as the number of cashflow dates in the portfolio that is under scrutiny. The volatilities and correlations for all these variables could be derived from the original data set leading to a very large correlation matrix. An alternative approach is to restrict the set of market variables to consist of only the spot rates and interest rates for a given set of periods (the RiskMetrics' vertex periods - 2.5.2 RiskMetrics data on page 201 gives details of the vertices for the different market variables in RiskMetrics). The Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 205 2 Market standards and calculations 2.5 Value-at-Risk calculations cashflows that fall between the vertex periods have to be mapped (redistributed) onto a standard grid of maturity vertices. This is illustrated as follows. In this way, the market variables of the cashflows are mapped onto the market variables of the RiskMetrics vertices. For example, if the interest rate of the second cashflow in the previous figure (at 5 months) is rc and r3m and r6m are the interest rates of the 3 month and 6 month RiskMetrics vertices respectively, then the present value of the cashflow, Vp(rc) will become Vp(r3m, r6m). The next step in the VaR approach is to calculate the vector δ (see 2.5.5.1 Calculating VaR deltas on page 207). This vector contains the VaR deltas (sensitivity of the position to a change in a market variable) for every market variable. The goal of the cashflow mapping is to transform this vector δ into another one, δ m , which contains the sensitivities to changes in the market variables at the maturity vertices used in the VaR calculations. This transformation takes the form of a matrix M where the elements Mij provide the mapping from the ith TRM market variable to the jth VaR market variable. Equation 2-402 VaR: Cashflow mapping δ m = Mδ 2.5.4.3.1 Risk equivalent method The mapping of a cashflow that falls between RiskMetrics vertices is based on the idea that the interest rate for such a cashflow can be considered as a result of an interpolation from the adjacent vertices. More precisely, consider a cashflow whose present value is a function Vp(rd) of the interest rate rd with maturity d. We can regard rd as a linear function of the two closest vertex interest rates r1 and r2. Equation 2-403 VaR: Risk equivalent method r d = ar 1 + br 2 where a and b are interpolation coefficients. Now, we can consider the present value of our cashflow to be a function Vp(ar1+br2) of r1 and r2 instead of rd. Using the risk equivalent method, we do not need to calculate the mapped cashflows as previously described to transform the VaR delta vector δ into δ m , but can simply calculate δ m from the IR exposure (delta) of the original cashflow. This is particularly convenient for derivative instruments where the IR exposure is not calculated directly from the cashflows. 206 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.5 Value-at-Risk calculations To be more specific, we have: Equation 2-404 VaR: Risk equivalent method ∂V ∂V ∂r d ------= ------- ------∂r 1 ∂r d ∂r 1 ∂V p = a ---------∂r d and Equation 2-405 VaR: Risk equivalent method ∂V ∂r d ∂V ------= ------- ------∂r d ∂r 2 ∂r 2 ∂V p = b ---------∂r d Also since a+b=1, the total IR sensitivity is Equation 2-406 VaR: Total IR sensitivity ∂V p ∂V ∂V ---------- = ---------p- + ---------p∂r d ∂r 1 ∂r 2 It can therefore be seen that in this risk equivalent method, the cashflow itself does not get mapped, but the IR risk (exposure) does. 2.5.5 VaR calculations The method used in TRM to calculate value-at-risk is the linear (delta) method. The function V() of the value of the position is approximated with a linear function via a Taylor series expansion: Equation 2-407 VaR: Linear (delta) method (Taylor series expansion) V ( x 1, x 2, …, x n ) ≈ V p + δ 1 ( x 1 – X 1 ) + δ 2 ( x 2 – X 2 ) + … + δ n ( x n – X n ) = V p + δ x where Vp is the current present value, the xi represent the market variables and Xi the current values of those market variables, the δ i (elements of the VaR delta vector δ ) are the partial derivatives of the value function V() with respect to each xi (see 2.5.5.1 Calculating VaR deltas on page 207). In order to produce an estimate of the value-at-risk, first of all the VaR deltas need to be calculated (shown in next section). The standard deviation of the position in question can then be calculated using these VaR deltas and the variance-covariance matrix (see 2.5.2.1 Variance-covariance matrix on page 202). From the standard deviation we know the probability function of the position and this is then used to estimate the value-at-risk at a certain confidence level (probability). 2.5.5.1 Calculating VaR deltas In order to be able to calculate the overall risk for our position, we shall need the vector δ = ( δ 1, δ 2, …, δ n )′ Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 207 2 Market standards and calculations 2.5 Value-at-Risk calculations defined by Equation 2-408 VaR: Vector ∂V p δ i = ---------∂x i where δ i is the sensitivity of the present value Vp to a change in the market variable xi 2.5.5.1.1 Simple cashflows The present value of a simple cashflow of amount A is Equation 2-409 VaR: Present value (simple cashflows) A l V p = ---------------- S = V p × S D ( r, t ) A l V p = ---------------D ( r, t ) where S is the spot rate between the cashflow currency and the portfolio currency and D(r,t) is the discount factor calculated with interest rate r and period t. There is therefore dependency on two market variables, S and r, the spot rate and the interest rate for the cashflow date. Note: Strictly speaking, due to the complicated method of calculating the discount factor, it may depend on the interest rate on more than one date. The error made in ignoring this fact is, however, insignificant. The corresponding VaR deltas are: • FX Delta Equation 2-410 VaR: FX delta δ FX • ∂V p A = = ---------------∂S D ( r, t ) IR Delta Depending on the value of the configuration parameter called var yield volatility, the IR deltas will not be calculated in the same way. The var yield volatility parameter is described in more detail in the TRM System Admin Guide. 208 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.5 Value-at-Risk calculations When the value is true, TRM considers the volatilities stored in the VaR scenarios to be yield volatilities and calculates the IR deltas as follows: Equation 2-411 VaR: IR delta calculations l Vp = Vp × S l l ΔV p = S × Δ V p + V p × ΔS l ∂V p l ΔV p = S × ---------- × Δr + V p × ΔS ∂r ∂V p l ΔV p = ---------- × Δr + V p × ΔS ∂r ∂V p Δr l ΔV p = r × ---------- × ------ + V p × ΔS ∂r r so that ∂V p δ IR = r × ---------∂r In TRM terms: IR Delta = 1000 x IR Exposure (1bp) x Interest Rate with IR Exposure (1bp): Sensitivity of your cashflow Present Value to a change of 1 basis point in the interest rate. Interest Rate: Zero-coupon rate used in the Present Value and IR Exposure (1bp) calculation. When the parameter - var yield volatility is set to false, TRM considers that the volatilities stored in the VaR scenarios are price volatilities and calculates the IR deltas as follows: Equation 2-412 VaR: IR delta calculations (in TRM) l Vp = Vp × S l l ΔV p = S × Δ V p + V p × ΔS l ∂V p l ΔV p = S × ---------- × ΔD + V p × ΔS ∂D ∂V p l ΔV p = ---------- × ΔD + V p × ΔS ∂D ∂V p ΔD l ΔV p = D × ---------- × -------- + V p × ΔS ∂D D so that ∂V p δ IR = D × ---------∂D In TRM terms: IR Delta = Discounted Risk Value Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 209 2 Market standards and calculations 2.5 Value-at-Risk calculations 2.5.5.1.2 Par method If Quoted method is used for the value-at-risk of an instrument (see 2.5.3.2 TRM market data on page 203) then delta is the present value of the instrument itself. 2.5.5.1.3 FX options For FX options, we have option deltas for both the asset and cash currencies, δ a and δ c which are calculated with the normal FX option formulas. Similarly the VaR deltas with respect to the interest rates are obtained by multiplying the IR exposures of the corresponding FX forward deal by the delta of the option. 2.5.5.1.4 IR options From cashflows associated with IR options the VaR currency delta is obtained by dividing the FX exposure by the FX risk offset, and the VaR IR delta by dividing the IR exposure by the IR risk offset (as shown in 2.5.5.1.1 Simple cashflows on page 208). 2.5.5.1.5 Equities An equity transaction creates FX, IR, and Price (equity) exposures. The FX and IR exposures are used to calculate the VaR FX and IR deltas in the normal manner: the FX or IR exposure is divided by the corresponding risk offset (as in 2.5.5.1.1 Simple cashflows on page 208). For Price exposure there are two alternatives. The first is that each equity is mapped to its own market variable. This approach requires that there is volatility and correlation data for each equity dealt with. However, it is more realistic to assume that the volatility and correlation data only exist for each equity index. Each equity can then be mapped to the index it belongs to. With this approach, the variation between the volatilities of the various equities can be determined via the betas. Each equity is assigned its own beta factor β which describes how strong the link between the movement of the stock and the index is. (The betas for individual stocks are calculated outside TRM and are fed in through Rate Monitor.) If beta is equal to one, the volatility of the equity is the same as the index volatility (the price of the stock is directly proportional to the value of the index). If beta is two, the equity's volatility is double the index's volatility and so on. A negative beta means that the price of the stock varies inversely to the value of the index; for example a beta of -2 means that the value of the stock decreases by 20% if there is an increase of 10% in the value of the index. The VaR equity delta of an equity is calculated by: Equation 2-413 VaR: Equities δ EQ = βN where N is the number of equities in the position. 2.5.5.1.6 Equity options The equity exposure of an equity option is based on the delta of the option. Therefore, the VaR equity delta of an equity option is calculated from: Equation 2-414 VaR: Equity options δ EQ = βδN where N is the number of underlying shares in the contract and δ is the option's delta. 2.5.5.2 Mapped deltas The VaR IR deltas described above may need to be mapped to RiskMetrics vertices as described in the 2.5.4.3.1 Risk equivalent method on page 206. 210 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.5 Value-at-Risk calculations If the VaR IR delta δ is with respect to an interest rate r for a period t which is not VaR vertex, then if the closest VaR vertices to t are t1 and t2, δ is mapped to corresponding deltas δ 1 and δ 2 so that Equation 2-415 VaR: Mapped deltas δ 1 = aδ r δ 2 = bδ r where t2 – t a = -------------t2 – t1 t – t1 b = -------------t2 – t1 2.5.5.3 Proportional deltas The correlation and volatility data from RiskMetrics are given as relative values. To get the actual values, we have to multiply these relative values by the current values of the market variables. In order to do this, we use the vector Δ , defined below, instead of the VaR delta vector δ in the VaR calculations (Equation 2-408 on page 208). Equation 2-416 VaR: Proportional deltas Δ = ( δ 1 X 1, δ 2 X 2, …, δ n X n ) where δ 1 is the VaR delta corresponding to the present value in question, and Xi is the current value of the market variable. 2.5.5.4 Value-at-Risk Once we know the delta vector for the position (which is then converted into the vector Δ as shown in Equation 2-416 on page 211) and the appropriate covariances (the variance-covariance matrix Σ as defined in Equation 2-392 on page 202), we can obtain the standard deviation σ of the total position: Equation 2-417 VaR: standard deviation of the total position 2 σ p = Δ′ΣΔ = ∑ Δi ∑ Σij Δj i j From σ , we can construct various risk measures, the most common of which is the (two-sided) confidence interval I 90 = 1.65σ p . The probability that the value of our position changes under the risk horizon less than I90 is 90%. Other confidence intervals can be derived, for example, the probability that the value of the position changes less than I 95 = 1.96σ p is 95%. Even if the value does not remain within the interval, it is not necessary that the position's value diminish, since the value could move up instead of down. Since the tails of the distribution are symmetric, the probability of moving up beyond the confidence interval is 5% for the 1.65σ p interval and 2.5% for the 1.96σ p interval. Thus, the probability of losing more than 1.65σ p is, in fact, only 5% and the probability of losing more than 1.96σ p just 2.5%. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 211 2 Market standards and calculations 2.5 Value-at-Risk calculations In the following figure, the shaded area represents the probability that the value of the position will move below the value-at-risk figure 1.65σ . This probability is 5%. The VaR key-figures which can be selected in Treasury Monitor are described in more detail in the TRM User Guide. 2.5.6 Incremental VaR Incremental VaR is a statistic providing information on the sensitivity of VaR to changes in portfolio holdings. Let wi be the i component of the delta vector of the portfolio and VaR the total value at risk of the portfolio, with the i component of the incremental VAR defined as: Equation 2-418 VaR: Incremental VaR definition ∂VAR IVAR i = w i ---------------∂w i As a consequence of the definition, Equation 2-419 VaR: Incremental VaR calculation ∑ I VARi = VAR i 2.5.6.1 Calculation of incremental VaR Let Cij denote the covariance matrix, w the delta vector and wT the transpose of the delta vector. Since Equation 2-420 VaR: Incremental VaR calculation VAR = T w Cw the i component of the incremental VaR (IVAR) is defined as Equation 2-421 Incremental VaR (IVAR) Incremental VaR can then be interpreted as the product of the exposures of the position with respect to each risk factor wi and the sensitivity of the VaR of the portfolio with respect to changes in each of those risk factors. 212 © Wall Street Systems IPH AB - Confidential 2 Market standards and calculations 2.5 Value-at-Risk calculations ∑ Cij wj j IVAR i = w i ------------------VAR Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 213 2 Market standards and calculations 2.5 Value-at-Risk calculations 214 © Wall Street Systems IPH AB - Confidential Chapter 3 Debt instruments 3.1 Bond Bonds are negotiable issues, which means that their cashflows are known (in terms of structure and dates) when the bond is issued. They can be traded in the market. In TRM, there is a clear distinction between loans and bonds. Loan agreements are set up mostly at deal entry, while bond issues must be completely defined at instrument level (notably in terms of cashflows). As is the case for loans, the definition of cashflows relies completely on the schedule concept (or cashflow structure). See Appendix B Schedules on page 883. Several schedules must be attached to a bond and they drive the generation of the cashflow structure for the deal. For the simplest bond, two schedules are associated with the deal: one schedule for interest flows; and one schedule for principal flows. It is possible to have additional interest schedules in the case of parallel interest flows. Bond instruments must be based on an instrument type derived from the class BOND. 3.1.1 Fixed-rate bond This is the simplest type of bond. Fixed-rate bonds are usually managed as described in the following sections. 3.1.1.1 Instrument setup • Bond main characteristics This information may be relevant to any kind of fixed-rate bond. Information Description Issuer Issuer of the bond. Currency Currency in which the bond is issued. Amount Rounding Specify with how many decimals and with which method the amounts will be rounded. Default Price Denom. For fractional prices, defines the default denominator. If a default price denominator is specified, the Deal Price can be entered as a fraction at deal entry. For example, if you enter 32 in this field, a Deal Price entered as 100-5 is displayed as 100 5/32. See the TRM User Guide. Accrued Interest Method How the system computes settlement accrued interest. For most bonds, the Linear method can be used, but some bonds require a specific method. For bonds traded at dirty price (i.e. price that includes accrued interest), it is also possible to specify an accrued interest method. In this case, the accrued interest is calculated for accounting purposes only (as settlement principal based on dirty price already includes accrued interest). If this field is left blank, no settlement AI is calculated See 2.1.6.1 Accrued interest calculations on page 67 for details of accrued interest methods. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 215 3 Debt instruments 3.1 Bond Information Description Settlement Switches If the bond is traded in dirty price it has to be specified here. Coupon Rate The interest rate of the fixed-rate bond. It is also possible to define whether rounding of the settlement principal is per trading unit, that is, the rounding is done for one unit and then the amount is multiplied by the number of units to obtain the settlement principal and accrued interest. See A.2.51 Bond on page 734. – Dates details The issue date and the maturity date must be specified for the bond. – Trading unit details It is possible to define a minimum bid size or trading units of a bond. If a minimum denomination is defined, deal entry is available either in units or amount and TRM ensures that the amount is a multiple of the denomination size. • Schedules Select the cashflow structure template you want for the instrument. For each set of cashflows defined in the template, select the generation parameters. One system template is provided for fixed-rate plain vanilla bonds (see B.2.1.1.21 Fixed, Bullet Repayment on page 894); you can choose this template or any other template derived from it. Once the template is applied to the instrument, the schedules are created and it is then possible to define their characteristics, such as, date basis, payment convention, calendars, and so on. See Appendix B Schedules on page 883. • Cashflows As the cashflows are an intrinsic characteristic of an issue, they must be defined at instrument level. Generation of the cashflows is automatically done in the instrument setup and takes into account all the information specified in the schedule. Some fields can be manually modified at cashflow level if necessary. The cashflows are saved in the database along with the instrument, and they will be used directly to generate the cashflows of the deal when the bond is sold or purchased. • Trading yield Specify how the yield/price conversion will be made when dealing the instrument. Information Description Yield Convention The convention defines how the yield/price conversion will be made. TRM supports the standard conventions. See 2.1.4 Yield/price conversions on page 38. Price and Rate rounding Defines how the system should round prices and rates. See A.2.323 Trading Yield on page 872. • Quoted It is necessary to specify how a bond is quoted on the market. 216 Information Description Price Type Price % or Yield for a bond. Quote Handling If the Bond quote handling is used, the system will notify Rate Monitor that it is a fixed-rate bond. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond Information Description Currency This quoted notion is time dependant (price type and/or currency may change over the life of a bond). See A.2.274 Quoted on page 849. It is also possible to set up: • Spot day calculations • Cashflow and transaction charge rules • Collateral • Branch Codes • Security Identifiers • Delivery. See Appendix A Features on page 713. 3.1.1.2 Deal capture 3.1.1.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a deal on a fixed-rate bond. Information Description Deal Price or Deal Rate If there is a yield/price convention set on the instrument, it is possible to enter either a rate or a price. The conversion will be made automatically. If there is no convention set, the deal must be entered in price. If a default price denominator is specified at instrument setup, Deal Price can be entered as a fraction. For more information about fractional prices, see the TRM User Guide. By default, Deal Price is considered as clean (i.e. does not include accrued interest). Deal Price is considered dirty if so defined at instrument level (in Settlement Switches) or if you set the Force Dirty Price transaction column value to Yes when entering the transaction. Nominal Amount Face Amount Value Date Enter either the nominal amount or face amount, and the system will compute the other automatically. Official date when money is transferred. This defaults to the spot date of the transaction. In addition, the following optional information can be captured: Information Description Units If the denomination of a bond instrument is specified at instrument setup, the deal can be input in units, and the nominal and face amounts are computed by the system. Trading Unit Size Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 217 3 Debt instruments 3.1 Bond 3.1.1.2.2 Generated data • Transaction Book Value (BV) = NA * price / 100 where: NA = nominal amount price = deal price • Cashflows TRM copies all the future cashflows of the bond and scales them according to the nominal amount engaged (using rounding). Additionally, the system generates a settlement cashflow with amount = BV (see above) and an accrued interest cashflow according to the AI Method. The following cashflow structure is generated for a fixed-rate bond: 3.1.1.3 Processing This section describes the actions that can be done throughout the life of a bond. 3.1.1.3.1 Asset swap You can easily create an asset swap from a bond transaction by executing the Asset Swap action. The asset swap is an interest rate swap where the cashflow structure of one leg (the asset leg) is similar but opposite to the cashflow structure of the bond, and the other leg corresponds to what you have specified (e.g. quarterly floating). • Setup To enable this action, the Allow Swap feature must be associated with the instrument. See A.2.23 Allow Swap on page 722. • Execution Right-click a bond transaction that uses an instrument with the Allow Swap feature, and select Asset Swap action in Transaction Manager. When you execute this action, use the following table to specify the parameters. Information Description Swap Instrument Select the instrument for the asset swap transaction. See 11.1.2 Asset swap on page 656 for information about setting up the Swap Instrument. 218 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond Information Description Opening Date The opening date and value date of the asset swap transaction. Value Date Swap Amount The nominal amount being swapped, which defaults to the nominal amount of the underlying bond transaction. This can be changed in order to swap a fraction of the bond. Asset Amount Read-only. The nominal amount of the underlying bond. Swap Units Read-only. The number of units being swapped (if the underlying bond is traded by units). Asset Units Read-only. The number of units of the underlying bond (if the underlying bond is traded by units). Leg Leg of the swap that will reflect the asset leg, i.e. which reverses the cashflows of the bond. Zero-Coupon Style Switch on so that the nominal amount of the other leg (i.e. the non-asset leg) of the asset swap is adjusted with the deal price of the underlying bond. The system automatically defaults to the zero-coupon style when there are no interest cashflows found in the bond transaction. Include Fees after Value Date Switch on so that fees that are to be settled after the value date of the bond are also copied and reversed asset swap. If this switch is not on, the fees after the value date are ignored. Price/Fee Method Method for reflecting the deal price and the fees of the bond in the asset swap transaction. As for all swaps, a price that is different from par (100) will result in upfront payments in the swap. Choose from: • All-In Price - All-In Price of the underlying bond is used as the price of the asset leg • Deal Price - Deal Price of the underlying bond is used as the price of the asset leg of of the swap. the swap. • Deal Price with Fees - Deal Price of the underlying bond is used as the price of the asset leg of the swap. In addition, the fees of the bond transaction can be reflected (copied and reversed) as upfront payments in the asset swap transaction. The Copied Fees field is used for determining which fees are to be reflected in the swap. • Par - Price of the asset leg of the swap is Par, i.e. 100. • Par with Discount/Premium and Fees - Price of the asset leg of the swap is Par, i.e. 100, but in addition discount/premium and fees of the bond transaction can be reflected (copied and reversed) as upfront payments in the asset swap transaction. The Copied Fees field is used for determining which fees are to be reflected in the swap. • Re-Offer Price - Re-Offer Price of the underlying bond is used as the price of the asset leg of the swap. Copied Fees Fees () Select which fees are to be copied (as reversed) from the bond transaction to the swap transaction as upfront payments: • None - No fees are copied. • All Fees - All fees are copied. • All-In Fees - Only All-In fees are copied (i.e. fees with the All-In attribute). • Re-Offer Fees - Only Re-Offer fees are copied (i.e. fees with the Re-Offer attribute). The fee amounts (in the relevant currency) copied/reversed from the underlying bond transaction and considered as upfront payments in the asset swap transaction. The values are defaulted from the bond transaction according to the selections in Price/Fee Method and Copied Fees fields. You can modify the amounts if needed. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 219 3 Debt instruments 3.1 Bond Information Description Adjust Leg 2 Price With Up-Fronts Switch on so that the Deal Price of the other leg (i.e. the non-asset leg) of the asset swap is adjusted with the upfront payments on the asset leg. By Nominal Amount If the underlying bond is traded in units, you can 'force' the swap transaction to be based on the nominal amount rather than units by setting this switch. If the swap is based on units, the interest amounts are calculated by one unit and multiplied by the number of units. The execution of the action generates a swap transaction. • Cancellation Cancellation of the action is done by canceling the swap transaction. 3.1.1.3.2 Pricing Pricing of bond transactions can be performed at transaction level using a right-click processing action. • Setup A choice of two types of Pricing action are available on the transaction if the Bond Pricing feature is associated with the instrument: Swap Spread or Yield/Price to Maturity. See A.2.79 Bond Pricing on page 746. • Execution – Swap Spread This Pricing action calculates the spread to be add to the floating leg of an asset swap generated from a given bond so that the market value of the asset swap is zero. – Information Description Swap Instrument ID of the Asset Swap instrument. Floating Leg Currency Currency of the floating leg. Floating Leg Frequency Frequency of the floating coupon. Swap Deal Price Deal price of the swap. Swap Spread Calculated spread after pricing. Yield/Price to Maturity This Pricing action calculates a yield (Price) using a given price (Yield) and vice versa. The calculation assumes the Yield Convention (*ISMA-30E360-ANNUAL or other) as defined in the Trading Yield page of the Instrument. 220 Information Description Interest Rate Rate type of the yield. Date Basis Date basis used to convert the time. Pricing Date Opening date of the bond transaction. Pricing Variable Yield (or the price). Pricing Target Variable (Information only) Price (or the yield). © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond Information Description Pricing Target (in %) Target value that you want to achieve. Pricing Result (Information only) Calculated value of the variable after pricing. 3.1.1.3.3 Benchmarking It is possible to analyze and compare a bond issue against those of another bond (the benchmark) or a swap curve, in terms of yields, swap spreads, or par swap rates. See 3.2 Structured bonds on page 244. 3.1.1.3.4 Transaction conversion It is possible to allow schedule conversion at predefined dates during a bond's life. • Setup (at instrument level) This process is available on the transaction if the Transaction Conversion feature is associated with the instrument. See A.2.325 Transaction Conversion on page 873. Then, the user can attach conversion schedules (at the instrument level) in the Schedule page of the Instrument Editor. • Execution – At instrument level: To execute the conversion at a predefined date, in the Instrument Editor, Cashflow page, the user selects the conversion flow and performs Convert action. After this conversion, when capturing a transaction, cashflows are generated according to the converted schedules. – At transaction level: When capturing a transaction before the conversion date, conversion events are also generated in the transaction. To execute the conversion, the user right-clicks the row of the corresponding transaction event and selects Transaction Conversion. The conversion inputs are displayed. See A.2.325 Transaction Conversion on page 873. The execution generates a conversion transaction with the following attributes: – Kind: Conversion – Opening Date: Conversion opening date – Value Date: Conversion value date. The remaining attributes are inherited from the initial transaction. The conversion transaction generates closing cashflows for the initial transaction; and future cashflows are reopened according to the conversion schedules defined at instrument level. 3.1.1.4 Position monitoring 3.1.1.4.1 Setup The cashflow discounting method used in IR risk calculation depends on the instrument set up: • Risk setup: The default risk method is Zero-Coupon or you can select Z-Spread or Yield to Maturity. For more information about these methods, see A.2.288 Risk Setup (BOND) on page 858. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 221 3 Debt instruments 3.1 Bond IR exposure setup: • – By default, TRM uses the valuation curve interpolation settings (IR Quote and Yield Curve Editor - Interpolation page). For example, if the interpolation settings are set up with Interest Type Continuous Yield, then risk calculations use continuously compounding discounting of the cashflows. – If IR Exposure is set up at the instrument level, then TRM uses these settings. For example, if IR exposure is set up with yield type Periodic Rate, then risk calculations use periodic discounting of the cashflows. See A.2.48 Base IR Exposure Setup on page 732. – If the risk method Yield to Maturity is used, then the date basis and interest rate defined for the risk yield are applied, even if there is an IR exposure setup. For more information about these calculations, see 2.3 Key-figures on page 112. 3.1.1.4.2 Calculations In this section, numerical examples demonstrate how the different figures are calculated for fixed-rate bonds. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. This example shows a fixed-rate bond with the following deal data: Setup data Instrument Date Basis Act/360 Currency EUR Valuation Method Theoretical Risk Method Theoretical Valuation Date Figure Date Risk Date Figure Date Risk Yield Type Continuous AI Method Linear Schedule Fixed, Bullet Repayment Result IR: Accrued Interest Linear Result IR: Accrual Method Linear Accrual Accrual Yield: Interest Type Periodic Rate Accrual Yield: Date Basis Actual/360 Unless otherwise stated, the figure date used in the calculations is 2001-05-15. On this date, the market data is as follows: Market data on 2001-05-15 Figure Date d_f 2001-05-15 Days to Spot d_fs 2 Discount Rate r_d 3.048771% Other figures calculated by the system are as follows: • 222 Time to Spot t_s = d_fs / B 0.005555556 = 2 / 360 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond • MV Spot Discount Factor D_s = EXP (-t_s * r_d) = 0.9998306382 Transaction data specific to the principal cashflow is as follows: Transaction data Opening Date 2001-02-16 Nominal Amount A 1,000,000 Value Date dt_v.p 2004-01-01 Payment Date dt_p.p 2004-01-02 Issue Date dt_i 2001-01-01 Book Value V_b.p = A 1,000,000 On the figure date, the market data specific to the principal amount is as follows: Market data on 2001-05-15 Interest Rate r.p 4.56933049% Other market data and figures specific to the principal amount are calculated by the system as follows: • Time to Payment t_p.p = (dt_p.p - d_f) / B 2.67222222 = (2004/01/02 – 2001/05/15) / 360 • MV Discount Factor D_V.p = D_s * D_f.p = 0.8851322685 • PV Discount Factor D_P.p = D_s * D_f.p = 0.8851322685 • Discount Factor From Spot D_f.p = EXP (-(t_p.p - t_s) * r.p) = 0.8852822015 On the figure date, the market data specific to the coupons is as follows: Market data Coupon 1 Interest Rate r.c1 Coupon 2 3.5485079% r.c2 Coupon 3 4.145317% r.c3 4.56933049% Transaction data specific to the coupon cashflows is as follows: Transaction data Coupon 1 Coupon 2 Coupon 3 Amount A.c1 50,000 A.c2 50,000 A.c3 50,000 Value Date dt_v.c1 2002-01-01 dt_v.c2 2003-01-01 dt_v.c3 2004-01-01 Payment Date dt_p.c1 2002-01-02 dt_p.c2 2003-01-02 dt_p.c3 2004-01-02 Other market data and figures specific to the coupons are calculated by the system as follows: • Coupon 1 Time to Payment t_p.c1 = (dt_p.c1 - d_f) / B 0.644444444 = (2002/01/02– 2001/05/15) / 360 MV Discount Factor D_V.c1 = D_s * D_f.c1 = 0.977418468 PV Discount Factor D_P.c1 = D_s * D_f.c1 = 0.977418468 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 223 3 Debt instruments 3.1 Bond Discount Factor from Spot D_f.c1 = EXP (- (t_p.c1 - t_s) * r.c1) = 0.977584034 • Coupon 2 Time to Payment t_p.c2 = (dt_p.c2 - d_f) / B 1.658333333 = (2003/01/02 – 2001/05/15) / 360 MV Discount Factor D_V.c2 = D_s * D_f.c2 = 0.933623285 PV Discount Factor D_P.c2 = D_s * D_f.c2 = 0.933623285 Discount Factor from Spot D_f.c2 = EXP (- (t_p.c2 - t_s) * r.c2) = 0.933781432 • Coupon 3 Time to Payment t_p.c3 = (dt_p.c3 - d_f) / B 2.672222222 = (2004/01/02 – 2001/05/15) / 360 MV Discount Factor D_V.c3 = D_s * D_f.c3 = 0.885132268 PV Discount Factor D_P.c3 = D_s * D_f.c3 = 0.885132268 Discount Factor from Spot D_f.c3 = EXP (- (t_p.c3 - t_s) * r.c3) = 0.885282201 3.1.1.4.3 Valuation figures The valuation method commonly used for a fixed-rate bond is the Theoretical method. • Principal flow figures Market Value V.p = A * D_V.p 885,132.27 = 1,000,000 * 0.8851322685 Clean Market Value CMV.p = A * D_f.p 885,282.20 = 1,000,000 * 0.8852822015 • Coupon 1 figures Market Value V.c1 = A.c1 * D_V.c1 48,870.92 = 50,000 * 0.977418468 Clean Market Value CMV.c1 = A.c1 * D_f.c1 - Accrued_Interest_Spot 29,990.31 = 50,000 * 0.977584034 - 18,888.89 • Coupon 2 figures Market Value V.c2 = A.c2 * D_V.c2 46,681.16 = 50,000 * 0.933623285 Clean Market Value CMV.c2 = A.c2 * D_f.c2 46,689.07 = 50,000 * 0.933781432 • Coupon 3 figures Market Value V.c3 = A.c3 * D_V.c3 44,256.61 = 50,000 * 0.885132280 Clean Market Value CMVc3 = A.c3 * D_f.c3 44,264.11 = 50,000 * 0.885282201 • Total transaction figures Market Value = V.p +V.c1 + V.c2 + V.c3 = 1,024,940.97 224 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond Clean Market Value = CMV.p + CMV.c1 + CMV.c2 + CMV.c3 =1,006,225.70 3.1.1.4.4 Result figures The setup of the instrument impacts the way result figures are computed. • Principal flow figures Total Profit Total_Profit.p = V.p - V_b.p -114,867.73 = 885,132.27 – 1,000,000 MtoM Profit MtoM_Profit.p = A * D_f.p - V_b.p -114,717.80 = 1,000,000 * 0.8852822015 – 1,000,000 Other Profit Other_Profit.p = Total_Profit.p - MtoM_Profit.p -149.93 = -114,867.73 – (-114,717.80) • Coupon 1 figures Total Profit Total_Profit.c1 = = V.c1 - V_b.c1 48,870.92 = 48,870.92 - 0 MtoM Profit MtoM_Profit.c1 = A.c1 * D_f.c1 - V_b.c1 - Accrued_Interest.Spot 29,990.31 = 50,000 * 0.977584034 – 0 – 18,888.89 Accrued Interest Accrued_Interest.c1 = A.c1 * (d_f - dt_i) / B 18,611.11 = 50,000 * (2001/05/15 – 2001/01/01) / 360 Other Profit Other_Profit.c1 = Total_Profit.c1 - MtoM_Profit.c1 - Accrued_Interest.c1 269.50 = 48,870.92 - 29,990.31 - 18,611.11 • Coupon 2 figures Total Profit Total_Profit.c2 = V.c2 - V_b.c2 46,681.16 = 46,681.16 - 0 MtoM Profit MtoM_Profit.c2 = A.c2 * D_f.c2 - V_b.c2 46,689.07 = 50,000 * 0.933781432 - 0 Other Profit Other_Profit.c2 = Total_Profit.c2 - MtoM_Profit.c2 -7.91 = 46,681.16 - 46,689.07 • Coupon 3 figures Total Profit Total_Profit.c3 = V.c3 - V_b.c3 44,256.61 = 44,256.61 - 0 MtoM Profit MtoM_Profit.c3 = A.c3 * D_f.c3 - V_b.c3 44,264.11 = 50,000 * 0.885282201 - 0 Other Profit Other_Profit.c3 = Total_Profit.c3 - MtoM_Profit.c3 -7.50 = 44,256.61 - 44,264.11 • Total transaction figures Total Profit = Total_Profit.p + Total_Profit.c1 +Total_Profit.c2 + Total_Profit.c3 = 24,940.97 MtoM Profit = MtoM_Profit.p + MtoM_Profit.c1 + MtoM_Profit.c2 + MtoM_Profit.c3 = 6,225.70 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 225 3 Debt instruments 3.1 Bond Accrued Interest = Accrued_Interest.c1 = 18,611.11 Other Profit = Total_Profit.total - MtoM_Profit.total - Accrued_Interest.total = 104.16 3.1.1.4.5 Risk figures The risk method commonly used for a bond is the Theoretical method. • Principal flow figures IR Exposure 1bp E_i.p = A * (- (t_p.p - t_s) * D_f.p * D_s - t_s * D_f.p * D_s) * 0.0001 -236.53 = 1,000,000*(-(2.6722222-0.005555556)*0.8852822015*0.9998306382-t_s*D_f.p*D_s)*0.0001 Effective Duration U_eff.p = -E_i.p / V.p / 0.0001 2.672222 = -(-236.53) / 885,132.27 / 0.0001 • Coupon 1 figures IR Exposure 1bp E_i.c1 = A.c1 * (- (t_p.c1 - t_s) * D_f.c1 * D_s - t_s * D_f.c1 * D_s) * 0.0001 -3.15 = 50,000 * (-(0.64444444–0.005555556)*0.977584034*0.9998306382–t_s*D_f.c1*D_s)*0.0001 Effective Duration U_eff.c1 = -E_i.c1 / V.c1 / 0.0001 0.64444 = -3.15 / 48,870.92 / 0.0001 • Coupon 2 figures IR Exposure 1bp E_i.c2 = A.c2 * (- (t_p.c2 - t_s) * D_f.c2 * D_s - t_s * D_f.c2 * D_s) * 0.0001 -7.74 = 50,000 * (-(1.658333333-0.005555556)*0.933781432*0.9998306382-t_s*D_f.c2* D_s)*0.0001 Effective Duration U_eff.c2 = -E_i.c2 / V.c2 / 0.0001 1.65833 = -7.74 / 46,681.16 / 0.0001 • Coupon 3 figures IR Exposure 1bp E_i.c3 = A.c3 * (-(t_p.c3 - t_s) * D_f.c3 * D_s - t_s * D_f.c3 * D_s) * 0.0001 -11.83 = 50.000*(-(2.672222222-0.005555556)*0.885282201*0.9998306382-t_s*D_f.c3* D_s)*0.0001 Effective Duration U_eff.c3 = -E_i.c3 / V.c3 / 0.0001 2.672222222 = -11.83 / 44,256.61 / 0.0001 • Total transaction figures IR Exposure 1bp = E_i.p +E_i.c1 + E_i.c2 + E_i.c3 = -259.24 Effective Duration = -E_i.total / V.total / 0.0001 = 2.529357 226 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond 3.1.1.5 Norwegian government bond Norwegian government bonds are based on annual coupon and Actual/365 accrual date basis. The ex-coupon period starts 14 calendar days prior to the interest payment. Accrued interest is calculated as shown in Equation 2-51 Accrued Interest: Norwegian on page 55. 3.1.1.5.1 Instrument setup Norwegian bond instruments must be based on an instrument type derived from the class BOND. • Main characteristics They are set up in a similar way to bonds (3.1.1 Fixed-rate bond on page 215), except for the following. Information Description Currency NOK AI Method Norwegian. See Norwegian on page 77. – Schedule Select a cashflow structure based on the Fixed, Bullet Repayment system template, (FIXED-BULLET). See B.2.1.1.21 Fixed, Bullet Repayment on page 894. • Trading Yield Information Description Yield Convention GOVT-NO-ACT365 (Norwegian Government Actual365) See A.2.323 Trading Yield on page 872. • Quoted parameters Information Description Price Type Yield Quote Handling Bond Currency NOK See A.2.274 Quoted on page 849. • Result parameters Information Description AI Method Coupon % See A.2.49 Base IR Setup on page 733. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 227 3 Debt instruments 3.1 Bond 3.1.2 Floating rate note Floating Rate Notes (FRNs) have interest payments linked to a reference rate which has to be fixed for each coupon. 3.1.2.1 Instrument setup Instrument setup for a floating rate note is similar to that of a fixed-rate bond (see 3.1.1 Fixed-rate bond on page 215), except for the following: • Bond main characteristics The coupon rate needs to be null. • Schedules Select the cashflow structure template you want for the instrument and, for each set of cashflows defined in the template, select the generation parameters. One system template is provided for floating rate bonds (B.2.1.1.22 Floating, Bullet Repayment on page 894); you can choose this template or any other template derived from it. Once the template is applied to the instrument, the schedules are created and it is then possible to define their characteristics. One important set of characteristics in the case of a floating rate note are the fixing parameters: – Fixing Rate (the yield curve) optionally * by a factor and + a spread – Fixing period (3M, 6M, 1Y, and so on) – Price Scenario used to retrieve the price which will be used for fixing – Fixing offset and type (in advance or in arrears). If in advance, the rate of the first cashflow is required. See Appendix B Schedules on page 883. • Discount margin calculation Most FRNs have a known first/next coupon payment, while subsequent coupons will usually be set in terms of a margin over a specific reference rate (such as, LIBOR). As a result, a current margin relative to the reference rate is often calculated. – Discount margin setup Define the parameters used to calculate the discount margin if you want to take it into account in the estimation of the instrument’s future flows. See A.2.343 Z-DM/Spread Setup on page 882. – Quoted It is necessary to specify how the FRN is quoted on the market. Information Description Quote Handling FRN It will then be possible to use the Bid Z-DM/Spread and Ask Z-DM/Spread figures to convert Price into Discount Margin in Rate Monitor. See A.2.274 Quoted on page 849. 228 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond – Risk parameters After the calculation of the discount margin, the payment discount factor of each flow is adjusted. The derived risk structure is achieved by setting the following parameter: Information Description Risk Profile Plain Vanilla See A.2.338 Valuation Setup (Floating) on page 879. 3.1.2.2 Deal capture 3.1.2.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a deal on a floating-rate bond. Information Description Deal Price Price paid for the FRN as a percentage of the Nominal Amount. Nominal Amount Enter either the nominal amount or face amount, and the system will compute the other automatically. Face Amount Value Date Official date when money is transferred. This defaults to the spot date of the transaction. In addition, the following optional information can be captured: Information Description Units If the denomination of a bond instrument is specified at instrument setup, the deal can be input in units, and the nominal and face amounts are computed by the system. Trading Unit Size Nominal/Spot Rate Current "running" coupon can be entered in this field (if fixing of the first coupon has not been carried out in Instrument Editor: see 3.1.2.3.1 Fixing on page 230). 3.1.2.2.2 Generated data • Transaction Book Value (BV) = NA * price / 100 where: NA = nominal amount price = deal price • Cashflows The system copies all the future cashflows of the bond and scales them according to the nominal amount engaged (using rounding). Additionally the system generates a settlement cashflow with amount = BV (see above) and an accrued interest cashflow according to the AI Method. Note: The bond must be fixed at instrument level in order for the accrued interest flow to be generated (see 3.1.2.3.1 Fixing on page 230). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 229 3 Debt instruments 3.1 Bond The following cashflow structure is generated for a floating-rate bond: 3.1.2.3 Processing This section describes the actions that can be done throughout the life of a floating-rate bond. 3.1.2.3.1 Fixing The major process for a floating-rate note is the fixing of the flows. • Setup Depending on the instrument setup (schedules) the fixing can be done in advance (the standard case, at the beginning of each coupon period) or in arrears (at the end of each coupon period). In both cases there can be an offset of n days (before the beginning or end of the coupon period). • Execution When fixing is executed, the rate is retrieved for the specified fixing rate and period according to the designated fixing scenario. The scenario to be used for fixing is configured at the system level, see TRM System Admin Guide. The fixing subscenario is specified at the cashflow level. The following information is stored on the fixed cashflow: The fixing date The rate of the yield curve The coupon rate which is the rate of the yield curve (and optionally * factor + spread) The amount of the coupon. The fixing process can be performed in two ways in TRM: the process itself is exactly the same in each case: the coupon is fixed at both instrument and transaction level. The methods of fixing are as follows: – Directly on the cashflow (in Instrument Editor’s Cashflow page) using the Fix Price action: the fixing affects all deals on this instrument. – Using the Fixing Bond Cashflow activity: all instruments and their deals that need to be fixed for a particular date are affected. See the TRM User Guide for information on the activity parameters. Note: The bond issue must be fixed at instrument level in order for the accrued interest flow to be generated (for transactions captured between coupon fixing date and fixing value date). 230 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond • Cancellation It is possible to cancel the cashflow fixing either manually, using the Undo Fixing action in Instrument Editor; or automatically, using the Fixing Bond Cashflow - Undo activity. See the TRM User Guide for information on the activity parameters. 3.1.2.4 Position monitoring 3.1.2.4.1 Setup The cashflow discounting method used in IR risk calculation depends on the instrument set up: • • Risk setup: – The default risk method is Zero-Coupon or you can select risk method Zero Discount Margin (Z-DM). For more information about these methods, see A.2.289 Risk Setup (FRN) on page 858. – If discount margin is set up at the instrument level (see A.2.164 FRN Valuation on page 791), then the discount margin is used in the valuation and is added to the valuation curve specified for the instrument, and the day count method and yield type used are taken from the interpolation method of this valuation curve. For more information about Discount Margin calculations, see 2.1.5 Discount Margin on page 66. IR exposure setup: – By default, TRM uses the valuation curve interpolation settings (IR Quote and Yield Curve Editor - Interpolation page). For example, if the interpolation settings are set up with Interest Type Continuous Yield, then risk calculations use continuously compounding discounting of the cashflows. – If IR Exposure is set up at the instrument level, then TRM uses these settings. For example, if IR exposure is set up with yield type Periodic Rate, then risk calculations use periodic discounting of the cashflows. See A.2.48 Base IR Exposure Setup on page 732. For more information about these calculations, see 2.3 Key-figures on page 112. 3.1.2.4.2 Calculations - Discount Margin example Let us consider a floating rate note with two coupons remaining, where the next coupon is fixed: • Input data Data Symbol Example Next coupon (fixed) c1 0.0556111111111111 Last coupon (estimated) c2 0.0232101439796721 Time from spot to next coupon (Act/365) t1 13/365 = 0.035616438356164383 Time from spot to last coupon (Act/365) t2 196/365 = 0.53698630136986303 Discount factor from spot to next coupon D1 0.999066136779281 Discount factor from spot to last coupon D2 0.981278683885205 Clean price from market quote P 0.98 Accrued interest Ia 0.05163888888888888 Dirty price Pd P + Ia = 1.0316388888888888 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 231 3 Debt instruments 3.1 Bond Choosing continuous compounded rate as the discount margin yield type, we get the following results: Data Calculation Underlying rate to next coupon r1 = - log[D1] / t1 = - log[0.999] / 0.0356 = 0.026232256389534768 Underlying rate to last coupon r2 = - log[D2] / t2 = - log[0.981] / 0.0537 = 0.035194153518686676 Discount margin must satisfy the following equation: from which we can solve numerically: m = 0.052423976963667664. 3.1.2.4.3 Calculations - FRN example The numerical example in this section demonstrates how the different figures are calculated for a floating-rate note. Instrument data • • Schedule page (Floating Coupon) Interest Type Periodic Rate Date Basis (B) Actual/360 Base Valuation page (Valuation) Method • • 360 Theoretical IR Exposure page Date Basis (B_r) Actual/360 Yield Type Continuous Yield 360 Floating Valuation page Risk Profile Plain Vanilla Transaction data • Nominal Amount A = 1,000,000.00 Deal Price p = 98.00% Spot Date d_v = 2002-02-26 Rate r_c = 0.05 Calculated transaction data Book Value 232 V_b = p*A = 980000 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond Market data Coupon Period (_p_c) Time to Value Date (_t_v) Risk Date (_d_r) Time to Risk Date (_t_r) Principal 1.713888889 2/22/2004 1.713888889 Coupon 1 0.188888889 8/22/2002 0.188888889 Coupon 2 0.7 Risk Cash Flow Start 2 177 8/22/2002 0.188888889 Risk Cash Flow End 2 184 2/22/2003 0.7 2/22/2003 0.7 8/22/2003 1.202777778 8/22/2003 1.202777778 2/22/2004 1.713888889 Coupon 3 1.202777778 Risk Cash Flow Start 3 Risk Cash Flow End 3 181 Coupon 4 1.713888889 Risk Cash Flow Start 4 Risk Cash Flow End 4 184 Valuation data Figure or Valuation Date d_f = 2002-06-15 Figure Market Value Spot Discount Factor D_s = 0.999746283358179 Valuation figures • • • Figure Market Value (_V_) Principal =_A_e*_D_p = 930990.3649 Coupon 1 =_A_e*_D_p = 24432.46813 Coupon 2 =_A_e*_D_p = 18638.33299 Coupon 3 =_A_e*_D_p = 20688.99262 Coupon 4 =_A_e*_D_p = 23545.42006 Transaction V_Tr = SUM(_V) = 1018295.579 Figure Fixing Rate (_r_x) Coupon 1 =r_c = 0.05 Coupon 2 =(INDEX(_D_p,A28,1)/(_D_p)-1)/(_p_c/360) = 0.037392717 Coupon 3 =(INDEX(_D_p,A29,1)/(_D_p)-1)/(_p_c/360) = 0.043109308 Coupon 4 =(INDEX(_D_p,A32,1)/(_D_p)-1)/(_p_c/360) = 0.049481851 Figure Amount (_A_e) Principal =A = 1000000 Coupon 1 =A*_r_x*_p_c/B = 24583.33333 Coupon 2 =A*_r_x*_p_c/B = 19111.8329 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 233 3 Debt instruments 3.1 Bond • Coupon 3 =A*_r_x*_p_c/B = 21674.4023 Coupon 4 =A*_r_x*_p_c/B = 25290.72367 Figure IR Exposure 1bp (_E_i1) Principal =_V_r*(-_t_r*_D_p)*0.0001 = -159.5614042 Coupon 1 =_V_r*(-_t_r*_D_p)*0.0001 = -0.461502176 Coupon 2 Risk Cash Flow Start 2 =_V_r*(-_t_r*_D_p)*0.0001 = -18.77296987 Risk Cash Flow End 2 =_V_r*(-_t_r*_D_p)*0.0001 = 68.26573443 Coupon 3 Risk Cash Flow Start 3 =_V_r*(-_t_r*_D_p)*0.0001 = -68.26573443 Risk Cash Flow End 3 =_V_r*(-_t_r*_D_p)*0.0001 = 114.809443 Coupon 4 Risk Cash Flow Start 4 =_V_r*(-_t_r*_D_p)*0.0001 = -114.809443 Risk Cash Flow End 4 =_V_r*(-_t_r*_D_p)*0.0001 = 159.5614042 Transaction • E_i1_Tr = SUM(_E_i1) = -19.23447204 Figure Risk Value (_V_r) Principal = A = 1000000 Coupon 1 = _A_e = 24583.33333 Coupon 2 Risk Cash Flow Start 2 = A = 1000000 Risk Cash Flow End 2 = -A = -1000000 Coupon 3 Risk Cash Flow Start 3 = A = 1000000 Risk Cash Flow End 3 = -A = -1000000 Coupon 4 Risk Cash Flow Start 4 = A = 1000000 Risk Cash Flow End 4 = -A = -1000000 Transaction • Figure Present Value (_V_p) Principal = _V_r*_D_p = 930990.3649 Coupon 1 = _V_r*_D_p = 24432.46813 Coupon 2 Risk Cash Flow Start 2 = _V_r*_D_p = 993863.1105 Risk Cash Flow End 2 = _V_r*_D_p = -975224.7775 Coupon 3 234 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond Risk Cash Flow Start 3 = _V_r*_D_p = 975224.7775 Risk Cash Flow End 3 = _V_r*_D_p = -954535.7849 Coupon 4 Risk Cash Flow Start 4 = _V_r*_D_p = 954535.7849 Risk Cash Flow End 4 = _V_r*_D_p = -930990.3649 Transaction V_p_Tr = SUM(_V_p) = 1018295.579 Result figures • • • • • Figure MtoM Profit (_P_m) Principal =A*_D_p/D_s-V_b-_P_a = -51776.12227 Coupon 1 =_A_e*_D_p/D_s-_AI = 9299.779742 Coupon 2 =_A_e*_D_p/D_s-_AI = 18643.06305 Coupon 3 =_A_e*_D_p/D_s-_AI = 20694.24309 Coupon 4 =_A_e*_D_p/D_s-_AI = 23551.39544 Transaction P_m_Tr = SUM(_P_m) = 20412.35905 Figure Accrued Interest (_AI) Coupon 1 = (d_f-d_v)/(_d_v-d_v)*_A_e = 15138.88889 Transaction AI_Tr = SUM(_AI) = 15138.88889 Figure Accrued Profit (_P_a) Principal = (d_f-d_v)/(_d_v-d_v)*(A-V_b) = 3002.754821 Transaction P_a_Tr = SUM(_P_a) = 3002.754821 Figure Other Profit (_P_o) Principal = _P_T-_P_m-_P_a-_AI = -236.267694 Coupon 1 = _P_T-_P_m-_P_a-_AI = -6.200496936 Coupon 2 = _P_T-_P_m-_P_a-_AI = -4.73005535 Coupon 3 = _P_T-_P_m-_P_a-_AI = -5.250473862 Coupon 4 = _P_T-_P_m-_P_a-_AI = -5.975380961 Transaction P_o_Tr = SUM(_P_o) = -258.4241011 Total Profit (_P_T) Principal =_V-V_b = -49009.63514 Coupon 1 =_V = 24432.46813 Coupon 2 =_V = 18638.33299 Coupon 3 =_V = 20688.99262 Coupon 4 =_V = 23545.42006 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 235 3 Debt instruments 3.1 Bond Risk figures Figure Effective Duration • Transaction U_eff_Tr = E_i1_Tr/V_Tr/0.0001 = -0.188888889 3.1.3 Australian floating rate note An Australian floating rate note (FRN) is a medium-term bond that provides investors with the ability to achieve returns at a fixed margin above a floating benchmark, usually the 90-day Bank Bill Swap Rate (BBSW). BBSW rates are compiled daily by the Australian Financial Markets Association using the mid-rates of 14 banks. Australian floating rate notes are traded at a trading margin and swap rate, not at a price or yield. The interest margin is determined on the issue date by the credit rating of the issuer, the term to maturity and the market perception of the issuer. The official Treasury Adjustable Rate Bond Pricing Formula is as follows: Price per $100 face value: Equation 3-1 Official Treasury Adjustable Rate Bond Pricing formula where: C 0 if the next interest is not fixed at instrument level, otherwise 1. b The Index (as a percentage) from the last interest reset date to the next interest payment date defined as the average three month Australian bank bill swap reference mid-rate (BBSW) as indicated by Reuters, rounded to four decimal places. IM Spread% defined at schedule level. d The number of days in the current interest period. TM Trading Margin (expressed as a percentage) to express the yield margin to the Index. an v n 236 The number of complete interest periods to maturity at the next interest payment date. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond i s The quarterly swap rate for the period starting on the settlement date and ending on the maturity date. If the frequency of the swap rate is not quarterly, the swap rate is converted to a quarterly compounding rate before it is used. The conversion formula is given as follows: Equation 3-2 Swap Rate Conversion where: • r_in is the swap rate to be converted. • r_out is the resultant compounding rate, num_in and num_out are the number of periods in a year for the frequencies related to r_in and r_out respectively. For example, the number of periods in a year for a quarterly frequency is 4. • r is the discount rate (expressed as a percentage) as determined on the offering date for the period from the settlement date to the next interest payment date, and rounded to four decimal places. • f is the number of days from the settlement date to the next interest payment date. 3.1.3.1 Instrument setup Australian FRN instruments must be based on an instrument type derived from the class BOND. They are set up in a similar way to bonds, but require a different primary feature. • Main characteristics Same set up as for a usual FRN, see 3.1.2 Floating rate note on page 228. See A.2.30 Australian FRN on page 724. • Quotation information Information Description Price Type Select Trading Margin to trade Australian FRN instruments at a trading margin. Quote Handling Select FRN Australian to convert the quotation (trading margin) to the price of the instrument. See Equation 3-1 on page 236. See A.2.274 Quoted on page 849. • Yield Curve Default The setup of the feature Quote Default (Australian FRN) is similar to the usual Quote Default feature, except that it adds the Yield Curve Default page to select the Par rate yield curve to be used for reference rate defaulting. Information Description Currency The currency that you want to specify. Select AUD. Yield Curve Select corresponding yield curve to be used instead of the yield curve defined at the currency level (Currency Editor). A.2.267 Quote Default (Australian FRN) on page 846. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 237 3 Debt instruments 3.1 Bond Valuation approach • To use the quoted valuation method, i.e. market value calculation using the trading margin to price formula (Equation 3-1 on page 236). A.2.31 Australian FRN Method on page 725. 3.1.3.2 Deal capture 3.1.3.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a deal on an Australian FRN: Information Description Trading Margin Instrument quotation. In addition, the following defaulted information can be modified: Information Description Reference Rate Quarterly swap rate for the period from settlement date to maturity date (from the yield curve specified in Yield Curve Default page when provided, otherwise uses the default yield curve defined at currency level). Discount Rate Computed from the settlement date and the next coupon date of the instrument (from the default yield curve defined at currency level). AU Rate Scenario Scenario used to calculate the reference and discount rates. This scenario defaults to the scenario defined at the instrument level (Quote Default page). You can change the default scenario by selecting Quote Default Configuration from the Options menu. See TRM User Guide for more information about changing this configuration. Deal Price Computed using the trading margin to the price formula (Equation 3-1 on page 236). 3.1.3.2.2 Generated data Same as for usual FRN, see 3.1.2.2.2 Generated data on page 229. 3.1.3.3 Processing The actions that can be done throughout the life of an Australian FRN are the same ones as for a usual FRN, see 3.1.2.3 Processing on page 230. 3.1.3.4 Position monitoring There are two basic methods for valuation of Australian FRN instruments: Quoted or Theoretical. When the Theoretical valuation method is used, the Australian FRN is valuated in the same way as a usual FRN instruments. On the other hand, if you want to use the pricing formula (Equation 3-1 on page 236) to compute the market value with the reference rate and discount rate taken on the valuation date as described previously, then you need to attach feature Australian FRN Method (A.2.31 Australian FRN Method on page 725) and use the Quoted valuation method. Swap and discount rates used in the pricing formula are retrieved as follows: • Reference Rate: The quarterly swap rate for the period from valuation date to maturity date is computed from the yield curve specified in the Yield Curves page (Valuation Curve Setup feature) with Usage set to Valuation when provided, otherwise uses the valuation yield curve defined at the currency level. • Discount Rate: Computed between valuation date and next coupon date of the instrument (computed from the yield curve specified in the Yield Curves page (Valuation Curve Setup feature) 238 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond with Usage set to Discount when provided, otherwise uses the valuation yield curve defined at currency level). Note: For the valuation when the next coupon is not fixed, the estimation curve is used to compute the next fixing rate and the discount rate in the pricing formula. If the estimation curve is not defined at the instrument level, then the currency estimation curve is used instead. If no currency estimation curve is defined, then the currency valuation curve will be used. See feature A.2.337 Valuation Curve Setup on page 878. 3.1.4 Zero-coupon bond A zero-coupon bond does not pay any interest during its life, but is instead paid at a significant discount and repays its entire face value at maturity. 3.1.4.1 Instrument setup Instrument setup for a zero-coupon bond resembles a fixed-rate bond except for the following: • Bond main characteristics The coupon rate needs to be null. • Schedules Select the cashflow structure template you want for the instrument and, for each set of cashflow defined in the template, select the generation parameters. One system template is provided for zero-coupon bonds (B.2.1.1.46 Zero-Coupon on page 899); you can choose this template or any other template derived from it. Once the template is applied to the instrument, the schedules are created and it is then possible to define their characteristics. See Appendix B Schedules on page 883. • Trading yield Specify how the yield/price conversion will be made when dealing the instrument. Information Yield Convention Description Select *ISMA-30E360-ANNUAL. For more information about these conventions, see 2.1.4 Yield/price conversions on page 38. Note: *U.S.STREET can also be used when applicable. For example, use *U.S.STREET-ACTACT-SEMIANNUAL for U.S. and UK STRIPS. See A.2.323 Trading Yield on page 872. 3.1.4.2 Deal capture 3.1.4.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a deal on a zero-coupon bond. Information Description Deal Price or If there is a yield/price convention set on the instrument, it is possible to enter either a rate or a price and conversion is made automatically. If there is no convention set, the deal must be entered in price. Deal Rate Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 239 3 Debt instruments 3.1 Bond Information Description Nominal Amount Enter either the nominal amount or face amount, and the system will compute the other automatically. Face Amount Value Date Official date when money is transferred. This defaults to the spot date of the transaction. In addition, the following optional information can be captured: Information Description Units If the denomination of a bond instrument is specified at instrument setup, the deal can be input in units, and the nominal and face amounts are computed by the system. Trading Unit Size 3.1.4.2.2 Generated data • Transaction Book Value (BV) = NA * price / 100 where: NA = nominal amount price = deal price • Cashflows TRM generates a settlement cashflow with amount = BV (see above) and a principal payback cashflow for the nominal amount. The following cashflow structure is generated for a Zero-Coupon bond (bought): 3.1.4.3 Processing This section describes the actions that can be done throughout the life of a zero-coupon bond. 3.1.4.3.1 Asset swap It is possible to carry out the Asset Swap action on a zero-coupon bond (see 3.1.1.3.1 Asset swap on page 218). In this case, the Zero-Coupon Style switch is on by default (no interest flows) and the Book Value instead of the Nominal Amount is used for the second leg of the swap. 3.1.4.3.2 Transaction conversion It is possible to allow schedule conversion at predefined dates during a bond's life. • Setup (at instrument level) This process is available on the transaction if the Transaction Conversion feature is associated with the instrument. 240 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond See A.2.325 Transaction Conversion on page 873. Then, the user can attach conversion schedules (at the instrument level) in the Schedule page of the Instrument Editor. • Execution – At instrument level: To execute the conversion at a predefined date, in the Instrument Editor, Cashflow page, the user selects the conversion flow and performs Convert action. After this conversion, when capturing a transaction, cashflows are generated according to the converted schedules. – At transaction level: When capturing a transaction before the conversion date, conversion events are also generated in the transaction. To execute the conversion, the user right-clicks the row of the corresponding transaction event and selects Transaction Conversion. The conversion inputs are displayed. See A.2.325 Transaction Conversion on page 873. The execution generates a conversion transaction with the following attributes: – Kind: Conversion – Opening Date: Conversion opening date – Value Date: Conversion value date. The remaining attributes are inherited from the initial transaction. The conversion transaction generates closing cashflows for the initial transaction; and future cashflows are reopened according to the conversion schedules defined at instrument level. If the conversion price is different to the original deal price, then a P/L flow is generated, showing the differences between the conversion price and the original deal price. 3.1.5 Amortizing bond An amortizing bond repays the principal according to a pre-defined schedule. Amortizing bonds can be fixed-rate or floaters. A special case of an amortizing bond is the constant annuity. In this case, the rate is fixed and the repayments, occurring at each coupon payment, are calculated so that the sum of the interest + the repayment is constant during the life of the bond. In simple terms, this means that the interest payments are decreasing, while the principal payments are increasing. Note: TRM does not support repayments in the middle of a coupon period but only at coupon payment dates. 3.1.5.1 Instrument setup Most of the characteristics of an amortizing bond are the same as for a fixed/floating rate bond with the following differences. • Schedules Select the cashflow structure template you want for the instrument and, for each set of cashflow defined in the template, select the generation parameters. Depending on whether the rate is floating or fixed, you need to apply either the Floating, Bullet Repayment template (see B.2.1.1.22 Floating, Bullet Repayment on page 894), or the Fixed, Bullet Repayment template (see B.2.1.1.21 Fixed, Bullet Repayment on page 894), or any other template derived from them. Then, for the principal schedule you have to specify the repayment frequency, the method used for repayment calculation, and how much is repaid at each amortization. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 241 3 Debt instruments 3.1 Bond The most common methods are: linear, percentage, and amount. For the interest schedule, the parameters are the same as those for fixed or floating rate bonds. See Appendix B Schedules on page 883. Note that for an annuity repayment, you have to select the Fixed, Annuity Repayment template (see B.2.1.1.20 Fixed, Annuity Repayment on page 894). 3.1.5.2 Deal capture 3.1.5.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a deal on an amortizing fixed-rate bond. Information Description Deal Price or If there is a yield/price convention set on the instrument, it is possible to enter either a rate or a price, and conversion is made automatically. If there is no convention set, the deal must be entered in price. Deal Rate Nominal Amount Nominal amount of the deal. Value Date Official date when money is transferred. This defaults to the spot date of the transaction. In addition, the following optional information can be captured: Information Description Trading Units If the denomination of a bond instrument is specified at instrument setup, the deal can be input in face amount/units and the Nominal Amount will be computed by the system. Face Amount 3.1.5.2.2 Generated data • Transaction Book Value (BV) = NA * price / 100 where: NA = nominal amount price = deal price • Cashflows The system copies all the future cashflows of the bond and scales them according to the nominal amount engaged (using rounding). Additionally, TRM generates a settlement cashflow with amount = BV (see above) and an accrued interest cashflow according to the AI Method. 242 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.1 Bond The following cashflow structure is generated for an amortizing fixed-rate bond: For a fixed annuity they are as follows: 3.1.6 Step-up bond Step-up bonds have interest payments which increase during the life of the bond. 3.1.6.1 Instrument setup Instrument setup for a step-up bond is similar to that of a fixed-rate bond, except for the following: • Schedules The cashflow structure template assigned to the instrument can be the same one used for a fixed-rate bond. However, you also have to specify the rate offset to be applied for each coupon. See Appendix B Schedules on page 883. 3.1.6.2 Deal capture 3.1.6.2.1 Input data The data required is the same as for a fixed-rate bond (see 3.1.1 Fixed-rate bond on page 215). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 243 3 Debt instruments 3.2 Structured bonds 3.1.6.2.2 Generated data • Transaction Book Value (BV) = NA * price / 100 where: NA = nominal amount price = deal price • Cashflows The following cashflow structure is generated for a step-up bond: 3.2 Structured bonds 3.2.1 Callable bond A callable (or puttable) bond is modeled by adding a call or put event to an ordinary bond cashflow structure template. 3.2.1.1 Instrument setup Instrument setup for a callable bond is similar to that of a standard bond (see 3.1.1 Fixed-rate bond on page 215 or 3.1.2 Floating rate note on page 228), except for the following: • Schedule Select the cashflow structure template you want for the instrument. For each set of cashflows defined in the template, select the generation parameters. Call or put events are added to a cashflow structure using a secondary template. Several system-defined secondary templates are provided for use with callable bonds: see B.2.1.2 Secondary templates on page 900; you can choose one of these templates or a user-defined template derived from one of them. Once the template is applied to the instrument, the schedules are created and it is then possible to define their characteristics. The call or put event should specify the following information: 244 – Call/put periods or dates – Call/put price © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.2 Structured bonds – Any other characteristics, for example, whether the call/put option gives the issuer of the bond the right to terminate (call: Transaction Sign = "+") or the holder (put: Transaction Sign = "-"). – If a call/put event has the attribute Special, the original call/put price can be overwritten at call execution. 3.2.1.2 Processing This section describes the processing actions that are specific to transactions on callable bonds. 3.2.1.2.1 Call/Put • Setup To add call or put events to a cashflow structure, you need to select a system-defined secondary template or a user-defined template derived from one of them. • Execution The Execute Call/Put action performed in Transaction Manager's Event view allows you to specify the following information: Information Description Settlement Date The settlement date of the selected event. Amount to Call Defaults to the amount left. Should be less than or equal to the amount left. Counterparty Defaults to the bond issuer. The counterparty of the call transaction. Match with Parent at Apply Automatically matches the call transaction with the original transaction when applied. Executing the Call/Put action on a bond creates a transaction similar to a normal buyback or sell transaction. In other words, the resulting transaction is generated with settlement and position cashflows. Call/Put transactions can be identified as follows: Transaction Kind = Call/Put (Bond) Closing and P/L cashflows are created as part of the end-of-day processing according to the selling method (average balance, FIFO selling, or by manual matching). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 245 3 Debt instruments 3.2 Structured bonds 3.2.2 Dual-currency bond Bond issues can be structured to involve several different currencies. With a dual-currency bond, the currency in which the bond is issued (principal currency) differs from the currency in which the principal is repaid (redemption currency). The currency of the coupon can be either the principal currency, the redemption currency, or another currency. The FX rate to apply can be known (determined on the date of issue) or unknown (determined a number of days before the payment date of the interest cashflow or period start of the coupon). Setting up a dual-currency bond in TRM involves specifying the Dual Currency feature in the instrument definition. Schedule templates for known FX rates or unknown rates (whose rates will be fixed at a defined date) are also applied at instrument level. 3.2.2.1 Instrument setup Instrument setup for a dual-currency bond is similar to that of a standard bond (see 3.1.1 Fixed-rate bond on page 215 or 3.1.2 Floating rate note on page 228), except for the following: • Bond main characteristics Information Description AI Method The method used by the system to compute settlement accrued interests. The usual AI Methods (e.g. linear, and so on) are relevant. See 2.1.6.1 Accrued interest calculations on page 67 for more information. Note: The AI Settlement is generated when the fixing date method is set to In Advance. However, when the fixing date method is set to In Arrears, the accrued interest settlement is unknown and so no AI is calculated. • Dual-currency attributes This information defines the characteristics of the principal cashflow. Information Description Settlement Currency Currency in which the principal cashflow is settled. Settlement FX Rate Rate used to calculate the settlement amount of the principal cashflow. Need Fixing Specify whether the FX rate needs to be fixed: • Select No when the FX rate is known • Select Yes, Unmarked when the FX rate is unknown. Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max. Offset Maximum number of days’ offset allowed. See A.2.125 Dual Currency on page 771. • Schedules Select a suitable Dual Currency cashflow structure template for the instrument. For each set of cashflows defined in the template, specify the generation parameters. The following system templates are provided for dual-currency structures: – Dual-Currency Known FX This is a fixed bullet structure used for dual currency instruments when the FX rate is known when the deal is entered. For both interest and redemption schedules you can choose a different settlement currency and specify the settlement FX rate. 246 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.2 Structured bonds See B.2.1.1.15 Dual Currency, Known FX Rate on page 893. – Dual-Currency Known FX Floating This is a floating bullet structure used for dual currency instruments when the FX rate is known when the deal is entered. For both interest and redemption schedules you can choose a different settlement currency and specify the settlement FX rate. See B.2.1.1.16 Dual Currency, Known FX Rate, Floating on page 893. – Dual-Currency Unknown FX This is a fixed bullet structure used for dual currency instruments when the settlement FX rate is not known beforehand. For both interest and principal schedules you can choose a different settlement currency. See B.2.1.1.17 Dual Currency, Unknown FX Rate on page 893. Note: This template covers fixed interest rates only. For floating rate issues, you also have to use the Fixing Dates secondary template (see B.2.1.2.15 Fixing Dates on page 903). You can choose one of these templates or any other template derived from them. After the template is applied to the instrument, the schedules are created, it is then possible to define the settlement currency characteristics, as well as other characteristics, such as date basis, payment convention, calendars, and so on. See Appendix A Features on page 713. • FX fixing If the settlement FX rate is unknown when the deal is entered, then this feature needs to be included in the instrument definition. See A.2.174 FX Fixing on page 797. 3.2.2.2 Deal capture 3.2.2.2.1 Input data Deals on dual-currency bonds are captured in the same way as a standard bond (see 3.1.1 Fixed-rate bond on page 215 or 3.1.2 Floating rate note on page 228). 3.2.2.2.2 Generated data • Cashflows Settlement Currency = Settlement Currency (as defined in the schedule) Settlement FX Rate = Settlement FX Rate (as defined in the schedule) Settlement Amount = Amount * Settlement FX Rate 3.2.2.3 Processing This section describes the actions that can be done throughout the life of a dual-currency bond. 3.2.2.3.1 FX fixing When the settlement FX rate of a dual-currency bond is not known beforehand, the FX rates need to be fixed at the agreed fixing date. • Setup Depending on the instrument setup, the fixing can be done in advance (at the beginning of each coupon period) or in arrears (the standard case, at the end of each coupon period). In both cases there can be an offset of n days (before the beginning or end of the coupon period). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 247 3 Debt instruments 3.2 Structured bonds Execution • There are two ways to execute the FX Fixing action, one in the Instrument Editor, the other in Transaction Manager as described further on. – The FX Fixing action performed in Instrument Editor's Cashflow page allows you to set the FX rate. The following values can be input: Information Description Settlement FX Rate Fixing market quote to be entered manually. After the manual entry, the Fix Fx Rate action is available and should be performed to fix the specified FX rate. The fixing process is performed directly on an individual cashflow in the Cashflow page. It is possible to modify the fixing values. – Alternatively, the FX Fixing action performed in Transaction Manager’s Cashflow view on the cashflow allows you to set the FX rate. The following values can be input: Information Description Fixing Date Day the cashflow is fixed. Reference FX Rate Fixing market quote. This is defaulted by the system to the FX cross rate between the actual currency and the currency on the fixing date and can be changed by the user. The fixing process is performed directly on an individual cashflow in the Cashflow view. It is possible to modify the fixing values. Cancellation • It is possible to undo the FX fixing using the Undo FX Fixing action. 3.2.2.3.2 Asset swap It is possible to carry out the Asset Swap action on a dual-currency bond (see 3.1.1.3.1 Asset swap on page 218). 3.2.2.4 Position monitoring For the valuation of the dual-currency bond, an estimation of the future accrued interests can be defined by setting up the feature Generic IR Valuation with the following parameters (see A.2.201 Generic IR Valuation on page 811 for more details): Information Description AI Method The method used by the system to compute accrued interests in the calculation of the market value. For dual-currency bonds, there are two types of dual-currency methods: • Dual Currency Estimated - The estimated accrued interest is calculated using the • Dual Currency Last - The accrued interest is calculated using the FX rate of the forward FX rates. previous FX fixing. Note: Both methods round the figure value in the cashflow currency before converting it into the settlement currency. See 2.1.6.1 Accrued interest calculations on page 67 for more information. 248 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.2 Structured bonds Information Description Settlement Switches Activate the switches that apply to this instrument: • Dirty Price - determines whether price used for valuation includes accrued interest (dirty price) or not. Note: If it is on, the market value for accrued interest is not calculated, even if the AI Method has been configured. Method For dual-currency bond, leave empty. Valuation Modes Valuation mode: Default, Benchmark, or Theoretical. For information about dual currency calculations, see 2.3.5 Dual currency on page 147. 3.2.3 Credit step-up bond Credit step-up bonds are corporate bonds that contain a provision stating that the coupon payment increases as the credit rating of the issuer declines. When the credit rating of the issuer goes up again, the coupon payment goes back down but is floored by the initial rate. A credit-linked note usually offers a higher yield compared to a vanilla bond with a similar credit rating. A Collateralized Debt Obligation (CDO), a common type of credit-linked note, represents a leveraged position in a portfolio of credit risk and enables investors to gain exposure to a large diversified pool of underlying credit risk. 3.2.3.1 Instrument setup Credit step-up bonds are based on an instrument type derived from the class CREDIT-STEP-UP. Instrument setup for a credit step-up bond is similar to that of a fixed-rate or floating-rate bond (see 3.1.1 Fixed-rate bond on page 215 and 3.1.2 Floating rate note on page 228), except for the following additional attributes. • Credit step-up characteristics You set the credit event information at instrument level. Information Credit event type Description Select from Downgrade or Upgrade: • Downgrade when the credit rating deteriorates • Upgrade when the credit rating improves. Date information Date the step up/down action comes into effect and the date after which the coupons are affected by the change in credit rating. Offset parameters Offset that applies to fixed rate or floating rate flows. When the credit event information is saved, the coupon flows at transaction level are updated. See A.2.115 Credit-Step-Up on page 765. • Schedule The cashflow structure template assigned to the instrument can be the same one used for a fixed-rate or floating-rate bond. However, you also have to specify the rate offset or spread offset to be applied for each coupon. See Appendix B Schedules on page 883. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 249 3 Debt instruments 3.3 Schuldscheindarlehen 3.2.3.2 Deal capture 3.2.3.2.1 Input data Deals on credit step-up bonds are captured in the same way as a standard bond (see 3.1.1 Fixed-rate bond on page 215 and 3.1.2 Floating rate note on page 228). 3.2.3.2.2 Generated data Credit events (downgrade/upgrade) saved at instrument level trigger the recalculation of the yield-to-maturity used for accruing discount (or amortizing premium) on transactions on credit step-up bonds. 3.2.3.3 Processing The processing actions that are available on credit step-up bonds are the same as those on standard bonds (see 3.1.1 Fixed-rate bond on page 215 and 3.1.2 Floating rate note on page 228), except for the following. 3.2.3.3.1 Credit event Adding or removing a credit event on the instrument triggers the invalidation of the future cashflows on all the existing deals. It also triggers the regeneration of a new set of cashflows with the new rate or spread defined in the instrument setup. 3.3 Schuldscheindarlehen Schuldscheindarlehen is a bond security representing collateralized ownership in a German loan, with the lending bank participating in the underlying group of banks. Schuldscheindarlehen is a special type of Bond and differs from a plain vanilla bond in the following manner: • The Schuldscheindarlehen is traded without any accrued interest settlement by the buyer. Instead, the issuer pays at the end of the coupon period the exact portion of the coupon that the buyer is entitled to, on a pro-rata-temporis basis (e.g. if the owner buys the Schuldschein at half year and the coupon is due at the end of the year, the owner will only receive half of the coupon amount). • The issuer also pays any previous owners within the coupon period the interest amount on a pro-rata-temporis basis to compensate them for holding the Schuldscheindarlehen for a given period. The coupon amount is split between the different owners during the coupon period according to their holding period. 3.3.1 Instrument setup Schuldschein bonds are based on an instrument type derived from the class BOND. Instrument setup for a Schuldscheindarlehen is similar to that of a fixed-rate bond (see 3.1.1 Fixed-rate bond on page 215), except for the following: • Schuldschein This feature indicates that no accrued interest is settled, but the first coupon is adjusted to the pro-rata-temporis ownership of the coupon, and is settled on the coupon payment date directly by the issuer. A.2.294 Schuldschein on page 860. 250 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.3 Schuldscheindarlehen 3.3.2 Deal capture 3.3.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a Schuldscheindarlehen (both primary and secondary markets): Information Description Nominal Amount Enter either the nominal amount or face amount, and the system will compute the other automatically. Face Amount Value Date Official date when money is transferred. This defaults to the spot date of the transaction. Deal Price Price paid for the bond (expressed as a percentage of the nominal amount). Note: If you need to monitor the ownership transfer, you must record and maintain the subsequent transactions in the secondary market. You can then use standard TRM monitoring and reporting tools to monitor the identity of the holders, the volume of the bonds held by each holder, and the date of purchase and sale of the bonds by the holders. 3.3.2.2 Generated data • Transaction Yields are calculated from the reduced coupon. • Cashflows – The first coupon is reduced and settled on the pro-rata-temporis of the ownership from the transaction's value date to the coupon value date. No accrued interest is generated. – On the coupon payment date, the Issuer of the Schuldschein calculates the interest for each holder of the bond according to their holding period (from the purchase value date to the sale value date). 3.3.3 Processing The actions that can be done throughout the life of a Schuldschein bond are the same ones as for a fixed-rate bond (see 3.1.1.3 Processing on page 218). 3.3.4 Position monitoring This section describes how the Schuldschein bonds are calculated and provides a numerical example that demonstrates the calculations of a Schuldschein bond instrument. 3.3.4.1 Setup There are two basic methods for valuation of Schuldschein bond instruments: Quoted or Theoretical. When the Theoretical method is used, the valuation is similar to the one used to calculate a fixed-rate bond (3.1.1.4 Position monitoring on page 221). When the Quoted method is used, the calculations are processed as described in section 3.3.4.2 Calculations on page 251. 3.3.4.2 Calculations This section describes the model and calculations of Schuldschein bond instruments. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 251 3 Debt instruments 3.3 Schuldscheindarlehen 3.3.4.2.1 Valuation model The market value of a quoted Schuldschein (Quoted valuation method) is calculated as follows: Equation 3-3 Quoted Schuldschein bond where P The price of the deal. A The nominal amount. Ia The accrued interest is calculated according to the generic formula described in 2.1.6.1 Accrued interest calculations on page 67. where: D_f • C is the coupon • t is the length of the accrual period (in years), calculated as follows: • T is the length of the coupon period (in years, calculated with the appropriate date basis) The Discount Factor from figure spot to figure valuation date. 3.3.4.2.2 Numerical example This section demonstrates how the different figures are calculated for a quoted Schuldscheindarlehen. This example shows a Schuldscheindarlehen EUR 1,000,000.00, 5%, issued on 2008-01-01, and due on 2012-01-01. Setup: • Data Symbol Example Instrument Date Basis (30E/360) B 360 Valuation Method Quoted First Coupon Payment 2009-01-01 Issue Date dt_i 2008-01-01 Maturity Date d_m 2012-01-01 Coupon Rate c 5% Coupon Frequency 1 Spot Days 3 Currency EUR AI Method Linear Schedule Fixed, Bullet Repayment • 252 Transaction data (Schuldschein issue - primary market): © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.3 Schuldscheindarlehen On 2008-01-01, Bank1 issues 100,000,000.00 to Bank2. Data Symbol Example Opening Date dt_o_1 2008-01-01 Nominal Amount A_1 100,000,000.00 Issuer Bank1 Counterparty Bank2 Price P 100% Value Date dt_v.p 2008-01-04 Issue Date Formula 2008-01-01 Book Value V_b.p 100,000,000.00 Coupon 1 Amount A_1.c1 5,000,000.00 Coupon 1 Time to Value Date t_v.c1 360 =A Transaction data (transfer of ownership - secondary market): • On 2008-01-02, Bank2 sells its position EUR 30,000,000 and EUR 70,000,000 to two different holders: Holder1 and Holder2 respectively. Data Symbol Example Seller Bank2 Counterparty Holder1 Formula Opening Date dt_o_2 2008-01-02 Nominal Amount A_2 30,000,000.00 Value Date dt_v.p 2008-01-07 Book Value V_b.p 30,000,000.00 =A_2 Symbol Example Formula and Data • Seller Bank2 Counterparty Holder2 Opening Date dt_o_2 2008-01-02 Nominal Amount A_3 70,000,000.00 Value Date dt_v.p 2008-01-07 Book Value V_b.p 70,000,000.00 =A_3 Data Symbol Example Formula Figure Date d_f 2008-01-02 Time to Spot d_s 2008-01-07 Valuation Figure: Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 253 3 Debt instruments 3.4 Denominated bond Data Symbol Example Principal A_1.P 100,000,000.00 Accrued Interest (Coupon 1) 69,444.44 Formula A_1.c1 * (d_s - d_f) / B Calculated transaction data (first coupon payment): • 2009-01-01, the issuer Bank1 pays the coupon amount pro-rata-temporis of the ownership to each holder. Data Symbol Example Formula Amount (Coupon 1) A.c1 5,000,000.00 Value Date (Coupon 1) dt_v.c1 2009-01-01 First coupon to Bank2 1c.p 13,888.89 A_1.c * (dt_0_2 – dt_0_1)/B First coupon to Holder1 2c.p 1,495,833.33 A_2.c * (t_v.c1 -dt_0_2)/B First coupon to Holder2 3c.p 3,490,277.77 A_3.c * (t_v.c1 -dt_0_2)/B 3.4 Denominated bond Bonds (and swaps) with multiple denominations are traditionally a spin off from markets where physical bonds or certificates were used. Some markets still trade bonds or certificates, and these are physically delivered between parties. These certificates were used for secondary trading and made it easier for traders to break down a large issue tranche, facilitating smaller value trades on the back of the original issue. The denominations are aggregated into a single transaction but denomination details are maintained and recorded. In case of physical presentation of coupons, clearing houses and/or paying agents have to pay investors (retail) the exact coupon amounts. However, with the advent of settlement houses the practice of physical delivery is now the exception rather than the rule. The settlement agents merely move electronic representations of the bonds or certificates between accounts. 3.4.1 Instrument setup Denominated bonds must be based on an instrument type derived from the class BOND or SWAP. The setup for multiple-denomination bonds and swaps is similar to that of a fixed-rate bond (see 3.1.1 Fixed-rate bond on page 215), except that you can define the denominations that can be used when capturing transactions at the instrument or hedging swap leg level: • Bond main characteristics Information Description Amount Rounding Nearest number to which the coupon amount is rounded. By default, it is set to 2 decimals (0.01). Note: The rounding step applies to the accrued interest when the Settlement Switch, Round Per Unit is activated (see below). Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Settlement Switches Round Per Unit If the switch Round per Unit is activated, Accrued Interest is based on rounding per denomination (see 3.4.4.2 Calculations on page 256). 254 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.4 Denominated bond • Denominated bond If the denomination of a bond instrument is specified at instrument level using feature Denominated Bond, the deal can be input in units and the Nominal Amount is computed by the system. A.2.120 Denominated Bond on page 767. • Bond Denominations Setup The valid denominations can be defined at the instrument level. Only those denominations will be allowed at deal capture. A.2.60 Bond Denominations Setup on page 739. Note: For monitoring purposes, you can view the positions by Trading Unit in Treasury Monitor, Transaction grouping. For more information, see TRM User Guide. 3.4.2 Deal capture 3.4.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a denominated bond: • Transaction view: Information Description New Denomination The deal is captured by selecting the denominations defined at the instrument level. To select a denomination, right-click the transaction, select the action New Denomination from the drop-down list, and then select the relevant denomination from the list. A new row is added to the Denomination view. You need to populate the Unit column. Note: To delete a denomination, simply right-click the row you want to delete and select Delete Denomination. • Denomination view: Information Description Trading Unit Displays the selected denomination. Units The deal can be input in units and the Nominal Amount is calculated by the system. Leg Group Displays the number of the (Swap) leg group where the denomination applies. 3.4.2.2 Generated data • Transaction Book Value (BV) = NA * price / 100 where: NA = Nominal Amount price = Deal Price • Cashflows Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 255 3 Debt instruments 3.4 Denominated bond When denominations are used at deal capture, the interest (coupon) payments are calculated separately for each denomination according to the following formula: Ic = Units * round[Denomination * Period Length * Coupon Rate,Amount Rounding] where: Ic = interest (coupon) payments Amount Rounding = number of decimals to be used when rounding amounts. 3.4.3 Processing This section describes the actions that can be done throughout the life of a denominated bond. 3.4.3.1 Buyback (sale) and Unwinding (early expiration) When an issue is bought back (or a long position is sold), or when a swap is unwound (early-expired), you enter the denominations and units in the same way as when entering a new transaction. See 3.4.2.1 Input data on page 255 for more information about capturing denominations and units. This information is used the same way as for new transactions, to 'close' (offset) the future interest and redemption payments accordingly. For a swap, a net amount (amount to be settled between the parties) is entered in the same way as in a swap without denominations. See 11.1.2 Asset swap on page 656. Note: For accounting purposes: The fact that buybacks or corresponding issues may have multiple denominations has no impact on realized results. The reason for this is that buybacks are booked at par, and the difference between par and buyback price is recorded directly into P/L. So, there is no linking between the issue price and the buyback price per denomination. 3.4.4 Position monitoring There are two basic methods for valuation of denominated bond instruments: Quoted or Theoretical. 3.4.4.1 Setup The valuation setup for denominated is the same as for usual bonds. 3.1.1.4 Position monitoring on page 221. 3.4.4.2 Calculations The numerical example in this section demonstrates how the different figures are calculated for a multiple denominated bond using the Theoretical method. This example shows a multiple denominated bond with the following data: Setup • Data Symbol Example Issue Date dt_i 2008-01-01 Maturity Date 2012-01-01 Currency EUR Valuation Method Theoretical Coupon 5.6333% AI Method Actual/Actual Annually 256 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.4 Denominated bond Data • Symbol Example Amount Rounding 0.01 Rounding Method Nearest Schedule Fixed, Bullet Repayment Denominations Trading Units 1000 and 5000 Transaction data: Note: When entering a transaction the coupon amount will be different in the two denominations. • Data Symbol Example Formula Opening Data dt_o 2008-01-23 Value Date dt_v 2008-01-25 Interest Rate r 5.6333% First Denomination de_1 1000 Trading Units (First Denomination) n_m_1 100 Nominal Amount (First Denomination) A_1 100 000 de_1 * n_m_1 Coupon Amount (First Denomination) Ic_1 5633 (rounding to 2 decimals) r* de_1=56.333 = 56.33 * n_m_1 Second Denomination de_2 5000 Trading Units (Second Denomination) n_m_2 20 Nominal Amount (Second Denomination) A_2 = 100 000 de_1 * n_m_1 Coupon Amount (Second Denomination) Ic_2 5633.4 (rounding to 2 decimals) r* de_2=281.665 = 281.67 * n_m_2 Accrued interest may be based on rounding per denomination or not depending on whether the settlement switch Round Per Unit (Instrument Editor - Bond page) is activated at the instrument level. – If the switch Round Per Unit is not activated, the accrued interest is calculated like any other bond (Equation 2-71 Accrued interest (generic formula) on page 67): Data Symbol Example Date Basis B 366 Time to Accrued Interest Formula 2008-01-25 2008-01-01 = 24 dt_v - dt_i Accrued Interest (First Denomination) Ia _1 = 369.38 (rounded to 2 decimal places) Ic_1*(dt_v - dt_i)/B= 369.377 Accrued Interest (Second Denomination) Ia _2 = 369.40 (rounded to 2 decimal places) Ic_2*( dt_v - dt_i)/B= 369.4033 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 257 3 Debt instruments 3.5 Convertible bond – "If the switch Round Per Unit is activated, the accrued interest is calculated using the denomination rounding calculation: Equation 3-4 Denomination rounding equation Ia = Unit × round [ Denomination × Periodlength × CouponRate, AmountRounding ] Data Symbol Example Date Basis B 366 Time to Accrued Interest Formula 2008-01-25 2008-01-01 = 24 dt_v - dt_i Accrued Interest (First Denomination) Ia _1 = 369 (rounded to 2 decimal places) r* de_1*(dt_v - dt_i)/B= 3.693967 = 3.69* n_m_1 Accrued Interest (Second Denomination) Ia _2 = 369.40 (rounded to 2 decimal places) r* de_2*(dt_v - dt_i)/B= 18.46984 = 18.47 * n_m_2 Note: Accrued interest at settlement, and 'clean' settlement (principal) amount (i.e. the full settlement amount minus accrued interest and fees/taxes) is calculated directly from the total interest (coupon) amount and total nominal amount respectively, i.e. they are not calculated separately for each denomination. 3.5 Convertible bond Convertible bonds are fixed rate bonds that can be converted to equity, typically to shares of the issuer. The bond can be converted on certain dates or during certain periods. Usually the holder of the bond can decide to convert the bond but sometimes the issuer also has the right to force the conversion. Some convertibles are also callable. The conversion price (and ratio) may depend on time. Usually corporate actions (splits and dividends) also affect the conversion price. 3.5.1 Instrument setup Convertible bond instruments must be based on an instrument type derived from the class CONVERTIBLE-BOND. They are set up in a similar way to fixed-rate bonds (see 3.1.1 Fixed-rate bond on page 215), except for the following characteristics. • Schedules Select a suitable schedule template that includes coupons, redemptions, call events (if the bond is callable), and conversion events. To define the conversion events, TRM provides a pre-defined secondary template designed for this purpose (see B.2.1.2.11 Convertible Conversion on page 902). See Appendix B Schedules on page 883. 258 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.5 Convertible bond • Convertible Bond The conversion price (or ratio) is defined using this feature. Initially one entry is needed. If the conversion price changes due to corporate actions, a new entry must be added each time. Information Description Active From Period during which this conversion price is applicable. Active To Type Defines whether the user can enter conversion price or conversion ratio. Par Value If the convertible bond is traded using units, enter the par value of one unit. Conversion Price If Type = Conversion Price, you can enter the conversion ratio. Otherwise, it is calculated using the conversion price and par value: Conversion Price = Par Value/Conversion Ratio Conversion Ratio If Type = Conversion Ratio, you can enter the conversion price. Otherwise it is calculated using the conversion ratio and par value: Conversion Ratio = Par Value/Conversion Price Underlying The instrument into which the convertible can be converted. Comment Any comment you want to add about the instrument. See A.2.103 Convertible Bond on page 759. 3.5.2 Deal capture 3.5.2.1 Input data The data required is the same as for a fixed-rate bond (see 3.1.1 Fixed-rate bond on page 215). 3.5.2.2 Generated data • Cashflows The following cashflow structure is generated for a convertible bond: Interest flows Accrued interest Nominal Book value Spot Opening date Value date Maturity Maturity date 3.5.3 Processing This section describes the actions that can be done throughout the life of a convertible bond. 3.5.3.1 Conversion The convertible bond is converted to the underlying instrument using the Conversion action. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 259 3 Debt instruments 3.6 Index-linked bond • Setup Conversion parameters are defined in the instrument setup. • Execution Conversion can be executed in Transaction Manager. The following parameters are used: Information Description Conversion Date Date on which the conversion is done. Amount to Convert Nominal amount of the convertible to convert. Delivery Type Usually Delivery Type = Physical Delivery. If the underlying is not delivered, but the profit/loss is settled instead, select Delivery Type = Cash Settlement. Scenario Scenario from which you want to retrieve the market price of the underlying. This parameter is used for cash settlement only. Price Price of the underlying. This parameter is used for cash settlement only. Cash to Receive Amount of cash to receive. This parameter is used for cash settlement or settling the residual if the number of units to be delivered is rounded. This field can be modified. The execution of the action generates a conversion transaction which closes the existing convertible position and replaces it with the appropriate number of units of the underlying instrument. • Cancellation Cancellation of the action is done by canceling the conversion transaction. 3.6 Index-linked bond Index-linked bonds are linked in some way to a standard index. The bond’s cashflows vary according to an underlying index. For example, in inflation index-linked bonds, the coupon and principal payments are adjusted to compensate for changes in inflation. These payments are adjusted in relation to a Consumer Price Index (CPI) value or a Retail Prices Index (RPI) value for a country. A period of time usually elapses between the measurement of price levels and the publication of an index, therefore the index value associated with a given cashflow will be the index as published for a time in the past. This time difference is called the indexation lag. The way in which the index-linked bonds are traded and valued varies according to market conventions. Index-linked bonds must be based on an instrument type derived from the class INDEX-LINKED-BOND. 3.6.1 Instrument setup The following information is relevant to any kind of index-linked bond. Index-linked bonds are set up in a similar way to fixed-rate bonds (see 3.1.1 Fixed-rate bond on page 215) or zero-coupon bonds (see 3.1.4 Zero-coupon bond on page 239), depending on whether there are any coupon payments. The additional values required to set up index-linked bonds are described in the following sections. 260 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond • Index-linked bond main characteristics – • The primary feature A.2.210 Index-Linked Bond on page 818. Trading characteristics Each index-linked bond type has its own specific trading feature. Special risk characteristics • Special risk characteristics Interest sensitivity of index-linked bonds is, by default, calculated in the same way as for similar fixed rate bonds. However, you can capture a factor (e.g. yield beta, a number between 0 and 1) for scaling the IR sensitivity of the instrument, which is then used as a multiplier for scaling IR exposure and duration figures. Effective convexity is scaled by the factor squared. This factor can be entered either as a static sensitivity scaling factor at instrument level using the instrument feature Base IR Exposure Setup, or as Beta for the instrument in Rate Monitor allowing time-dependent scaling factors. For more information relating to the setup and structure of specific types of index-linked bond, see: • – 3.6.4 Australian index-linked annuity bond on page 263 – 3.6.5 Australian index-linked bond on page 267 – 3.6.6 Brazilian (LFT) selic-linked security on page 270 – 3.6.7 Brazilian FX-linked NBC-E/NTN-D on page 271 – 3.6.8 Brazilian inflation-linked NTN on page 272 – 3.6.9 Canadian real return bond on page 273 – 3.6.10 French OAT€i on page 274 – 3.6.11 Greek index-linked bond on page 277 – 3.6.12 Israeli index-linked bond on page 279 – 3.6.13 Italian BTP €i on page 281 – 3.6.14 Japanese index-linked bond on page 282 – 3.6.15 Swedish index-linked bond on page 283 – 3.6.16 UK index-linked gilt on page 287 – 3.6.17 US Tips on page 292. Schedules Select the cashflow structure template that is appropriate for the instrument. System templates are provided for several types of index-linked bonds; you can choose one of these templates or any other template derived from them. Once a template is applied to the instrument, the schedules are created and it is then possible to define their characteristics, such as, date basis, payment convention, calendars, and so on. See Appendix B Schedules on page 883. • Quoted It is necessary to specify how the index-linked bond is quoted on the market. Each index-linked bond type has its own specific quote handler. See A.2.274 Quoted on page 849. • Valuation approach Each index-linked bond type has its own specific valuation approach feature. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 261 3 Debt instruments 3.6 Index-linked bond 3.6.2 Deal capture 3.6.2.1 Input data In addition to the standard deal parameters, the information required to enter a deal on an index-linked bond is similar to the data required for a fixed-rate bond (see 3.1.1 Fixed-rate bond on page 215). Information Description Deal Price or If there is a yield/price convention set on the instrument, it is possible to enter either a rate or a price and conversion is made automatically. If there is no convention set, the deal must be entered in price. Deal Rate Nominal Amount Face Amount Enter either the nominal amount or face amount, and the system will compute the other automatically. Value Date Official date when money is transferred. This defaults to the spot date of the transaction. Index Value of the index (to which the instrument is index-linked) at trade date. In addition, the following optional information can be captured: Information Description Units If the denomination of a bond instrument is specified at instrument setup, the deal can be input in units, and the nominal and face amounts are computed by the system. Trading Unit Size Index Prolong Rate (For UK index-linked bonds only) Interest rate by which the index rate is prolonged into the future. Index Ratio Index ratio used to adjust the coupon and redemption flows of the bond. Note: If this is defined at instrument level, this is used as the default in the transaction and cannot be modified: for example, see 3.6.7 Brazilian FX-linked NBC-E/NTN-D on page 271. 3.6.2.2 Generated data • Cashflows The following cashflows are generated: – Principal – Interest (unless it is a zero-coupon index-linked bond) – Redemption. 3.6.3 Processing This section describes the actions that can be done throughout the life of an index-linked bond. 3.6.3.1 Fixing The major process for an index-linked bond is the fixing of the coupon and the redemption flows. These need to be adjusted to account for changes in the index. • Setup Depending on the instrument setup (schedules) the fixing can be done in advance or in arrears. In both cases there can be an offset of n days (before the beginning or end of the coupon period). The fixing parameters that define how the fixing rate is calculated are defined in the schedule. 262 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond • Execution When fixing is executed, the rate is retrieved for the specified fixing rate and period according to the designated fixing scenario. The fixing scenario is configured at the system level, see TRM System Admin Guide. The fixing subscenario is specified at the cashflow level. The expression value gives the current value of the expression and is used to calculate the index value. The following information is stored on the fixed cashflow: The The The The fixing date fixing quote expression and expression value amount of the coupon or redemption flow. The fixing process can be performed in two ways in TRM: the process is exactly the same in each case: the coupon is fixed at both instrument and transaction level. The methods of fixing are as follows: – Directly on the cashflow (in Instrument Editor’s Cashflow page) using the Fix Price action: the fixing affects all deals on this instrument. – Using an activity (Fixing Bond Cashflow): all instruments and their deals which need to be fixed for a particular date are affected. Note: The bond issue must be fixed at instrument level in order for the accrued interest flow to be generated (for transactions captured between coupon fixing date and fixing value date). • Cancellation It is possible to cancel the cashflow fixing either manually, using the Undo Fixing action in Instrument Editor; or automatically, using the Fixing Bond Cashflow - Undo activity. 3.6.4 Australian index-linked annuity bond The following sections describe the characteristics that are specific to Australian index-linked annuity bonds. 3.6.4.1 Instrument setup Instrument setup for this type of index-linked bond is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following: • Trading characteristics - issue index parameters The Australian CPI is published quarterly and is applied to settlement calculations and valuations starting from the publication date. The index is set up similarly to other indexes. Information Index Description Select the Instrument ID of the underlying index you previously defined. See 7.1 Index types on page 425. Issue Index Enter the value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. See A.2.32 Australian IAB on page 725 or A.2.34 Australian IAB (Round to 3) on page 725. • Bond characteristics Information Description Currency AUD Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 263 3 Debt instruments 3.6 Index-linked bond • Information Description AI Method Australian Index Linked (IAB), or for three decimal places rounding, Australian Index Linked (IAB) (3 dec). Settlement Switches Dirty Price. Coupon Rate Coupon rate of the bond. Schedule parameters Select the cashflow structure template BOND-AU-IAB (Australian Indexed Annuity Bond). See B.2.1.1.4 Australian Indexed Annuity Bond on page 890. In the Interest Adjustment schedule, set the parameter Factor equal to the rounded value of the annuity payment. Note: For rounding to three decimal places, change the expression in the Interest Adjustment schedule to: round((ixau/divider)*factor,0.001)*100 - 100 * factor Set the required fixing characteristics as follows: Information Description Factor Enter the annuity payment percentage. Note: The Fixing Rate and Divider fields default to the values you selected in the Issue Index page. Method Select 4th Wednesday (M) as the index is published (and index adjustment cashflows fixed) on the 4th Wednesday of the publishing month. Frequency Enter 3. First Date Enter the first publishing (fixing) date applicable to this instrument. The subsequent publishing dates are calculated from this date onwards using the monthly frequency specified in the Frequency field. After you have generated the cashflows, remove the default value from the field Amount Rounding in the Schedule page and leave the field Amount Rounding empty for all Interest Adjustment cashflows in the Cashflow page. • • Trading yield parameters Information Description Yield Convention Australian Government Index Annuity - GOVT-AU-IX-ANNUITY Quoted Information Description Price Type Yield (w/o rounding) Quote Handling Depending on how you want to round the adjusted annuity, select one of the following: Currency 264 • Index-Linked Annuity Bond (Australian): six decimal places rounding • Index-Linked Annuity Bond (Australian 3 Digits Rounding): three decimal places rounding AUD © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond • • Result parameters Information Description AI Method Australian Index Linked (IAB), or for three decimal places rounding, Australian Index Linked (IAB) (3 dec). Valuation approach Australian Indexed Annuity Bonds can be valuated either using a direct (yield) quote, or taken from the yield curve. – For a direct quote, see A.2.33 Australian IAB Valuation on page 725), or if adjusted annuities are to be rounded to 3 decimal places, see A.2.35 Australian IAB Valuation (Round to 3) on page 726. – For a valuation taken from the yield curve (loans only), see A.2.36 Australian IAB Par Curve Valuation on page 726, or if adjusted annuities are to be rounded to 3 decimal places, see A.2.37 Australian IAB Par Curve Valuation (Round to 3) on page 727. Note: To use a yield curve, you must first set one up in the IR Quote and Yield Curve Editor. For general information about setting up yield curves, see TRM User Guide. 3.6.4.2 Deal capture 3.6.4.2.1 Input data In addition to standard deal parameters, the information required to enter a deal on an australian index-linked bond is similar to usual index-linked bonds (see 3.6 Index-linked bond on page 260). Information Description Face Amount Enter the face amount. The Nominal Amount is automatically calculated by the system. Nominal Amount Shows the remaining amount taking into account the annuity payments. In addition, the following optional information can be captured: Information Description Index The system automatically fetches the latest available CPI value for the settlement date. You may change the index value. Note: In Rate Monitor, the index value of a given quarter is associated with the first day of the quarter (Jan. 1, Apr. 1, Jul. 1, Oct. 1). The publication date is given in the field Period From. Deal Rate Enter the trade yield. 3.6.4.2.2 Generated data • Transaction The formula used to calculate the price depends on whether the CPI value that will determine the next coupon is known or not. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 265 3 Debt instruments 3.6 Index-linked bond – If the value is not known, we use the inflation rate (q) for coupon estimation: Equation 3-5 Coupon estimation: CPI value unknown – If the value is known, the formula is: Equation 3-6 Coupon estimation: CPI value known where Br – 1 Previous annuity payment B0 Original unadjusted annuity payment h Rounding precision, 3 or 6, depending on the issue q Quarterly inflation factor Ii CPI for quarter I: where I = 0 corresponds to the quarter before the issue date of the bond, and I = 1 corresponds to the latest quarter for which the CPI has been issued on the settlement date y Trading yield v • n Number of full quarters from the next annuity payment to maturity f Number of days from settlement to the next annuity payment date d Number of days in the full quarter ending on the next annuity payment date Z 1 if there is an annuity payment to the purchaser at the next annuity payment date, otherwise 0. Cashflows The following cashflows are generated: 266 – Principal – Interest – Interest Adjustment – Amortization – Delivery. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond • Fixing In the fixing of Australian index-linked annuity bonds, rounding is carried out at the total annuity payment level. To make sure that the total of the fixed interest and amortization payments are correct, one of the cashflows takes into account the rounding of the other. Note: In Rate Monitor, the index value of a given quarter is associated with the first day of the quarter (Jan. 1, Apr. 1, Jul. 1, Oct. 1). The publication date is given in the field Period From. 3.6.4.3 Processing 3.6.4.3.1 Fixing The fixing of the inflation adjustment (Interest Adjustment cashflow) is carried out at the instrument level in Instrument Editor - Cashflow page. • Execution Information Description Fixing Quote Select action Fix Price. The appropriate CPI value is displayed and the amount of the inflation adjustment is automatically calculated. You can also first set the relevant CPI value, and then select the action Fix Price. Update the cashflows (click Update) and save the instrument. 3.6.5 Australian index-linked bond The following sections describe the characteristics that are specific to Australian index-linked bonds. 3.6.5.1 Instrument setup Instrument setup for this type of index-linked bond is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following: • Trading characteristics See A.2.29 Australian CIB on page 724. – Issue Index parameters Information Description Index Instrument ID of the underlying index. See 7.1 Index types on page 425. Issue Index (Not used for Australian index-linked bonds) However, a value must be entered as 100.00 for calculation purposes only. • Bond characteristics Information Description Currency AUD Settlement parameters Dirty Price. Coupon Rate Coupon rate of the bond. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 267 3 Debt instruments 3.6 Index-linked bond Schedule parameters • Select the cashflow structure template BOND-AU-CIB (Australian Capital Indexed Bond). See B.2.1.1.3 Australian Capital Indexed Bond on page 890. Trading yield • Information Description Yield Convention Australian Government Index - GOVT-AU-IX Quoted • Information Description Price Type Yield (w/o rounding) Quote Handling Index-Linked Bond (Australian) Currency AUD Valuation approach • See A.2.38 Australian Index-Linked Bond Valuation on page 727. 3.6.5.2 Position monitoring In this section, numerical examples demonstrate how the different figures are calculated for Australian Treasury index-linked bonds. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. This example shows an Australian Treasury index-linked bond, with the following deal data: Setup data First interest payment date 1994-08-20 (Q3 / 1994) First reference quarter Q4 / 1993 Maturity date dt_m 2015-08-20 Interest r 4.00% Face amount 1,000.00 Transaction data Settlement date dt_s 2007-01-23 Next coupon date dt_c 2007-02-20 (Q1 / 2007) Yield y 2.76% Current quarter length dp 92 Index factor p 1.25 Adjustment factor K_t 141.270 (Q3 / 2006) 268 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond Other important deal data is calculated by the system as follows: • Quarters left n = FLOOR(YEARFRAC(dt_s, st_m, 0) * 4, 1) = 34 • Reference index v = ROUND (1 / (1 + y / 4), 9) = 99.31% • Days to next coupon dc = dt_c - dt_s 28 = 2007/02/20 - 2007/01/23 • Time to next coupon t_n = dc / dp 0.3043478 = 28 / 92 • Unadjusted dirty price Pdu =ROUND (POWER (v, t_n) * (ROUND (r / 4,9) * (1 + ROUND ((1 - POWER (v., n)) / (y / 4), 9)) + POWER (v, n)) * POWER (1 + p / 100, -t_n.), 9) = 109.71994% • Adjusted dirty price P_d = ROUND (K_t. * Pdu / 100,5) = 155.001% • Accrued interest I_a = ROUND ((r / 4) * K_t / 100 * (dp - dc) / dp, 5) = 0.98300000000% • Clean price P_c = P_d - I_a = 154.018% 3.6.5.2.1 Settlement figures Settlement flows for the transaction are calculated as follows: • Nominal amount A.s = 10,000,000.00 • Clean price P_c.s = A * P_c 15,401,800.00 = 10,000,000.00 * 1.54018 • Accrued interest I_a.s = A * I_a 98,300.00 • Total = 15,500,100.00 3.6.5.2.2 Fixing figures Fixing flows for the transaction are calculated using the following data: Fixing data Coupon date 2007-05-20 Fixing date 2007-02-20 Reference quarter 141.82 (Q4 / 2006) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 269 3 Debt instruments 3.6 Index-linked bond • Index adjustment factor cf = 141.82 / 100 = 1.41820 • Nominal coupon cn = r / 4 0.0100000 = 0.04 /4 • Adjusted amount Ap = A * cn *cf 141,820.00 = 10,000,000 * 0.010000 * 1.41820 3.6.5.2.3 Valuation figures Unless otherwise stated, the figure date used in the calculations is 2007-01-20. On this date, the market data is as follows: Market data on 2007-01-20 Market quote (dirty, adjusted) p_q 155.00 Figure D D_s 0.99960191 • Market value = p_q / 100 * A * D_s 15,493,829.60 = 155.00 / 100 * 10,000,000 * 0.99960191 3.6.6 Brazilian (LFT) selic-linked security Brazilian LFT (Letra Financeira do Tesouro) instruments are zero-coupon bonds linked to the O/N SELIC interest rate. The maturities can be over two years. These instruments are traded and quoted in 1000’s (Date Basis = BRL/252) and have a unique security ID (ISIN number), issue and maturity date. 3.6.6.1 Instrument setup Instrument setup for this type of index-linked bond is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics See A.2.52 Bond - Brazilian LFT on page 737. • • Bond characteristics Information Description Currency BRL Schedule parameters The Brazilian LFT Bond system-defined primary template is provided for this type of index-linked bond, where: – Fixing parameters Need Fixing = Yes Fixing Date Method = In Arrears Expression = iix/trading unit where: iix = instrument-specific index entered in Rate Monitor together with Bid and Ask (select the Rate Monitor figure Index Value). See B.2.1.1.7 Brazilian LFT Bond on page 891. 270 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond • • • Trading yield Information Description Yield Convention Brazilian LFT - BOND-BR-LFT Quoted Information Description Price Type Yield Quote Handling Index-Link Bond (LFT) Currency BRL Valuation approach See A.2.53 Bond - Brazilian LFT Valuation on page 737. 3.6.7 Brazilian FX-linked NBC-E/NTN-D NBC-E/NTN-D instruments are fixed-rate bonds linked to the PTAX-index (FX rate). The maturities are 2Y, 3Y, and 5Y. The fixed rate is 12% pa. These instruments are traded and quoted in 1000’s and have a unique security ID (ISIN number), issue date, and maturity date. The coupons and redemption cashflows are adjusted by the index ratio, and the fixing dates are the coupon/redemption value dates. 3.6.7.1 Instrument setup Instrument setup for these index-linked bonds is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics See A.2.54 Bond - Brazilian FX-Linked NBC on page 737. – Issue index parameters Information Description Index Instrument ID of the underlying index: PTAX-index (FX rate). See 7.1 Index types on page 425. Issue Index • • Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. Bond characteristics Information Description Currency BRL Settlement parameters Dirty Price Coupon Rate Coupon rate is 12% and the coupon is paid semi-annually. Schedule The Brazilian FX-Linked Bond (NBC) system-defined primary template is provided for these index-linked bonds, where: Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 271 3 Debt instruments 3.6 Index-linked bond – Fixing parameters Need Fixing = Yes Fixing Date Method = In Arrears Expression = ixlag_d/divider*price where: ixlag_d = lagged index value of one day divider = index value on the transaction’s opening date inserted on deal capture price = quoted bond price See B.2.1.1.5 Brazilian FX-Linked Bond (NBC) on page 890. • • • Trading yield Information Description Yield Convention Brazilian NBC - BOND-BR-NBC Quoted Information Description Price Type Yield Quote Handling Index-Link Bond (NBC) Currency BRL Valuation approach See A.2.55 Bond - Brazilian FX-Linked NBC Valuation on page 737. 3.6.8 Brazilian inflation-linked NTN Brazilian NTN-B/NTN-C (Nota do Tesouro Nacional) instruments are inflation-linked securities, setup as fixed-rate bonds, linked to the IGPM-index (NTN-C) or the ICPA-index (NTN-B). The maturities are 2Y, 3Y, and 5Y. The fixed rate is 12% p.a. or 6% p.a. These instruments are traded and quoted in 1000’s and have a unique security ID (ISIN number), issue date, and maturity date. The coupons and redemption cashflow are adjusted by the index ratio and the fixing dates are the coupon/redemption value dates. 3.6.8.1 Instrument setup Instrument setup for this type of index-linked bond is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics See A.2.56 Bond - Brazilian Inflation-Linked NTN on page 738. – Issue Index parameters Information Description Index Instrument ID of the underlying index: IGPM-index (NTN-C) or the ICPA-index (NTN-B). See 7.1 Index types on page 425. Issue Index 272 Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond • Schedule Information Description Fixing parameters • • • • • Need Fixing = Yes • Fixing Date Method = In Arrears • Expression = ix/divider*price Bond characteristics Information Description Currency BRL Settlement parameters Dirty Price Coupon Rate Coupon rate is 6% or 12% and the coupon is paid semi-annually. Trading yield Information Description Yield Convention Brazilian NTN - BOND-BR-NTN Quoted Information Description Price Type Yield Quote Handling Bond Currency BRL Valuation approach See A.2.57 Bond - Brazilian Inflation-Linked NTN Valuation on page 738. 3.6.9 Canadian real return bond The following sections describe the characteristics that are specific to Canadian real return bonds. 3.6.9.1 Instrument setup Instrument setup for Canadian real return bonds is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics – Issue Index parameters Information Index Description Instrument ID of the underlying index. See 7.1 Index types on page 425. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. See A.2.58 Bond - Canadian RRB on page 738. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 273 3 Debt instruments 3.6 Index-linked bond • Bond characteristics Information Description AI Method Canadian See Canadian on page 73. Currency CAD Coupon Rate Coupon rate of the bond. See A.2.210 Index-Linked Bond on page 818. • Schedule parameters The Canadian real return bonds system-defined primary template is provided for these index-linked bonds, where: Information Description Fixing parameters • Need Fixing = Yes • Fixing Date Method = In Arrears • Expression = ixratio*price See B.2.1.1.8 Canadian Real Return Bond on page 891. • Trading yield Information Description Yield Convention Canadian Government See 2.1.4.2.18 GOVT-CA (financial/instrument/canadian@price) on page 51. • • Quoted Information Description Price Type Price % Quote Handling Index-Linked Bond (Canadian) Currency CAD Valuation approach See A.2.59 Bond - Canadian Index-Linked Bond Valuation on page 738. 3.6.10 French OAT€i The following sections describe the characteristics that are specific to French OAT€i bonds. 3.6.10.1 Instrument setup Instrument setup for this type of index-linked bond is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics See A.2.65 Bond - French OAT€i on page 741. 274 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond – Issue Index parameters Information Description Index Instrument ID of the underlying index. See 7.1 Index types on page 425. Issue Index • • Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. Bond characteristics Information Description Currency EUR Coupon Rate Coupon rate of the bond. Schedule parameters – The French Index-Linked Bond (OAT) system-defined primary template is provided for this type of index-linked bond, where: Information Description Fixing parameters • Need Fixing = Yes • Fixing Date Method = In Arrears • Expression = max (ixratio, 1) * price See B.2.1.1.24 French Index-Linked Bond (OAT) on page 895. • • • Trading yield Information Description Yield Convention French Government OAT - GOVT-FR-OAT Quoted Information Description Price Type Price % Quote Handling Index-Linked Bond (French) Currency EUR Valuation approach See A.2.66 Bond - French Index-Linked Bond Valuation on page 742. 3.6.10.2 Position monitoring In this section, numerical examples demonstrate how the different figures are calculated for French OAT€i linked bonds. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 275 3 Debt instruments 3.6 Index-linked bond This example shows a French OAT€i linked bond, with the following deal data: Setup data Index at issue v_0 92.98393 Maturity date dt_m 2012-07-25 Interest c_m 3.00% Rounding decimals 5 Yield rounding y_round 6 Settlement date dt_s 2007-06-20 Next coupon date dt_c 2007-07-25 Yield y 2.40% (= round(2.396461364098%, 2)) Last index (2007-03) v_1 103.39 Current index (2007-04) v_2 104.05 Day of month d_1 20 Transaction data Other important deal data is calculated by the system as follows: • Coupons left n_c = FLOOR (YEARFRAC (dt_s, dt_m, 4), 1) +1 =6 • Reference index v = ROUND (v_1 + (d_1 - 1) / DAY (EOMONTH (dt_s, 0)) * (v_2 - v_1), decimals) = 103.80800 • Dirty price p_d_n = (POWER (1 + y, -n_c. + 1) + c_m * ((1 + y) * (1 - POWER (1 + y, -n_c))) / (y)) * POWER (1 + y, -d_c / 365) = 105.57230% • Accrued interest unadjusted I_a_n = c_m * (365 - d_c) / 365 2.7123288% = 0.03 * (365 - 35) / 365 • Accrued interest I_a = g_i * I_a_n 3.0280710% = 1.1164100000 * 0.027123288 • Clean price unadjusted p_c_n = p_d_n - ROUND (I_a_n, y_round) = 102.8600% • Clean price p_c = p_c_n * g_i 114.83393259% = 1.028600 * 1.1164100000 • Days to next coupon dcv = DAYS360 (dt_s, dt_c) = 35 • Index adjustment factor g_i = ROUND (v / v_0, decimals) = 1.1164100000 3.6.10.2.1 Settlement figures Settlement flows for the transaction are calculated as follows: • 276 Nominal amount A = 1,000,000.00 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond • Clean price p_c.s = A * p_c 1,148,339.33 = 1,000,000.00 * 1.1483393259 • Accrued interest I_a.s = A * I_a 30,280.71 = 1,000,000.00 * 0.03280710 • Total = 1,178,620.04 3.6.10.2.2 Fixing figures Fixing flows for the transaction are calculated using the following data: Fixing data Fixing date Index on 2007-04-25 2007-07-25 vf • Index adjustment factor gf = ROUND (vf / v_0, decimals) 1.12923 = 105 / 92.98393 • Nominal coupon cn = ROUND(c_m * gf, 7) 0.033876900 = ROUND (0.03 * 1.12923, 7) • Adjusted amount Ap = A * cn 33,876.00 = 1,000,000 * 0.033876900 105 3.6.10.2.3 Valuation figures Unless otherwise stated, the figure date used in the calculations is 2007-06-18. On this date, the market data is as follows: Market data on 2007-06-18 Figure date 2007-06-18 Figure spot date d_s.f 2007-06-20 Market quote (clean unadjusted) p_q 102.86% Index adjustment factor gv 1.11641 Spot discount factor Ds 0.9998027 Days to next coupon dcv 35 • Accrued interest ai.f = A * c_m * (365 - dcv) / 365 * gv * Ds 30,274.73 = 1,000,000 * 0.03 * (365 / 35) / 365 * 1.11641 * 0.9998027 • Clean price = A * p_q * gv * Ds 1,148,112.72 = 1,000,000 * 1.0286 * 1.11641 * 0.9998027 3.6.11 Greek index-linked bond The following sections describe the characteristics that are specific to Greek index-linked bonds. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 277 3 Debt instruments 3.6 Index-linked bond 3.6.11.1 Instrument setup Instrument setup for this type of index-linked bond is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics See A.2.71 Bond - Greek Index-Linked Bond on page 744. – Issue Index parameters Information Description Index Instrument ID of the underlying index. See 7.2.1 Simple Index on page 426. Issue Index • • Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. Bond characteristics Information Description Currency EUR AI Method Greek (3 decimals). See Greek (3 decimals) on page 74. Coupon Rate Coupon rate of the bond. Schedule parameters – The Greek Index-Linked Bond system-defined primary template is provided for this type of index-linked bond, where: Information Description Fixing parameters • Need Fixing = Yes • Expression = ixratio*price See B.2.1.1.25 Greek Index-Linked Bond on page 895. • • • Trading yield Information Description Yield Convention GOVT-EUROZONE Quoted Information Description Price Type Price % Quote Handling Index-Linked Bond (Greek) Currency EUR Valuation approach See A.2.72 Bond - Greek Index-linked Bond Valuation on page 744. 278 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond 3.6.12 Israeli index-linked bond Israeli index-linked bond instruments must be based on an instrument type derived from the class INDEX-LINKED-BOND. The following sections describe the characteristics that are specific to Israeli index-linked bonds. 3.6.12.1 Instrument setup Instrument setup for this type of index-linked bond is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics - Issue Index parameters Information Index Description Instrument ID of the underlying index. See 7.1 Index types on page 425. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. See A.2.73 Bond - Israeli Index-Linked Bond on page 744. • Bond characteristics Information Description Currency ILS AI Method Israeli (Linear, 5 decimals) See Israeli (Linear, 5 decimals) on page 76. • Settlement Switches Dirty Price. Coupon Rate Coupon rate of the bond. Note: According to the market convention, the deal price of Israeli index-linked bonds is treated not just as Dirty Price but as an inflation-adjusted dirty price. At deal entry, this means that you should capture the dirty price as well as the index ratio. The settlement amount is equal to the deal price times the nominal amount. Schedule parameters The Israeli Index-Linked Bond system-defined primary template (BOND-IL-IX) is provided for this type of index-linked bond, where: Information Description Fixing parameters • Need Fixing = Yes • Fixing Date Method = In Arrears • Expression = round(ixratio*price,0.0000001) See B.2.1.1.28 Israeli Index-Linked Bond on page 895. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 279 3 Debt instruments 3.6 Index-linked bond For Israeli GALIL Index-Linked Bond, the system-defined primary template (BOND-IL-IX-GALIL) is provided for this type of index-linked bond, where: Information Description Fixing parameters • Need Fixing = Yes • Fixing Date Method = In Arrears • Expression = round((max(ixratio,1)*((1+price/100)^(years)-1)),0.0000001)*nom inal • Fixing rate Type = Amount See B.2.1.1.29 Israeli Index-Linked Bond Galil on page 896. • Trading yield Information Description Yield Convention *U.S.STREET-ACTACT-SEMIANNUAL See 2.1.4.2.12 *U.S.STREET-ACTACT-ANNUAL (financial/instrument/us-street@price-1) on page 45. • • Quoted Information Description Price Type Price % Quote Handling Index-Linked Bond (Israeli) Currency ILS Optionally, time-dependent index value Complete the following parameters: Information Description Date Date when rebasing is done. Type Choices are: Value or Factor • Value - When you select this option, the New / Old Value fields are available for editing, the Factor field is no longer available. • Factor - When you select this option, only the Factor field is available for editing, the New / Old Value fields are no longer available. Old Value Index value before the rebase. Defaults to the same value as specified in the Factor field when type Factor is selected. New Value Index Value after the rebase. Defaults to 1 when type Factor is selected. Factor Rebase factor. When type Value is selected, this field displays Old Value / New Value, rounded to 9 decimals (i.e. trailing zeros are not displayed). See A.2.214 Index Rebase (Index-Linked Bond) on page 820. • Valuation approach See A.2.74 Bond - Israeli Index-Linked Bond Valuation on page 745. 280 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond 3.6.12.2 Deal capture In addition to standard deal parameters, the information required to enter a deal on an Israeli index-linked bond is similar to usual index-linked bonds (see 3.6 Index-linked bond on page 260). 3.6.12.2.1 Input data Index at Issue and Index Ratio columns (take into account all the rebases that took place from the bond's issue date until (and including) the transaction's opening date). Information Description Index at Issue The Index at Issue column is calculated according to the issue index value defined at instrument level (Issue Index page), divided by each published rebase factor between the bond's issue date and the transaction's opening date: Equation 3-7 Israel index-linked bonds: Index at Issue calculations Where - V0 is the base index of the bond on the issue day as defined in the Issue Index page of the index-linked bond. - rbti is the rebase factor at time ti between the issue date and the opening date of the transaction, as defined in the Rebase page of the index. Index Ratio The Index Ratio takes into account the rebased index at issue and and the latest index value. For Israeli index-linked bond the Index Ratio is rounded to 7 decimals. For information about this calculation, see D.4.3.4.3 Calculation for Israeli index-linked bonds on page 925. 3.6.12.3 Processing The processing of an Israeli index-linked bond is the same as for a standard index-linked bond, see 3.6 Index-linked bond on page 260. 3.6.13 Italian BTP €i The following sections describe the characteristics that are specific to Italian BTP€i bonds. 3.6.13.1 Instrument setup Instrument setup for this type of index-linked bond is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics See A.2.75 Bond - Italian BTP€i on page 745. – Issue Index parameters Information Description Index Instrument ID of the underlying index. See 7.2.1 Simple Index on page 426. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 281 3 Debt instruments 3.6 Index-linked bond • • Bond characteristics Information Description Currency EUR AI Method Italian (5 decimals). See Italian (5 decimals) on page 77. Coupon Rate Coupon rate of the bond. Schedule parameters – The Italian Index-Linked Bond (BTP) system-defined primary template is provided for this type of index-linked bond, where: Information Description Fixing parameters • Need Fixing = Yes • Expression = max (ixratio, 1) * price See B.2.1.1.30 Italian Index-Linked Bond (BTP) on page 896. • • • Trading yield Information Description Yield Convention Italian Government - GOVT-IT Quoted Information Description Price Type Price % Quote Handling Index-Linked Bond (Italian) Currency EUR Valuation approach See A.2.76 Bond - Italian Index-Linked Bond Valuation on page 745. 3.6.14 Japanese index-linked bond The following sections describe the characteristics that are specific to Japanese index-linked bonds. 3.6.14.1 Instrument setup Instrument setup for this type of index-linked bond is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics – Issue Index parameters Information Index Description Instrument ID of the underlying index. See 7.1 Index types on page 425. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. See A.2.225 Japanese JGBi on page 825. 282 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond • Bond characteristics Information Description Currency JPY AI Method Japanese Yield (7 decimals) See Japanese Yield (7 decimals) on page 77. Coupon Rate • Coupon rate of the bond. Schedule parameters The Japanese Index-Linked Bond system-defined primary template is provided for this type of index-linked bond, where: Information Description Fixing parameters • Need Fixing = Yes • Fixing Date Method = In Arrears • Expression = ixratio*price See B.2.1.1.31 Japanese Index-Linked Bond on page 896. • Trading yield Information Description Yield Convention Japanese Government See 2.1.4.2.29 GOVT-JP (financial/instrument/simple-yield@price) on page 59. • • Quoted Information Description Price Type Price % Quote Handling Index-Linked Bond (Japanese) Currency JPY Valuation approach See A.2.226 Japanese Index-Linked Bond Valuation on page 826. 3.6.15 Swedish index-linked bond The following sections describe the characteristics that are specific to Swedish index-linked bonds. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 283 3 Debt instruments 3.6 Index-linked bond 3.6.15.1 Instrument setup Instrument setup for this type of index-linked bond is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics – Issue Index parameters Information Description Index Instrument ID of the underlying index. See 7.1 Index types on page 425. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. See A.2.317 Swedish Index-Linked Treasury Bond on page 869. • • Bond characteristics Information Description Currency SEK Coupon Rate Coupon rate of the bond (unless it is a zero-coupon bond). Schedule parameters – The Swedish Index-Linked Bond system-defined primary template is provided for this type of index-linked bond, where: Information Description Fixing parameters • Need Fixing = Yes • Fixing Date Method = In Arrears • Expression = round (ixse / divider * price, 0.0000001) ixse = expression specific to Swedish index-linked bonds, see D.4.3.6 Swedish CPI market reference - ixse on page 926. See B.2.1.1.38 Swedish Index-Linked Bond on page 898. – For zero-coupon bonds, the Swedish Index-Linked Zero-Coupon Bond system-defined primary template is provided, where: Information Description Fixing parameters • Need Fixing = Yes • Fixing Date Method = In Arrears • Expression = max (ixse / divider, 1) * price ixse = expression specific to Swedish index-linked bonds. See B.2.1.1.39 Swedish Index-Linked ZC Bond on page 898. • 284 Trading yield Information Description Yield Convention Swedish Government - GOVT-SE © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond Quoted • Information Description Price Type Yield Quote Handling Index-Linked Bond (Swedish) Currency SEK Valuation approach • See A.2.318 Swedish Index-Linked Bond Valuation on page 870. 3.6.15.2 Position monitoring In this section, numerical examples demonstrate how the different figures are calculated for Swedish index-linked bonds. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. This example shows a Swedish index-linked bond, with the following deal data: Setup data Index at issue v_0 245.1 Maturity date dt_m 2008-12-01 Interest c_m 4.00% Settlement date dt_s 2003-04-30 Next coupon date dt_c 2003-12-01 Yield y 2.30% Nominal amount A 1,000,000.00 Last index (2003-01-01) v_1 276.0 Current index (2003-02-01) v_2 278.4 Day of month d_1 30 Transaction data Other important deal data is calculated by the system as follows: • Coupons left n_c = FLOOR (YEARFRAC (dt_s, dt_m, 4), 1) + 1 =6 • Dirty price p_d = (POWER (1 + y, -n_c + 1) + c_m * ((1 + y) * (1 - POWER (1 + y, -n_c))) / (y)) * Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 285 3 Debt instruments 3.6 Index-linked bond POWER (1 + y, -d_c / 360) * g_i = 125.43308% • Accrued interest I_a = g_i * (360 - d_c) / 360 * c_m = 0.018799437871 • Clean price p_c = p_d - I_a = 123.55313963% • Reference index v = v_1 + (MIN(d_1, 30) -1) / 30 *(v_2 - v_1) = 278.32 • Days to next coupon d_c = DAYS360 (dt_s, dt_c) = 211 • Index adjustment factor g_i = v / v_0 = 1.1355365157 3.6.15.2.1 Settlement figures Settlement flows for the transaction are calculated as follows: • Principal flow P = A * P_c 1,235,531.40 = 1,000,000 * 1.2355313963 • Accrued interest flow AI = A * I_a 18,799.44 = 1,000,000 * 0.018799437871 3.6.15.2.2 Fixing figures Fixing flows for the transaction are calculated using the following data: Fixing data Fixing date Index on 2002-09-01 2002-12-01 vf • Index adjustment factor gf = vf / v_0 1.11995104 = 274.50 / 245.1 • Nominal coupon cn = ROUND(c_m * gf, 7) 0.0447980 = ROUND (0.04 * 1.11995104, 7) • Adjusted amount Ap = A * cn 44,798.00 = 1,000,000 * 0.0447980 274.50 3.6.15.2.3 Valuation figures Unless otherwise stated, the figure date used in the calculations is 2003-04-28. On this date, the market data is as follows: Market data on 2003-04-28 Figure date 2003-04-28 Figure spot date d_s.f 2003-04-30 Market quote (real yield) y_f 2.30% Index adjustment factor g_f 1.135536516 286 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond Market data on 2003-04-28 Spot discount factor D_s.f 1.00 • Days to next coupon d_c.f = DAYS360 (d_s.f, dt_c) = 211.00 • Dirty price d_p.f = (POWER(1 + y_f, -n_c. + 1) + c_m * ((1 + y_f) * (1 - POWER (1 + y_f, -n_c))) / (y_f.)) * POWER (1 + y_f,- d_c.f / 360) * g_f 1.254330834 • Accrued interest ai.f = g_f * (360 - d_c.f) / 360 * c_m = 0.018799438 • Clean price = p_d.f - ai.f = 1.235531396 • Market value = A * ai.f * D_s.f + A * p_c.f * D_s.f = 1,254,330.83 3.6.16 UK index-linked gilt The following sections describe the characteristics that are specific to UK (3 month and 8 month) index-linked gilts. 3.6.16.1 Instrument setup Instrument setup for UK index-linked gilts is the same as for index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics See A.2.329 UK ILG (3M) on page 876 and A.2.330 UK ILG (8M) on page 876. – Issue Index parameters Information Description Index Instrument ID of the underlying index. See 7.1 Index types on page 425. Issue Index • • Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. Bond characteristics Information Description Currency GBP Coupon Rate Coupon rate of the bond. Schedule parameters Select the appropriate cashflow structure template, BOND-UK-IG-3M or BOND-UK-IG-8M. See B.2.1.1.42 United Kingdom Index-Linked Gilt (3M) on page 898 or B.2.1.1.43 United Kingdom Index-Linked Gilt (8M) on page 899. Note: These templates correspond to rounding down to 4 decimal places. Some issues (both 8M and 3M) use different rounding conventions. To round down to 2 decimal places, replace Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 287 3 Debt instruments 3.6 Index-linked bond the function round ( , 0.000001, -1) by round ( ,0.0001, -1). To round to nearest 6 decimal places, use round ( , 0.00000001). Trading yield • Information Description Yield Convention UK Government - GOVT-UK Quoted • Information Description Price Type Price % Quote Handling Index-Linked Bond (UK 3M) or Index-Linked Bond (UK 8M) Currency GBP Valuation approach • See A.2.331 UK Index-Linked Bond (3M) Valuation on page 876 and A.2.332 UK Index-Linked Bond (8M) Valuation on page 877. 3.6.16.2 Position monitoring In the following sections, numerical examples demonstrate how the different figures are calculated for UK 3 month and 8 month index-linked gilts. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. 3.6.16.2.1 Calculations - UK 3 month This example shows a UK 3 month index-linked gilt, with the following deal data: Setup • Data Symbol Example Index at issue v_0 193.725 Maturity date dt_m 2012-11-22 Interest c_m 1.25% Rounding decimals 5 Yield rounding y_round 6 Dividend rounding decimals_div 6 Data Symbol Example Settlement date dt_s 2007-06-18 Previous coupon date dt_p 2007-05-22 Next coupon date dt_c 2007-11-22 Coupons left n_c 21 Yield y 2.19% Transaction data • 288 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond Data Symbol Example Last index (2007-03) v_1 204.40 Current index (2007-04) v_2 205.40 Day of month d_1 18 Other important deal data is calculated by the system as follows: • Dirty price d_p = (POWER (1 + y / 2, -n_c + 1) + c_m / 2 * ((1 + y / 2) * (1 - POWER (1 + y / 2, -n_c))) / (y / 2)) * POWER (1 + y / 2, -d_c / 183) = 91.37171% • Accrued interest unadjusted I_u = c_m / 2 * (p_c - d_c) / p_c = 0.0917120% • Accrued interest I_ a = g_i * I_u = 0.0970340% • Clean price unadjusted p_cu = d_p - I_u = 91.2800% • Clean price Pca =p_cu * g_i = 96.57697839% • Reference index v = ROUND (v_1 + (d_1 - 1) / DAY(EOMONTH (dt_s, 0)) * (v_2 - v_1), decimals) = 204.96667 • Coupon period p_c = dt_c - dt_p = 184 • Days to next coupon d_c = dt_c - dt_s = 157 • Index adjustment factor g_i = ROUND (v / v_0, decimals) = 1.0580300000 Settlement figures Settlement flows for the transaction are calculated as follows: • Nominal amount A = 1,000,000.00 • Clean price Pca.s = A * Pca = 965,769.78 • Accrued Interest I_a.s = A * I_a = 970.34 • Total = 966,740.12 Fixing figures Fixing flows for the transaction are calculated using the following data: Data Symbol Fixing date Index on 2007-08-22 Example 2007-11-22 vf 205.40 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 289 3 Debt instruments 3.6 Index-linked bond • Index adjustment factor gf = ROUND (vf / v_0, decimals) = 1.06027 • Nominal coupon cn = ROUND (c_m / 2 * gf, decimals_div + 2) = 0.006626690 • Adjusted amount Ap = A * cn = 6,626.69 Valuation figures Unless otherwise stated, the figure date used in the calculations is 2007-06-16. On this date, the market data is as follows: Market data on 2007-06-16 • Data Symbol Figure date Example 2007-06-16 Figure spot date d_s.f 2007-06-18 Market quote (clean unadjusted) Pcu 91.28% Index adjustment factor gv 1.05803 Spot discount factor Ds 0.999564 Days to next coupon dnv 157 • Accrued interest = A * (c_m / 2) * (p_c - dnv) / p_c * gv * D_s = 969.92 • Principal = A * Pcu * gv * D_s = 965,348.87 3.6.16.2.2 Calculations - UK 8 month This example shows a UK 8 month index-linked gilt, with the following deal data: Setup data • Data Symbol Example Issue date 1982-01-28 Index at issue (5/1981) 294.10 Rebasing index (2/1983) 394.50 Index at issue rebased v_0 74.55006337136 Maturity date dt_m 20011-08-23 Interest r 2.50% Rounding decimals dec 0.0001000 Symbol Example Transaction data • Data Opening date 2007-03-28 Settlement date d.s 2007-03-29 Previous coupon date d.pc 2007-02-23 Next coupon date dt.c 2007-08-23 290 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond Data Symbol Example Reference index for next coupon v 202.70 Latest published index v_l 203.10 Forecast delay months m_d 2 Next but one coupon date 2008-02-23 Coupons left n 8 Index Prolong Rate pi 3% Note: Index Prolong Rate (for the underlying index) is shown in Rate Monitor under key figure Index Rate. If the index rate is not given, the default value is 3%. Other important deal data is calculated by the system as follows: • Index forecast factor g_f = (v_l / v0) * POWER (u, m_d * 2 / 12) = 2.710955377 • Next but one coupon amount estimate d2 = (r / 2) * g_f / u = 3.4391490% • Days to next coupon d.n = dt.c - d.s = 147 • Current coupon period p = dt.c - d.pc = 181 • Time to next coupon t_n = d.n / p = 0.81215 Price from real yield • Yield (real) y = 2.2656270% • Semi-annual real discount factor) w = 1 / (1 + y. / 2) = 0.988798754 • Semi-annual inflation factor) u = POWER (1 + pi, -0.5) = 0.985329278 • Dirty price P_d = (d1 + d2 * u * w + (g_f * r * w * w) / (2 * (1 - w)) * (1 - POWER (w, n -1))) * POWER (u * w, d.n / p) + g_f * POWER (u, d.n / p) * POWER (w, n + d.n / p) = 271.106796% • Accrued interest (adjusted) I_a = d1 * ((p - d.n) / p) = 0.63679558% • Clean price (adjusted) p_c = P_d - I_a = 270.4700% • Nominal from real = 2 * ((y / 2 + 1) * SQRT(1 + pi) - 1) = 5.2771916% Settlement figures Settlement flows for the transaction are calculated as follows: • Nominal amount A = 10,000,000.00 • Clean price p_c.s = A * p_c = 27,047,000.00 • Accrued interest I_a.s = I_a * A = 63,679.56 • Total = 27,110,679.56 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 291 3 Debt instruments 3.6 Index-linked bond Fixing figures Fixing flows for the transaction are calculated using the following data: Fixing data Coupon date 2007-08-23 Index on 2006-12-01 vf • Index adjustment factor g_i = v / v0 = 2.718978239 • Adjusted coupon d1 = FLOOR ((r / 2) * g_i, dec) = 3.3900% • Adjusted amount Ap = A * d1 = 339,000.00 202.70 Valuation figures Unless otherwise stated, the figure date used in the calculations is 2007-03-28. On this date, the market data is as follows: Market data on 2007-03-28 Figure date 2007-03-28 Figure spot date d_s.f 2007-03-29 Discount factor for spot date Ds 0.999854679 Market quote Pc 270.47% Days to next coupon dvc 147 • Principal market value = A * Pc * Ds = 27,043,069.49 • Accrued interest market value = A * d1 * (p - dvc) / p * Ds = 63,670.30 3.6.17 US Tips The following sections describe the characteristics that are specific to US Treasury index-linked bonds. 3.6.17.1 Instrument setup Instrument setup for US Tips is the same as for other index-linked bonds (see 3.6 Index-linked bond on page 260) except for the following parameters: • Trading characteristics See A.2.334 US TIPS on page 877. – Issue Index parameters Information Index Description Instrument ID of the underlying index. See 7.1 Index types on page 425. Issue Index 292 Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond • • Bond characteristics Information Description Currency USD Coupon Rate Coupon rate of the bond. Schedule parameters The US Treasury Inflation Protected Security system-defined primary template is provided for these index-linked bonds, where: Information Description Fixing parameters • Need Fixing = Yes • Fixing Date Method = In Arrears • Expression = ixratio*price See B.2.1.1.44 US Treasury Inflation Protected Security on page 899. • • • Trading yield Information Description Yield Convention U.S. Treasury - *U.S.TREASURY Quoted Information Description Price Type Price % Quote Handling Index-Linked Bond (US TIPS) Currency USD Valuation approach See A.2.333 US Index-Linked Bond Valuation on page 877. 3.6.17.2 Position monitoring In the following sections, numerical examples demonstrate how the different figures are calculated for US Treasury index-linked bonds, both at the time of issue and at trading. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. 3.6.17.2.1 Calculations - at issue This example shows a US Treasury index-linked bond, with the following deal data (at issue): Setup data Issue date 1998-01-15 Index at issue v_0 161.55484 Maturity date dt_m 2008-01-15 Interest r 3.625% Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 293 3 Debt instruments 3.6 Index-linked bond Transaction data Opening date 1998-10-13 Spot days 2 Settlement date dt_s 1998-10-15 Previous coupon date dt_c0 1998-07-15 Next coupon date dt_c 1999-01-15 Yield y 3.650% Last index v_1 163.20 Current index v_2 163.40 Day of month d_1 (= dt_s) 15 Length of month m_1 31 Other important deal data is calculated by the system as follows: • Coupons left c_n = FLOOR (YEARFRAC (dt_c, dt_m, 0) * 2, 1) = 18 • Yield factor vy = 1 / (1 + y / 2) = 0.9821 • Dirty price unadjusted P_u = (r / 2 + (1 - POWER (vy, c_n)) / (y / 2) * (r / 2) + POWER (vy, c_n)) / (1 + (d / p) * (y / 2)) = 100.7032666% • Accrued interest unadjusted I_u = ROUND ((pn - dn) / pn * r / 2, 8) = 0.00906250 • Accrued interest adjusted I_a = ROUND (I_u * g_i, 8) = 0.0091598300 294 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.6 Index-linked bond • Clean price unadjusted P_cu = ROUND (P_u - I_u, 5) = 99.79700% • Clean price adjusted P_a = ROUND (P_cu * g_i, 5) = 100.86900% • Reference index v = ROUND (v1 + (d_1 - 1) / m_1 * (v2 - v1), 5) = 163.2903200 • Index adjustment factor g_i = ROUND (v / v_0, 5) = 1.0107400000 • Days to next coupon d = dt_c - dt_s = 92 • Current coupon period p = dt_c - dt_c0 = 184 Settlement figures • Nominal amount An = 1,000,000.00 • Clean price = An * P_a = 1,008,690.00 • Accrued interest = An * I_a = 9,159.83 • Total = 1,017,849.83 Fixing figures Fixing flows for the transaction are calculated using the following data: Fixing data Coupon date Index on 2002-09-01 1999-01-15 vf • Index adjustment factor gf = ROUND (vf / v_0, 5) = 1.01514 • Nominal coupon cn = r / 2 * gf = 0.0183994 • Adjusted amount Ap = cn * An = 18,399.41 164 Valuation figures Unless otherwise stated, the figure date used in the calculations is 1998-10-13. On this date, the market data is as follows: Market data on 1998-10-13 Figure date 1998-10-13 Figure spot date d_s.f 1998-10-15 Market quote (clean unadjusted price) Pq 99.7970% Index adjustment factor g_v 1.010740 Spot discount factor D_s 1 Days to next coupon dcv 92 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 295 3 Debt instruments 3.6 Index-linked bond • Accrued interest = An * ROUND ((pn - dcv) / pn * r / 2, 8) * g_v * D_s = 9,159.83 • Principal = An * Pq * g_v = 1,008,688.20 3.6.17.2.2 Calculations - at trading This example shows a US Treasury index-linked bond, with the following deal data (at trading): Setup data Index at issue v_0 198.47742 Maturity date dt_m 2016-01-15 Interest r 2.00% Settlement date dt_s 2007-06-18 Previous coupon date dt_c0 2007-01-15 Next coupon date dt_c 2007-07-15 Yield y 2.783% Last index v_1 205.35200 Current index v_2 206.68600 Day of month d_1 (= dt_s) 18 Length of month m_1 30 Transaction data Other important deal data is calculated by the system as follows: • Coupons left c_n = FLOOR (YEARFRAC (dt_c, dt_m, 0) * 2, 1) = 17 • Yield factor vy = 1 / (1 + y / 2) = 0.9863 • Dirty price unadjusted P_u = (r / 2 + (1 - POWER (vy, c_n)) / (y / 2) * (r / 2) + POWER (vy, c_n)) / (1 + (d_1 / m_1) * (y / 2)) = 94.9133290% • Accrued interest unadjusted I_u = ROUND ((pn - dn) / pn * r / 2, 8) = 0.00850829 • Accrued interest adjusted I_a = I_u * g_i = 0.0088354338 • Clean price unadjusted P_a = P_u - I_u = 94.06250% • Clean price adjusted P_a = P_cu * g_i = 97.67920% • Reference index v = ROUND (v1 + (d_1 - 1) / m_1 * (v2 - v1), 5) = 206.1079300 • Index adjustment factor g_i = ROUND (v / v_0, 5) = 1.0384500000 • Days to next coupon dn = dt_c - dt_s = 27 • Current coupon period pn = dt_c - dt_c0 = 181 296 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.7 Asset backed security Settlement figures • Nominal amount An = 1,000,000.00 • Clean price = An * P_a = 976,792.03 • Accrued Interest = An * I_a = 8,835.43 • Total = 985,627.47 3.7 Asset backed security With normal bonds, the investor is dependent on the creditworthiness of the issuer for payment of the coupons and repayment of the original investment. In contrast, asset-backed securities have a pool of assets that collateralize the bond and generate the cashflows. Asset-backed securities (ABS) are backed by assets such as consumer loans, credit card receivables, royalties, and leases. However, the majority of the market consists of securities backed by residential mortgage loans with mortgage-backed securities (MBS). The main risk for the investor is the risk of repayment. When an individual asset is repaid (repayment), the security is amortized by the principal amount of that mortgage or loan. The structure of the security determines precisely how this amortization is passed on to investors; however it is done, it is impossible to predict the cashflows precisely for fixed or floating-rate instruments. Note: TRM does not support repayments in the middle of a coupon period but only at coupon payment dates. 3.7.1 Instrument setup Asset-backed security instruments must be based on an instrument type derived from the class ABS. They are set up in a similar way to standard bonds (see 3.1 Bond on page 215). The additional values required to set up ABS instruments are described in the following sections. • ABS main characteristics The main characteristics of an ABS are defined in the same way as a Bond instrument, but using the primary feature ABS: see A.2.1 ABS - Asset Backed Security on page 713. • Schedules Select the cashflow structure template that is appropriate for the instrument. System templates are provided for both fixed-rate ABS (see B.2.1.1.1 ABS-MBS, Fixed Rate on page 890) and floating-rate ABS (see B.2.1.1.2 ABS-MBS, Floating Rate on page 890); you can choose one of these templates or any other template derived from them. Note: It is possible to modify the Start Date value for the redemption cashflow to reflect any restrictions on the date when repayments are allowed to begin on the ABS. • Repayment estimation The estimations of future repayments are defined and stored in the Repayment Estimates page. To define a new set of repayments, click Generate to open the resulting dialog and enter the following parameters: Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 297 3 Debt instruments 3.7 Asset backed security Important: Do not use the Add/Remove and Clear buttons in the Repayment Estimates page. Information Description Estimation Date Date from when the estimation is valid. Outstanding Read-only. Percentage of the initial nominal amount which is outstanding (the current repayment included) on the Estimation Date. Legal Maturity Read-only. Legal maturity of the instrument. Expected Maturity Expected maturity of the instrument. The date must be later than the estimation date and earlier or equal to the legal maturity date. Default is the legal maturity date. Method Defines which method to use to generate the estimate: • Annuity does a fixed annuity calculation. • Copy Previous + Fixed % copies the previous estimation, if it exists, and adds % between % From and % To. • Fixed % creates a repayment of % between % From and % To. • Linear performs linear amortization of the outstanding principal until the date specified in the Expected Maturity field. • WAL Date allow the user to enter an expected maturity date different from the coupon date. The selected WAL (Weighted Average Life) date is displayed in WAL Date field of the Repayment Estimates page. When this method is used, two repayments are automatically created from this date, by splitting the redemption amount between previous and next coupon dates (according to the WAL date) as follows: - PrevCD is the first coupon value date immediately before the WAL date: P*OutstandingAmount is prepaid at PrevCD. - NextCD is the first coupon value date immediately after the WAL date: (1-P)* OutstandingAmount is paid at NextCD. where P = (WAL date - PrevCD)/(NextCD - PrevCD) Note: WAL Date is visible in Transaction Manager. Interest Rate The last known fixed rate (only used for annuity calculation). % From Date from when % should apply in Copy Previous + Fixed % and Fixed % methods. % To Date until when % should apply in Copy Previous + Fixed % and Fixed % methods. % Percentage to use in Copy Previous + Fixed % and Fixed % methods. Click OK to display the repayments generated for this date. The information displayed is as follows: 298 Information Description Outstanding Read-only. Percentage of the initial nominal amount which is outstanding (the current repayment included). WAL Date This date is used when the expected maturity date is different to the coupon date, i.e. when the method WAL Date is selected during the generation. Value Date Read-only. Date on which the repayment may occur for the selected row, valid for the specified estimation date. Estimation Date Date from when the estimation is valid. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.7 Asset backed security Information Description Percentage For the selected row, the percentage of the principal which is estimated to be repaid on a specified estimation date. Active From/To Read-only. First and/or last date that the estimation is valid. Each row displayed consists of a repayment estimate, valid for a given period (defined by the fields Active From/Active To). – To refine the repayment estimate for this value date, you can edit the percentage of a row. Click Update to validate the modification. – To generate a new set of estimates for a different date, enter this date in Estimation Date and generate again as described above. – To remove a set of estimations, click Delete. All the estimates with Active From included in the period defined in the Delete dialog are removed. Alternative repayment parameters • Optionally, you can add the feature Alternative Repayment Estimates to override the repayment parameters set up in the Repayment Estimates page. This feature adds two pages, Alternative Repayment Estimate Setup and Alternative Repayment Estimates. The Alternative Repayment Estimates page is set up in the same way as the Repayment Estimates page. A.2.27 Alternative Repayment Estimates on page 723. Note: For accounting: Alternative repayments should not be used for the valuation modes used in accounting. Accounting should use the set of estimates defined in the Repayment Estimates page to ensure that the accrual figures are consistent with the yield calculation. (The yield is calculated based on the estimates defined in the Repayment Estimates page.) 3.7.2 Deal capture A deal involving an asset-backed security is entered in a similar way to a bond deal. 3.7.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a deal on an asset-backed security. Information Description Price or Rate If there is a yield/price convention set on the instrument, it is possible to enter either a rate or a price, and conversion is made automatically. If there is no convention set, the deal must be entered in price. Face Amount The deal can be input in face amount or units, in which case, the Nominal Amount is computed by the system. or Units Amount Nominal amount of the deal. This amount is computed by the system when the face amount or units are entered. 3.7.2.2 Generated data • Cashflows Only definite cashflows are generated on a deal with an ABS instrument: – Position cashflow Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 299 3 Debt instruments 3.7 Asset backed security – Known future amortization flows and corresponding interest flows (no uncertain cashflows are generated) – Accrued interest flow – Delivery flow (pseudo) 3.7.3 Processing This section describes the actions that can be done throughout the life of an ABS. 3.7.3.1 Fixing repayment flows Repayment flows for an ABS are not known in advance and can only be estimated. Therefore, when you know a repayment is definitely going to take place, the cashflow needs to be fixed. The following information is needed to fix a repayment: Fixing Rate = Real percentage of principal • Execution There are two ways to execute fixing of repayment flows. In both cases, the results of the action are identical. The action parameters are defaulted from the repayment percentage specified in the Repayment page. If the WAL (Years) is provided, then it is used to calculate the expected maturity in the subsequent estimate regeneration. The methods of fixing are as follows: – Directly on the cashflow (in Instrument Editor’s Cashflow page) using the Fix Repayment action: the fixing affects all deals on the instrument by updating the cashflows at transaction level when the instrument is saved. – Using the activity Fixing ABS Repayment: all instruments and their deals which need to be fixed for a particular date are affected by the activity. Note: See the TRM User Guide for general information on running activities, and also specific information on the activity parameters. When the fixing of the repayment is done, the cashflows are updated as follows: – The repayment flow and the next interest flow are added to the deal. – The position flow is added to reflect the outstanding principal amount. Additionally, after the fixing of the repayment, the system automatically prompts to re-estimate the repayment estimate based on the result of the fixing. The action parameters are defaulted from the previous estimation. Click OK to accept these defaults. Note: This action can be executed automatically using the Selling Values activity. See the TRM User Guide for information on the activity parameters. In case of Floating Rate ABS, the next interest should be fixed before the repayment can be fixed. This is required to ensure the correct recalculation of yield accrual and regeneration of estimates for a annuity repayment. 3.7.3.2 Full Repayment When an ABS is fully repaid, the current position of the corresponding ABS is closed by creating a Sell transaction with the outstanding amount as the nominal amount. • Execution There are two ways for full repayment of an ABS, in both cases, the results are identical. 300 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.7 Asset backed security Directly on the cashflow at the instrument level (Instrument Editor - Cashflow page) using the Full Repayment action. This closes the current position on the corresponding ABS as follows: – A Sell transaction is generated (consolidated per Portfolio/Counterparty/Result mode) with a nominal amount equal to the amount left at the full repayment date. The Sell transaction has a position flow that closes the current position and a settlement flow to repay the ABS. Note: No delivery flow is generated in this transaction in order to reflect the market practice where the issuer may call back the security, usually after the full repayment date. You can generate the security settlement (delivery flow) at a later date as described in the next section. Using the activity Fixing ABS Repayment (Full Repayment), see TRM User Guide for more information about this activity. – After a full repayment, you can generate the security settlement (delivery flow) by right-clicking the previously generated Sell transaction and selecting ABS Custody Account Clearing. This action also clears the custody balance. Enter the following parameters in the resulting dialog: Information Description Opening Date Defaults to the opening date of the Sell transaction. Value Date Defaults to the opening date plus the spot date. From (Read-only) Defaults to the owner of the original transaction. From Custodian Custody account defined for the owner. Only the accounts with Custody account kind are available for selection. From Account Account from the custody account you selected in the From Custodian field. To Defaults to the issuer of the ABS. You can modify the issuer. To Custodian Custody account defined for the issuer you selected in the To field. Only the accounts with Custody account kind are available for selection. To Account Account from the custody account you selected in the To Custodian field. Click OK. A transfer transaction is created to generate a delivery cashflow between the Owner of the transaction and the Issuer of the ABS. Note: You can cancel the transfer transaction by clicking the Cancel command at the transaction level. • Cancellation You can cancel a full repayment by selecting the Cancel Full Repayment action on the corresponding redemption flow (Instrument Editor - Cashflow page). 3.7.3.3 Fixing coupon flows The unknown interest flows for a floating-rate ABS need to be fixed. The procedure for fixing these flows is the same as the one used for floating-rate notes. See 3.1.2.3.1 Fixing on page 230 for more information. 3.7.3.4 Selling Values activity If yield accrual is used, you can set up an activity (using type Selling Values) to have accrued profit available for the selling process. You must run the activity before processing the selling. This can be Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 301 3 Debt instruments 3.7 Asset backed security done by setting activity to run automatically, for example, at the end of each day, before the end of day accounting processing. Note: See the TRM User Guide for information about how to set up and use activities in general. 3.7.4 Position monitoring 3.7.4.1 Setup The presence of the valuation method feature ABS Valuation in the instrument definition determines that the instrument is valuated as an asset-backed security. See A.2.2 ABS Valuation on page 714. 3.7.4.2 Calculations TRM values an asset-backed security according to the current valid estimates on the valuation dates. It does so by expanding a cashflow structure matching the estimated repayment structure according to the parameters defined at the instrument level. Note: The expanded repayment estimate of an ABS that can be seen in Treasury Monitor corresponds to the cashflow structure of an equivalent bond instrument. Therefore, ABS valuation behaves in exactly the same way as valuation of an equivalent bond. 3.7.5 Australian MBS Australian MBS are similar to other MBS instruments already handled by TRM, except that they are quoted in trading margin, and that the formula used to compute the price is specific. This specific formula is used to convert the trading margin (market quote) to the instrument's price: Equation 3-8 Trading Margin conversion - Australian MBS then MarketValue = Price * Outs tan ding Principal where: C Next coupon amount per $100 FV IM Spread% defined at schedule level. TM Quoted yield in % f Number of days from settlement to next coupon date. d Number of days between previous and next coupon dates. 302 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.7 Asset backed security a Annuity Factor i s Quarterly Swap Rate between settlement date and maturity date, this rate is interpolated on the yield curve defined in the Quote Default page at the instrument level. The corresponding frequency is retrieved from the Yield Type field of the yield curve. Note: If not quarterly, the corresponding rate is converted according to the Equation 3-2 on page 237. r Discount Rate between settlement date and next coupon date (interpolated on the default yield curve defined at currency editor level). n Number of coupon periods between the next coupon date and the Weighted Average Life (WAL) date with the appropriate ’n’ rounding convention applied (see 3.7.5.1 Instrument setup on page 303 for information about this setup): Equation 3-9 Number of coupon periods where: • WAL is calculated as shown in 3.7.5.2.1 Input data on page 304. • 365.25 or 365 corresponds to the Days Divisor selected at the instrument level in the Bond page. 3.7.5.1 Instrument setup Australian MBS must be based on an instrument type derived from the class ABS. They are set up in a similar way to ABS, but require a different primary feature. • Main characteristics Same setup as for usual ABS with the following additional parameter: Information Description N-Periods’ Rounding Nearest number to which the number of coupon periods ’n’ (as calculated in Equation 3-9 on page 303) between the next coupon date and the Weighted Average Life date is rounded. For example, 0 for none, 1 for an integer, or 0.1 for a rounding to the first decimal. N-Periods’ Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified N-Periods’ Rounding number. Days Divisor The divisor used in the pricing (valuation) formula . Choices are: • 365 • 365.25. See A.2.39 Australian MBS on page 727. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 303 3 Debt instruments 3.7 Asset backed security Quotation information • Information Description Price Type Select Trading Margin to trade Australian MBS at a trading margin. Quote Handling Select MBS (Australian) to convert the quotation (trading margin) to the price of the instrument. See Equation 3-8 on page 302. See A.2.274 Quoted on page 849. Yield Curve Default • The setup of the feature Quote Default (Australian MBS) is similar to the usual Quote Default feature except that it adds the Yield Curve Default page to select the Par rate yield curve to be used for reference rate defaulting. Information Description Currency The currency that you want to specify. Select AUD. Yield Curve Select corresponding yield curve to be used instead of the yield curve defined at the currency level (Currency Editor). A.2.268 Quote Default (Australian MBS) on page 846. Valuation approach • To allow quoted valuation of market value calculation instead of the usual valuation of ABS. A.2.40 Australian MBS Valuation on page 728. 3.7.5.2 Deal capture 3.7.5.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a deal on an Australian MBS: Information Description Trading Margin Instrument quotation. In addition, the following defaulted information can be modified: Information Description Reference Rate Quarterly swap rate for the period from settlement date to maturity date (from the yield curve specified in Yield Curve Default page when provided, otherwise uses the default yield curve defined at currency level). Discount Rate Computed from the settlement date and the next coupon date of the instrument (from the default yield curve defined at currency level). AU Rate Scenario Scenario used to calculate the reference and discount rates. This scenario defaults to the scenario defined at the instrument level (Quote Default page). You can change the default scenario by selecting Quote Default Configuration from the Options menu. See TRM User Guide for more information about changing this configuration. 304 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.8 Short term loan Information Description WAL Date If repayments were created with the WAL Date method at the instrument level, then the entered date is automatically populated according to that date, otherwise the WAL date is computed as follows for each row of repayments according to the value date to the transaction settlement date: Equation 3-10 WAL Date Deal Price Computed using the trading margin to the price formula (Equation 3-8 on page 302). 3.7.5.3 Processing The actions that can be done throughout the life of an Australian MBS are the same ones as for a usual MBS (see 3.7.3 Processing on page 300). 3.7.5.4 Position monitoring There are two basic methods for valuation of Australian MBS instruments: Quoted or Theoretical. 3.7.5.4.1 Setup When the Theoretical valuation method is used, the Australian MBS is valuated in the same way as a usual MBS. On the other hand, if you want to use the pricing formula (Equation 3-8 on page 302) to compute the market value, then you need to attach the feature Australian MBS Method (A.2.40 Australian MBS Valuation on page 728) and use the Quoted valuation method. Swap and discount rates used in the pricing formula are retrieved as follows: • Reference Rate: The quarterly swap rate for the period from valuation date to maturity date is computed from the yield curve specified in the Yield Curves page (Valuation Curve Setup feature) with Usage set to Valuation, when provided, otherwise uses the valuation yield curve defined at the currency level. • Discount Rate: Computed between valuation date and next coupon date of the instrument (computed from the yield curve specified in the Yield Curves page (Valuation Curve Setup feature) with Usage set to Discount, when provided, otherwise uses the valuation yield curve defined at currency level). Note: For the valuation when the next coupon is not fixed, the estimation curve is used to compute the next fixing rate and the discount rate in the pricing formula. If the estimation curve is not defined at the instrument level, then the currency estimation curve is used instead. If no currency estimation curve is defined, then the currency valuation curve will be used. See feature A.2.337 Valuation Curve Setup on page 878. 3.8 Short term loan Deposits and short-term loans are usually fixed-rate agreements to deposit or borrow a specified amount for a specified period. They are basically the same instrument, with the name simply depending on whether they are seen from the borrower's (loan) or the depositor's (deposit) standpoint. A buy transaction is made by the lender while a sell transaction is made by the borrower. The maturity is usually less than one year and the principal and interest are paid out at expiration. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 305 3 Debt instruments 3.8 Short term loan 3.8.1 Instrument setup Short-term loans must be based on an instrument type derived from the class SHORT-LOAN. • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of short term loan/deposit. Information Description Currency Currency of the instrument. If the currency is not defined at instrument level, it needs to be specified separately for each transaction. Date Basis Date basis of the instrument. If the date basis is not defined at instrument level, it can be specified separately for each transaction. Rounding parameters Method and precision used to round cashflow amounts. Interest Type Interest rate type used to calculate the cashflows of the instrument. Transaction Sign Sign of the transaction. If the sign is not defined at instrument level, it needs to be specified separately for each transaction. Principal Subtype Type of repayment and interest cashflows (default values are Redemption and Interest). Interest Subtype See A.2.299 Short Term Loan on page 862. • Maturity definition It is possible to set up maturity information at instrument level. Information Description Calendar parameters Calendars used to calculate the maturity date. Gap Set Gap set used for supplying the available maturity periods. Maturity Date Period If defined, this maturity period is applied to each transaction. See A.2.230 Maturity Date Setup on page 827. • Short loan margin definition It is possible to input margins when entering a loan. See A.2.300 Short Term Loan Margin Result on page 863. For a short-term loan/deposit it is also possible to set up: • Spot date calculation • Value date calculation to enable easy entry of forward deals with this instrument • Cashflow and transaction charge rules • Manual charges • Branch codes • Deal rate defaulting when entering the transaction See Appendix A Features on page 713. 306 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.8 Short term loan 3.8.2 Deal capture 3.8.2.1 Input data Note: For margin loans, make sure that the columns Margin and Margin (bp) are visible in the Transaction view. In addition to the standard deal parameters, the following information is required to enter a short-term loan/deposit: Information Description Currency Currency of the transaction. Value Date Date when the loan/deposit starts, and from which interest starts to accrue. This defaults to the spot date of the transaction. Maturity Date Date when the transaction matures. If you enter a maturity code, the date is calculated automatically; otherwise you can enter the date manually. Maturity Code If the maturity definition parameters are defined at instrument level, these are used by default and cannot be modified. Nominal Amount Amount deposited/lent, that is, the amount exchanged on the value date of the transaction, and the amount on which interest is calculated. Deal Rate Rate at which interest is calculated for the transaction. In addition, the following optional information can be captured: Information Description Value Date Code If the Value Date Setup feature is applied at instrument level, you can enter the value date period you want to use to calculate the value date for the transaction, for example, 3M (3 months). This can be used to compute the value date for a forward purchase of a short-term loan/deposit. Note: If you specify a value date period in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.339 Value Date Setup on page 879. Date Basis Date basis of the transaction. If the date basis is not defined at instrument level, it can be specified separately for each transaction. Margin You can enter the margin as a percentage in the Margin column or as basis points in the Margin (bp) column, in which case, the margins are stored as a percentage but displayed as basis points (multiplied by 100). Margin (bp) The margin added or subtracted from the Nominal/Spot Rate to get Deal Rate. Positive margins are always in favor of the portfolio owner and negative margins against the portfolio owner. Thus, for short-term loans placed, the margin will be added to Nominal/Spot Rate to get Deal Rate, and for short-term loans taken, the margin will be subtracted from Nominal/Spot Rate to get Deal Rate. The exact calculation is the following: Deal Rate = Nominal / Spot Rate + Transaction Sign * Margin Nominal Spot / Rate The interest rate excluding margins. 3.8.2.2 Generated data • Transaction – Book value of the transaction is automatically defaulted to the nominal amount. – Issuer is determined by the transaction direction: Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 307 3 Debt instruments 3.8 Short term loan Transaction Sign = Buy, Issuer = Counterparty Transaction Sign = Sell, Issuer = Portfolio Owner • Cashflows The following cashflow structure is generated for a bought transaction (depositor side). The interest amount is calculated as follows: rounder (A * (1 / D - 1)) where: D = discount factor A = nominal amount rounder depends on the instrument’s rounding parameters – Margin cashflows A Margin cashflow is generated if a transaction margin rate is entered and the instrument has the feature Short Term Loan Margin. The Margin cashflow is only used for calculating Margin Profit. The Margin cashflow is calculated in the same way as the interest, using the captured margin rate. This cashflow effectively represents the margin rates contribution in the final interest amount. 3.8.3 Processing This section describes the actions that can be done throughout the life of a short-term loan/deposit. 3.8.3.1 Early expiration Short-term loans/deposits can be matured earlier than their agreed maturity date. This process is referred to as early expiration. However, the action is only enabled for transactions that have reached a certain state in the transaction flow. • Execution Early expiration of short-term deposits/loans can be done in two different ways. In both cases, the following information is needed to process the early-expiration: 308 Information Description Opening Date Date when the early expiration is executed. By default, this is today’s date. Value Date Date when the early expiration is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Amount to Expire Amount to be early expired. This defaults to the amount still available to be early expired, taking into account previous partial early expirations and roll overs. Rate Rate at which the early expiration is done. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.8 Short term loan The execution generates an early expiration transaction with the following attributes: Transaction sign = opposite of initial transaction Nominal amount = amount to expire Rate = early expiration rate Opening date = date when the early expiration is done Value date = date when the early expiration is settled Kind = Early Expiration The remaining attributes are inherited from the initial transaction. • Cancellation You can undo the early expiration by canceling the early expiration transaction. 3.8.3.2 Early expiration with margins You can also specify margins when you early expire short term loans. See A.2.300 Short Term Loan Margin Result on page 863. • Execution When early expiring a short loan with margin, the following information is displayed/ calculated instead of the Rate field: Information Description Nominal Rate Defaulted from the original deal. Margin Defaulted from the original deal and cannot be modified. Margin is added to or subtracted from the Nominal Rate to get the Deal Rate. Deal Rate Rate at which the early expiration is done. Defaulted from the original deal. When a transaction being early expired has margin cashflows (i.e. instrument has feature Short Term Loan Margin), the margin accrued from the value date of the underlying deposit until the settlement date of the early expiration is realized. • Cancellation You can undo the early expiration by canceling the early expiration transaction. 3.8.3.3 Roll over You can defer the maturity of a short-term loan/deposit to a later date. This process is referred to as a roll-over. See A.2.14 Allow Roll Over (Short Loan) on page 719. • Setup It is possible to restrict the use of the roll-over methods at instrument level (see below for methods description). It is also possible to specify the default method for the instrument. • Execution Roll-over of short-term deposits/loans can be done in four different ways. In all cases, the following information is needed to process the roll-over: Information Description Roll Over Date Date when the roll-over is executed. Value Date Date of the roll over transaction. Corresponds to the maturity date of the initial transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 309 3 Debt instruments 3.8 Short term loan Information Description Roll Over Method Method used for the roll over: Settle All, Settle Interest, Delay Interest, Compound Interest, Settle Interest and Allow Increase, Capitalize Interest and Allow Increase. The outcome of the roll over depends on the chosen method, see further on in this section for more information. Nominal Amount Amount of the roll-over. This defaults to the amount left of the initial transaction but you can override this if you want to perform a partial roll-over. Additional Amount Amount to be added to the initial principal amount if you want to increase capital at roll over. This field becomes available when one of the Allow Increase roll over methods has been selected. New Nominal Amount Original nominal amount plus interest (if interest is capitalized) plus the additional amount. This field becomes available when one of the Allow Increase roll over methods has been selected. Gap Maturity Date Gap set used for supplying the available maturity periods. The maturity date for the loan/deposit. The defaulting is defined as follows: • If the parent transaction was defined with a maturity period, the roll over maturity date defaults according to that period, otherwise you have to enter the maturity date. • If the switch No Maturity Defaulting is selected at the instrument level (Roll Over page), then the maturity date of the rollover is never defaulted and you must enter it. Note: If the specified maturity date does not fall on a business day, you can choose to keep the non business day or to change it. Deal Rate (Mandatory) New interest rate for the roll-over, that is, the rate at which interest is calculated from the old maturity date until the new maturity date. By default, the rate is defaulted from the initial transaction however it is possible to disable this defaulting by selecting the switch No Rate Defaulting at the instrument level (Roll Over page). The outcome of the roll-over depends on the method chosen as follows: Method Description Settle All The initial transaction is paid in its entirety at the initial maturity date. The default nominal amount of the roll-over transaction equals the sum of the interest and principal cashflows of the initial transaction. Settle Interest The interest of the initial transaction is paid at the initial maturity date, but the principal payment is deferred. The part of the principal which is rolled over is paid back at the end of the roll-over transaction. The default nominal amount of the roll-over transaction equals the principal cashflow of the initial transaction but can be reduced (partial roll-over). Settle Interest, Allow Increase This method allows the user to provide additional capital (increase the principal) as part of the roll over process. The interest from the underlying deposit/loan is settled, and the original principal amount (plus the additional capital) is rolled over. Capitalize Interest, Allow Increase 310 This method allows the user to provide additional capital (increase the principal) as part of the roll over process. The interest from the underlying deposit/loan is capitalized (that is, realized and added to the initial nominal amount) and included with the additional capital in the roll over. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.8 Short term loan Method Description Delay Interest Nothing is paid at the initial maturity date: both the interest and principal payments are deferred. The parts of the principal and interest cashflows which are rolled over are paid back at the end of the roll-over transaction. The default nominal amount of the roll-over transaction equals the principal cashflow of the initial transaction but can be reduced (partial roll-over). Compound Interest This method is the same as Delay Interest, but the closed interest of the initial transaction is reinvested in the roll-over. New interest accrues on top of the initial transaction’s interest. The default nominal amount of the roll-over transaction equals the principal cashflow of the initial transaction but can be reduced (partial roll-over). The execution generates a new transaction with the following attributes: Nominal amount = amount (can be smaller than the initial transaction) Rate = roll-over rate Opening date = date when the roll-over is done Value date = maturity date of the initial transaction Maturity date = maturity of the roll-over Kind = Roll-over • Cancellation You can undo the roll-over by canceling the roll-over transaction. 3.8.3.4 Roll over with margins You can specify margins in case you roll over short term loans. See A.2.15 Allow Roll Over (Short Loan - Margin Result) on page 719. • Execution This roll over behaves exactly as the roll over without margins, except that instead of just the Deal Rate field, the following fields are available: • Information Description Nominal Rate Defaulted from the original deal. Margin Defaulted from the original deal. Added to or subtracted from the Nominal Rate to get Deal Rate. Cancellation You can undo the roll-over by canceling the roll-over transaction. 3.8.4 Position monitoring 3.8.4.1 Setup The presence of the valuation method feature Short Term Loan Valuation in the instrument definition determines that the instrument is valuated as a short term loan. See A.2.301 Short Term Loan Valuation on page 863. 3.8.4.2 Calculations In this section, numerical examples demonstrate how the different figures are calculated for short-term deposit/loan transactions. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 311 3 Debt instruments 3.8 Short term loan If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. This example shows a 6 month USD deposit with a 3% Periodic Rate, with the following deal data: Setup data Instrument Date Basis Act/360 Instrument Yield Type Periodic Valuation Method Theoretical Risk Method Theoretical Valuation Date Figure Date Result IR: AI Method Linear Result IR: Accrual Method Linear Accrual Accrual Yield: Interest Type Periodic Rate Accrual Yield: Date Basis Actual/360 Result FX: Profit Method FX Forward FX Exposure Offset e_fx 0.01 IR Risk Rate e_ir 0.0001 Transaction data Opening Date 2004-06-01 Spot Date d_p 2004-06-03 Maturity Date d_m 2004-12-03 Nominal Amount c_m 1,000,000 Deal Rate r_b 3% Base Book FX Rate (EUR/USD) S_b 1.18710 Currency USD Portfolio Currency EUR Other important deal data is calculated by the system as follows: • Period t_p = (d_m - d_p) / B 0.508333333 = (2004/12/03 – 2004/06/03) / 360 • Discount Factor D_b = 1 / (1 + t_p * r_b) 0.984979069 = 1 / (1 + 0.508333333 * 0.03) • Interest Cashflow c_I = c_m * r_b * t_p 15,250.00 = 1,000,000 * 0.03 * 0.508333333 • Book Value (Local) V_b = (c_m + c_I) * D_b 1,000,000.00= (1,000,000 + 15,250) * 0.984979069 • Book Value V_bp = ROUND(V_b / S_b ,2) 842,389.02 = ROUND(1,000,000 / 1.18710 ,2) 312 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.8 Short term loan Unless otherwise stated, the figure date used in the calculations is 2004-08-17. On this date, the market data is as follows: Market data on 2004-08-17 Figure Date d_f 2004-08-17 Days to Spot d_fs 2 Interest Rate r_f 1.105695% Discount Rate r_d 1.044985% FX Spot Rate S 1.20000 FX Spot CCY Base Rate S_p 1.2 Other figures are calculated by the system as follows: • Days to Maturity = d_m - d_f 108 = 2004/12/03 – 2004/08/17 • Time to Maturity t_m = (d_m - d_f) / B 0.30000 = 108 / 360 • Time to Spot t_s = d_fs / B 0.00555556 = 2 / 360 • Market Value Discount Factor D_V = D_s * D_I = 0.9966917723 • Present Value Discount Factor D_P = D_s * D_I = 0.9966917723 • Market Value Spot Discount Factor D_s = EXP(-t_s * r_d) = 0.9999419470 • Discount Factor From Spot D_I =EXP(-(t_m - t_s)* r_f) = 0.9967496366 3.8.4.2.1 Valuation figures The valuation method commonly used for a short-term loan/deposit is the Theoretical method. • Principal flow figures Local Market Value V_lp = c_m * D_V 996,691.77 = 1,000,000 * 0.9966917723 Market Value V_p = V_lp / S 830,576.48 = 996,691.77 / 1.200 Clean Market Value CMV_p = V_p / D_s 830,624.70 = 830,576.48 / 0.9999419470 • Interest flow figures Local Market Value V_li = c_I * D_V 15,199.55 = 15,250 * 0.9966917723 Market Value V_i = V_li / S 12,666.29 = 15,199.55 / 1.200 Clean Market Value CMV_i = (c_I * D_V / D_s - (c_I * (t_p - t_m + t_s)) / t_p) / S 7,319.80 = (15,250 * 0.9966917723 - (c_I * (0.50833333 - 0.3 + 0.00555556)) / t_p) / 1.2 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 313 3 Debt instruments 3.8 Short term loan • Transaction figures Local Market Value = V_lp + V_li 1,011,891.32 = 996,691.77 + 15,199.55 Market Value = V_p + V_i 843,242.77 = 830,576.48 + 12,666.29 Clean Market Value = CMV_p + CMV_i 837,944.50 = 830,624.70 + 7,319.80 3.8.4.2.2 Result figures The setup of the instrument impacts the way result figures are computed. • Principal flow figures Total Profit (Local) P_tlp = V_lp - V_b -3,308.23 = 996,691.77 – 1,000,000 MtoM Profit (Local) P_mlp = c_m * D_V / D_s - V_b -3,250.36 = 1,000,000 * (0.9966917723/0.9999419470) – 1,000,000 Accrued Interest (Local) I_alp = 0 Accrued Profit (Local) P_alp = 0 Other Profit (Local) P_olp = P_tlp - P_mlp -57.86 = (-3,308.23) – (-3,250.36) FX Profit P_fxp = V_b * (1 / S_p) - V_bp -9,055.68 = 1,000,000 * (1 / 1.2000) – 842,389.02 Total Profit P_tp = V_p - V_bp -11,812.54 = 830,576.48 – 842,389.02 MtoM Profit P_mp = P_mlp / S -2,708.64 = -3,250.36 / 1.2 Accrued Interest I_ap = 0 Accrued Profit P_ap = 0 Other Profit P_op = P_tp - P_fxp - P_mp -48.22 = (-11,812.54) – (-9,055.68) – (-2,708.64) • Interest flow figures Total Profit (Local) P_tli = V_li = 15,199.55 MtoM Profit (Local) P_mli = =c_I * D_V / D_s - (c_I * (t_p - t_m + t_s)) / t_p 8,783.77 = 15,250 * (0.9966917723 / 0.9999419470) – (c_I * (0.508333333 - 0.3 + 0.00555556)) / t_p Accrued Interest (Local) I_ali = c_I * (t_p - t_m) / t_p 6,250.00 = 15,250 * (0.508333333 – 0.3) / 0.508333333 Other Profit (Local) P_oli = P_tli - P_mli – I_ali 165.78 = 15,199.55 – 8,783.77 – 6,250.00 314 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.8 Short term loan Total Profit P_ti = V_i = 12,666.29 MtoM Profit P_mi = P_mli / S 7,319.80 = 8,783.77 / 1.2 Accrued Interest I_ai = I_ali / S 5,208.33 = 6,250.00 / 1.2 Other Profit P_oi = P_ti - P_mi – I_ai 138.15 = 12,666.29 -7,319.80 – 5,208.33 • Transaction figures Total Profit (Local) = P_tlp + P_tli 11,891.32 = -3,308.23 + 15,199.55 MtoM Profit (Local) = P_mlp + P_mli 5,533.40 = -3,250.36 + 8,783.77 Accrued Interest (Local) = I_ali = 6,250.00 Other Profit (Local) = P_olp + P_oli -58.75 = (-57.86) + (-0.88) FX Profit = P_fxp = -9,055.69 Total Profit = P_tp + P_ti 853.75 = -11,812.54 + 12,666.29 MtoM Profit = P_mp + P_mi 4,611.17 = -2,708.64 + 7,319.80 Accrued Interest = I_ap + I_ai 5,208.33 = 0 + 5,208.33 Other Profit = P_op + P_oi 89.93 = (-48.22) + 138.15 3.8.4.2.3 Risk figures The risk method commonly used for a short-term loan/deposit is the Theoretical method. • Principal flow figures IR Exposure 1bp E_ip = (c_m) * (-(t_m - t_s)*D_I*D_s - t_s*D_I*D_s) / S * e_ir -24.92 = 1,000,000*(-(0.3-0.005555556)*0.9967496366*0.9999419470-0.005555556*D_I*D_s) /1.2*0.0001 FX Exposure E_fxp = V_p * e_fx 8,305.76 = 830,576.48 * 0.01 Effective Duration U_eff = -E_ip / V_p / 0.0001 0.300000 = -(-24.92) / 830,576.48 / 0.0001 • Interest flow figures IR Exposure 1bp E_ipi = (c_I) * (-(t_m - t_s)* D_I * D_s - t_s * D_I * D_s) / S * e_ir -0.38 = 15,250.00 *(-(0.3 - 0.005555556) * 0.9967496366 * 0.9999419470 - t_s * D_I * D_s) / 1.2 * 0.0001 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 315 3 Debt instruments 3.9 Discount paper FX Exposure E_fxi = V_i * e_fx 126.66 = 12,666.29 * 0.01 Effective Duration U_eff = -E_ipi / V_i / 0.0001 0.300000 = -(-0.38) / 12,666.29 / 0.0001 • Transaction figures IR Exposure 1bp = E_ip + E_ipi -25.30 = (-24.92) + (-0.38) FX Exposure = E_fxp + E_fxi 8432.43 = 8,305.76 + 126.66 Effective Duration U_eff = -(E_ip + E_ipi) / (V_p + V_i) / 0.0001 0.300000 = -((-24.92) + (-0.38)) / (830,576.48 + 12,666.29) / 0.0001 3.9 Discount paper A discount paper is a short-term instrument which pays its face amount at maturity and is purchased at a discount price. Most discount papers are listed instruments. The most commonly traded discount paper is the US Treasury-Bill. 3.9.1 Instrument setup Discount papers are based on an instrument type derived from the class DISCOUNT. • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of discount paper. Information Description Currency Currency of the discount paper (that is, if it is a listed discount paper). Leave this field blank if you want to specify the currency when you enter the deal in Transaction Manager when you are defining an OTC discount paper. Date Basis Date basis of the instrument. If the date basis is not defined at instrument level, it needs to be specified separately for each transaction. Rounding parameters Method and precision used to round cashflow amounts. Yield Type Yield type of the discount paper, typically a discount rate. Transaction Sign Sign of the transaction. If the sign is not defined at instrument level, it needs to be specified separately for each transaction. Principal Subtype Type of principal or interest cashflows. Interest Subtype Issuer Issuer of the instrument. See A.2.121 Discount Paper on page 768 or A.2.122 Discount Paper OTC on page 770. – Date details For listed discount papers, you must specify the issue date and maturity date of the instrument. 316 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.9 Discount paper For OTC discount papers, you can set up maturity information. – Information Description Calendar Calendars used to calculate the maturity date. Gap Set Gap set used for supplying the available maturity periods. Maturity Date Period If defined, this maturity period is applied to each transaction. Trading unit details It is possible to define a minimum bid size or trading units of a discount paper. If a minimum denomination is defined, deal entry is available either in units or amount and TRM ensures that the amount is a multiple of the denomination size. • Quoted If you want to enter quotes for a discount paper, this must be specified at instrument level. Information Description Price Type Select Yield. Select Discount Paper to display yields and prices in Rate Monitor. Quote Handling See A.2.274 Quoted on page 849. • Valuation approach Discount papers can be valuated using either Fixed IR Valuation or Discount Valuation features. See A.2.150 Fixed IR Valuation on page 784 or A.2.123 Discount Valuation on page 770. Examples of calculations using these methods are provided in section 3.9.4 Position monitoring on page 320. It is also possible to set up: • Spot date calculation • Value date calculation to enable easy entry of forward deals with this instrument • Cashflow and transaction charge rules • Collateral • Branch codes • Quotation information. See Appendix A Features on page 713. 3.9.2 Deal capture 3.9.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a discount paper: Information Currency Description Currency of the transaction. If you specified the currency in the instrument setup (for example, for a US T-Bill), this is used as the default currency in the transaction and cannot be modified. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 317 3 Debt instruments 3.9 Discount paper Information Description Maturity Date Date for the maturity of the contract. If you enter a maturity code, the date is calculated automatically; otherwise you can enter the date manually. Maturity Code Note: For listed discount papers, the maturity date defaults from the instrument setup and cannot be changed. Value Date Date when the transaction starts. This defaults to the spot date of the transaction. Nominal Amount Amount of the discount paper. This is equal to the principal (the amount on which the interest is calculated). Units For listed discount papers, the nominal amount must be a multiple of the minimum contract size defined in the instrument setup. Deal Rate Rate used to discount the nominal amount (the book rate). In addition, the following optional information can be captured: Information Description Deal Price Deal price of the transaction (expressed as a percentage of the nominal amount) used to calculate the book value and the settlement amount. Value Date Code If the Value Date Setup feature is applied at instrument level, you can enter the value date period you want to use to calculate the value date for the transaction, for example, 3M (3 months). This can be used to compute the value date for a forward purchase of a discount paper. Note: If you specify a value date period in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.339 Value Date Setup on page 879. Issuer Issuer of the discount paper. If Issuer is defined at instrument level, this is used by default and cannot be modified. Date Basis Date basis of the transaction. If this value is defined at instrument level, this is used by default and cannot be modified at deal entry. 3.9.2.2 Generated data • Transaction A discount paper is bought or sold at a discount price. This means that the Book Value (BV) is equal to the nominal amount discounted with the deal rate. BV = NA * D • Cashflows The following cashflows are generated: 318 – The principal/settlement cashflow is generated with amount = book value – There is only one payback cashflow (principal/payback) – There is no interest cashflow. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.9 Discount paper The figure below illustrates the cashflows which are established in TRM when a discount paper is purchased. 3.9.3 Processing This section describes the actions that can be done throughout the life of a discount paper. 3.9.3.1 Early expiration Discount papers can be matured earlier than their agreed maturity date. This process is referred to as early expiration. However, the action is only enabled for transactions that have reached a certain state in the transaction flow. • Execution The following information is needed to process the early-expiration: Information Description Opening Date Date when the early expiration is executed. By default, this is today’s date. Value Date Date when the early expiration is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Amount to Expire Amount to be early expired. This defaults to the amount still available to be early expired, taking into account previous partial early expirations and roll overs. Rate Rate at which the early expiration is done. The execution generates an early expiration transaction with the following attributes: Transaction sign = opposite of initial transaction Nominal amount = amount to expire Rate = early expiration rate Opening date = date when the early expiration is done Value date = date when the early expiration is settled Kind = Early Expiration The remaining attributes are inherited from the initial transaction. • Cancellation You can undo the early expiration by canceling the early expiration transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 319 3 Debt instruments 3.9 Discount paper 3.9.4 Position monitoring 3.9.4.1 Setup In addition to the basic valuation setup which can be set up for every instrument (see A.2.50 Base Valuation Setup on page 734) it is possible to set up the following: Information Description AI Method It is possible to override the standard linear method in order to accrue interest differently for the valuation figures (see A.2.49 Base IR Setup on page 733, Chapter 1 Concepts on page 21, A.2.337 Valuation Curve Setup on page 878). Spread Curve It is possible to add spread curves to correspond to the credit risk (see A.2.305 Spread Curve Setup on page 865, Chapter 1 Concepts on page 21, A.2.337 Valuation Curve Setup on page 878). 3.9.4.2 Calculations - Theoretical In this section, numerical examples demonstrate how the different figures are calculated for discount papers. See Chapter 2 Market standards and calculations on page 33. This example shows a US T-Bill, with the following deal data: Setup data Instrument Date Basis Act/360 Instrument Yield Type Discount Valuation Method Theoretical Valuation Date Figure Date Risk Date Figure Date Risk Yield Type Continuous Result IR: Accrued Interest Linear Result IR: Accrual Method Linear Accrual Accrual Yield: Interest Type Periodic Rate Accrual Yield: Date Basis Actual/360 FX Exposure Offset e_fx 0.01 Transaction data Opening Date 2004-02-02 Nominal Amount c_m 1,000,000 Deal Rate r_b 3% Base Book FX Rate (EUR/USD) S_b 1.2 Maturity Date d_m 2004-07-01 Value Date d_a 2004-02-04 Currency USD Portfolio Currency EUR 320 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.9 Discount paper Other important deal data is calculated by the system as follows: • Book Value (Local) V_b = c_m * D_b 987,750.00 = 1,000,000 * 0.98775 • Book Value V_p = V_b / S_b 823,125.00 = 987,750.00 / 1.2 • Period t_p = DAYS360(d_a,d_m,TRUE) / B 0.408333333 = (2004/02/04,2004/07/01,TRUE) / 360 • Discount Factor D_b = 1 – t_p * r_b 0.98775 = 1 – 0.408333333 * 0.03 Unless otherwise stated, the figure date used in the calculations is 2004-03-01. On this date, the market data is as follows: Market data on 2004-03-01 Figure Date d_f 2004-03-01 Interest Rate r_f 1.113119% Days to Spot d_fs 2 Discount Rate r_d 1.044985% FX Conversion Rate S 1.260000 Other figures are calculated by the system as follows: • Days to Maturity = d_m - d_f 122 = 2004/07/01 – 2004/03/01 • Time to Maturity t_m = (d_m - d_f) / B 0.33888889 = 122 / 360 • Time to Spot t_s = d_fs / B 0.005555556 = 2 / 360 • Market Value Discount Factor D_V = D_s * D_I = 0.996238639 • Present Value Discount Factor D_P = D_s * D_I = 0.996238639 • Spot Discount Factor D_s = EXP(-t_s*r_d) = 0.999941947 • Spot-Maturity Discount Factor D_I =EXP(-(t_m-t_s)*r_f) = 0.996296478 Valuation figures The valuation method commonly used for a discount paper is the Theoretical method. • Local Market Value V_l = c_m * D_V 996,238.64 = 1,000,000 * 0.996239 • Market Value V = V_l / S 790,665.59 = 996,238.64 / 1.2600 • Clean Market Value = V / D_s 790,711.49 = 790,665.59 / 0.999941947 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 321 3 Debt instruments 3.9 Discount paper Result figures The setup of the instrument impacts the way result figures are computed. • Total Profit (Local) P_tl = V_l – V_b 8,488.64 = 996,238.64 – 987,750.00 • MtoM Profit (Local) P_ml = -c_m * ((1 - r_b * (t_m - t_s)) - (D_I)) 6,296.48 = 1,000,000*((1 - 0.03 *(0.33888889-0.005555556)) - 0.996296478 • Accrued Profit (Local) P_al = = -c_m * (D_b -(1 - (t_m - t_s) * r_b)) 2,250.00 = -1,000,000*(0.98775-(1-(0.33888889-0.005555556)*0.03)) • Other Profit (Local) P_ol = P_tl - P_ml - P_al -57.84 = 8,488.64 – 6,296.48 – 2,250 • FX Profit P_fx = V_b * (1/S - 1/S_b) -39,196.43 = 987,750.00*(1 / 1.260000 – 1 / 1.20000) • Total Profit P_t = V – V_p -32,459.41 = 790,665.59 – 823,125.00 • MtoM Profit P_m = P_ml / S 4,997.20 = 6,296.48 / 1.260000 • Accrued Profit P_a = P_al / S 1,785.71 = 2,250.00 / 1.260000 • Other Profit P_o = P_t - P_m - P_a - P_fx -45.90 = -32,459.41 - 4,997.20 - 1,785.71 – (-39,196.43) Risk figures The risk method commonly used for a discount paper is the Theoretical method. • IR Exposure 1bp E_ip = c_m * (-(t_m-t_s) * D_I*D_s - t_s *D_I* D_s) /S * 0.0001 -26.79 = 1,000,000*(-(0.33888889-0.005555556)*0.996296478*0.999941947-t_s*(D_I*D_s)/1.26*0.0001 • IR Exposure 1bp from spot E_is = c_m * (-(t_m - t_s) * D_I) / S * 0.0001 -26.357050 = 1,000,000 * (-(0.33888889-0.005555556)*0.996296478 / 1.26 * 0.0001 • FX Exposure E_fx = e_fx * V 7,906.66 = 0.01 * 790,665.59 • Effective Duration U_eff = -E_ip / V / 0.0001 0.338889 = -(-26.79) / 790,665.59 / 0.0001 3.9.4.3 Calculations - Discount Yield Discount yield is calculated from quoted market value at spot, using Yield Type and Date Basis defined in IR Exposure page in the Instrument Editor: Equation 3-11 Discount yield where – 322 V is market value at spot, A is the amount © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.9 Discount paper – t v is time between spot date and value date calculated using the IR Exposure date basis – R[] is the function that converts discount factor into rate, according to the Yield Type defined for IR Exposure . 3.9.4.3.1 Example Instrument data • Discount Paper page Date Basis Actual/365 Interest Type Periodic Rate Price Rounding 0.001 (3 decimal places) pr = 3 • Dates page Maturity Date • • 2009-08-05 Base Valuation page Method Quoted Switches To Spot IR Exposure page Date Basis Actual/365 Yield Type Continuous Yield Switches To Spot Transaction data Nominal Amount A = 100000 Valuation data Valuation Date 2008-08-05 Figure Market Quote rm = 5 d v = 365 ds = 2 Days to Maturity Date Days to Spot Calculated data • Price (P) Let [ X ] k mean rounding to k decimal places. Then Equation 3-12 Discount Yield Price = 95.263 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 323 3 Debt instruments 3.9 Discount paper • Discount Yield (y) Using Equation 3-13 Discount Yield: Discount Yield (y) = 0.994520547945206 The discount yield (Figure Interest Rate) is: Equation 3-14 Discount Yield: Figure Interest Rate = 0.0487960741031 • IR Exposure (E1) Figure Risk Value is: Vr = A = 1000000 Sensitivity of discount factor is (for continuous yield): Equation 3-15 Discount Yield: IR Exposure (E1) = -0.947410109589 Figure IR Exposure 1bp is: Equation 3-16 Discount Yield: IR Exposure (1bp) E 1 = V r D r × 0.0001 = -94.7410109589 3.9.4.4 Calculations - Modified Duration / Effective Duration The following numerical example demonstrates how Modified Duration and Effective Duration figures are calculated for depo/discount papers. For more information about Duration key figures, see 2.3.4.9 Duration figures on page 142. 3.9.4.4.1 Example: Depo/Discount Paper The example in this section shows an overnight paper of 100,000,000 at 0.70 with a price of 99,998,088.89. Transaction data • On November 9th, the Principal cashflow was equal to -99 998 088.89 • On November 10th, the Principal cashflow was equal to 100,000,000.00 324 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.9 Discount paper Valuation data Valuation Date 2009-11-09 Valuation Mode Theoretical Date Basis Actual/365 Risk figures • Principal cashflow (risk date = 2009-11-09) Equation 3-17 Time to maturity of the cashflow dr – dv t i = ---------------- = 0 365 • Present Value Discount Factor Dp = 1 Present Value Vp= -99,998,088.89 IR Exposure E { i1 } = 0 Amortization cashflow (risk date = 2009-11-10) Equation 3-18 Time to maturity of the cashflow dr – dv t i = ---------------- = 1 ⁄ 365 365 Present Value Discount Factor Dp = 0.999964445709 Present Value Vp = -99,996,444.57 IR Exposure E { i1 } = – V p × t i × 0.0001 = 27.39628618 Transaction figures IR Exposure E { i1 } = – V p × t i × 0.0001 = 0 + 27.39628618 = 27.39628618 Present Value Modified Duration Effective Duration Vp = -99,998,088.89+99,996,444.57 = -1644.3 Sett Pos 1000 × [ Ei1 + E i1 ] 10000 × [ 27.39628618 ] U Mod = ------------------------------------------------------= ------------------------------------------------------------------------------------------------------------- = 0.002739704 Sett Pos 0.5 × ( – 99 , 998, 088.89 + 99, 996, 444.57 ) 0.5 × ( V p + Vp ) – E { i1 } – 27.39628618 U eff = ⎛⎝ ----------------⎞⎠ × 10000 = ⎛⎝ ----------------------------------⎞⎠ × 10000 = 166.6117372 Vp – 1644.3191 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 325 3 Debt instruments 3.10 Loan 3.10 Loan In TRM, loans are agreements to lend or borrow money for a medium/long term with multiple interest (and potentially principal) payments occurring during the life of the deal. The key concept concerning loans is that of the cashflow schedule. Several schedules must be attached to a loan deal, and they drive the generation of the cashflow structure for the deal. For the simplest types of loans, two schedules are associated with the deal: one schedule for interest flows; and one schedule for principal flows. For more complex deals, there will be additional schedules for optional events, additional interest cashflows, and so on. Loans belong to the instrument class LOAN. This class covers a diverse set of instruments: from fixed annual interest / bullet repayment loans to more complex, exotic structures. Therefore, this chapter is organized into the following sections: – How TRM handles fixed-rate loans – How TRM deals with floating-rate loans – A list of more exotic deals that can be set up in TRM. 3.10.1 Fixed-rate loan Fixed-rate loans pay interest at a pre-defined (fixed) rate. 3.10.1.1 Instrument setup • Loan main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of fixed-rate loan. Information Currency Description Currency of the loan. Leave this field blank if you want to specify the currency when you enter the deal in Transaction Manager. Transaction Sign Sign of the transaction. If the sign is not defined at instrument level, it needs to be specified separately for each transaction. AI Method Method used to calculate accrued interest if interest starts to accrue before the value date of the transaction. Settlement Switches Dirty Price: Switch on to use the dirty price for the instrument, that is, to include accrued interest in the instrument’s price. Par: Switch on in order to have the deal price defaulted to 100. Rounding Parameters Method and precision used to round cashflow amounts. Structure Schedule template to be used for the loan. If a structure is not defined at instrument level, a schedule needs to be specified for each transaction. Usually the structure is defined at the instrument level. If this is not the case, then you have to define it for each transaction at transaction level. See A.2.202 Generic Loan on page 812. 326 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.10 Loan • Maturity definition It is possible to set up maturity information at instrument level. Information Description Calendar parameters Calendars used to calculate the maturity date. Gap Set Gap set used for supplying the available maturity periods. Maturity Date Period If defined, this maturity period is applied to each transaction. See A.2.230 Maturity Date Setup on page 827. • Selectable cashflow structures With this option, you can limit the choice of schedules available to assign to a loan in Transaction Manager by associating one or several schedule template groups to the instrument. At deal entry, only the templates belonging to these groups will be available for selection. If a cashflow structure is already set up in the instrument’s main characteristics, it will override any schedule groups. See A.2.293 Schedule Template Setup on page 859. It is also possible to set up: • Spot day calculations • Manual charges • Cashflow and transaction charge rules • Branch codes. See Appendix A Features on page 713. 3.10.1.2 Deal capture Depending on the selected cashflow structure, the information needed to deal the instrument and the generated cashflows are very different. The transaction level information is the same. 3.10.1.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a deal on a fixed rate loan: Information Currency Description Currency of the transaction. If you specified the currency in the instrument setup, this is used as the default currency in the transaction and cannot be modified. Maturity Date Date for the maturity of the contract. If you use maturity date setup, the date is calculated automatically from the selected maturity period, otherwise you can enter the date manually. Nominal Amount Amount of the loan. This is equal to the principal (the amount on which the interest is calculated). Deal Price Deal price of the transaction (expressed as a percentage of the nominal amount) used to calculate the book value and the settlement amount. In order to have the deal price defaulted to 100, you should set the settlement switch Par in Instrument Editor. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 327 3 Debt instruments 3.10 Loan These values alone are not sufficient to define the deal. To complete the creation of a fixed-rate loan, the cashflow structure of the deal also needs to be specified, either in the instrument setup, or at deal entry, by applying a schedule template. The following sections explain how the system handles standard fixed-rate cashflow structures. 3.10.1.2.2 Generated data • Book Value (clean price): BV = A * p /100 where: A = Nominal Amount p = deal price • Book Value (dirty price): BV = (A * p /100) - AI where: A = Nominal Amount p = deal price AI = Accrued Interest 3.10.1.2.3 Bullet repayment structure A fixed-rate loan with periodic interest and total repayment of the principal at maturity represents a bullet repayment structure. • Input data To define this kind of structure, a template is required which contains at least one schedule for fixed-rate interest flows, and one schedule for repayment flows. TRM provides a pre-defined system template designed for this: see B.2.1.1.21 Fixed, Bullet Repayment on page 894. For each set of cashflows, the following information must be supplied at deal entry: – – Interest flows Information Description Frequency Method and Period The frequency method/period for the interest cashflows (for example, Years/1 generates one interest flow per year). Interest Rate The fixed interest rate (for example, 5%). Repayment flows No information required. • Generated data – Schedule When a template is selected, one schedule is created for each item in the template. Some of the values are automatically defaulted from the transaction parameters (see Appendix B Schedules on page 883), while others can be modified at deal entry (see above). 328 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.10 Loan – Cashflows For a fixed-rate loan with repayment at maturity, the cashflows generated are as follows: 3.10.1.2.4 Fixed-rate loan - amortizing structure A fixed-rate loan with periodic interest and repayment of the principal in several steps during the deal represents an amortizing structure. • Input data To define this kind of structure, a template which contains at least one schedule for fixed-rate interest cashflows, and one schedule for repayment cashflows is required. TRM provides a pre-defined system template (B.2.1.1.21 Fixed, Bullet Repayment on page 894) designed for this purpose. For each set of cashflows, the following information must be supplied at deal entry: – – Interest flows Information Description Frequency Method and Period The frequency method/period for the interest cashflows (for example, Years/1 generates one interest flow per year). Interest Rate The fixed interest rate (for example, 5%). Repayment flows Information Description Frequency Method and Period The frequency method/period for the repayment cashflow (for example, Times/Year-1 means that one repayment will occur every year). Calculation Method and Repayment % Defines how the repayments have to be generated. Start Date • For example, using percentage 10% as the method means 10% of the initial capital at each repayment, with the remaining capital being repaid at maturity. Start date can be moved forward in order to start amortizing later. Generated data – Schedule When a template is selected, one schedule is created for each item in the template. Some of the values are automatically defaulted from the transaction parameters, while others can be modified at deal entry. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 329 3 Debt instruments 3.10 Loan – Cashflows For an amortizing loan, the cashflows generated are as follows: 3.10.1.2.5 Fixed-rate loan - fixed annuity structure A fixed-rate loan with a fixed amount of principal and interest over the life of the deal represents a fixed annuity structure. • Input data To define this kind of structure, TRM provides a pre-defined system template (B.2.1.1.20 Fixed, Annuity Repayment on page 894) designed for this purpose. For each set of cashflows, the following information must be supplied at deal entry: – – Interest flows Information Description Frequency Method and Period The frequency method/period for the interest cashflows (for example, Years/1 generates one interest flow per year). Interest Rate The fixed interest rate (for example, 5%). Repayment flows No information required. • Generated data – Schedule When a template is selected, one schedule is created for each item in the template. Some of the values are automatically defaulted from the transaction parameters (see Appendix B Schedules on page 883), while others can be modified at deal entry (see above). 330 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.10 Loan – Cashflows For a fixed-annuity loan, the cashflows generated are as follows: 3.10.1.2.6 Fixed-rate loan - irregular annuity With an irregular annuity, the flows are computed equally throughout the life of the loan except for the final payment, which is adjusted according to how much of the loan remains outstanding. • Input data To define this kind of structure, the following information must be supplied at deal entry in the Schedule view: – • Principal schedule Information Description Interest Rate The fixed interest rate (for example, 5%). Generated data – The annuity is computed equally across all flows, except the last one. – The remaining principal is repaid on the final cashflow (100 - rate). 3.10.1.2.7 Fixed-rate loan - margin It is possible to specify a margin when entering a fixed rate loan. As well as the standard fixed-rate loan input data and generated cashflows there are input data and generated cashflows for margins. • Input data For margin loans, you need to attach a secondary schedule Margin to the interest schedule and specify the margin in the Spread schedule field (of the Margin schedule). • Generated data – Margin flows A Margin cashflow is generated if a margin schedule is attached to the transaction and a margin rate is entered (in the Spread field). The Margin cashflow is only used for calculating Margin Profit. The Margin cashflow is calculated in the same way as the interest, using the captured margin rate. This cashflow effectively represents the margin rates contribution in the final interest amount. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 331 3 Debt instruments 3.10 Loan 3.10.1.3 Processing This section describes the actions that can be done throughout the life of a loan. 3.10.1.3.1 Early expiration Loans can be matured earlier than their agreed maturity date. This process is referred to as early expiration. • Execution Early expiration of loans requires the following information: Information Description Opening Date Date when the early expiration is executed. By default, this is today’s date unless a Fixing/Action Date was specified at transaction level. Value Date Date when the early expiration is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Settlement Date Date when early-expiration price is paid. Amount to Expire Amount to be early expired. This defaults to the amount still available to be early expired, taking into account previous partial early expirations and roll overs. Price The premium or discount the early expiration is made at. Settlement Price Method Clean Price: AI is created as Payable cashflow and P/L flow is the difference between early-expiration price and original deal price. Dirty Price: AI is created as Not Payable cashflow, and P/L flow is reduce by the AI amount. Accrued Interest The accrued interest that will be paid in the early expiration transaction. This value can be modified. Options • Amortize P/L Switch on to amortize the P/L from the value date until the original maturity date. If this switch is off, the Sell P/L flow created by the early expiration (arising from Net Amount – Accrued Interest) occurs on the early expiration value date. • No Fee Realization Switch on to continue to amortize fees to maturity. For example, this can be used in the case of an asset swap, which mirrors the issue fees, to keep the fees amortizing even when the asset swap is fully unwound. If this switch is off, at early expiration, the fees that were amortizing until the maturity date are closed. • Delay Interest (only available when the settlement price method is set to Clean Price) Switch on to delay the accrued interest payment to the next interest payment date. The execution generates an early expiration transaction with the following attributes: Transaction sign = opposite of initial transaction Nominal amount = amount to expire Price = early expiration rate Opening date = date when the early expiration is done Value date = date when the early expiration is settled Kind = Early Expiration The remaining attributes are inherited from the initial transaction. The early expiration transaction generates closing cashflows for the initial transaction and P/L cashflows if there is a difference between the early expiration price and the original deal price. 332 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.10 Loan • Cancellation You can undo the early expiration by canceling the early expiration transaction. 3.10.1.3.2 Roll over You can defer the maturity of a loan to a later date. This process is referred to as a roll-over. See A.2.9 Allow Roll Over on page 716. • Setup It is possible to restrict the use of the roll-over methods at instrument level (see below for methods description). It is also possible to specify the default roll over method for the instrument. • Execution Roll-over of loans can be done in four different ways. In all cases, the following information is needed to process the roll over: Information Description Roll Over Date Date when the roll over is executed. Maturity Date New maturity date for the loan. This must be later than the maturity date of the initial transaction. The maturity date is calculated automatically from the maturity period of the initial transaction. Nominal Amount Amount of the roll over. This defaults to the amount left of the initial transaction but you can override this if you want to perform a partial roll over. Additional Amount Amount to be added to the initial principal amount if you want to increase capital at roll over. This field becomes available when one of the Allow Increase roll over methods has been selected. New Nominal Amount Original nominal amount plus interest (if interest is capitalized) plus the additional amount. This field becomes available when one of the Allow Increase roll over methods has been selected. Rate A new interest rate for the roll over, that is, the rate at which interest is calculated from the old maturity date until the new maturity date. By default, the rate displayed is taken from the interest schedule information, and is used to generate the interest schedule of the new roll over transaction. Roll Over Method Method used for the roll over. The outcome of the roll-over depends on the method chosen as follows: Method Description Settle All The initial transaction is paid in its entirety at the initial maturity date. The default nominal amount of the roll over transaction equals the sum of the interest and principal cashflows of the initial transaction. Settle Interest The interest of the initial transaction is paid at the initial maturity date, but the principal payment is deferred. The part of the principal which is rolled over is paid back at the end of the roll over transaction. Settle Interest, Allow Increase This method allows the user to provide additional capital (increase the principal) as part of the roll over process. The interest from the underlying loan is settled, and the original principal amount (plus the additional capital) is rolled over. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 333 3 Debt instruments 3.10 Loan Method Description Capitalize Interest, Allow Increase This method allows the user to provide additional capital (increase the principal) as part of the roll over process. Delay Interest Nothing is paid at the initial maturity date: both the interest and principal payments are deferred. The parts of the principal and interest cashflows which are rolled over are paid back when the first interest payment of the roll over transaction occurs. Compound Interest This method is the same as Delay Interest, but the closed interest of the initial transaction is reinvested in the roll over. New interest accrues on top of the initial transaction’s interest. The interest from the underlying loan is capitalized (that is, realized and added to the initial nominal amount) and included with the additional capital in the roll over. The execution generates a new transaction with the following attributes: Nominal amount = amount (can be smaller than initial one) Rate = roll-over rate Opening date = date when the roll-over is done Value date = maturity date of the initial transaction Maturity date = maturity of the roll-over Kind = Roll-over • Cancellation You can undo the roll over by canceling the roll over transaction. 3.10.1.3.3 Trade assignment Trade assignments are changes of ownership of transactions. • Execution Change of ownership during the life of a transaction can be performed in two steps: – Right-click the existing transaction and choose Assignment(sale) action. This action closes the existing transaction, and when required, exchanges settlement amounts between the old and new owners of the transaction. – Right-click the generated transaction and choose Assignment (purchase) action. This action creates the new transaction with the new owner. Assignment (sale) of a transaction to another client requires the following information: Information Description Opening Date Date when the early expiration is executed. By default, this is today’s date unless a Fixing/Action Date was specified at transaction level. Value Date Date when the early expiration is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Settlement Date Date when assignment price is paid. Amount Left Read-only. Remaining amount of the initial transaction. Assignee New owner of the transaction Settlement Price Method Clean Price: AI is created as Payable cashflow and P/L flow is the difference between assignment price and original deal price. Dirty Price: AI is created as Not Payable cashflow, and P/L flow is reduce by the AI amount. Currency 334 Read-only. Currency of loan. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.10 Loan Information Description Settlement Price The price of the assignment. Accrued Interest Read-only. Interest accrued on specified date. Options • Amortize P/L Switch on Amortize P/L to amortize the P/L from the value date until the original maturity date. If this switch is off, the Sell P/L flow created by the assignment (arising from Net Amount – Accrued Interest) occurs on the assignment value date. • No Fee Realization Switch on No Fee Realization so that fees keep amortizing to maturity. If this switch is off at assignment, the fees that were amortizing until the maturity date are closed. Execution generates an Assignment transaction with following cashflows: – Cashflows to close the future cashflows of the original transactions (closing of cashflows where payment date is after the assignment value date) – Settlement flows between the assignor and the assignee, reflecting the settlement amounts. The generated transaction has the following attributes: Information Description Transaction Sign Opposite of the original transaction sign. Nominal Amount Amount to assign. Opening Date Opening date of action. Value Date Value date of action. Kind Assignment. The original transaction remains unchanged. The assignee can then select the Assignment (purchase) action on the generated closing transaction. Selecting the portfolio from the resulting dialog generates a new transaction, reflecting the future cashflows of the original transaction and settlement flows between assignee and assignor. Note: The Counterparty field is open, to allow Counterparty change if required. • Cancellation You can undo the assignment action by canceling the generated assignment transaction. 3.10.1.3.4 Changing the counterparty of a transaction You can terminate the existing transaction against one counterparty and reopen it against another counterparty. The following information is required: Information Description Opening Date Date when the transfer is executed. By default, this is today’s date unless a Fixing/Action Date was specified at transaction level. Value Date Date when the transfer is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Counterparty New counterparty for the transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 335 3 Debt instruments 3.10 Loan A transaction will be generated whose Kind is Counterparty Conversion. The characteristics of the new transaction will be the same than the old one, except for Counterparty and opening/value date. This action generates closing cashflows for the future cashflows from the original transaction, and futures cashflows between the original owner and the new counterparty. No settlement/result flows will be affected to the generated transaction, as the assignment is between the counterparties only. The generated transaction can be canceled to undo the action. 3.10.1.3.5 Transferring transactions between portfolios You can transfer the transaction from one portfolio to another. This is effectively a sale in one portfolio and a purchase in another. Portfolio transfer of an existing transaction can be performed at transaction level by right-clicking and choosing Transfer. Transfer of a transaction to another portfolio requires the following information: Information Description Opening Date Date when the transfer is executed. By default, this is today’s date unless a Fixing/Action Date was specified at transaction level. Value Date Date when the transfer is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Settlement Date Payment date for settlement flows. New Portfolio New portfolio for the transaction No Settlement switch If On, the generated settlement amount is marked as pseudo (i.e. not bookable, not payable). Settlement Price Method Clean Price: AI is created as Payable cashflow and P/L flow is the difference between transfer price and original deal price. Dirty Price: AI is created as Not Payable cashflow, and P/L flow is reduce by the AI amount. Currency Read-only. Currency of loan. Settlement Price The price of the assignment. Accrued Interest Read-only. Interest accrued on specified date. Options • Amortize P/L • No Fee Realization Two Transfer transactions are generated: 1. A sale is created in the source portfolio of the transfer, i.e. closing cashflows of the original transaction and settlement flows (real or pseudo, depending on inputs). 2. A purchase is then created in the receiving portfolio, with future flows and settlement flows (real or pseudo, depending on inputs). The original transaction remains unchanged. The user can undo the portfolio transfer action by canceling the generated transactions. 3.10.1.3.6 Transaction Conversion To allow schedule conversion at predefined dates during transaction's life. • Setup This process is available on the transaction if the Transaction Conversion feature is associated with the instrument. See A.2.325 Transaction Conversion on page 873. 336 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.10 Loan Then, the user is allowed to attach the Conversion schedule to the existing schedule and to define conversion events and converted schedules. • Execution When conversion schedules are defined, the user is allowed to execute generated conversion events. The conversion inputs are displayed. See A.2.325 Transaction Conversion on page 873. The execution generates a conversion transaction with the following attributes: – Kind: Conversion – Opening Date: Conversion opening date – Value Date: Conversion value date. The conversion transaction generates closing cashflows for the initial transaction. If the conversion price is different to the original deal price, then a P/L flow is generated, showing the differences between the conversion price and the original deal price. 3.10.1.4 Position monitoring 3.10.1.4.1 Setup The cashflow discounting method (periodic, continuously compounded) used in IR risk calculation depends on the instrument set up. By default, TRM uses the valuation curve interpolation settings (IR Quote and Yield Curve Editor Interpolation page). For example, if the interpolation settings are set up with Interest Type Continuous Yield, then risk calculations use continuously compounding discounting of the cashflows. If IR Exposure is set up at the instrument level, then TRM uses these settings. For example, if IR exposure is set up with Yield Type Periodic, then risk calculations use periodic discounting of the cashflows. For more information about risk calculations, see 2.3 Key-figures on page 112. 3.10.2 Floating-rate loan Interest cashflows for a floating-rate loan are linked to a market reference. The market reference has to be observed for each interest period. The fixing of the interest rate can be done before interest starts accruing (classical in-advance fixing), or at the end of the period (in-arrears fixing). 3.10.2.1 Instrument setup Floating-rate loans are set up in a similar way to fixed-rate loans, but refer to a different type of cashflow structure: the structure you choose needs to generate floating interest cashflows. You can pre-define the cashflow structure in the main characteristics of the loan, or restrict the available schedule templates at deal entry using the Schedule Groups option. See A.2.293 Schedule Template Setup on page 859. 3.10.2.2 Deal capture Depending on the selected cashflow structure, the information needed to deal the instrument and the generated cashflows are very different. The transaction level information is always the same. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 337 3 Debt instruments 3.10 Loan 3.10.2.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a deal on a floating-rate loan: Information Description Currency Currency of the transaction. If you specified the currency in the instrument setup, this is used as the default currency in the transaction and cannot be modified. Maturity Date Date for the maturity of the contract. If you use maturity date setup the date is calculated automatically from the selected maturity period, otherwise you can enter the date manually. Nominal Amount Amount of the loan. This is equal to the principal (the amount on which the interest is calculated). Deal Price Deal price of the transaction (expressed as a percentage of the nominal amount) used to calculate the book value and the settlement amount. 3.10.2.2.2 Generated data • Book Value (clean price): BV = A * p /100 where: A = Nominal Amount p = deal price • Book Value (dirty price): BV = (A * p /100) - AI where: A = Nominal Amount p = deal price AI = Accrued Interest These values alone are not sufficient to define the deal. To complete the creation of a floating-rate loan, the cashflow structure of the deal also needs to be specified, either in the instrument setup, or at deal entry. See Appendix B Schedules on page 883. 3.10.2.2.3 Bullet repayment structure For a floating-rate loan, a template which contains at least one schedule for floating-rate interest cashflows and one schedule for repayment flows is required. • Input data For each set of cashflows, the following information must be supplied: – 338 Interest flows Information Description Frequency Method and Period The frequency method/period for the interest cashflows (for example, Years/1 generates one interest flow per year). Interest Rate The first rate of interest (for example, 5%), if known. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.10 Loan Information Description Fixing parameters Formulae used to evaluate the rate. This is known as an "expression" in TRM. Typical expressions would be, for example, "ir", referring to an ir rate market reference (yield curve) or "ir + spread%". See Appendix D Expressions on page 917. Yield curve to be used in the expression. Period (for example, 3M or 6M) and the scenario used to get the rates when fixing the cashflows. Define if the fixing will be done in-advance or in-arrears and enter the offset in days. – Repayment flows Information Description Frequency Method and Period The frequency method/period for the repayment cashflow (for example, Bullet means that the loan will be entirely repaid at maturity). It is also possible to define amortizable or accreting principal cashflows. Some other parameters in the schedule can be adjusted to modify the way the cashflows are generated. See Appendix B Schedules on page 883. • Generated data – Schedule When a template is selected, one schedule is created for each item in the template. Some of the values are automatically defaulted from the transaction parameters (see Appendix B Schedules on page 883), while others can be modified at deal entry (see above). – Cashflows For a floating-rate loan with repayment at maturity, the cashflows generated are as follows: 3.10.2.3 Processing Floating-rate loans are processed in a similar way to fixed-rate loans, but with the following additional process. 3.10.2.3.1 Interest fixing For a floating-rate loan, the amount of each interest flow has to be determined before it is paid: this process is known as fixing. • Execution Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 339 3 Debt instruments 3.10 Loan Each interest cashflow of a floating-rate deal contains some parameters that define how its amount is fixed. – The fixing period determined by a from/to date value pair indicates when the amount of the flow has to be fixed; it can be before the interest starts accruing (in-advance fixing), or before the payment of the interest (in-arrears fixing). – The fixing parameters (expression, rate, spread, and so on) that define how the fixing rate is calculated. – An "expression value" which is informative and gives the current value of the expression. Executing the fixing modifies the cashflow as follows: Marks it as being fixed Sets the fixing date Stores the rate of the market reference used for fixing Stores the effective interest rate (nominal rate) on the cashflow Sets the amount of the cashflow The fixing process can be performed in four ways in TRM: the process which is triggered is exactly the same in the four cases, the only difference being the quantity of deals or cashflows which are affected. The four ways of fixing are as follows: – Directly on the deal: the fixing only affects the deal – Directly on an individual cashflow in the Cashflow view: the fixing affects an individual cashflow – On the instrument (in Instrument Editor): the fixing affects all the deals on this instrument – Using an automated activity (Fixing Transaction Cashflow): potentially all deals which have to be fixed for a particular date may be affected. See the TRM User Guide for general information on running activities, and also specific information on the activity parameters. If the Fixing action is carried out directly on an individual cashflow using the second method, it is possible to modify the fixing values. When the fixing quote is modified, this updates both the nominal rate and the amount accordingly. Similarly, if the nominal rate is modified, the amount is affected (but not the fixing quote). It is also possible to modify the amount independently from the other fixing values. This may be necessary when rounding differences arise, for example. • Cancellation It is possible to cancel the fixing either manually, using the Undo Fixing action; or automatically, using the Fixing Transaction Cashflow - Undo activity. See the TRM User Guide for general information on running activities, and also specific information on the activity parameters. 3.10.3 Other loan structures All the cashflow structures available for bonds are also available for loans (see 3.1 Bond on page 215). You can also find information about all system-defined cashflow structures available in TRM in Appendix B Schedules on page 883. Some of the structures that can be generated for a loan are described in this section. 3.10.3.1 Dual currency structure • Regular dual-currency: The currency in which the instrument is issued (principal currency) differs from the currency in which the principal is repaid (redemption currency). The currency of the interest flow can be either the principal currency or the redemption currency. The FX rate to apply can be known (determined on the date of issue) or fixed later (determined a number of days before the payment date of the interest cashflow). 340 © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.10 Loan • Reverse dual-currency: The principal currency and redemption currency are identical, but interest payments are in a different currency. The FX rate used for the calculation of interest is either known when the loan is agreed or fixed later. 3.10.3.1.1 Instrument setup Instrument setup for a dual-currency loan is similar to that of a standard loan (see 3.10 Loan on page 326), except for the following: • Loan main characteristics Information Description AI Method The method used by the system to compute settlement accrued interests. For dual-currency loans, there are two types of dual-currency methods: • Dual Currency Estimated • Dual Currency Last. See 2.1.6.1 Accrued interest calculations on page 67 for more information. • Dual-currency attributes This information defines the characteristics of the principal cashflow. Leave these fields blank if you want to specify the details when you enter the deal. Information Description Settlement Currency Currency in which the principal cashflow is settled. Settlement FX Rate Rate used to calculate the settlement amount of the principal cashflow. Need Fixing Specify whether the FX rate needs to be fixed: • Select No when the FX rate is known • Select Yes, FX Rate when the FX rate is unknown. The old value "Yes, Unmarked" is not used. Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max. Offset Maximum number of days’ offset allowed. See A.2.125 Dual Currency on page 771. • FX fixing If the settlement FX rate is unknown when the deal is entered, then this feature needs to be included in the instrument definition. See A.2.174 FX Fixing on page 797. 3.10.3.1.2 Deal capture • Input data Deals on dual-currency loans are captured in a similar way to those on a standard loan. To complete the creation of a dual-currency loan transaction, the cashflow structure of the deal also needs to be specified, either in the instrument setup, or at deal entry, by applying a schedule template. The following system templates are provided for dual-currency structures: Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 341 3 Debt instruments 3.10 Loan – Dual-Currency Known FX This is a fixed bullet structure used for dual currency instruments when the FX rate is known when the deal is entered. For both interest and redemption schedules you can choose a different settlement currency and specify the settlement FX rate. See B.2.1.1.15 Dual Currency, Known FX Rate on page 893. – Dual-Currency Known FX Floating This is a floating bullet structure used for dual currency instruments when the FX rate is known when the deal is entered. For both interest and redemption schedules you can choose a different settlement currency and specify the settlement FX rate. See B.2.1.1.16 Dual Currency, Known FX Rate, Floating on page 893. – Dual-Currency Unknown FX This is a fixed bullet structure used for dual currency instruments when the settlement FX rate is not known beforehand. For both interest and principal schedules you can choose a different settlement currency. See B.2.1.1.17 Dual Currency, Unknown FX Rate on page 893. Note that this template covers fixed interest rates only. For floating rates, you also have to use the Fixing Dates secondary template (see B.2.1.2.15 Fixing Dates on page 903). You can choose one of these templates or any other template derived from them. Once the template is applied to the transaction, the schedules are created and it is then possible to define the settlement currency characteristics, as well as other characteristics such as, date basis, payment convention, calendars, and so on. See Appendix B Schedules on page 883. • Generated data – Cashflows Settlement Currency = Settlement Currency (as defined in the schedule) Settlement FX Rate = Settlement FX Rate (as defined in the schedule) Settlement Amount = Amount * Settlement FX Rate 3.10.3.1.3 Processing • Early expiration The early expiration of a dual currency loan is similar to that of a standard loan, except that you can set the Settlement FX Rate and view the settlement amount. See 3.10.1.3 Processing on page 332. – Execution You perform the Early Expiration action in the Transaction Manager’s Transaction view on the transaction that you want to early expire. You can enter the following information: 342 Information Description Settlement Currency (Read-only) Currency to use for settlement. Settlement FX Rate Rate used to calculate the settlement amount of the principal cashflow. Settlement Accrued Interest Final amount to be settled. © Wall Street Systems IPH AB - Confidential 3 Debt instruments 3.10 Loan • FX fixing When the settlement FX rate of a dual-currency loan is not known beforehand, the FX rates need to be fixed at the agreed fixing date. – Setup Depending on the instrument setup, the fixing can be done in advance or in arrears. In both cases there can be an offset of n days (before the beginning or end of the interest period). – Execution The FX Fixing action performed in Transaction Manager’s Cashflow view on the cashflow allows you to set the FX rate. The following values can be input: Information Description Fixing Date Day the cashflow is fixed. Reference FX Rate Fixing market quote. This is defaulted by the system to the FX cross rate between the actual currency and the currency on the fixing date and can be changed by the user. The fixing process is performed directly on an individual cashflow in the Cashflow view. It is possible to modify the fixing values. – Cancellation It is possible to undo the FX fixing using the Undo FX Fixing action. 3.10.3.1.4 Position monitoring For information about dual currency calculations, see 2.3.5 Dual currency on page 147. 3.10.3.2 Rainbow coupon structure In these structures there is an option on each interest payment to choose the payment in a different currency (a maximum of three currencies can be defined in TRM). 3.10.3.3 Callable structure These structures are used to create callable/puttable loans. Call/Put can be simply optional or triggered by a market event. It is also possible to have a Call/Put with barriers (in or out). 3.10.3.4 Currency transaction option Options for repayment to occur in a different currency: this option can be simple, triggered or linked with a barrier. This option can be applied to a principal repayment or a call option 3.10.3.5 Transaction conversion option Deals with an embedded option to move to a different cashflow structure, for example, an option to move from a fixed to a floating rate, or from an annual to a zero coupon structure. These transaction conversions can also be linked to barriers or triggers. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 343 3 Debt instruments 3.10 Loan 344 © Wall Street Systems IPH AB - Confidential Chapter 4 Equities In TRM, the term equity is used to cover the following instruments: • Common stock Common stock is security that represents ownership in a company that has issued stock. The stockholder has a right to receive dividends and the right to vote in the shareholders’ meeting. • Preferred stock Preferred stock is security that represents ownership in a company that has issued stock. Preferred stock typically has better rights to dividends than common stock, but less voting rights (or even none at all). • Subscription rights A subscription right gives the holder the right to buy the underlying security at a predetermined price. Typically, the rights have a short lifetime: they are detached from stock at a specific date and expire worthless if they are not used to purchase the underlying stock. • Mutual fund shares A mutual fund share represents one unit of ownership in the assets of a mutual fund. 4.1 Equity Equity instruments must be based on an instrument type derived from the class EQUITY. 4.1.1 Instrument setup • Equity main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of equity instrument. Information Description Issuer and Guarantor parameters Issuer and guarantor information for the equity instrument. Currency Currency in which the equity is traded. Rounding parameters Method and precision used to round cashflow amounts. See A.2.127 Equity on page 772. • Equity information The outstanding number of shares and voting rights for the equity may change over time. It is possible to define this information at instrument level. See A.2.132 Equity Info on page 776. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 345 4 Equities 4.1 Equity Quotation • You can specify quotation information for the equity at instrument level. See A.2.274 Quoted on page 849. Trading unit • Equities can be traded in multiples of a minimum bid size. It is possible to define this information in the instrument setup. See A.2.321 Trading Unit (Equity) on page 871. For an equity instrument, it is also possible to set up: • Spot date calculation • Value date calculation • Delivery (custodian) information • Cashflow and transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 4.1.2 Deal capture 4.1.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a transaction with an equity instrument: Information Description Value Date Official date when money is transferred. This defaults to the spot date as defined for the instrument. Trading Units Number of units bought or sold. The Equity Trading Unit feature is used to define the minimum bid size of shares or fund shares. See A.2.321 Trading Unit (Equity) on page 871. Deal Price Price of one unit. In addition, the following optional information can be captured: Information Description Value Date Code If the Value Date Setup feature is applied at instrument level, you can enter the value date period you want to use to calculate the value date for the transaction, for example, 3M (3 months). This can be used to compute the value date for a forward purchase of equity. Note: If you specify a value date period in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.339 Value Date Setup on page 879. 346 © Wall Street Systems IPH AB - Confidential 4 Equities 4.1 Equity 4.1.2.2 Generated data • Cashflows For an equity instrument, the cashflows generated are as follows: Value date Opening date Position cashflow Spot days Delivery cashflow Settlement amount 4.1.3 Processing When managing an equity portfolio, there are various corporate actions that need to be processed. The processing in TRM of the most commonly used corporate actions is described in this section. 4.1.3.1 Cash dividend In most cases, the holders of common stock, preferred stock, or mutual fund shares receive regular cash dividends up to four times each year. In addition, they may receive special dividends. • Setup When the information about the cash dividend is declared by the issuer of the security, the instrument definition needs to be updated with the dividend information. See A.2.128 Equity Cash Dividend on page 773. • Execution On the ex-dividend date, the equity is quoted without the dividend and the market price drops approximately by the amount of the dividend. The exact amount of the dividend is known at the end of the previous business day. It is calculated from the position at the close of business prior to the ex-dividend date. The activity Dividend that creates the dividend transaction(s) needs to be performed at the beginning of the ex-dividend date (or at the end of the previous day). The following information is needed to process the cash dividend: Information Description Portfolio The dividend is calculated for this portfolio and all of its subportfolios. Minimum Transaction State The minimum transaction state that is taken into account when the position is determined for the dividend calculation. Note: See the TRM User Guide for information about this activity and how to set up activities in general. The execution creates the dividend transaction, which has an incoming cashflow on the dividend payment date. From the ex-dividend date onwards, the market value of this transaction is calculated separately from the equity position. The execution processes each portfolio (and owner) separately: a dividend transaction is created in each portfolio (and for each owner) where there is a position on the relevant equity on the day preceding the ex-dividend date. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 347 4 Equities 4.1 Equity • Cancellation In case the dividend transactions are incorrect it is possible to cancel them manually and rerun the dividend activity. 4.1.3.2 Split and reverse split When an equity instrument is split, the number of outstanding shares increases: each share is split into a certain number of shares. For example: Before the split: Buy 5,000 units of equity where the price of each unit = 10 EUR (total book value = 50,000 EUR) split 1 unit into 5 shares After the split: The position is 25,000 units of equity where the price of each unit = 2 EUR (total book value = 50,000 EUR) In a reverse split, the number of outstanding shares decreases with a certain ratio. For example: Before the split: Buy 5,000 units of equity where the price of each unit = 10 EUR (total book value = 50,000 EUR) split 5 units into 1 share After the split: The position is 1,000 units of equity where the price of each unit = 50 EUR (total book value = 50,000 EUR) • Setup The data used to split an equity position is defined in the instrument setup. The following information is required to process the split: Information Description Date Date on which the split was declared or the information was entered in the instrument setup. Split parameters Date of the split, the split ratio, and the action required if an Odd Lot results from the split. See A.2.138 Equity Split on page 779. • Execution If there are no Odd Lots or, if you do not want to create an Odd Lot adjustment transaction, you can perform the split or reverse split simply by defining the split information using the Equity Split feature in the instrument setup (see above). Otherwise, if any Odd Lots do result from the split or reverse split (and you do want to create the corresponding adjustment transactions), the Split activity must be used. Note: See the TRM User Guide for general information on running activities, and also specific information on the activity parameters. 348 © Wall Street Systems IPH AB - Confidential 4 Equities 4.1 Equity Each portfolio is processed separately. Based on the existing position, a new position is created using the following rules: Old units = Number of units in the position at the moment of the split (that is, at the end of the day before the split date) New units = Old units * From/To Units, rounded using the rounding parameters specified in the feature Odd lot = Old units – Used units Factor = Used units / Old units If there is an Odd Lot, a Sell transaction is created to sell the Odd Lot for the specified compensation price (as defined in the instrument definition): Odd lot compensation = Odd lot compensation price * Odd lot The existing position is adjusted so that the Odd Lot compensation amount (the resulting number of units) is now considered as new units. The book value is adjusted by the factor. If the factor = 1, there is no Odd Lot compensation and the book value is not adjusted. • Cancellation If you need to cancel or correct the split or reverse split: – Correct the Equity Split parameters defined in the instrument setup – Cancel the incorrect Odd Lot transactions, if any – Rerun the Split activity, if you wish to create Odd Lot adjustment transactions. 4.1.3.3 Detachment Detachment is a corporate action that takes place typically when a shareholder receives subscription rights in place of equity. The number of subscription rights received by the shareholder is proportional to the number of equity units held. If subscription rights are detached from an equity, it is also possible to transfer part of the book value from the equity to the subscription right (when the value of the equity and the value of the right are specified). For example: Before the detachment: Buy 5,000 units of equity where the price of each unit = 10 EUR (total book value = 50,000 EUR) Detachment of subscription rights: 1 right per 5 shares Market price for 1 share = 8 EUR Market price for subscription right = 2 EUR After the detachment: The book value that is transferred for the original position to the new one: 50,000 EUR * (1/5) * (2/8) = 2,500 EUR Receipt of subscription rights incurs a cost (1 EUR), therefore the following position cashflow is added to the generated detachment transaction: New units * Price per unit = 5,000 * (1/5) * 1 = 1,000 Note: At a later date, subscription rights can also be used to buy equity (either the same as the original equity or different equity) at a certain price (see 4.1.3.4 Conversion on page 351). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 349 4 Equities 4.1 Equity • Setup When the information about the detachment is known, the instrument definition needs to be updated. Information Description Date Date on which the detachment was declared or the information was entered in the instrument setup. Detachment parameters Date of the detachment and the action required if an Odd Lot results from the detachment. Value of the Right Values required to determine how much of the book value is transferred from the original equity to the new one. Value of the Equity See A.2.130 Equity Detachment on page 774. • Execution The Detachment activity is used to calculate what the shareholder gets per share held. Note: See the TRM User Guide for general information on running activities, and also specific information on the Detachment activity parameters. Each portfolio is processed separately. Based on the existing position, a new position is created using the following rules: Old units = Number of units in the position at the moment of detachment (in general, this is the position at the end of the previous day) If, for example, there is a split on the same day as the detachment, you must define whether the detachment is processed before or after the split. New units = Units to receive * Round(Old units / Units to sell) rounded using the rounding parameters specified for the detachment at instrument level Odd units are computed as follows: Odd lot = Old units – Units to sell * Truncate(Old units / Units to sell) Odd lot compensation = Odd lot compensation price * Odd lot If there is an odd lot, the compensation amount is added as a profit/loss cashflow to the detachment transaction. Price to pay = Price to pay per unit * New units The price to pay is added as settlement principal to the detachment transaction. When subscription rights are detached from an equity, it is possible to determine the book value amount that is transferred from the equity to the subscription right, using the following calculation: Book value amount * (Units to receive * Value of right)/(Units to sell * Value of equity) • Cancellation You can cancel the detachment action by cancelling the detachment transactions and also the generated cashflows in the original transaction. 350 © Wall Street Systems IPH AB - Confidential 4 Equities 4.1 Equity 4.1.3.4 Conversion Subscription rights can be used to purchase new shares (either the same as the original equity or different equity) at a certain price. This corporate action is known as Conversion. Conversion can be used, for example, in a merger where shares held in one company are converted to shares in another company. • Setup When the information about the conversion is known, the instrument definition needs to be updated. Information Description Date Date on which the conversion was declared or the information was entered in the instrument setup. Conversion parameters Date of the conversion, the conversion ratio, and the action required if an Odd Lot results from the conversion. See A.2.129 Equity Conversion on page 773. • Execution The Conversion activity is used to convert shares or subscription rights into new equity. The following information is needed to run the activity: Information Description Portfolio Conversion is processed for this portfolio and all of its subportfolios. Minimum Transaction State Minimum transaction state that is taken into account when the position is determined for the conversion. Note: See the TRM User Guide for information about how to set up activities in general. Each portfolio is processed separately. Based on the existing position, a new position is created using the following rules: Old units = Number of units in the position at the moment of conversion New units = Units to receive * Round(Old units / Units to sell), rounded using the rounding parameters specified for the detachment at instrument level The new position is created with the correct number of units with regard to the rounding conventions. Price to pay = Price to pay per unit * New units This amount is added as settlement principal to the conversion transaction. Factor = Units to sell * Truncate(Old units / Units to sell) / Old units This factor determines the part of the book value that is moved from the old position to the new converted position. The old position is closed completely if there is no odd lot (that is, a sell transaction is generated with the whole number of units). The position is closed partially in the case of an odd lot. The odd lot is sold at the compensation price. The odd lot sell transaction has the following characteristics: Odd lot units = Old units - Units to sell * Truncate(Old units / Units to sell) Book value = Odd lot compensation = Odd lot selling price * Odd lot units Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 351 4 Equities 4.1 Equity Cancellation • You can cancel the conversion by cancelling the conversion transactions. 4.1.3.5 Return of capital Return of Capital occurs when the company pays back part of the capital to the shareholders. This corporate action differs from a cash dividend (see 4.1.3.1 Cash dividend on page 347), because the book value of the shares is decreased by the amount of the capital returned. Setup • When the information about the return of capital is known, the instrument definition needs to be updated. Information Description Date Date on which the return of capital was declared or the information was entered in the instrument setup. Return of capital parameters Date of the return of capital, and information required to determine the capital to be returned. See A.2.137 Equity Return of Capital on page 778. Execution • The Return of Capital activity is used to pay back the capital to the shareholders. Running this activity decreases the book value by the amount of capital returned (the number of units multiplied by capital per unit). The returned capital is shown as a principal cashflow. Note: See the TRM User Guide for general information on running activities, and also specific information on the activity parameters. Cancellation • You can cancel the return of capital action by cancelling the return of capital transactions and also the generated cashflows in the original transaction. 4.1.4 Position monitoring In this section, numerical examples demonstrate how the different figures are calculated for an equity instrument. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. This example shows a share, with the following deal data: Setup • Data Symbol Valuation Method FX Exposure Offset Example Quoted, to Spot h_fx 0.01 Symbol Example Transaction • Data Opening Date Trading Units 352 2004-02-02 n_m 10,000 © Wall Street Systems IPH AB - Confidential 4 Equities 4.1 Equity Data Symbol Example Deal Price P_b 3.00 Base Book FX Rate (EUR/USD) S_b 1.2 Value Date d_a 2004-02-04 Currency USD Portfolio Currency EUR Other important deal data is calculated by the system as follows: Data Symbol Example Formula Book Value (Local) V_b 30,000.00 = 10,000 * 3.00 = n_m * P_b Book Value V_p 25,000.00 = 30,000.00 / 1.2 = V_b / S_b Unless otherwise stated, the figure date used in the calculations is 2004-03-01. On this date, the market data is as follows: • • Market data on 2004-03-01 Data Symbol Example Figure date d_f 2004-03-01 Market Price P_f 3.20 FX Conversion Rate S 1.260000 Valuation figures The valuation method commonly used for an equity instrument is the Par method. Data Symbol Example Formula Local Market Value V_l 32,000.00 = 10,000 * 3.20 = n_m * P_f Market Value V 25,396.93 = 32,000.00 / 1.2600 = V_l / S Clean Market Value V_clean 32,000 = 10,000 * 3.20 / 1.2600 = n_m * P_f / S Note that if the instrument is not defined as being valued To Spot, Market Value will be discounted from spot to the figure date. However, Clean Market Value will not; therefore, the Clean Market Value figure may be different from the Market Value figure. • Result figures The setup of the instrument impacts the way result figures are computed. Data Symbol Example Formula Total Profit (Local) P_tl 2,000.00 = 32,000.00 – 30,000.00 = V_l – V_b MtoM Profit (Local) P_ml 2,000.00 = 32,000.00 – 30,000.00 = V_l – V_b FX Profit P_fx -1,190.48 = 30,000.00*(1/1.260000 – 1/1.20000) = V_b*(1/S - 1/S_b) Total Profit P_t 396.83 = 25,396.83 – 25,000.00 = V – V_p MtoM Profit P_m 1,587.30 = 2,000.00 / 1.260000 = P_ml / S Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 353 4 Equities 4.1 Equity Risk figures • Data Symbol Example Formula FX Exposure E_fx 253.97 = 0.01 * 25,396.83 = h_fx * V 354 © Wall Street Systems IPH AB - Confidential Chapter 5 Security lending 5.1 Repurchase agreement In a repurchase agreement (repo), one party sells a security to another party with the agreement to repurchase the same security at a fixed future date and at an agreed price. In essence, the seller of the security is borrowing the amount received from the sale and placing the sold securities with the purchaser as collateral. The difference between the sale price of the security and the cost of repurchase is, in effect, interest charged to the borrower. The period of time between the sale and the repurchase is called the repo period. Physical transfer of the security from the custody of the borrower to the custody of the lender usually takes place, but in the case of overnight repos, for example, there may be no transfer. If the security does not physically change hands, the buyer of the security is exposed to a higher credit risk. Underlying a repo transaction is usually a fixed-rate government bond or discount paper. Collateral delivered against the cash in a repo transaction can be in a single (single-collateral repo) or in multiple (multi-collateral repo) underlying instruments. These collateral instruments must be defined with the feature Collateral in order to be available as collateral, see 5.1.4 Collateral on page 365. TRM also allows you to use cash as collateral. To do so, you must define cash collateral account instruments, see 5.1.7 Cash Collateral on page 376. You can use both collateral instruments and cash collateral instruments for margin movement transactions. Margin movements are required when the exposure exceeds the threshold defined in the collateral agreement (Margin page). You must set up specific margin movement instruments to handle this type of situation, see 5.1.6 Margin movement on page 370. In some situations, you may need to substitute a collateral instrument for another during the lifetime of a repo transaction. You must set up specific substitution instruments for this event, see 5.1.5 Substitution on page 366. To enable substitution, you need to set up the conditions for substitution in the collateral agreement (Substitution page). See TRM User Guide for more information about collateral agreements. Repos are driven either by the need to lend or borrow cash, or the need to borrow a specific security. 5.1.1 Repo (classic) The following information is relevant to any kind of repo. If you want to setup a Buy/sell back repo see 5.1.2 Buy/sell back and sell/buy back on page 362. 5.1.1.1 Instrument setup Repo instruments must be based on an instrument type derived from the class REPO. • Repo main characteristics Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 355 5 Security lending 5.1 Repurchase agreement This information may be relevant to any kind of repo instrument. Information Currency Description Currency of the repo deal. Leave this field blank if you want to specify the currency of the repo transaction when you enter the deal. Transaction Sign Interest Type Date Basis Sign to be applied to the transaction: Reverse Repo (Buy/Lend) or Repo (Sell/Borrow). • Select either Repo or Reverse Repo if you want this to be the default direction of the transaction, that is, the direction cannot be modified at deal entry. • Leave this field blank if you want to specify the direction of the repo deal at deal entry. Type of interest rate used to calculate the repo interest amount, for example, Periodic Rate. Date basis used to calculate the interest of the repo. If this is not defined at instrument level, the date basis of the currency is used unless you provide another date basis at deal entry. Amount Rounding parameters Method used to round cashflow amounts of the repo. Principal Cashflow Type Type of repayment cashflow (for example, Principal or Expiration). Interest Cashflow Type Type of interest cashflows. Collateral Calculation Method Calculation method defaulted to transaction column Collateral Calculation Method of new transactions in repo instrument and applied when collateral amount of a collateral entry in a repo transaction is manually updated. • Single: Select Single, if you want the system to keep settlement amount of the collateral and recalculate collateral market price to match the new collateral amount, This method can only be used in single collateral repo transaction. • Multiple: Select Multiple, if you want the system to keep the collateral market price of the collateral and recalculate settlement amount to match the new collateral amount. This method allows you to enter multiple collateral to a repo transaction. Note: The Collateral Calculation Method always defaults to Multiple in substitution and open margin transactions, but can be manually set to Single. Switches • Use Dirty Price: Switch on to define that the Collateral Price/Maturity Collateral Price should be expressed as the dirty price. This information is displayed at transaction level as Dirty Collateral Price. • Use Collateral Price Rounding: Switch on to define that Collateral Price and Maturity Collateral Price are rounded using the rounding parameters of the underlying collateral instrument. If this switch is not on, collateral prices are always calculated exactly. If the feature Repo Rounding is used, the rounding parameters are taken from the rounding setup of the collateral instrument (see A.2.280 Repo Rounding on page 854). Otherwise, the rounding parameters are taken from Trading Yield setup of the collateral instrument (see A.2.323 Trading Yield on page 872). See A.2.283 Repurchase Agreement on page 854. • 356 Maturity definition © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement It is possible to set up maturity information at instrument level. Information Description Calendar parameters Calendars used to calculate the maturity date. Gap Set Gap set used for supplying the available maturity periods. Maturity Date Period If defined, this maturity period is applied to each transaction. See A.2.230 Maturity Date Setup on page 827. • Collateral agreement definition It is possible to set up collateral agreement to be used in transactions at instrument level. Information Description Agreement The collateral agreement you want to use in the repo transactions. • If defined, this collateral agreement is defaulted to all new transactions. The defaulted agreement can be changed to any other valid collateral agreement in Transaction Manager. • If not defined, collateral agreement is defaulted according to collateral agreement setup given in Client Editor for the owner of the transaction. For more information about the setup of a collateral agreement at the client-level, see TRM User Guide. See A.2.95 Collateral Setup on page 756. • Collateral Quote defaulting If feature Quote Default (Collateral) is selected for a repo instrument, the current market price or yield is automatically defaulted according to the setup of the feature to fields collateral market price or collateral market rate of a new collateral entry in a repo transaction as soon as a new collateral instrument has been selected. Information Description Scenario Scenario to use to price the transactions. Mode Pricing mode: Method • Select Automatic if you want to retrieve the quotes automatically in Transaction Manager. • Select Manual if you want to retrieve the quotes manually in Transaction Manager. Defaulting method: Ask, Bid, Buy/Sell, or Mid. If you select Buy/Sell: when the transaction sign is positive the Ask price is used, and when the transaction sign is negative, the Bid price is used. See A.2.270 Quote Default (Collateral) on page 847. • Repo Cash Delivery definition This feature sets all non-delivery cashflows of a repo transaction with the attribute Not Payable and creates a separate cash delivery flow corresponding to a delivery flow for each collateral instrument. Concretely, the total settlement and maturity amounts on value date and maturity date of the repo, respectively, are split by collateral instrument for settlement purposes. As cash delivery flows have corresponding collateral instrument as leg instrument of the flow, these flows can be identified by leg instrument in rules. This enables the setting of cash settlement instructions correctly when they are dependent on collateral instruments. The splitting of settlement amounts by collateral instrument also enables delivery versus payment (DvP) settlements to be generated from multi-collateral repos. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 357 5 Security lending 5.1 Repurchase agreement See A.2.277 Repo Cash Delivery on page 853. It is also possible to set up: • Spot day and value date calculations • Manual charges • Cashflow and transaction charge rules • Branch codes. See Appendix A Features on page 713. 5.1.1.2 Deal capture Repo transactions can be entered in a cash-driven or collateral-driven manner depending on if the transaction is initially agreed with the counterparty for a specific cash amount against any acceptable collateral or for a specific amount of particular collateral. 5.1.1.2.1 Input data – cash amount In addition to the standard deal parameters, the following information is required if you want to trade cash versus general collateral. • Transaction view Information Currency Description Currency of the repo deal. If the currency is not defined at instrument level, it can be specified separately for each transaction. Maturity Date Date when the repo deal matures. Maturity Code • If you enter a maturity code, the date is calculated automatically; otherwise you can enter the date manually. • (Information only.) If the maturity definition parameters are defined at instrument level, these are used by default. Nominal Amount Cash amount of the repo. Deal Rate Repo rate (expressed as a percentage) used to calculate the repo interest (cash). Date Basis Date basis of the repo deal. If the date basis is not defined at instrument level, it can be specified separately for each transaction. Collateral Agreement Collateral Agreement of the repo deal. If the agreement is not defined at instrument level, it defaults according to collateral agreement definition given in Client Editor for the owner of the transaction. You can change the default agreement to any other collateral agreement as long as it is valid for the counterparty of the repo. Collateral agreement specifies various conditions applied for the repo including: • Collateral Valuation Currency • Collateral Requirement calculation • Cover Haircut of the repo • Total Collateral Haircut • Eligible collateral • Collateral Substitution • Margin calls and returns See TRM User Guide for more information about the Collateral Agreement Editor. 358 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement • Repo view In this view, you can add collateral to the repo transaction by using the New Collateral action. Information Description Collateral Instrument Instrument (bonds, discount papers, and additionally cash collateral account) to be used as collateral. Only instruments with the Collateral feature (A.2.93 Collateral on page 755) attached and not flagged as ineligible in Collateral Haircut definition of the selected collateral agreement are available for selection. For information about the collateral instrument setup, 5.1.4 Collateral on page 365. Collateral Market Price Market price of the collateral instrument. This price can be defaulted by the system when the feature Quote Default (Collateral) is used. See A.2.270 Quote Default (Collateral) on page 847. The system calculates the required amount of collateral automatically based on the above transaction and repo attributes as well as the following: – Cover Haircut of the repo. – Total Collateral Haircut. These are assigned automatically by the system according to the selected collateral agreement. The calculated collateral amount or collateral units is rounded up to the closest deliverable amount/units using minimum bid size or trading units definition of the collateral instrument. If the multiple collateral are delivered against cash, the Collateral Calculation Method must be set to Multiple at the transaction level and the collateral amount or collateral units of the first collateral must be manually adjusted down to the correct amount/units before adding a new collateral in Repo view by using the New Collateral action. If the Collateral Calculation Method is set to Single before adjusting down collateral amount, the system recalculates collateral market price to match settlement amount of the collateral and the new collateral amount, instead of recalculating the settlement amount. Adding new collateral after that will not be possible because the transaction is already fully collateralized. Note: Manually changing the collateral calculation method of the transaction at any time will always affect the calculations of the last collateral of the transaction. When a collateral instrument is selected, the eligibility of the selected instrument is validated against the selected collateral agreement. 5.1.1.2.2 Input data - collateral amount If you want to trade a specific amount of a security against cash, then the nominal amount of the transaction is not given. Unlike a cash-driven scenario where you only have to enter the collateral instrument and collateral market price, in a collateral-driven scenario, you must also give collateral instrument, collateral market price and collateral amount. Based on this information, the system calculates automatically correct nominal amount for the transaction., using collateral price rounding if the repo instrument is set up with switch Use Collateral Price Rounding. As long as nominal amount of the transaction has not been manually given, the system continues to treat the transaction as a collateral-driven one and updates the nominal amount according to collateral attributes that you provided. 5.1.1.3 Processing This section describes the actions that can be done throughout the life of a repo transaction. 5.1.1.3.1 Roll over You can defer the maturity of a repo transaction to a later date. This process is called a rollover. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 359 5 Security lending 5.1 Repurchase agreement • Setup The feature Allow Roll Over (repo) enables repo transactions to be rolled over. Repo transactions can be rolled over in a similar manner to short-term loans. • See A.2.13 Allow Roll Over (repo) on page 719. • Execution Rollover of a repo is always collateral-driven in that any partial rollovers are identified by adjusting down the collateral amount of one or several collaterals of the maturing repo. Rollover transactions are created by executing the Roll Over action from an outstanding repo deal in Transaction Manager or Collateral Valuation Board. Rollover is available if the remaining collateral amount of at least one of the collateral instruments is greater than zero. This action can be triggered from the following places: – Transaction Manager - Transaction view (for all collaterals of the transaction) – Transaction Manager - Repo view (for a specific collateral) – Collateral Valuation Board - Collateral Position view (for all collaterals of the transaction). See TRM User Guide for more information. Rollover transactions are created by executing the Roll Over action from an outstanding repo deal in Transaction Manager or Collateral Valuation Board. Rollover is available if the remaining collateral amount of at least one of the collateral instruments is greater than zero. This action can be triggered from either of the following places: – Transaction Manager - Transaction view (for all collaterals of the transaction) – Transaction Manager - Repo view (for a specific collateral) – Collateral Valuation Board - Collateral Position view (for all collaterals of the transaction) Required input for the rollover is given in the Roll Over dialog but can be modified or completed in Repo view of Transaction Manager in the new row created by the action. When the action is selected from the right-click action, the system opens one of two dialogs depending on whether single or multiple maturing collateral instruments are affected by the rollover. Note, that all previous collateral substitutions are taken into account when the system identifies collateral for the roll-over transaction. This means that the roll-over collateral is not necessarily the same as the original collateral of the repo being rolled over. If the action is executed from Transaction view of Transaction Manager and multiple collateral instruments with remaining collateral amount greater than zero are found, you must capture the following information: Information Description Opening Date Opening date of the rollover transaction. Defaulted to the current date or if given before selecting the action, as fixing/action date of the underlying transaction. Value Date (Information only.) Value date of the rollover transaction. Defaulted to the opening date adjusted with spot days of the repo instrument. Roll over Method (Mandatory) Method used for the rollover. Defaulted according to the select default method at instrument-level, but can be modified to any of the other methods if these are not identified as excluded. Gap Gap used to calculate new maturity date from value date of the rollover. If the maturity gap is identified in the maturing repo, the same gap is defaulted to the rollover as well, but can be modified to any other gap. 360 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement Information Description Maturity Date Maturity Date of the rollover. The maturity date is calculated by the system based on value date and selected the maturity gap, but can be modified to any other valid date. Deal Rate Repo rate of the rollover. Defaulted to the deal rate of the maturing repo, but can be modified to any other rate. Re-Price Collateral If set the collateral of the repo transaction is re-priced using the market price at the time of the rollover to calculate the cash amount of the rollover. The difference between the maturing cash amount of the repo and new cash amount of the rollover is settled as part of the maturity settlement of the maturing repo and included in the nominal amount of the rollover. This is defaulted according to corresponding setup in the repo instrument but can be manually set/cleared in the dialog. If only one collateral instrument with a remaining collateral amount greater than zero is found, the dialog contains the following additional fields: Information Description Collateral Instrument (Information only.) Collateral instrument of the maturing collateral. Collateral Amount Collateral amount of the maturing collateral. Defaulted to the remaining collateral amount, but can be modified to any amount that does not exceed the remaining amount. Collateral Units Units of the maturing collateral if the collateral instrument is set up with trading units. Collateral Market Rate Current market yield of the collateral instrument, if Re-Price Collateral is used. Collateral Market Price Current market price of the collateral instrument, if Re-Price Collateral is used. All deliveries of rolled-over collateral (as well as settlements of maturing principal) are always deferred to the maturity date of the rollover. The various rollover methods available in the dialog reflect different treatments of maturing interest in the rollover. Each method can be used with or without Re-Price Collateral, resulting in an additional cash settlement that reflects the difference between original and current value of the rolled-over collateral, increasing or decreasing the nominal amount of the rollover transaction accordingly. The following methods are supported: Method Description Settle Interest The interest of the maturing repo transaction is paid at the initial maturity date. The nominal amount of the rolled over transaction is equal to the principal cashflow of the initial transaction according to the collateral amount of the rollover (i.e. if half of the maturing collateral is rolled over, the nominal amount is half of the principal) adjusted up or down when Re-Price Collateral is used. Delay Interest The interest of the maturing repo transaction is deferred to the new maturity date of the rollover. The nominal amount of the rolled over transaction is equal to the principal cashflow of the initial transaction according to the collateral amount of the rollover adjusted up or down when Re-Price Collateral is used. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 361 5 Security lending 5.1 Repurchase agreement Method Description Compound Interest The interest of the maturing repo transaction is deferred to the new maturity date of the rollover, and the new interest of the rollover transaction is calculated based on the total of the nominal amount and deferred interest. The nominal amount of the rolled over transaction is equal to the principal cashflow of the initial transaction according to the collateral amount of the rollover adjusted up or down when Re-Price Collateral is used. Capitalize Interest The interest of the maturing repo transaction is capitalized to the principal of the rollover transaction, and the new interest of the rollover transaction is calculated from the nominal amount including capitalized interest. The nominal amount of the rolled over transaction is equal equal to the total of principal and interest cashflows of the initial transaction according to the collateral amount of the rollover adjusted up or down when Re-Price Collateral is used. Accepting the dialog creates a new rollover transaction, if necessary, you can finalize this rollover transaction in the Repo view of Transaction Manager. If the action was executed from Transaction view of Transaction Manager for more than one maturing collateral instruments, you can modify the defaulted collateral amount or units of each collateral to a smaller value in the event of a partial rollover, or delete one or several of the maturing collaterals to restrict the rollover to a subset of collaterals. If Re-Price Collateral was used, you can also adjust the defaulted collateral market prices. • Cancellation You can undo the roll-over by canceling the roll-over transaction. 5.1.2 Buy/sell back and sell/buy back Sell/buy backs and buy/sell backs are similar to classic repos and reverse repos respectively. With sell/buy backs and buy/sell backs, however, the coupon that is payable during the repo term and received by the buyer of the bond is not immediately transferred to the seller, as in a classic repo or reverse repo, but paid back at the end of the repo term, compounded by the repo rate. 5.1.1 Repo (classic) on page 355. 5.1.2.1 Instrument setup A buy/sell back (and sell/buy back) instrument is set up in the same way as a normal repo instrument (see 5.1.1 Repo (classic) on page 355) with the following additional attributes: • Repo main characteristics Information Description Switches • Reinvest Coupon: Switch on for a buy/sell back where the coupon is received by the buyer of the bond and only paid back at the end of the repo. This information is displayed in the Reinvest Coupon column in Transaction Manager’s Transaction view. See A.2.283 Repurchase Agreement on page 854. 5.1.2.2 Deal capture • Input data Buy/sell back (and sell/buy back) deals are captured in a similar way to collateral-driven repo deals (see 5.1.1.2 Deal capture on page 358). The following additional fields may also be used at deal entry. 362 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement – Transaction view Information Description Reinvestment Rate Rate used to reinvest the coupon. By default, this is the same as the repo rate (i.e Deal Rate of the transaction) but can be set manually to a different rate. 5.1.3 Floating Repo A floating repo is like a classic repo except that the single interest payment (which is payable at repo maturity) is not agreed up front as with a normal repo but is fixed in arrears at the end of the repo period. In all other aspects, the transaction is like a normal classic repo. 5.1.3.1 Instrument setup The setup for a floating-repo instrument is, for the most part, identical to that of a normal fixed-rate repo instrument. The differences are described below. Floating-repo instruments must be based on an instrument type derived from the class REPO-FLOATING. • Main characteristics In addition to the standard information that applies to any repo instrument (provided in the Repo page), you can define the floating characteristics of the instrument in the Floating Repo page. Information Description Interest Method Interest calculation method that controls which expression is used in the floating interest cashflow of the transaction. The following methods are available: • Average: The expression 'average' is used to support the calculation of the interest rate as an average of daily observations during the interest period. • Average (Business Days): The expression 'average_q' is used to support the calculation of the interest rate as an average of daily observations during the interest period using quotations on business days only. • Compound: The expression 'compound' is used to support the calculation of the interest rate as a compund rate using daily observations during the interest period. • In Arrears: The expression 'ir+spread' is used to support the calculation of the interest rate using a single observation at the end of the interest period. Fixing Rate IR Quote reference used when fixing the cashflow. Fixing Period Tenor from which the quotation is retrieved when fixing the interest rate of the transaction, for example, O/N or 1M. Fixing Subscenario Rate subscenario from which the interest rate is retrieved. Fixing Offset Number of business days before the interest date. Fixing of interest occurs on this date. If the fixing offset is set to anything other than 0 when average/compound interest methods are used, the quotation of the fixing date is used for all dates between the fixing date and the interest date. Fixing Calendar Calendar used for fixing. See A.2.284 Repurchase Agreement (Floating) on page 856. • Repo cash delivery (floating) definition Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 363 5 Security lending 5.1 Repurchase agreement The feature Repo Cash Delivery (Floating), like the feature Repo Cash Delivery for fixed-rate repos, sets all non-delivery cashflows of a repo transaction to Not Payable and creates a separate cash delivery flow corresponding to a delivery flow for each collateral instrument. The difference between the two features is that in floating-rate repos, cash delivery flows are only created for the value date of the repo when the transaction is captured. Corresponding flows for the maturity date are created by the Fixing action executed on the fixing date of the interest cashflow. See A.2.278 Repo Cash Delivery (Floating) on page 853. • Repo valuation (floating) definition The normal valuation setup options used in floating loans are available in floating-repo instruments too. In particular, it is important to select the correct risk profile after selecting the feature Valuation Setup (Floating). For information on risk profiles see 2.3.4.8 Risk profiles on page 124. See A.2.338 Valuation Setup (Floating) on page 879. 5.1.3.2 Deal capture Floating repo transactions are entered in the same way as fixed-rate repos with the few exceptions described below. 5.1.3.2.1 Input data In addition to the standard deal parameters and repo specific parameters described earlier (see 5.1.2.1 Instrument setup on page 362), the following information is required if you want to trade a floating-rate repo. • Transaction view Information Description Deal Rate The Deal Rate of a floating-rate repo is the spread over or under the reference given as basis points. For example, 2.50 is interpreted as a spread of 0.025%. The value given in this field is propagated to the Spread field of the interest cashflow. This field is mandatory. Fixing Rate IR Quote reference used when fixing the cashflow. This field is automatically populated if the Fixing Rate is given at instrument level. If not, any valid IR Quote with usage Fixing can be given for the transaction. This field is mandatory. Fixing Period Tenor from which the quotation is retrieved when fixing the interest rate of the transaction, for example, O/N or 1M. This field is automatically populated if the Fixing Period is given at instrument level. Otherwise, any valid tenor in the identified Fixing Rate can be given for the transaction. This field is mandatory. Fixing Subscenario Rate subscenario from which the interest rate is retrieved. This field is automatically populated if the Fixing Subscenario is given at instrument level. Otherwise, any valid subscenario can be given for the transaction. If nothing is given, the system uses the default subscenario. Fixing Offset Number of business days before the interest date. This field is automatically populated if the Fixing Offset is given at instrument level. Otherwise, any number of business days can be given in the field. If nothing is given, 0 is used by the system and the Fixing To date of the floating interest cashflow is always set to the Maturity Date of the transaction. 364 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement Information Description Fixing Calendar Calendar used for fixing. This field is automatically populated if Fixing Calendar is given at the instrument level. Otherwise, any valid calendar can be given for the transaction. If nothing is given, the calendar of the currency of the transaction is used when setting the fixing date for the floating interest cashflow. 5.1.3.3 Processing This section describes the different actions that can be done throughout the life of a floating-rate repo transaction as opposed to a fixed-rate repo transaction. 5.1.3.3.1 Interest fixing Like for a floating-rate loan, the amount of each interest flow in a floating repo transaction has to be determined before it is paid: this process is known as fixing. Fixing is done in exactly the same way as for a floating loan transaction. When fixing is executed for a floating repo transaction with an instrument with feature Repo Cash Delivery (Floating), the system also creates Cash Delivery flows required for maturity date settlement. This cannot be done before fixing because the final cash settlement amount on the maturity date is not known. See 3.10.2.3.1 Interest fixing on page 339 for more information. 5.1.3.3.2 Roll over Floating repo transactions can be rolled over in the same way as fixed-rate repos but with two minor differences: 1. The Rollover action is only available for a floating repo transaction after it has been fixed. This is because the final interest payment at the maturity of the original floating-repo transaction must be known before the rollover can be successfully processed. 2. In the same way as in the capture of a new floating repo transaction, the Deal Rate of the rollover given in the Rollover action dialog is interpreted as a spread over or under the fixing reference as basis points and passed to the Spread field of the floating interest cashflow of the new rollover transaction. See 5.1.1.3.1 Roll over on page 359 for more information. 5.1.4 Collateral Some instrument setup affecting repo transactions is made directly in the collateral instruments instead of the repo instrument. You can define the following instruments as collateral instruments available for repo transactions: • Bonds: 3.1 Bond on page 215. • Discount papers: 3.9 Discount paper on page 316. • Floating Rate Notes (FRNs): 3.1.2 Floating rate note on page 228. To use these instruments as collateral, you must ensure that they are properly set up with feature Collateral, see A.2.93 Collateral on page 755. Additionally, you can define the following instruments to support using cash as margin collateral in repo operations: • Cash collateral account: 5.1.7 Cash Collateral on page 376. 5.1.4.1 Instrument setup • Main characteristics – Trading Units definition Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 365 5 Security lending 5.1 Repurchase agreement Smallest possible denomination of the security that can be delivered under a (Repo) transaction in the market can be identified in Trading Unit setup of the collateral instrument. Information Description Trading Units If the instrument is traded in units, the size of one unit is given here (for example, 10,000.00). Units definition should only be used if the instrument is structured in units. This setup should not be made only to indicate the smallest deliverable denomination since trading units definition makes all cashflow calculations (for example, interest amounts) to be first made for one unit of instrument and then multiplied by the number of units of the transaction, instead of calculating the amounts for the full nominal amount of the transaction directly. Minimum Bid Size If the instrument is traded and delivered in nominal amount instead of units, the smallest deliverable denomination can be given as Minimum Bid Size (for example, 10,000.00). Minimum Bid Size has no impact on cashflow calculations, only on rounding of nominal amount (transactions traded directly in the instrument) and collateral amount (repo transactions using the instrument as collateral). Note that only one of the definitions can be given for any given instrument (either Trading Units or Minimum Bid Size). Refer to the relevant primary feature. • Collateral definition This feature identifies the instrument as a valid collateral to be used in repo transactions. See A.2.93 Collateral on page 755. • Repo rounding feature This feature allows you to define the pricing precision to be used in repo transactions for the collateral instrument. If defined, this setup overrides the rounding parameters of the instrument specified with the Trading Yield feature (unless Use Bond Rounding has been set in the repo instrument) when collateral price and collateral maturity price are calculated in repo transactions. Information Description Price rounding parameters Rounding used for collateral price. Maturity price rounding parameters Rounding used for maturity collateral price. This can be specified at deal entry in the Repo view. This can be specified at deal entry in the Repo view. See A.2.280 Repo Rounding on page 854. 5.1.5 Substitution Collateral substitution takes place when existing collateral that is held or given against a repo exposure is partially or fully substituted against new collateral. The return of the existing collateral and receipt of the new collateral can be settled free or versus a cash payment. If delivery versus payment is used, the cash amount to be settled against the delivery of securities can be either the initial amount of cash that was originally settled against the delivery of existing collateral or the value of original collateral at the time of substitution. In both cases, the same amount of cash is used in the delivery of both collateral instruments. The net cash effect is zero but both deliveries take place as DvP (Delivery versus Payment). 366 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement The value of original collateral to be substituted is used to calculate required amount of new collateral. Either initial value of the substituted collateral in the repo transaction or the current value of it at the time of substitution can be used as a basis for this calculation. The method used is specified at collateral agreement level by identifying the substitution method to be used in the agreement. If no method has been identified in a collateral agreement, substitutions are not allowed for any repos in it. The substitution is modeled with an independent action transaction created from the original repo. The substitution transaction is not created in the original repo instrument but a separate substitution instrument is used instead. 5.1.5.1 Instrument setup Substitution instruments must be based on an instrument type derived from the class SUBSTITUTION. • Main characteristics Substitution features use the primary feature Substitution (see A.2.306 Substitution on page 865). Substitution instruments do not require any specific set up. • Collateral Quote defaulting This feature can also be used in a substitution instrument to make the system automatically default current market price or yield according to the setup of the feature for both old (if substitution method Current Value is used) and new collateral in a substitution transaction. See A.2.270 Quote Default (Collateral) on page 847. • Repo Cash Delivery definition The feature Repo Cash Delivery (Substitution) must be used in substitution instruments when delivery-versus-payment settlements are required on the value date of the substitution. Typically, a substitution instrument with this feature is used if the repo instrument of the transaction from which the substitution transaction is created uses feature Repo Cash Delivery. This feature creates a separate Cash Delivery flow corresponding to a delivery flow in each collateral instrument on the value date of the substitution. As in a repo, the total settlement amount on the value date of the substitution is split by the collateral instrument for settlement purposes. See A.2.277 Repo Cash Delivery on page 853. It is also possible to set up: • Spot day calculations • Manual charges • Cashflow and transaction charge rules • Branch codes. See Appendix A Features on page 713. 5.1.5.2 Deal capture 5.1.5.2.1 Input data Substitution transactions are always created by executing a Substitution action from an outstanding repo or earlier substitution deal. This action can be triggered from one of the following places: • Transaction view of Transaction Manager (for all collaterals of the transaction). • Repo view of Transaction Manager (for a specific collateral). • Collateral view of Collateral Valuation Board (for a specific collateral). When the action is triggered from Transaction view of Transaction Manager, any number of existing collateral holdings can be substituted in the same substitution action from a multi-collateral repo. In Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 367 5 Security lending 5.1 Repurchase agreement the other two views, this action is executed from a specific collateral holding and only that collateral is substituted. In all cases, old collateral can be substituted for new collateral in one or several collateral instruments. 5.1.5.3 Processing This section describes the actions that can be done throughout the life of a repo transaction. 5.1.5.3.1 Substitution Substitution action is available if the remaining collateral amount of at least one of the collateral instruments is greater than zero and if the collateral agreement of the transaction allows substitutions. Required input data for the substitution is given in the action dialog and in the new transaction created by the action in the Repo view of Transaction Manager. • Setup The collateral agreement defines whether the Substitution action is enabled (Collateral Agreement Editor - Substitution page). See the TRM User Guide for more information about collateral agreements. • Execution When the Substitution action is selected from the right-click menu, the system opens one of two dialogs depending on whether single or multiple old collateral instruments are affected by the substitution. If the action is executed from Transaction view of Transaction Manager and multiple collateral instruments with remaining collateral amount greater than zero are found, you must provide the following information. Information Description Opening Date Opening Date of the substitution transaction. This is defaulted as current date or, if given before selecting the action, as fixing/action date of the underlying transaction. Value Date Value Date of the substitution transaction. This is defaulted as opening date adjusted with spot days of the substitution instrument identified in the collateral agreement of the underlying transaction. Substitution Method Method used to calculate the value of substituted collateral. This is defaulted as the method identified in the Collateral Agreement of the underlying transaction as one of the following: • Original Collateral Value Original value of old collateral in the underlying transaction is used to calculate required amount of new collateral • Current Collateral Value Current value of old collateral calculated by using the latest available collateral market price is used to calculate required amount of new collateral. If only one collateral instrument with the remaining collateral amount greater than zero is found, the dialog contains the following additional fields. Information Description Substitution Collateral (Information only.) The collateral instrument of the old collateral. Amount Amount of old collateral. This is defaulted to the full remaining collateral amount but can be modified to any smaller amount. 368 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement Information Description Units Units of old collateral if collateral instrument has been set up with trading units. Market Rate This field is used to identify current market yield of the collateral instrument if the substitution method Current Collateral Value is used. Market Price This field is used to identify current market price of the collateral instrument if the substitution method Current Collateral Value is used. Accepting the dialog creates a new substitution transaction which must be completed by adding the new collateral delivered against the substituted collateral in Repo view of Transaction Manager. – If the action is executed from Collateral Valuation Board, a Transaction Manager application in which the substitution transaction is created is opened automatically. – If the action is executed from Transaction view of Transaction Manager for more than one old collateral instrument, you can modify defaulted collateral amount/units of each collateral to a smaller value in case of a partial substitution, or delete one or several of the old collaterals to restrict the substitution to a subset of collaterals. If the substitution method Current Collateral Value is used, you can also adjust defaulted collateral market prices of old collaterals. After this, you can add the first new collateral using the New Collateral action. When the first new collateral is added, the old collateral is frozen and can no longer be modified. – If the action was executed for a single old collateral instrument, the system freezes the old collateral and creates the first new collateral automatically. After the first new collateral has been manually or automatically created, you can finalize the transaction by giving the details of new collateral delivered against the substituted collateral as follows: Information Description Collateral Instrument Instrument (bonds, discount papers, and additionally cash collateral account) to be used as collateral. Only instruments with the Collateral feature (A.2.93 Collateral on page 755) attached and not flagged as ineligible in collateral haircut definition of the selected collateral agreement are available for selection. For information about the collateral instrument setup, 5.1.4 Collateral on page 365. Collateral Market Price Market price of the collateral instrument. This price can be defaulted by the system when the feature Quote Default (Collateral) is used. See A.2.269 Quote Default (Collateral) on page 673. Collateral Amount Amount of the collateral. Collateral Units Number of units of the collateral if collateral instrument has been set up with Trading Units. When new collateral is added to a substitution transaction, it behaves like a cash-driven repo transaction. The system sets the nominal amount of the transaction as the value of old collateral and automatically calculates the required collateral amount/units of new collateral based on collateral market price as soon as the collateral instrument has been selected. Note: The Collateral Calculation Method always defaults to Multiple in substitution transactions, but it can be manually set to Single to affect calculations resulting from a manual adjustment of collateral amount in the last new collateral of the substitution transaction in the same manner as in a cash-driven repo transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 369 5 Security lending 5.1 Repurchase agreement 5.1.6 Margin movement A margin movement transaction (a margin call) is required when exposure exceeds the threshold defined in a collateral agreement and an additional deposit of collateral is required. Note: Managing collateral is described in the TRM User Guide. 5.1.6.1 Instrument setup Margin movement instruments must be based on an instrument type derived from the class MARGIN-MOVEMENT. • Main characteristics Margin movement instruments do not require any specific set up. They are simply recognized by the following feature in the Margin Movement instrument class: – • The primary feature Margin-Movement (see A.2.229 Margin Movement on page 827). Collateral Quote defaulting If feature Quote Default (Collateral) is selected for a margin instrument, current market price or yield is automatically defaulted according to the setup of the feature to fields collateral market price or collateral market rate of a new collateral entry in a margin transaction as soon as a new collateral instrument has been selected. See A.2.270 Quote Default (Collateral) on page 847. • Collateral Agreement definition It is possible to set up collateral agreement to be used in transactions at instrument level. Information Description Agreement If defined, this collateral agreement is defaulted to all new transactions. The defaulted agreement can be changed to any other valid collateral agreement in Transaction Manager. If not defined, collateral agreement is defaulted according to collateral agreement setup given in Client Editor for the owner of the transaction. See A.2.95 Collateral Setup on page 756. It is also possible to set up: • Spot day calculations • Manual charges • Cashflow and transaction charge rules • Branch codes. See Appendix A Features on page 713. 5.1.6.2 Deal capture Margin movements can be made for an indefinite maturity against overall exposure of a counterparty under a specific collateral agreement (Open Margin) or for the remaining maturity of a specific repo transaction against the exposure of that particular repo (Margin). 5.1.6.2.1 Input data - Open Margin Open Margin transactions are independent new transactions that can be captured in Transaction Manager or through the Open Margin Movement action in Collateral Position view of Collateral Valuation Board. 370 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement Capturing an open margin transaction directly in Transaction Manager is very similar to capturing a new repo transaction. Margin movements are normally made to deliver a specific value of collateral required to bring the total value of collateral in balance with the value of underlying exposure it is securing. Consequently, transactions are typically entered in a cash-driven manner where the target value of margin collateral is given as nominal amount of the transaction before identifying the collateral. It is also possible to enter an open margin transaction in a collateral-driven manner. In addition to the standard deal parameters, the following information is required, if you want to capture a margin call directly in Transaction Manager. • Transaction view Information Description Nominal Amount Value of the margin collateral. If the nominal amount is not given, the system automatically calculates it based on collateral amounts and collateral market prices of the selected collateral instruments. Collateral Agreement Collateral agreement of the margin call. If the agreement is not defined at the instrument level, it is defaulted according to collateral agreement definition given in Client Editor for the Owner of the transaction. You can change the default agreement to any other valid collateral agreement for the counterparty of the repo. Collateral agreement specifies various conditions applied for the margin call transaction including: • • Currency • Total Collateral Haircut • Eligible collateral. Repo view In this view, you can add collateral to the open margin transaction by click New Collateral from the right-click menu. Information Description Collateral Instrument Instrument (bonds, discount papers, and additionally cash collateral account) to be used as collateral. Only instruments with the Collateral feature (A.2.93 Collateral on page 755) attached and not flagged as ineligible in Collateral Haircut definition of the selected collateral agreement are available for selection. For information about the collateral instrument setup, 5.1.4 Collateral on page 365. Collateral Market Price Market price of the collateral instrument. This price can be defaulted by the system when the feature Quote Default (Collateral) is used. See A.2.270 Quote Default (Collateral) on page 847. Collateral Amount Amount of collateral If the nominal amount was given in the transaction, the system calculates the required amount of the collateral automatically based on the above transaction and repo attributes, as well as valuation haircut of the collateral instrument assigned automatically by the system according to the setup of the selected collateral agreement. If multiple margin collateral is delivered against a target value identified in nominal amount of transaction, the collateral amount of the first collateral must be manually adjusted down to the correct amount before adding a new collateral in Repo view by clicking New Collateral in the right-click menu. Collateral Units Units of collateral if the collateral instrument is set up with Trading Units. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 371 5 Security lending 5.1 Repurchase agreement Note: As in substitutions, the Collateral Calculation Method always defaults to Multiple, but can be manually set to Single to affect calculations resulting from a manual adjustment of collateral amount in the last new collateral of the margin transaction in the same manner as in a cash-driven repo transaction. 5.1.6.2.2 Generated data • • • Transaction Type = Margin or Open Margin: – If a specific maturity date is specified (maturity date of the underlying repo transaction), Transaction Type = Margin. – If the maturity date is not specified at deal entry, Transaction Type = Open Margin. Collateral Amount – If the amount is input at deal entry, the collateral amount (nominal amount) is calculated from the collateral instrument/market price and valuation haircut. – The calculation of the collateral amount also takes into account the contract size of the collateral. Collateral Amount Rounding – If margin is received, the collateral amount is rounded up. – If margin is given, the collateral amount is rounded down. 5.1.6.3 Processing 5.1.6.3.1 Open Margin Movement • Execution If an open margin transaction is created using Open Margin Movement action from Collateral Position view of Collateral Valuation Board, a dialog with following fields is opened: Information Opening Date Description Opening date of the open margin transaction. Defaulted to the current date but can be modified to any other valid date. Value Date Value date of the open margin transaction. Defaulted to the opening date adjusted with spot days of the margin instrument identified in the collateral agreement of the collateral position but can be modified to any other valid date. Portfolio Portfolio of the open margin transaction. Defaulted to the portfolio of the collateral position but can be modified to any other valid portfolio. Counterparty Counterparty of the open margin transaction. Defaulted to the counterparty of the collateral position and cannot be changed. Collateral Agreement Collateral agreement of the open margin transaction. Defaulted to the collateral agreement of the collateral position and cannot be changed. Sign Transaction sign of the open margin transaction. Default according to the action in the column Collateral Action of the collateral position and cannot be changed. Currency (Information only.) Currency of the open margin transaction. Defaulted to the currency of the collateral position. 372 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement Information Description Value Target value of the margin collateral. Defaulted based on cover difference of the collateral position and can be modified to any other value larger than minimum movement value of the collateral agreement of the collateral position. When the dialog is accepted, a Transaction Manager application is opened and a new open margin transaction with the first new collateral is automatically created in it. You can then finalize the transaction by giving the details of margin collateral normally in Repo view of Transaction Manager. Since open margin transactions are for an indefinite period of time, return of the margin collateral does not happen automatically, you must create a separate margin return transaction must be created when you want the margin collateral to be returned. Also, all future cashflows of fixed income securities, including both coupons and principal repayments, are created in the open margin transactions to support settlements of these flows both against the issuer or clearing client of the security and against the counterparty of margin transaction. • Cancellation You can undo this action by canceling the open margin movement transaction. 5.1.6.3.2 Margin Movement Margin transactions are always created by using the Margin Movement action from an outstanding repo transaction either in Transaction Manager or in Collateral Position view of Collateral Valuation Board. • Execution If the action is selected directly from an existing repo transaction in Transaction Manager, the action dialog contains the following fields and default values: Information Description Opening Date Opening date of the margin transaction. Defaulted to the current date or, if given before selecting the action, as fixing/action date of the underlying transaction but can be modified to any other valid date Value Date Value date of the margin transaction. Defaulted to the opening date adjusted with spot days of the margin instrument identified in the collateral agreement of the underlying transaction but can be modified to any other valid date Sign Transaction sign of the margin transaction. Defaulted to +1 (i.e. collateral received from margin call). Currency Currency of the margin transaction. Defaulted to the currency of the collateral agreement of the underlying transaction and cannot be changed. Value Target value of the margin collateral. Defaulted to the minimum movement value of the collateral agreement of the underlying transaction but can be modified to any higher value. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 373 5 Security lending 5.1 Repurchase agreement If the action is selected from Collateral Position view (grouped by Collateral Number) of Collateral Valuation Board, the action dialog is slightly different: Information Description Opening Date Opening date of the margin transaction. Defaulted to the current date but can be modified to any other valid date Value Date Value Date of the margin transaction. Defaulted to the opening date adjusted with spot days of the margin instrument identified in the collateral agreement of the collateral position but can be modified to any other valid date. Collateral Number (Information only.) Transaction number of the repo transaction underlying the collateral position. This is defaulted as collateral number of the collateral position. Sign (Information only.) Transaction sign of the margin transaction. Default according to the action in the column Collateral Action of the collateral position. Currency (Information only.) Currency of the margin transaction. Defaulted to the currency of the collateral agreement of the collateral position. Value Target value of the margin collateral. This is defaulted based on cover difference of the collateral position and can be modified to any other value larger than minimum movement value of the collateral agreement of the collateral position. Note: If the action was executed from Collateral Valuation Board, a Transaction Manager application in which the margin call transaction is created is opened automatically. In both cases, a new margin transaction with the first new collateral is automatically created. You can then finalize the transaction by giving the details of margin collateral normally in Repo view of Transaction Manager. Since margin transactions are for the specific remaining maturity of the underlying repo transaction, return of the margin collateral happens automatically on the maturity date of the underlying repo. Also, coupons and principal repayment cashflows of fixed income securities are only created if they are due for payment before the maturity of the underlying repo transaction. • Cancellation You can undo this action by canceling the margin movement transaction. 5.1.6.3.3 Margin Return A separate margin return (of an earlier margin call) transaction is required when margin collateral must be returned in an unscheduled manner. This is always true when returning margin collateral delivered in an earlier open margin transaction and when the collateral received in a margin transaction must be returned before the scheduled return on the maturity date of the underlying repo transaction. Margin return transactions can only be created using a margin return action from Collateral view of Collateral Valuation Board for a margin collateral holding in a specific collateral instrument. The logic for Margin Return is exactly the same as for Open Margin Return. • 374 Execution © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement When an Open Margin Return or Margin Return action is selected in the Collateral view of Collateral Valuation Board, a dialog with following fields is opened: Information Description Opening Date Opening date of the margin return transaction. Defaulted to the current date but can be modified to any other valid date Value Date Value date of the margin return transaction. Defaulted to the opening date adjusted with spot days of the margin instrument identified in the Collateral Agreement of the underlying margin transaction(s) but can be modified to any other valid date Portfolio Portfolio of the margin return transaction. Defaulted to the portfolio of the underlying margin transaction(s) and cannot be changed. Counterparty Counterparty of the margin return transaction. Defaulted to the counterparty of the underlying margin transaction(s) and cannot be changed. Collateral Agreement Collateral agreement of the margin return transaction. Defaulted to the collateral agreement of the underlying margin transaction(s) and cannot be changed. Sign Transaction Sign of the margin return transaction. Defaulted to the opposite of the sign of the underlying margin transaction(s) and cannot be changed. Currency Currency of the margin return transaction. Defaulted to the currency of the collateral agreement of the underlying margin transaction(s) and cannot be changed. Collateral Currency Currency of the margin collateral instrument. Defaulted to the currency of the collateral instrument of the underlying margin transaction(s) and cannot be changed. FX Rate FX Rate used to convert value of collateral instrument from collateral currency to Currency of the collateral agreement. Defaulted to the current FX spot rate between collateral currency and currency but can be modified to any other rate when collateral currency and currency are not the same. Instrument Collateral instrument being returned. Defaulted to the collateral instrument of the underlying margin transaction(s) and cannot be changed. Collateral Amount Amount of collateral to return. Calculated by the system as the smallest deliverable of the collateral amount with adequate collateral value to match total collateral value to return, but can be modified to any other deliverable amount less than total collateral amount of the underlying margin transaction(s). Collateral Units Units of collateral to return when collateral instrument has been set up with trading units. Collateral Market Price Current market price of collateral instrument. Collateral Market Rate Current market yield of collateral instrument. Cover Value Cover value of the identified collateral amount of the collateral instrument. Calculated by the system using collateral amount, collateral market price and valuation haircuts as defined in the collateral agreement. This value can be modified to any other value, in which case the new collateral amount is calculated accordingly. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 375 5 Security lending 5.1 Repurchase agreement Information Description Total Cover Value To Return (Information only.) Total cover value required to be returned to correct over-collateralization of the collateral position. Defaulted to the cover difference of collateral position. Cover Difference The difference between cover value and total cover value to return. This value is informative only and can be used to check whether cover value of selected collateral to be returned is sufficient. A negative value indicates that more collateral must be returned to correct over-collateralization of the collateral position. When the dialog is accepted, a Transaction Manager application is opened, all underlying margin or open margin transactions affected by the margin return are identified and a new margin return transaction is created, returning the given amount of collateral and closing the current margin or open margin transaction. The new transaction is completed with the data given in the dialog and can be applied and accepted forward in the flow directly. • Cancellation You can undo this action by canceling the margin return transaction. 5.1.7 Cash Collateral Cash can also be used as collateral for an underlying exposure in a collateral agreement. Cash collateral is delivered in a similar manner to security collateral in margin movement transactions (margin calls). Cash collateral is managed in the system as balances with ability to accrue interest. The general characteristics of cash collateral account transactions are the same as those of call Account transactions. See 8.2 Call account on page 446. 5.1.7.1 Instrument setup Cash collateral instruments must be based on an instrument type derived from the class CASH-COLLATERAL-ACCOUNT. • Main characteristics The following basic information may be captured when defining a cash collateral account instrument. Information Description Currency Currency of the cash collateral account. Balance Minimum and maximum balance allowed on the cash collateral account. information Notice period information • Required notice period for cash movements. Interest accrual parameters For cash collateral accounts, you can specify the interest rates used, and the method and frequency that interest is accrued on the cash collateral account. • Interest realization parameters You can also specify how the accrued interest is realized on the cash collateral account. See A.2.90 Cash Collateral Account on page 752. It is also possible to set up: 376 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement • Spot day calculations • Collateral • Manual charges • Cashflow and transaction charge rules • Branch codes. See Appendix A Features on page 713. 5.1.7.2 Deal capture Cash collateral account transactions are made for an indefinite maturity either against overall exposure of a counterparty under a specific collateral agreement (Open Cash Collateral) or against the exposure of a particular repo operation (Cash Collateral). In order to be able to use cash collateral in a collateral agreement, at least one cash collateral instrument must be identified as eligible collateral in the agreement. 5.1.7.2.1 Input data – Open Cash Collateral New Open Cash Collateral (Account) transactions as well as new movements in existing transactions can be captured and managed in Cash Collateral applications in a similar manner to call accounts. New transactions and movements can also be created using actions from the Collateral Position view in Collateral Valuation Board. Capturing an Open Margin transaction directly in a Cash Collateral Account application is almost identical to capturing a call account transaction. The only difference is that a cash collateral transaction must always be attached to a collateral agreement. Open Cash Collateral transactions are not linked to an existing collateral number, but always attached to a collateral agreement. In addition to the standard deal parameters, the following information is required if you want to capture a new cash collateral account in a Cash Collateral Account application. • • Transaction view Information Description Movement / Initial Balance Initial cash movement (inflow or outflow) on the cash collateral account. Collateral Agreement Collateral Agreement of the cash collateral account. This amount can be zero if you want to open a cash collateral account without any initial movement of cash. Movement view In this view, you can add a cash collateral movement to an existing transaction using the New Movement action. Information Description Opening Date Opening date of the new movement. Value Date Value date of the new movement. This is set automatically by the system based on opening date and notice period setup of the instrument but can be manually changed to a different date. Amount Amount of the new movement. 5.1.7.2.2 Input data – Cash Collateral New Cash Collateral Account transactions targeting specific repos as well as new movements in them are always captured using actions either from the repo transaction in Transaction Manager or in the Collateral Valuation Board. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 377 5 Security lending 5.1 Repurchase agreement If the Cash Collateral action is selected directly from an existing repo transaction in Transaction Manager, the action dialog contains the following fields and default values: Information Description Opening Date Opening date of the cash collateral transaction or movement. Defaulted to the current date or, if given before selecting the action, as fixing/action date of the underlying transaction but can be modified to any other valid date. Value Date Value Date of the cash collateral transaction or movement. Defaulted to the opening date adjusted with spot days of the selected cash collateral instrument but can be modified to any other valid date. Margin Instrument Instrument used for the cash collateral transaction or movement. Manually select one of the eligible cash collateral instruments in the collateral agreement of the underlying repo transaction. Sign Transaction sign of the margin transaction. Defaulted to +1 (i.e. cash collateral given from margin call). Currency Currency of the margin transaction. Defaulted to the currency of the collateral agreement of the underlying repo transaction and cannot be changed. Amount Amount of the cash collateral movement. Defaulted to the minimum movement value of the collateral agreement of the underlying repo transaction but can be modified to any higher value. 5.1.7.3 Processing 5.1.7.3.1 Open Cash Collateral • Execution A cash Collateral transaction or movement can be created through the Open Cash Collateral action from Collateral Position view of Collateral Valuation Board. The following dialog is displayed: Information Opening Date Description Opening date of the cash collateral transaction or movement. Defaulted to the current date but can be modified to any other valid date. Value Date Value date of the cash collateral transaction or movement. Defaulted to the opening date adjusted with spot days of the selected cash collateral instrument but can be modified to any other valid date. Portfolio Portfolio of the cash collateral transaction or movement. Defaulted to the portfolio of the collateral position but can be modified to any other valid portfolio. Counterparty Counterparty of the cash collateral transaction or movement. Defaulted to the counterparty of the collateral position and cannot be changed. Collateral Agreement Collateral agreement of the cash collateral transaction or movement. This is defaulted as the collateral agreement of the collateral position and cannot be changed. Margin Instrument Instrument used for the cash collateral transaction or movement. This must be manually selected as one of the eligible cash collateral instruments in the collateral agreement. 378 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.1 Repurchase agreement Information Description Sign Sign of the cash collateral transaction or movement. Default according to the action in the column Collateral Action of the collateral position and cannot be changed. Currency (Information only.) Currency of the cash collateral transaction or movement. Defaulted to the currency of the collateral position. Amount Amount of the cash collateral movement. Defaulted according to the cover difference of the collateral position and can be modified to any other value larger than minimum movement value of the collateral agreement of the collateral position. When the dialog is accepted, a Cash Collateral Account application opens, usually Cash Collateral Account Trading (default setup). If the system cannot find an existing cash collateral transaction that matches the following values with those given in the dialog, a new cash collateral transaction with a first movement is automatically created: – Portfolio – Counterparty – Collateral Agreement – Margin Instrument – Currency. If an existing transaction is found, a new movement is added to the identified cash collateral transaction. There is no separate return of the cash collateral. Instead, both positive and negative movements of cash can be made in the same cash collateral transaction using the same functionality. • Cancellation To undo this action cancel the new movement, or if a new account transaction was created, cancel the whole transaction. 5.1.7.3.2 Cash Collateral • Execution If the Cash Collateral action is selected from Collateral Position view (grouped by Collateral Number) of Collateral Valuation Board, the dialog is the same as the Open Cash Collateral dialog with the following additions: Information Description Return Date Scheduled return date of the cash collateral. Defaulted to the maturity date of the underlying repo transaction and cannot be changed. The field is informative only and indicates the date as of which the underlying exposures is scheduled to expire. Collateral Number Transaction number of the repo transaction underlying the collateral position. Defaulted to the collateral number of the collateral position and cannot be changed. When the dialog is accepted in Transaction Manager or in Collateral Valuation Board, a Cash Collateral Account application opens, usually Cash Collateral Account Trading (default setup). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 379 5 Security lending 5.2 Security loan If the system cannot find an existing cash collateral transaction that matches the following values with those given in the dialog, a new cash collateral transaction with a first movement is automatically created. – Portfolio – Counterparty – Collateral Agreement – Margin Instrument – Currency – Collateral Number. If an existing transaction is found, a new movement is added to the identified cash collateral transaction. There is no automatic return of the cash collateral on the maturity date of the underlying repo transaction, therefore you must create a separate cash collateral movement in the Cash Collateral Account application when the cash is returned. Cancellation • To undo this action cancel the new movement, or if a new account transaction was created, cancel the whole transaction. 5.2 Security loan A security loan is a transaction in which a given interest-bearing or equity security is lent against a financial compensation. The loan is agreed for an open-ended transaction. Security loans impact only custody movements and balances. The actual security positions for purposes of valuation and accounting, for example, are not impacted. Coupons and dividends are also calculated without considering the security loan transactions. 5.2.1 Instrument setup Security loan instruments must be based on an instrument type derived from the class SECURITY-LOAN. The ALLOW-SECURITY-LOAN feature (see A.2.19 Allow Security Loan on page 721) specifies if the instrument can be loaned. 5.2.2 Deal capture 5.2.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a securities loan: Information Description Secondary Instrument The security being lent (bond or equity). Nominal Amount or Trading Unit nominal amount (bond) or trading unit (equity) to be lent out. Nominal Spot/Rate Lending fee. Currency Currency of instrument. 380 © Wall Street Systems IPH AB - Confidential 5 Security lending 5.2 Security loan 5.2.3 Processing This section describes the actions that can be taken throughout the life of a security loan. 5.2.3.1 Entering security loan fees A security loan fee can be entered at any time by selecting the Security Loan Fee action. • Execution The following information is required: • Information Description Direction Fee direction (In or Out). Amount Fee amount. Opening Date Fee opening date. Value Date Fee value date. Payment Date Fee payment date. From When Date Date from which fee payment is based. Cancellation An Undo Security Loan Fee action is available for undoing (deleting) selected fees. 5.2.3.2 Cutting a security loan transaction The security loan can be cut (matured) by selecting the Security Loan Cut action. • Execution The following information is required: • Information Description Opening Date Date of execution, used as opening date. Value Date Closing date of the transaction. Fee Direction In or Out. Fee Amount Amount. Fee Opening Date Fee opening date. Fee Value Date Fee value date. Fee Payment Date Fee payment date. Fee From When Date Date from which fee payment is based. Cancellation An Undo Security Loan Cut action is available to undo (delete) a captured cut. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 381 5 Security lending 5.2 Security loan 382 © Wall Street Systems IPH AB - Confidential Chapter 6 Forex 6.1 FX spot and FX forward In the foreign exchange market, buyers and sellers conduct foreign exchange (FX) transactions. A currency spot or forward transaction is a deal where one currency is exchanged for another (a base currency and a quote currency). If the value date is the spot date, then the transaction is called a spot deal. If the value date is further in the future, the transaction is a forward. Non-deliverable forwards (NDFs) are FX forward deals that can have a net settlement. Spot rates are quoted as one unit of the base currency against a number of units of the quote currency. In international financial markets, the US dollar is used as the base currency in most quotes. A direct quote is a foreign exchange rate quoted as the domestic currency per unit of the foreign currency. For example, in the US, a direct quote for Japanese yen would be USD/JPY. Conversely, in Japan, a direct quote for US dollars would be JPY/USD. An indirect quote is a foreign exchange rate quoted as the foreign currency per unit of the domestic currency. For example, in the US, an indirect quote for Japanese yen would be JPY/USD. Conversely, in Japan, an indirect quote for US dollars would be USD/JPY. In TRM, FX spot and forward transactions belong to the instrument class FX. 6.1.1 Instrument setup FX spot/forward instruments are based on an instrument type derived from the class FX. • Rate defaulting You can specify that you expect the system to default the rates from the market at deal entry. See A.2.272 Quote Default (FX) on page 848. • Currency information You can specify the currencies of the FX transaction either in the instrument setup or at deal entry. See A.2.192 FX Setup on page 806. • Date information It is possible to set up value date information at instrument level. Information Description Calendar parameters Calendars used to calculate the value date. Gap Set Gap set used for supplying the available value periods. Value Date Period If defined, this value period is applied to each transaction. For an FX instrument, it is also possible to set up: • Spot date calculation Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 383 6 Forex 6.1 FX spot and FX forward Note that it is recommended that you do not specify the spot days in the instrument setup as these are taken by default from the spot days of the two currencies at deal entry. • Cashflow and transaction charge rules • Manual charges • Branch codes • FX Margin Result. See Appendix A Features on page 713. The attributes required for the different types of FX instrument are described in the following sections. 6.1.1.1 FX forward FX forward instruments are set up in a similar way to FX spot instruments. To calculate forward points from currency pairs interest rates, you can specify additional parameters such as Absolute IR Difference. See A.2.175 FX Forward on page 797. 6.1.1.2 Non-deliverable forward (NDF) NDFs are FX forward deals that can have a net settlement. NDFs are set up in a similar way to FX forward instruments. NDFs should use the primary feature Non Deliverable Forward FX Instrument. See A.2.248 Non Deliverable Forward FX Instrument on page 837. 6.1.1.3 FX cross deal An FX spot/forward deal where neither currency is the portfolio base currency is called a cross deal. FX cross deals are set up in a similar way to FX spot/forward instruments, with the following additional parameters: • FX cross rate calculation You need to define how the FX rates (Base Spot FX and Base FX Rate) are calculated. See A.2.171 FX Cross Method on page 796. 6.1.2 Market information 6.1.2.1 Currencies Some additional parameters need to be defined for the currencies which are relevant to your FX transactions: see the TRM User Guide. 6.1.2.2 Quotations and market information Quotations for currencies can be viewed and modified in Rate Monitor. It is possible to define market information feeds for each currency (for example, from Reuters): see the TRM User Guide. 6.1.3 Deal capture 6.1.3.1 Input data • 384 FX spot © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward In addition to the standard deal parameters, the following information is required to enter an FX spot transaction: Information Description Base Currency Base currency of the transaction. (Currency) Quote Currency Quote currency of the transaction. (Currency 2nd) FX Base Amount Amount of the FX transaction in the base currency. FX Quote Amount Amount of the FX transaction in the quote currency. Deal Rate Final FX rate of the transaction = Nominal / Spot Rate + FX Forward Points (+ Margins if applicable) • FX forward (input forward points) In addition to the standard deal parameters, the following information is required to enter an FX forward transaction where the forward points are input manually: Information Description Base Currency Base currency of the transaction. (Currency) Quote Currency Quote currency of the transaction. (Currency 2nd) Value Date Official date when money is transferred. FX Base Amount Amount of the FX transaction in the base currency. FX Quote Amount Amount of the FX transaction in the quote currency. Nominal/Spot Rate Final FX spot rate. FX Forward Points Forward points for the transaction. Deal Rate Final FX rate of the transaction = Nominal / Spot Rate + FX Forward Points (+ Margins if applicable) • FX forward (calculated forward points) In addition to the standard deal parameters, the following information is required to enter an FX forward transaction where the forward points are calculated from Base Currency Interest % and Quote Currency Interest %: Information Description Base Currency Base currency of the transaction. (Currency) Quote Currency Quote currency of the transaction. (Currency 2nd) Value Date Official date when money is transferred. FX Base Amount Amount of the FX transaction in the base currency. FX Quote Amount Amount of the FX transaction in the quote currency. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 385 6 Forex 6.1 FX spot and FX forward Information Description Nominal/Spot Rate Final FX spot rate. Base CCY Interest % Interest rate of the base currency for the period from the opening date to the value date. Quote CCY Interest % Interest rate of the quote currency for the period from the opening date to the value date. 6.1.3.2 Generated data • Cashflows The figure below illustrates the cashflows which are established in TRM for an FX spot transaction. The figure below illustrates the cashflows which are established in TRM for an FX forward transaction: The figure below illustrates the cashflows which are established in TRM for a non-deliverable forward transaction: The following section describes the cashflows when the feature FX Margin Result is used. FX Margin Result creates one cashflow of type Margin with following characteristics: Currency = quote currency Active From = Opening date of the transaction Value Date; Payment Date; From When; Until When; Active To = Value date of the transaction Fixing Rate; Fixing Quote = Spot Margin + Forward Margin Amount = transaction quote amount - quote amount we would have had without any margin 386 © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward 6.1.4 Processing This section describes the actions that can be done throughout the life of an FX transaction. 6.1.4.1 Early expiration You can force FX transactions to mature earlier than their value date. This process is referred to as early expiration. • Execution The following information is needed to process the early expiration: Information Description Early Expiration Date Date when the early expiration is executed. Value Date Date when the early expiration is settled. This cannot be later than the maturity date of the initial transaction. Amount to Expire Amount to be early-expired. This defaults to the amount left and is expressed in the same currency (base or quote) as the input amount of the initial transaction. You can enter any amount between 0 and the remaining amount of the initial transaction. Currency The currency in which the above amount is expressed, can be base or quote currency depending on the initial transaction. (Read-only.) Forward Points Forward points of the early expiration transaction. This defaults to the number of forward points between the early expiration date and the maturity date of the initial transaction. Deal Rate Deal rate for the early expiration transaction. By default, this is today’s date unless a Fixing/Action Date is specified at transaction level. Deal Rate = Original Deal Rate - Forward Points Original Deal Rate The deal rate of the initial transaction. (Read-only.) Quote Amount The corresponding amount of the transaction. Quote Currency Shows the currency of the deal. The currency can be quote or base depending on default Currency. The execution generates an early expiration transaction with the following attributes: If the original input amount was FX Base Amount: FX base amount = amount to expire If the original input amount was FX Quote Amount: FX quote amount = amount to expire Deal Rate = early expiration deal rate Opening date = date when the early expiration is done Value date = date when the early expiration is settled Kind = Early Expiration The remaining attributes are inherited from the initial transaction. • Cancellation You can undo the early expiration by canceling the early expiration transaction. • Redo You can redo the action on the generated transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 387 6 Forex 6.1 FX spot and FX forward 6.1.4.2 Early expiration of NDFs You can force netted non-deliverable forwards to mature earlier than their value date. • Execution The following information is needed to process the early expiration of netted NDFs: Information Description Early Expiration Date Date when the early expiration is executed. By default, this is today's date unless a Fixing/Action Date is specified at transaction level. Value Date Date when the early expiration is settled. This cannot be later than the maturity date of the initial transaction. Base Currency Base currency of the transaction (information). Base Amount Left Amount left in base currency (information). Base Amount to Expire Defaults to the base amount left. (Modifiable if the initial deal was entered in base currency.) You can enter any amount between 0 and the amount left. Quote Currency Quote currency of the transaction (information). Quote Amount Left Amount left in quote currency (information). Quote Amount to Expire Defaults to the base amount left. (Modifiable if the initial deal was entered in base currency.) You can enter any amount between 0 and the amount left. Original Deal Rate The forward rate on the original NDF (information). FX Forward Rate The forward market rate at the date of Early Expiration. You can enter a different rate agreed with the counterparty. Netting Currency The currency in which the netting is calculated, either base or quote. (This is copied from the original deal and depends on the netting method specified on the instrument.) Forward Netting Amount Amount corresponding to the difference between the initial deal rate and the current forward rate (information). Discount Rate This is the rate to be used to discount the Forward Netting Amount to calculate the netting amount. (Modifiable) Netting Amount Amount to be settled, calculated as previously explained. The following fields are only visible if the initial NDF can be settled in a different currency to the netting currency. Information Description Settlement Currency Currency to use for settlement (information) Settlement FX Rate Cross rate between netting currency and settlement currency at settlement date (can be modified) Settlement Amount Final amount to be settled Early expiring a netted NDF results in the following: – All cashflows are closed at the original transaction’s maturity – A single netting cashflow is created at the early expiration date, where Amount = FX netting at maturity discounted to the early expiration date. The netting amount is calculated using the date basis and rate type defined for the interpolation method of the currency’s default curve. • 388 Redo © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward You can redo the action on the generated transaction. 6.1.4.3 Roll over You can defer the maturity of an FX transaction to a later date. This process is referred to as roll-over. See A.2.11 Allow Roll Over (FX) on page 717. • Execution If the Spot Rate for the roll-over equals the Original Deal Rate, the following information is needed to process the roll over: Information Description Roll Over Date Date when the roll over is done. The opening date of the roll over transaction. Value Date Value date of the roll over transaction. This corresponds to the maturity date of the initial transaction. Maturity Code Gap to add to the value date to calculate the maturity date. Maturity Date New maturity date of the FX deal. This must be later than the maturity date of the initial transaction. This defaults to the maturity code of the initial transaction. Amount Left Remaining amount of the initial transaction. (Read-only.) Amount Amount to roll over defaults to the amount left and is expressed in the same currency (base or quote) as the input amount of the initial transaction. You can enter any amount between 0 and the remaining amount of the initial transaction. Currency Shows the currency of the amount to roll over. The amount is expressed in either base or quote currency depending on the initial transaction. (Read-only.) The execution generates a roll over transaction with the following attributes: If the original input amount was FX Base Amount: FX Base amount = amount to roll over If the original input amount was FX Quote Amount: FX Quote amount = amount to roll over Deal Rate = roll over deal rate Opening Date = date when the roll over is done Maturity Date = new maturity date Kind = Roll Over The remaining attributes are inherited from the initial transaction. If the Spot Rate for the roll-over is different from the Original Deal Rate, the following additional information is needed to process the roll over and settle the subsequent difference: Information Description Settle Differential By default, this switch is off: the Spot Rate for the roll over is equal to the Original Deal Rate. Switch on if the Spot Rate for the roll-over is different from the Original Deal Rate. If this switch is on: the Spot Rate (see below) defaults to the spot rate of the market but can be modified. The roll over generates a netting cashflow to handle the settlement of the difference. Original Deal Rate The deal rate of the initial transaction. (Read-only.) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 389 6 Forex 6.1 FX spot and FX forward Information Description Spot Rate Exchange spot rate of the roll over. This defaults to the Original Deal Rate. If Settle Differential is activated (see above), this field becomes available. The Spot Rate defaults to the spot rate of the market but can be modified. Note: Roll Over Date, Value Date, Maturity Code, Maturity Date, and Settle Differential are adjusted automatically. Base CCY Interest % Interest rate of the base currency for the period from the original settlement date to the new settlement date. Quote CCY Interest % Interest rate of the quote currency for the period from the original settlement date to the new settlement date. Forward Points Forward points of the roll over transaction. This defaults to the number of forward points from the roll over date to the maturity date. Note: Roll Over Date, Value Date, Maturity Code, and Maturity Date are adjusted automatically. Deal Rate Deal rate for the roll over. • If the Spot Rate for the roll-over is equal to the Original Deal Rate: • If the Spot Rate for the roll-over is different from the Original Deal Rate: Deal Rate = Original Deal Rate + Forward Points Deal Rate = Spot Rate + Forward Points Quote Amount The corresponding amount of the roll over transaction. (Read-only.) Quote Currency Shows the currency of the deal. The currency can be quote or base depending on default Currency.(Read-only.) Clear Packaging Clears all packages from the roll over transaction. The execution generates a roll over transaction as before with an additional cashflow as follows: A netting cashflow is created to handle the settlement of the difference Value Date = Roll over value date Currency = Roll over currency 2 Amount = Base Amount * Original Deal Rate - (-Base Amount * Spot Rate) • Cancellation You can undo the roll over by canceling the roll over transaction. • Redo You can redo the action on the generated transaction. 6.1.4.4 Roll over with margins You can specify margins in case you roll over FX transactions. A.2.12 Allow Roll Over (FX - Margin Result) on page 718 • Execution If the Spot Rate for the roll-over margin equals the Original Deal Rate, the following information is needed to process the roll over: 390 Information Description Roll Over Date Date when the roll over is done. The opening date of the roll over transaction. Value Date Date of the roll over transaction. Corresponds to the maturity date of the initial transaction. Maturity Code Gap to add to the value date to calculate the maturity date. © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward Information Description Maturity Date Maturity date of the roll over transaction. Amount Left Remaining amount of the initial transaction. (Read-only.) Amount The amount you want to roll over, which can be any amount between 0 and the remaining amount of the initial transaction. Defaults to the amount left and is expressed in the same currency (base or quote) as the input amount of the initial transaction. Currency Shows the currency of the transaction. The amount is expressed in either base or quote currency depending on the initial transaction. (Read-only.) The execution generates a roll over transaction with the following attributes: If the original input amount was FX Base Amount: FX Base amount = amount to roll over If the original input amount was FX Quote Amount: FX Quote amount = amount to roll over Deal Rate = roll over deal rate Opening Date = date when the roll over is done Maturity Date = new maturity date Kind = Roll Over Margin The remaining attributes are inherited from the initial transaction. If the Spot Rate for the roll-over margin is different from the Original Deal Rate, the following additional information is needed to process the roll over and settle the subsequent difference: Information Description Settle Differential Switch on if the Spot Rate for the roll-over is different from the Original Deal Rate. By default, this switch is off. Original Deal Rate The deal rate of the initial transaction. (Read-only.) Spot Rate The spot rate of the roll over transaction. If Settle Differential is activated, this field becomes available. Spot Rate defaults to the spot rate of the market but this value can be modified. Note: Roll Over Date, Value Date, Maturity Code, Maturity Date, and Settle Differential are adjusted automatically. Spot Margin Margin to apply to the near leg of the roll over transaction. If Settle Differential is enabled, Spot Margin defaults to the price. Note: Settle Differential is adjusted automatically. Final Spot Rate (Read-only.) Spot rate including margins. If Settle Differential is activated, then Spot Rate + (Sign * Spot Margin / 10000) Forward Points Forward points of the roll over transaction. This defaults to the number of forward points from the roll over date to the maturity date. Note: Roll Over Date, Value Date, Maturity Code, and Maturity Date are adjusted automatically. Forward Margin Margin applied on the far leg of the roll over transaction. Deal Rate Deal rate for the roll over. Deal Rate = Spot Rate + Forward Points Quote Amount The corresponding amount of the roll over transaction. (Read-only.) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 391 6 Forex 6.1 FX spot and FX forward Information Description Quote Currency Shows the currency of the deal. The currency can be quote or base depending on default Currency.(Read-only.) The execution generates a roll over transaction as before with an additional cashflow as follows: A netting cashflow is created to handle the settlement of the difference Value Date = Roll over value date Currency = Roll over currency 2 Amount = Base Amount * Original Deal Rate - (-Base Amount * Spot Rate) • Redo You can redo the action on the generated transaction. 6.1.4.5 Netting Non-deliverable forwards (NDFs) are FX forward deals that can have a net settlement. Instead of exchanging principal amounts, the counterparties agree on the value date and the contractual spot rate. The difference between the actual spot rate and the contractual rate, multiplied by the nominal amount of the deal, is paid. See A.2.248 Non Deliverable Forward FX Instrument on page 837. • Setup The fixing parameters for the netting of non-deliverable forwards can be defined either at instrument level or at transaction level. Where the fixing parameters are defined depends on how narrow or open the instrument definition needs to be. The following information is required to set up netting for an NDF: Information Description Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Subscenario Subscenario from which the FX spot rate is retrieved. Calendar Calendar to use when calculating the fixing date. Netting Method Home Currency: When this method is used the netting currency is set to either base or quote, if one of those is equal to the portfolio currency; otherwise, it defaults to the base currency. • Execution The following information is needed to process the netting: Information Description Netting Date Date when netting is executed. Netting Currency Currency used to compute netting amount, either base or quote depending on instrument setup (read-only). Note: You can change the netting currency in the FX Netting Currency field in the Transaction view. 392 Other Currency Shows the other currency involved (read-only). Original Deal Rate The forward rate on the original NDF (read-only). FX Rate The current FX rate. © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward Information Description Netting Amount Amount to be settled calculated in netting currency. The following fields are only visible if the initial NDF can be settled in a different currency to the netting currency. Information Description Settlement Currency Currency to use for settlement (read-only). Settlement FX Rate Cross rate between netting currency and settlement currency at settlement date (can be modified). Settlement Amount Final amount to be settled. The execution sets the amount of the netting cashflow to the calculated net settlement amount (P/L). • Cancellation You can undo the netting of cash settlements for an FX transaction. 6.1.4.6 Currency pair shift It is possible to split a position from one underlying currency pair into two new positions, each of which contains one of the currencies with a third currency (usually, the portfolio currency). This process is called an FX Pair Shift. • Setup The FX Pair Shift action is available on an FX transaction if the Allow FX Currency Pair Shift feature is included in the instrument definition: see A.2.7 Allow FX Currency Pair Shift on page 716. • Execution See the TRM User Guide for information about this action. 6.1.5 Position monitoring There are two basic methods for valuation of FX instruments: Theoretical or Quoted: • In the Theoretical method, each cashflow is discounted to the spot date using the cashflow currency interest rate, converted to the portfolio currency using the spot rate, then discounted from spot date to valuation date using the portfolio currency interest rate. See 6.1.5.2 Calculations - Theoretical valuation method on page 394. • In the Quoted method, the cashflow is valuated using the forward FX rate between the cashflow currency and the valuation currency, and discounted using the valuation currency interest rate. See 6.1.5.3 Calculations - Quoted valuation method on page 402. Theoretical corresponds to the zero-coupon method and quoted to the par method. 6.1.5.1 Setup By default, the figures are calculated using the Theoretical valuation method. This is the default behavior, but it can be overridden using Base Valuation Setup. See A.2.50 Base Valuation Setup on page 734. If you need more information about the methods used in these calculations, see Chapter 2 Market standards and calculations on page 33. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 393 6 Forex 6.1 FX spot and FX forward 6.1.5.2 Calculations - Theoretical valuation method In this section, numerical examples demonstrate how the figures are calculated for the example FX forward deal using the Theoretical valuation method. This example shows an FX forward Buy 1,000,000 USD/EUR 3M, with the following deal data. Setup data • Data Symbol Example Instrument Date Basis B Act/360 Point Factor p_fact 0.0001 (from currency) FX Forward Points p_fx From Market Valuation Method Theoretical Valuation Date Figure Date Risk Date Figure Date Risk Yield Type Continuous Portfolio data • Data Symbol Example FX Exposure Offset e_fx 0.01 Formula Transaction data • Data Symbol Example Opening Date dt_o 2004-06-24 Spot Date dt_s 2004-06-28 Value Date dt_v 2004-09-28 Nominal Amount A 1,000,000 FX Spot Rate S_0 1.187100 FX Forward Points p_fx -0.1560000 Currency USD Currency 2nd EUR Portfolio Currency EUR Base CCY Interest % r_0.b 1.100000% Quote CCY Interest % r_0.q 1.616348% Date basis B 360 = (F_0 - S_0) * 100 = (S_0 / F_0 / D.b - 1) / t_p Calculated transaction data • Data Symbol Example Formula Deal Rate F_0 1.185540 = 1.1871 + (-15.6) * 0.0001 = S_0 + p_fx * p_fact FX Quote Amount A.q -843,497.48 = -1,000,000 / 1.18554 = -A / F_0 Period t_p 0.2555556 = (2004/09/28 – 2004/06/28) / 360 = (dt_v – dt_s) / B 394 © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward • • • • Calculated transaction data - Base CCY Data Symbol Example Formula Discount Factor D.b 0.99719677 = 1/(1+0.011*0.2555556) =1 / (1 + r_0.b * t_p) Result Value (Local) V_bl.b 997,196.77 = 1,000,000 * 0.99719677 = A * D.b Result Value V_b.b 840,027.60 = 997,196.77 / 1.1871 = V_bl.b / S_0 Base CCY Yield % 1.104512% = POWER(D, -1 / t_p) -1 Implied Interest 1.100000% = (1.185540 / 1.187100 / 0.99588633 - 1) / 0.255556 = (F_0 / S_0 / D.q - 1) / t_p Calculated transaction data - Quote CCY Data Symbol Example Formula Discount Factor D.q 0.99588633 = 1 / (1 + 0.01616348 * 0.2555556) = 1 / (1 + r_0.q * t_p) Result Value (Local) V_bl.q -840,027.60 = -V_b.b Result Value V_b.q -840,027.60 = V_bl.q Quote CCY Yield % 1.626098% = POWER (D.q, -1 / t_p) -1 Implied Interest 1.616348% = (1.187100 / 1.185540 / 0.99719677 – 1) / 0.2555556 =(S_0 / F_0 / D.b - 1) / t_p Market data on Figure Date Data Symbol Example Figure date dt_f 2004-08-16 Days to Spot d_fs 2 Discount Rate r_d 3.048771% FX Conversion Rate S 1.200000 FX Forward F 1.325000 Base CCY Interest Rate r_f.b 1.067917% Quote CCY Interest Rate r_f.q 3.197691% Calculated market data on Figure Date Data Symbol Days to Maturity • Example Formula 43 = 2004/09/28 -2004/08/16 = dt_v - dt_f Time to Spot t_s 0.00555556 = 2 / 360 = d_fs / B Time to Maturity t_m 0.11944444 = (2004/09/28 -2004/08/16) / 360 = (dt_v - dt_f) / B Discount Factor Spot D_s 0.999830638 = EXP (-t_s * r_d) The market data specific to the base currency on the figure date Data Symbol Example Market Value Discount Factor D_V.b 0.998615345 Formula Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 395 6 Forex 6.1 FX spot and FX forward Data Symbol Example Formula Present Value Discount Factor D_P.b 0.998615345 = 0.999830638 * 0.998784501 = D_s * D_f.b Discount Factor Spot Forward D_f.b 0.99878450 = EXP(-(t_m - t_s) * r_f.b) The market data specific to the quote currency on the figure date • Data Symbol Example Formula Market Value Discount Factor D_V.q 0.996196063 Present Value Discount Factor D_P.q 0.996196062 = 0.999830638 * 0.996364809 = D_s * D_f.q Discount Factor Spot Forward D_f.q 0.996364809 = EXP (-r_f.q * (t_m - t_s)) 6.1.5.2.1 Valuation figures The valuation method used for this deal is the Theoretical method. Base currency figures • Data Symbol Example Formula Local Market Value Local_Market_Value 998,615.35 = 1,000,000 * 0.998615345 = A * D_V.b Market Value V 832,179.45 = 998,615.35 / 1.2000 = Local_Market_Value / S Quote currency figures • Data Symbol Example Formula Local Market Value V_l_q -840,288.87 = -843,497.48 * 0.996196063 = A.q * D_V.q Market Value V.q -840,288.87 = V_l_q 6.1.5.2.2 Result figures Base currency figures • Data Symbol Example Formula Total Profit (Local) Total_Profit_Local 1,418.58 = 998,615.35 – 997,196.77 = Local_Market_Value V_bl.b Total Profit Total_Profit.b -7,848.15 = 832,179.45 – 840,027.60 = V - V_b.b Quote currency figures • Data Symbol Example Formula Total Profit Total_Profit.q -261.26 = -840,288.87 – (-840,027.60) = V.q - V_b.q 396 © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward Profit Method = FX Forward • • Base currency figures Data Symbol Example Formula MtoM Profit (Local) MtoM_Profit_Local.b 1,587.73 = 1,000,000 * 0.998784501 – 997,196.77 = A * D_f.b - V_bl.b Accrued Interest (Local) Accrued_Interest_Local.b =0 Accrued Profit (Local) P_al =0 Other Profit (Local) Other_Profit_Local.b -169.16 = 1,418.58 1,587.73 – 0 - 0 = Total_Profit_Local.b MtoM_Profit_Local.b Accrued_Interest_Local.b – P_al FX Profit FX_Profit -9,021.23 = 1,000,000 * (1/1.2 – 1/1.1871) * 0.9961960626 = A * (1 / S - 1 / S_0) * D_V.q MtoM Profit MtoM_Profit.b 1,323.11 = 1,587.73 / 1.2 = MtoM_Profit_Local.b / S Other Profit Other_Profit_b -150.03 = -7,848.15 1,323.11 – (-9,021.23) = Total_Profit.b MtoM_Profit.b - FX_Profit Clean Market Value CMV_b 832,179.45 =V Quote currency figures Data Symbol Example Formula Accrued Interest (Local) Accrued_Interest.q =0 Accrued Profit (Local) P_al =0 MtoM Profit MtoM_Profit.q -403.60 = -843,497.48 * 0.996364809 – (-840,027.60) = A.q * D_f.q - V_b.q Other Profit Other_Profit_q 142.34 = -261.26 – (-403.60) – 0 = Total_Profit.q - MtoM_Profit.q - Accrued_Interest.q Clean Market Value CMV_q -840,288.87 = V.q Profit Method = FX IR Difference • Base currency figures Data Symbol Example Formula MtoM Profit (Local) MtoM_Profit_Local.b 2,288.57 = 1,000,000 * 0.998784501 – 997,196.77 - (-700.84) = A * D_f.b - V_bl.b Accrued_Interest_Local.b Accrued Interest (Local) Accrued_Interest_Local.b -700.84 = 997,196.77 * (-0.516348) * (2004/08/16 - 2004/06/28) / 360 = V_bl.b * (-dr) * (dt_f dt_s) / B Other Profit (Local) Other_Profit_Local.b -169.16 = 1,418.58 – 2,288.57 – (-700.84) =Total_Profit_Local.b MtoM_Profit_Local.b Accrued_Interest_Local.b Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 397 6 Forex 6.1 FX spot and FX forward Data Symbol Example Formula FX Profit FX_Profit -9,021.23 = 1,000,000 * (1/1.2 – 1/1.1871) * 0.996196063 = A * (1 / S - 1 / S_0) * D_V.q MtoM Profit MtoM_Profit.b 1,913.49 = (1,000,000 * 0.998784501 - 997,196.77) / 1.2 - (-590.38) = (A * D_f.b - V_bl.b) / S Accrued_Interest.b Accrued Interest Accrued_Interest.b -590.38 = -840,027.60 * 0.516348 * (2004/08/16 2004/06/08) / 360 = (V_bl.q) * dr * (dt_f dt_s) / B Other Profit Other_Profit.b -150.03 = -7,848.15 1,913.49 – (-590.38) – (-9,021.23) = Total_Profit.b MtoM_Profit.b Accrued_Interest.b FX_Profit Clean Market Value CMV_b 832,769.83 = 832,179.45 (-590.38) = V - Accrued_Interest.b Quote currency figures • Data Symbol Example Formula Accrued Interest (Local) Accrued_Interest_Local.b MtoM Profit MtoM_Profit.q -403.60 = -843,497.48 * 0.996364809 – (-840,027.60) = A.q * D_f.q - V_b.q Other Profit (Local) Other_Profit.q 142.34 = -261.26 – (-403.60) –0 = Total_Profit.q MtoM_Profit.q Accrued_Interest.q Clean Market Value CMV_q -840,288.87 = V.q =0 Profit Method = FX Interest Base currency figures • Data Symbol Example Formula MtoM Profit (Local) MtoM_Profit_Local.b 1,587.73 = 1,000,000 * 0.998784501 – 997,196.77 = A * D_f.b - V_bl.b Accrued Interest (Local) Accrued_Interest_Local.b Other Profit (Local) Other_Profit_Local.b -169.16 = 1,418.58 – 1,587.73 = Total_Profit_Local.b MtoM_Profit_Local.b FX Profit FX_Profit -9,055.68 = 1,000,000 * (1 / 1.2000 – 1 / 1.187100) = A * (1 / S - 1 / S_0) MtoM Profit MtoM_Profit.b 1,323.11 = 1,587.73 / 1.2000 = MtoM_Profit_Local.b / S Accrued Interest Accrued_Interest.b 0 = Accrued_Interest_Local.b / S Other Profit Other_Profit.b -115.58 = -7,848.15 – 1,323.11 – (-9,055.68) = Total_Profit.b MtoM_Profit.b - FX_Profit Clean Market Value CMV_b 832,179.45 = 832,179.45 - 0 = V - Accrued_Interest.b 398 =0 © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward • Quote currency figures Data Symbol Example Formula MtoM Profit (Local) MtoM_Profit_Local.q 186.78 = -843,497.48 * 0.996364809 – (-840,027.60) – (-590.38) = A.q * D_f.q - V_b.q Accrued_Interest.q Accrued Interest (Local) Accrued_Interest.q -590.38 = -840,027.60 *0.00516348) * (2004/08/16 2004/06/28) / 360 = V_bl.q * dr * (dt_f - dt_s) / B Other Profit (Local) Other_Profit.q 142.34 = -261.26 – 186.78 – (-590.38) = Total_Profit.q MtoM_Profit_Local.q Accrued_Interest.q Clean Market Value CMV_q -839,698.49 = -840,288.87 (-590.38) = V.q - Accrued_Interest.q Profit Method = FX IR DIfference No Discount • • Base currency figures Data Symbol Example Formula MtoM Profit (Local) MtoM_Profit_Local.b 2,288.57 = 1,000,000 * 0.998784501 997,196.77 - (-700.84) = A * D_f.b - V_bl.b Accrued_Interest_Local.b Accrued Interest (Local) Accrued_Interest_Local.b -700.84 = 997,196.77 * (-0.516348) * (2004/08/16 2004/06/28) / 360 = V_bl.b * (-dr) * (dt_f - dt_s) /B Other Profit (Local) Other_Profit_Local.b -169.16 = 1,418.58 2,288.57 - (-700.84) = Total_Profit_Local.b MtoM_Profit_Local.b Accrued_Interest_Local.b FX Profit FX_Profit -9,055.68 = 1,000,000 * (1/1.2 - 1/1.187100) = A * (1 / S - 1 / S_0) MtoM Profit MtoM_Profit.b 1,913.49 = (1,000,000 * 0.998784501 997,196.77) / 1.2 (-590.38) = (A * D_f.b - V_bl.b) / S Accrued_Interest.b Accrued Interest Accrued_Interest.b -590.38 = (-840,027.60) * 0.516348 * (2004/08/16 2004/06/28) / 360 = (V_bl.q) * dr * (dt_f - dt_s) / B Other Profit Other_Profit.b -115.58 = -7,848.15 1,913.49 - (-590.38) (-9,055.68) = Total_Profit.b - MtoM_Profit.b - Accrued_Interest.b - FX_Profit Clean Market Value CMV_b 832,769.83 = 832,179.45 - (-590.38) = V - Accrued_Interest.b Quote currency figures Data Symbol Example Formula MtoM Profit (Local) MtoM_Profit.q -403.60 = -843,497.48 * 0.996364809 (-840,027.60) = A.q * D_f.q - V_b.q Accrued Interest (Local) Accrued_Interest.q =0 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 399 6 Forex 6.1 FX spot and FX forward Data Symbol Example Formula Other Profit (Local) Other_Profit.q 142.34 = -261.26 (-403.60) - 0 = Total_Profit.q - MtoM_Profit.q - Accrued_Interest.q Clean Market Value CMV_q -840,288.87 = V.q Profit Method = FX Implied Interest Base currency figures • Data Symbol Example Formula MtoM Profit (Local) MtoM_Profit_Local.b 94.71 = 1,000,000 * 0.998784501 – 997,196.77 – 1,493.03 = A * D_f.b - V_bl.b Accrued_Interest_Local.b Accrued Interest (Local) Accrued_Interest_Local.b 1,493.03 = 997,196.77 * 0.01100 * (2004/08/16 – 2004/06/28) / 360 = V_bl.b * r_0.b * (dt_f - dt_s) /B Other Profit (Local) Other_Profit_Local.b -169.16 = 1,418.58 – 94.71 -1,493.03 = Total_Profit_Local.b MtoM_Profit_Local.b Accrued_Interest_Local.b FX Profit FX_Profit -9,030.30 = 997,196.77 * (1 / 1.2000 – 1 / 1.187100) = V_bl.b * (1 / S – 1 / S_0) MtoM Profit MtoM_Profit.b 78.92 = 94.71 / 1.2000 = MtoM_Profit_Local.b / S Accrued Interest Accured_Interest.b 1,244.19 = 1,493.03 / 1.2000 = Accrued_Interest_Local.b / S Other Profit Other_Profit.b -140.96 = -7,848.15 – 78.92 - 1,244.19 – (-9,030.30) = Total_Profit.b - MtoM_Profit.b - Accrued_Interest.b - FX_Profit Clean Market Value CMV_b 830,935.27 = 832,179.45 -1,244.19 = V - Accrued_Interest.b Quote currency figures • Data Symbol Example Formula MtoM Profit (Local) MtoM_Profit.q 1,444.49 = -843,497.48 *0.996364809 – (-840,027.60) – (-1,848.09) = A.q * D_f.q - V_b.q Accrued_Interest.q Accrued Interest (Local) Accrued_Interest.q -1,848.08 = -840,027.60 * 0.01616348 * (2004/08/16 -2004/06/28) / B = V_bl.q * r_0.q * (dt_f - dt_s) /B Other Profit (Local) Other_Profit.q 142.34 = -261.26 – 1,444.49 – (-1,848.09) = Total_Profit.q - MtoM_Profit.q - Accrued_Interest.q Clean Market Value CMV_q -838,440.78 = -840,288.87 (-1,848.08) = V.q - Accrued_Interest.q 400 © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward Profit Method = FX Implied Yield • • Base currency figures Data Symbol Example Formula MtoM Profit (Local) MtoM_Profit_Local.b 95.69 = 1,000,000 * 0.998784501 – 997,196.77 - 1,492.05 = A * D_f.b - V_bl.b Accrued_Interest_Local.b Accrued Interest (Local) Accrued_Interest_Local.b 1,492.05 = 1,000,000*(POWER(1+0.0 1104512, -0.11944444) – POWER(1+0.01104512, -0.2555556)) =A* (POWER(1+Base_CCY_Yield, t_m) POWER(1+Base_CCY_Yield, -t_p)) Other Profit (Local) Other_Profit_Local.b -169.16 = 1,418.58 – 95.69 – 1,492.05 = Total_Profit_Local.b MtoM_Profit_Local.b Accrued_Interest_Local.b FX Profit FX_Profit -9,030.30 = 997,196.77 * (1 / 1.2000 – 1 / 1.187100) = V_bl.b * (1 / S – 1 / S_0) MtoM Profit MtoM_Profit.b 79.74 = 95.69 / 1.2000 = MtoM_Profit_Local.b / S Accrued Interest Accrued_Interest.b 1,243.37 = 1,492.05 / 1.2000 = Accrued_Interest_Local.b / S Other Profit Other_Profit.b -140.96 = -7,848.15 – 79.74 - 1,243.37 – (-9,030.30) = Total_Profit.b - MtoM_Profit.b - Accrued_Interest.b FX_Profit Clean Market Value CMV_b 830,936.08 = 832,179.45 - 1,243.37 = V - Accrued_Interest.b Quote currency figures Data Symbol Example Formula MtoM Profit (Local) MtoM_Profit.q 1,442.71 = -843,497.48 * 0.996364809 – (-840,027.60) = A.q * D_f.q - V_b.q Accrued_Interest.q Accrued Interest (Local) Accrued_Interest.q -1,846.30 = -843,497.48 * (POWER(1+0.01626098, 0.11944444) – POWER(1 + 0.01626098, - 0.2555556) = A.q * (POWER(1 + Quote_CCY_Yield, - t_m) POWER(1 + Quote_CCY_Yield, -t_p)) Other Profit (Local) Other_Profit.q 142.34 = -261.26 – 1,442.71 – (-1,846.30) =Total_Profit.q - MtoM_Profit.q - Accrued_Interest.q Clean Market Value CMV_q -838,442.56 = -840,288.87 (-1,846.30) = V.q - Accrued_Interest.q 6.1.5.2.3 Risk figures The risk method used for this FX forward deal is the Theoretical method. • Base currency figures Data Symbol Example Formula IR Exposure 1bp E_ip -9.94 = 1,000,000 * (-(0.11944444-0.00555556) * 0.01067917-t_s*D_f.b*D_s)/1.0*0.0001 = A * (-(t_m-t_s) * D_f.b * D_s - t_s *D_f.b* D_s) / S * 0.0001 FX Exposure E_fx 8,321.79 = 0.01 * 832,179.45 = e_fx * V Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 401 6 Forex 6.1 FX spot and FX forward Data Symbol Example Formula Effective Duration U_eff 0.1194444 = -9.94 / 832,179.45 / 0.0001 = -E_ip / V / 0.0001 Quote currency figures • Data Symbol Example Formula IR Exposure 1bp E_ipq 10.04 = -843,497.48 * (-(0.11944444-0.00555556) * 0.996364809*0.999830638-t_s*D_f.q*D_s) * 0.0001 = A.q * (-(t_m-t_s) * D_f.q * D_s - t_s * D_f.q * D_s) * 0.0001 FX Exposure E_fx Effective Duration U_eff =0 0.1194444 = 10.04 / (-840,288.87) / 0.0001 = -E_ipq / V.q / 0.0001 6.1.5.3 Calculations - Quoted valuation method In this section, numerical examples demonstrate how the different figures are calculated for the example FX forward deal using the Quoted valuation method. This example shows an FX forward Buy 1,000,000 USD/EUR 3M, with the following deal data. Transaction data Data Symbol Opening Date Example 2009-04-04 Spot Date dt_s 2009-04-07 Nominal Amount A_q 1,000,000 Deal Rate F_0 1.350000 FX Spot Rate S_0 1.400000 Base Spot FX Rate (Quote CCY) S_0_q 1.400000 Base Spot FX Rate (Base CCY) S_0_b 1.000000 Base FX Rate (Quote CCY) F_0_q 1.350000 Base FX Rate (Base CCY) F_0_b 1.000000 Base CCY Interest % r_0.b 2.000000% Maturity Date dt_m 2010-04-07 Date Basis (Base CCY) B_b 360 Date Basis (Quote CCY) B_q 360 Data Symbol Example Formula Base Amount A_b -740,740.74 =-A_q /F_0 IR Difference d_r 3.727042% =r_0.q*t_p_q / t_p_b -r_0.b Period t_p 1.0138889 =(dt_m-dt_s)/B_b Period (Quote CCY) t_p_q 1.0138889 =(dt_m-dt_s)/B_q Calculated transaction data 402 © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward Data Symbol Example Formula Base CCY Yield y_0.b 5.724808% =POWER(D_0_q, -1/t_p) - 1 Quote CCY Yield y_0.q 1.999724% =POWER(D_0_b,-1/t_p_q)-1 Discount Factor Base CCY: D_0_b 0.98012524 =1/(1+r_0_b * t_p_b) Quote CCY: D_0_q 0.94512077 =1/(1+r_0_q*t_p_q) Book/Reference Value Base CCY: V_b_b -700,089.46 =A_b * D_0_q Quote CCY: V_b_q 980,125.24 =A_q * D_0_b Data Symbol Example Formula Figure date dt_f 2009-06-15 Base CCY: D_V_b 0.971428368804 Market data on Figure Date Market Value Discount Factor Quote CCY: D_V_q Discount Factor Spot Base CCY: D_s_b 0.999862792158 Quote CCY: D_s_q FX Spot Rate FX Rate Time to maturity Base CCY: S_b 1.000000000 Quote CCY: S_q 1.2936 Base CCY: F_b 1.000000000 Quote CCY: F_q 1.2963 Base CCY: t_m_b 0.822222 =(dt_m- dt_f)/B_b Quote CCY: t_m_q 0.822222 =(dt_m - dt_f)/B_q 6.1.5.3.1 Valuation figures The valuation method used for this deal is the Quoted method. Data Market Value Result Value Symbol Example Formula Base CCY: V_b -719,576.57 =A_b * D_V_b / F_b Quote CCY: V_q 749,385.46 =A_q *D_V_q / F_q Base CCY: V_p_b -719,576.57 = A_b * D_V_b / F_0_b Quote CCY: V_p_q 719,576.57 = A_q * D_V_q / F_0_q 6.1.5.3.2 Result figures Data Symbol Example Formula Total Profit per CCY Base CCY: P_t_b 0.00 = V_b - V_p_b Quote CCY: P_t_q 29,808.89 = V_q - V_p_q Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 403 6 Forex 6.1 FX spot and FX forward Profit Method = FX Forward Data FX Profit MtoM Profit Other Profit Symbol Example Formula Base CCY: P_fx_b 0.00 =A_b * (1 / S_b-1 / S_0_b) * D_V_b Quote CCY: P_fx_q 57,072.17 = A_q * (1 / S_q-1 / S_0_q) * D_V_q Base CCY: P_mtom_b .00 =_b/D_s_b - V_p_b/D_s_b - P_fx_b Quote CCY: P_mtom_q -27,259.19 =V_q/D_s_q - V_p_q/D_s_q - P_fx_q Base CCY: 0.00 = P_t_b - P_fx_b - P_mtom_b Quote CCY: -4.09 = P_t_q - P_fx_q - P_mtom_q Profit Method = FX/IR Difference Data Symbol Example Formula Accrued Interest Base CCY: Ai_b .000000 =A_b*(1/S_0_b-1/F_0_b)*(t_p_b-t_m_b)/t_p_b Quote CCY: Ai_q -5,001.09 =A_q*(1/S_0_q-1/F_0_q) * (t_p_q t_m_q)/t_p_q Base CCY: .00 =P_fx_b Quote CCY: 57,072.17 =P_fx_q Base CCY: P_mtom_b_2 .00 =V_b/D_s_b - V_p_b / D_s_b - P_fx_b - Ai_b Quote CCY: P_mtom_q_2 -22,258.10 =V_q/D_s_q - V_p_q/D_s_q - P_fx_q - Ai_q Base CCY: .00 =P_t_b - P_fx_b - P_mtom_b_2 - Ai_b Quote CCY: -4.09 =P_t_q - P_fx_q - P_mtom_q_2 - Ai_q FX Profit MtoM Profit Other Profit Profit Method = FX/IR Difference No Discounting Data Symbol Example Formula Accrued Interest Base CCY: .00 =Ai_b Quote CCY: -5,001.09 =Ai_q Base CCY: P_fx_b_2 .00 =A_b*(1/S_b-1/S_0_b ) Quote CCY: P_fx_q_2 58,750.77 =A_q*(1/S_q-1/S_0_q) Base CCY: P_mtom_b_3 .00 = V_b/D_s_b - V_p_b / D_s_b - P_fx_b_2 Ai_b Quote CCY: P_mtom_q_3 -23,937.79 =V_q / D_s_q - V_p_q / D_s_q - P_fx_q_2 Ai_q Base CCY: missing .00 = P_t_b - P_fx_b_2 - P_mtom_b_3 - Ai_b Quote CCY: missing -4.09 =P_t_q - P_fx_q_2 - P_mtom_q_3 - Ai_q FX Profit MtoM Profit Other Profit 404 © Wall Street Systems IPH AB - Confidential 6 Forex 6.1 FX spot and FX forward Profit Method = FX Interest Data Accrued Interest FX Profit MtoM Profit Other Profit Symbol Example Formula Base CCY: Ai_b_3 -5,001.09 =A_b*(1 - F_0/S_0) * (t_p_b - t_m_b)/t_p_b Quote CCY: .00 =0 Base CCY: .00 =0 Quote CCY: 58,750.77 =P_fx_q_2 Base CCY: P_mtom_b_4 5,001.09 =V_b / D_s_b - V_p_b / D_s_b - P_fx_b_2 Ai_b_3 Quote CCY: P_mtom_q_4 -28,937.79 =V_q / D_s_q - V_p_q / D_s_q - P_fx_q_2 Base CCY: .00 =P_t_b - P_fx_b_2 - P_mtom_b_4 - Ai_b_3 Quote CCY: -4.09 =P_t_q - P_fx_q_2 - P_mtom_q_4 Profit Method = FX Implied Interest Data Accrued Interest FX Profit MtoM Profit Other Profit Symbol Example Formula Base CCY: Ai_b_2 -7,684.76 =A_b*r_0_q * (dt_f-dt_s)/B_q *D_0_q / S_b Quote CCY: Ai_q_2 2,904.41 =A_q*r_0_b * (dt_f-dt_s)/B_b *D_0_b / S_q Base CCY: P_fx_b_3 .00 =0 Quote CCY: P_fx_q_3 57,583.12 =V_b_q * (1/S_q-1/S_0_q) Base CCY: P_mtom_b_5 7,684.76 =V_b / D_s_b - V_p_b / D_s_b - P_fx_b_3 Ai_b_2 Quote CCY: P_mtom_q_5 -30,674.55 =V_q / D_s_q - V_p_q / D_s_q - P_fx_q_3 Ai_q_2 Base CCY: .00 =P_t_b - P_fx_b_3 - P_mtom_b_5- Ai_b_2 Quote CCY: -4.09 =P_t_q - P_fx_q_3 - P_mtom_q_5- Ai_q_2 Profit Method = FX Implied Yield Data Symbol Example Formula Accrued Interest Base CCY: Ai_b_4 -7,509.92 =A_b * (POWER(1+y_0.b,-t_m_b) -POWER(1+y_0.b,-t_p ))/S_b Quote CCY: Ai_q_4 2,880.82 =A_q * (POWER(1+y_0.q,-t_m_q) -POWER(1+y_0.q,-t_p ))/S_q Base CCY: .00 =0 Quote CCY: 57,583.12 =P_fx_q_3 Base CCY: P_mtom_b_6 7,509.92 =V_b / D_s_b - V_p_b / D_s_b - P_fx_b_3 Ai_b_4 FX Profit MtoM Profit Other Profit Quote CCY: P_mtom_q_6 -30,650.96 =V_q / D_s_q - V_p_q / D_s_q - P_fx_q_3 Ai_q_4 Base CCY: .00 =P_t_b - P_fx_b_3 - P_mtom_b_6- Ai_b_4 Quote CCY: -4.09 =P_t_q - P_fx_q_3 - P_mtom_q_6- Ai_q_4 6.1.5.3.3 Risk figures The risk method used for this FX forward deal is the Theoretical method: see 6.1.5.2.3 Risk figures on page 401. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 405 6 Forex 6.2 Average FX rate forward 6.2 Average FX rate forward An average rate forward gives the buyer the ability to create a hedge rate for a future exposure by locking in forward points and a spot rate today. At some point in the future, there is an averaging period of spot observations to determine an average rate which, when compared to the hedge rate, will set the payout. Unlike options, this hedge tool is a forward contract and has no premium cost associated with it. If the receivable currency is weaker during the averaging period compared to the hedge rate, the forward seller will make a payment to the forward buyer. Conversely, if the receivable currency appreciates during the averaging period, the forward buyer must make a payment to the forward seller. These structures are cash-settled. 6.2.1 Instrument setup Average FX rate forwards are based on an instrument type derived from the class FX. • Main characteristics Average FX rate forwards are set up in a similar way to non-deliverable FX forwards, except that you can configure the type of average rate forward in terms of observation dates and weights: Information Description Observation Method Choices are: Irregular and Business Days. • If you select Business Days, observation dates are defined for all business days (regarding the fixing currency at transaction level) between the spot date and the value date - the fixing offset (specified in the Netting page). • If you select Irregular, you can define the observation dates and weights at deal entry in the views Observation Date and Observation Schedule in Transaction Manager. Choices are: Irregular Weights and Equally Weighted (default). Weighting Method Note: Only editable when the observation method is Irregular. Average Rounding Method Average Rounding Rounding method and precision to be used for the average. See A.2.41 Average FX Rate Forward on page 728. 6.2.2 Deal capture 6.2.2.1 Input data In addition to the standard deal parameters, the following mandatory information is required to enter an average FX rate forward transaction. See 6.1.3.1 Input data on page 384. • Transaction view Note: This information defaults to the information defined at the instrument level. 406 Information Description Observation Method Choices are: Irregular and Business Days. • If you select Business Days, observation dates are defined for all business days (regarding the fixing currency at transaction level) between the spot date and the value date - the fixing offset (specified in the Netting page). • If you select Irregular, you can define the observation dates and weights at deal entry in the views Observation Date and Observation Schedule in Transaction Manager. © Wall Street Systems IPH AB - Confidential 6 Forex 6.2 Average FX rate forward Information Description Weighting Method Choices are: Equally Weighted (default) and Irregular Weights. If you select Irregular Weights, you will need to enter the weights manually at the transaction level in the Observation Date view. Note: Only editable when the observation method is Irregular. Average Rounding Method Average Rounding Rounding method and precision to be used for the average. The Fixing Calendar field can be edited at the transaction level to enable the user to specify the calendar to be used to generate the observation dates. The Fixing Subscenario field can be edited to specify the subscenario to be used for FX rates observations. When the observation method is set to Business Days, the observation dates are defined by the business days (according to the fixing calendar specified at the transaction level) between spot date and value date – fixing offset (specified at the instrument level in the Netting page) If you selected to use the Irregular method, you need to provide the relevant information in order to generate the observation dates. • Observation Schedule view Information Description Start Date Defaults to the spot date of the transaction. End Date Defaults to the transaction value value - the fixing offset. Method Combined with the specified frequency defines how often the cashflows will be generated. (Used with Frequency.) • Days, Business Days, Weeks, Months or Years: One flow every specified frequency days or business days or weeks or months or years. For example, if you select year and you specify a frequency of 1, you will have one flow every year; a frequency of 2, one flow every two years, and so on. • Times/Year: The specified frequency determines how many times per year. For example, if you specify a frequency of 1, the cashflows will be generated once per year; if you specify 2, the cashflows will be generated twice per year. • Last of Month: One flow the last day of every specified frequency month. • Months (sticky): The same as Last of Month, if the end date falls at month end, otherwise like Months. • ISDA Dates (Q): 15 March, 15 June, 15 Sept. and 15 Dec. • IMM Dates (M): One flow every 3rd Wednesday of every specified frequency month • Manual: Select if you want to be able to enter the dates directly in the Observation Date view. When this method is selected, the dates will no longer be generated from the transaction, and the following fields are cleared and are no longer editable. Frequency Number of time units (to be used with Method). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 407 6 Forex 6.2 Average FX rate forward Information Description Convention Convention used to adjust the observation dates: • Backward - previous business day • Following - next business day • Modified Backward - previous business day except if not in the same month (next in this case) • Modified Following - next business day except if not in the same month • None - no adjustment. (previous in this case) Holiday Calendar Additional calendar to supplement the calendar specified in the Fixing Calendar column (at the transaction level). Roll from Start Yes or No: When set to Yes, dates are calculated from Start Date rather than from the End Date. Long Stub Yes or No: To change the first coupon period to a long first coupon. By default, it is a short first coupon when the period is broken. For example, selecting Yes in the Roll from Start field causes a long last coupon. Fixed Roll Date • Specific date to be used in the schedule each year, without reference to the year: for example, 15 March annually. Observation Date Information Description Observation Date If you selected to enter the observation dates manually (Manual method in the Observation Schedule view), enter the dates, otherwise the dates generated from the inputs in the observation schedule are displayed. Weight Enter the weight if you selected the Irregular Weights method. 6.2.2.2 Generated data The generated cashflows are the same as for non-deliverable forwards, i.e. two pseudo FX settlement flows and one netting flow. 6.2.3 Processing This section describes the actions that can be done throughout the life of an average FX rate forward transaction. These actions are similar to those that can be done on non-deliverable forwards except for the differences explained further on. 6.2.3.1 Early expiration This action remains unchanged to FX non-deliverable forwards, except that the defaulted FX Forward Rate is replaced by the average of the already observed FX Rate and Forward FX rate based on the early expiration date: • Execution Right-click the transaction and select Early Expiration. As well as the usual information for an early expiration on a standard FX non-deliverable forward, the following information is required: 408 Information Description Avg FX Observed Rate Average value of already observed Fx rates. © Wall Street Systems IPH AB - Confidential 6 Forex 6.3 Open Window FX Forward (FX Time Option) Information Description Avg FX Forecasted Rate Average value of the forecast value of FX Rate (observations in the future according to the early expiration date). Avg FX Forward Rate Average value of the observed and forecast FX rates. See 6.1.4.2 Early expiration of NDFs on page 388. 6.2.3.2 Netting The netting action is similar to the netting action of a non-deliverable forward FX instrument, except that the FX Rate is replaced by the Average FX Rate. • Execution Right-click the netting cashflow and select Execute Netting. As well as the usual information for a netting action on a standard FX non-deliverable forward, the following information is needed: Information Description Avg FX Rate Defaults to the average value of past observation dates. Netting Amount Computed and rounded according to the values defined at the instrument and transaction levels. As usual, the execution of this action sets the amount of the netting cashflow, and stores the netting price in the Nominal Rate field at the cashflow level. See 6.1.4.5 Netting on page 392. 6.2.4 Position monitoring 6.2.4.1 Setup You need to use the specific valuation feature Average FX Rate Valuation to support specific Quoted valuation needed for this instrument. See A.2.42 Average FX Rate Valuation on page 728. 6.2.4.2 Calculations With this valuation feature Average FX Rate Valuation, the average rate forward is taken instead of forward FX rate when computing market value. Indeed, the cashflow is converted using the forward rate between cashflow currency and valuation currency before being discounted with valuation currency interest rate. The average rate is computed with the already observed FX rates and forecasted FX rates for the future dates regarding the valuation. This average FX rate is visible in Figure FX Rate. The Theoretical valuation is the same as for FX non-deliverable forward instruments. See 6.1.5 Position monitoring on page 393. 6.3 Open Window FX Forward (FX Time Option) An open window FX forward differs from a regular FX Forward in that the owner of the contract can choose the date (from within a defined time window) when the forward cashflows are exchanged. This means that the transaction is specified in terms of a maturity window rather than a single maturity date. The owner of the contract must also be specified. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 409 6 Forex 6.3 Open Window FX Forward (FX Time Option) 6.3.1 Instrument setup Open Window FX Forward instruments are based on an instrument type derived from the class FX-TIME-OPTION. Main characteristics • The main characteristics of an Open Window FX Forward instrument are defined using the primary feature FX Time Option. – Date information It is possible to define the periods for which the start and end of the exercise window are derived. – Information Description Value Date Period Period from which start of exercise window is derived. Maturity Date Period Period from which end of exercise window is derived. Time option owner It is possible to define the owner (counterparty or portfolio owner). Information Description Base Currency Base and quote currencies for the instrument. Quote Currency Leave these fields blank if you want to specify the currencies when you enter the deal. Transaction Sign Owner Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow: • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy/Lend or Sell/Borrow if you want this to be the direction of the transactions, that is, the direction cannot be modified at deal entry. Owner of the contract. Select Counterparty or Portfolio Owner. Leave this field blank if you want to specify the owner when you enter the deal. Note: This is used with Optimal maturity method when you are using the valuation approach FX Time Option Valuation. See A.2.198 FX Time Option on page 810. 6.3.2 Deal capture In addition to the standard deal parameters, the following information is required to enter an open window FX forward transaction: Information Description Value Date Start of the exercise period Maturity Date End of the exercise period. Time option owner The person who chooses the exercise day of the transaction (Portfolio Owner or Counterparty). If the owner is not defined at instrument level, it can be specified at the transaction level. Note: This is used with Optimal maturity method when you are using the valuation approach FX Time Option Valuation Method. 410 © Wall Street Systems IPH AB - Confidential 6 Forex 6.3 Open Window FX Forward (FX Time Option) 6.3.3 Processing This section describes the actions that can be done throughout the life of an FX transaction. 6.3.3.1 Exercise Within the window period, it is possible to exercise the transaction. That is, to determine the payment dates of the cashflows. • Execution The following information is needed to process the early expiration: Information Description Early Expiration Date Date when the exercise is done. Value Date Date when the early expiration is settled. This cannot be later than the maturity date of the initial transaction. Amount Left Remaining amount of the initial transaction. (Read-only.) Amount to Expire Amount to be exercised. This defaults to the amount left and is expressed in the same currency (base or quote) as the input amount of the initial transaction. You can enter any amount between 0 and the remaining amount of the initial transaction. Currency The currency in which the above amount is expressed, can be base or quote currency depending on the initial transaction. (Read-only.) Deal Rate Agreed forward rate for the exercised transaction. Quote Amount The corresponding amount of the transaction. Quote Currency Shows the currency of the deal. The currency can be quote or base depending on default Currency. By default, this is today’s date unless a Fixing/Action Date is specified at transaction level. 6.3.4 Position monitoring 6.3.4.1 Setup Time option valuation is chosen with the feature FX-TIME-OPTION-METHOD. Information Description Maturity Method Choose from Earliest, Latest, Optimal Valuation Modes Choose from Benchmark, Default, Theoretical. 6.3.4.2 Calculations This section describes the valuation and provides numerical examples to illustrate the calculations of Open Window FX Forward (FX Time Option) deals. 6.3.4.2.1 Valuation FX Time Option instruments use a special valuation feature FX Time Option Valuation (A.2.199 FX Time Option Valuation on page 811). This valuation method simply creates a virtual payment date for the forward cashflows, and then uses the standard fixed method for key figures. That is, the calculation of an Open Window FX Forward (FX Time Option) deal is similar to that of a regular FX Forward (6.1 FX spot and FX forward on page 383), except that we need to assume a payment date (from within a defined time window). To do this, the user chooses a maturity method from the available methods: • Earliest: Calculate open transactions with maturity at the start of the window. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 411 6 Forex 6.3 Open Window FX Forward (FX Time Option) Latest: Calculate open transactions with maturity at the end of the window. • For Earliest or Latest method, the payment date is directly copied from the window. Optimal: Calculate open transactions with maturity at either start (earliest) or end (latest) of the window, so that the value for the owner is maximized. Refer to the following section for a detailed description of the calculation. • Optimal method calculation For the Optimal method, the following logic is used to determine whether the start or end date of the window should be chosen as the virtual payment date to obtain the best value for the time option owner. (To set up the owner refer to 6.3.1 Instrument setup on page 410.) Let Ab and Aq be the (absolute) amounts of the bought and sold currencies, respectively, and Sb and Sq the corresponding spot exchange rates against the portfolio currency. Let D1b , D2b , D1q , D2q be the discount factors for the two currencies (superscript q or b) for the start and the end of the window (subscript 1 or 2). Then, if we own the right to choose the exercise date (Owner set to Portfolio Owner), the closer date is chosen if Equation 6-1 S b Ab D1b − S q Aq D1q > S b Ab D 2b − S q Aq D 2q Otherwise, the end date of the window is chosen. If the counterparty owns the right to choose (Owner set to Counterparty), then the decision logic is reversed. If Quoted valuation method is used, the closer date is chosen if Equation 6-2 Quoted valuation method Fb1 Ab D1p − Fq1 As D1p > Fb2 Ab D 2p − Fq2 As D 2p where now all discount factors are in portfolio currency, and Fi j are forward FX rates between the cashflow and portfolio currencies. If the currency pair’s figure spot date is within the window period, the start date used in the valuation is the spot date corresponding to the figure date. Result calculations are similar to those of an FX forward maturing on the virtual payment date. However, accrued interest is always calculated for the maturity period, regardless of the virtual payment date. 6.3.4.3 Numerical examples The numerical examples in this section demonstrate how the different figures are calculated for the example Open Window FX forward deal using the Theoretical valuation method. This example shows an FX forward Buy 1,000,000 USD/EUR 3M, with the following deal data: Setup • Data Valuation Method 412 Symbol Example Theoretical © Wall Street Systems IPH AB - Confidential 6 Forex 6.3 Open Window FX Forward (FX Time Option) • • Transaction data Data Symbol Example Opening Date dt_o 2007-11-09 Spot Date dt_s 2007-11-13 Nominal Amount A 1,000,000 Deal Rate F_0 2.050000 FX Spot Rate S_0 2.010000 Base FX Spot Rate S_B.b 1.430000 (base) Base FX Spot Rate S_B.q 1.405594 (quote) Base FX Rate F_B.* 1.434600 Base CCY Interest % r_0.b 5.000000% Value Date dt_v 2008-06-16 Maturity Date dt_m 2008-12-15 Date Basis (Base CCY) B 360 Date Basis (Quote CCY) B.q 365 Symbol Example Formula 1,000,000.00 =A Calculated transaction data Data Amount (Base CCY) • Amount (Quote CCY) A.q -487,804.88 = -A / F_0 FX Forward Points p_fx 400 =10000*(F_0-S_0) IR Difference dr -1.862483% = (S_0 / F_0 / D.b - 1) / t_p-r_0.b Quote CCY Interest % r_0.q End Period t_p 1.1055556 =(dt_m-dt_s)/B Other important calculated transaction data Data Symbol Example Formula Discount Factor D.b 0.94761779 =1/(1+r_0.b*t_p) 1,000,000.00 =A Base Value (Base CCY) • Base Value (Quote CCY) BaseValue.q -497,512.44 =-A / S_0 Result Value (Base CCY) ResultValue.b 662,669.79 =ResultValueLocal.b /S_B.b Result Value (Quote CCY) ResultValue.q -662,669.59 =ResultValueLocal.q * S_B.q Local Result Value (Base CCY) ResultValueLocal.b 947,617.79 = A * D.b Local Result Value (Quote CCY) ResultValueLocal.q -471,451.64 =-ResultValueLocal.b / S_0 Data Symbol Example Figure Date dt_f 12/12/2007 Market Data on Figure Date Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 413 6 Forex 6.3 Open Window FX Forward (FX Time Option) Data Symbol Example FX Spot Rate (Base CCY) F_S.b 1.4844 FX Spot Rate (Quote CCY) F_S.q 1.390697 Calculated Market Data on Figure Date • Data Symbol Example Formula FX Convert (Base CCY) S 0.673673 = 1 / F_S.b FX Convert (Quote CCY) S.q 1.390697 =F_S.q MV Discount Factor Start (Base CCY) D_V.s.b 0.961217301872 MV Discount Factor Start (Quote CCY) D_V.s.q 0.970243996748 MV Discount Factor End (Base CCY) D_V.e.b 0.925429031747 MV Discount Factor End (Quote CCY) D_V.e.q 0.942867984024 Discount Factor Spot (Base CCY) D_s 0.99975004706 Discount Factor Spot (Quote CCY) D_s.q 0.99975004706 6.3.4.3.1 Window start Key Figures on Figure Date Data Symbol Example Formula Local Market Value (Base CCY) LocalMarketV alue.s.b 961,217.30 =A*D_V.s.b Local Market Value (Quote CCY) LocalMarketV alue.s.q -473,289.75 =A.q*D_V.s.q Market Value (Base CCY) V.s.b 647,546.01 =LocalMarketValue.s.b * S Market Value (Quote CCY) V.s.q -639,631.06 =LocalMarketValue.s.q * S.q Result Figures - Method FX Forward Data Symbol Example Formula Local Total Profit (Base CCY) TotalProfitLo cal.s.b 13,599.51 =LocalMarketValue.s.b ResultValueLocal.b Local Total Profit (Quote CCY) TotalProfitLo cal.s.q -1,838.12 = LocalMarketValue.s.q ResultValueLocal.q Total Profit (Base CCY) TotalProfit.s. b -15,123.77 = V.s.b - ResultValue.b Total Profit (Quote CCY) TotalProfit.s. q 4,466.95 =V.s.q - ResultValue.q Local MtoM Profit (Base CCY) MtoMProfitLo cal.s.b 13,839.83 = A * D_V.s.b/D_s ResultValueLocal.b 414 © Wall Street Systems IPH AB - Confidential 6 Forex 6.3 Open Window FX Forward (FX Time Option) Data Symbol Example Formula Local MtoM Profit (Quote CCY) MtoMProfitLo cal.s.q -2,663.78 = A.q * D_V.s.q/D_s.q ResultValueLocal.q AccruedInterestLocal.s.q Local Accrued Interest (Quote CCY) AccruedInter estLocal.s.q 707.33 = ResultValueLocal.q * dr * (dt_f dt_s) / B Local Other Profit (Base CCY) Other_Profit _Local.b -240.32 =TotalProfitLocal.s.b-MtoMProfitLoca l.s.b 118.33 =TotalProfitLocal.s.q MtoMProfitLocal.s.q AccruedInterestLocal.s.q Local Other Profit (Quote CCY) FX Profit (Base CCY) FXProfit.s.b -25,627.83 = A * (1/F_S.b-1/S_B.b) FX Profit (Quote CCY) FXProfit.s.q 7,411.44 = BaseValue.q * (F_S.q-S_B.q) MtoM Profit (Base CCY) MtoMProfit.s. b 9,323.52 = MtoMProfitLocal.s.b / F_S.b MtoM Profit (Quote CCY) MtoMProfit.s. q -3,704.51 =MtoMProfitLocal.s.q * F_S.q Accrued Interest (Quote CCY) AccruedInter est.s.q 983.69 =AccruedInterestLocal.s.q * S.q Other Profit (Base CCY) Other_Profit _h 1,180.55 = TotalProfit.s.b - MtoMProfit.s.b FXProfit.s.b -223.67 = TotalProfit.s.q - FXProfit.s.q -MtoMProfit.s.q -AccruedInterest.s.q Other Profit (Quote CCY) 6.3.4.3.2 Window end Key Figures on Figure Date Data Symbol Example Formula Local Market Value (Base CCY) LocalMarket Value.e.b 925,429.03 =A*D_V.e.b Local Market Value (Quote CCY) LocalMarket Value.e.q -459,935.60 =A.q*D_V.e.q Market Value (Base CCY) V.e.b 623,436.43 =LocalMarketValue.e.b * S Market Value (Quote CCY) V.e.q -639,631.06 =LocalMarketValue.e.q * S.q Data Symbol Example Formula Local Total Profit (Base CCY) TotalProfitLo cal.e.b -22,188.76 =LocalMarketValue.e.b ResultValueLocal.b Local Total Profit (Quote CCY) TotalProfitLo cal.e.q 11,516.04 = LocalMarketValue.e.q ResultValueLocal.q Total Profit (Base CCY) TotalProfit.e. b -39,233.36 = V.e.b - ResultValue.b Total Profit (Quote CCY) TotalProfit.e. q 23,038.53 =V.e.q - ResultValue.q Result Figures - Method FX Forward Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 415 6 Forex 6.4 FX swap Data Symbol Example Formula Local MtoM Profit (Base CCY) MtoMProfitLo cal.e.b -21,957.39 = A * D_V.e.b/D_s ResultValueLocal.b Local MtoM Profit (Quote CCY) MtoMProfitLo cal.e.q 10,693.71 = A.q * D_V.e.q /D_s.qResultValueLocal.q AccruedInterestLocal.e.q Local Accrued Interest (Quote CCY) AccruedInter estLocal.e.q 707.33 = ResultValueLocal.q * dr * (dt_f dt_s) / B Local Other Profit (Base CCY) -231.37 =TotalProfitLocal.e.b MtoMProfitLocal.e.b Local Other Profit (Quote CCY) 114.99 =TotalProfitLocal.e.q MtoMProfitLocal.e.q AccruedInterestLocal.e.q FX Profit (Base CCY) FXProfit.e.b -25,627.83 = A * (1/F_S.b-1/S_B.b) FX Profit (Quote CCY) FXProfit.e.q 7,411.44 =BaseValue.q * (F_S.q-S_B.q) MtoM Profit (Base CCY) MtoMProfit.e .b -14,792.10 =MtoMProfitLocal.e.b / F_S.b MtoM Profit (Quote CCY) MtoMProfit.e .q 14,871.71 =MtoMProfitLocal.e.q * F_S.q Accrued Interest (Quote CCY) AccruedInter est.e.q 983.69 = AccruedInterestLocal.e.q * F_S.q Other Profit (Base CCY) OtherProfit.e .b 1,186.57 =TotalProfit.e.b - FXProfit.e.b MtoMProfit.e.b Other Profit (Quote CCY) OtherProfit.e .q -228.31 =TotalProfit.e.q - MtoMProfit.e.q AccruedInterest.e.q - FXProfit.e.q 6.4 FX swap A currency swap transaction in the inter-bank market is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. Both purchase and sale are with the same counterparty. A common type of swap is spot against forward. The dealer buys a currency as a spot market transaction and simultaneously sells the same amount back to the same counterparty as a forward transaction. Since this is executed as a single transaction with the same counterparty, TRM has a separate trade entry for FX swap transactions. In TRM, FX swaps belong to the instrument class FX-SWAP. 6.4.1 Instrument setup FX swaps are based on an instrument type derived from the class FX-SWAP. They are set up in a similar way to FX spot/forward instruments. • FX Swap main characteristics For an FX swap, you may want to set up maturity date and value date information. The maturity of the contract is calculated using the periods specified for both the maturity date and the value date. For example, to define a 3M/6M forward FX swap, you need to specify 3M for both periods. 416 © Wall Street Systems IPH AB - Confidential 6 Forex 6.4 FX swap For maturity and value date information: Information Description Gap Set Gap set used for supplying the value date periods; these in turn are used to define exact dates. Value Date Period Value date period used to calculate the value date for the instrument at deal entry. If this is specified at the instrument level, it is used as default in the transaction and cannot be modified. Maturity Date Period Maturity period used to calculate the maturity date for an instrument at deal entry, for example, 6M or 1Y. If you specify the maturity date period in the instrument setup, this is used as the default in the transaction and cannot be modified. Spot Days Number of business days between opening and value dates. Defaults to currency spot days when left blank. Note: It is recommended not to specify the spot days in the instrument setup as these are taken by default from the spot days of the two currencies at deal entry. Calendar Calendar and Holiday Calendar used to calculate the value date. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the value date calculation takes both calendars into account. Note: When you define the Calendar or Holiday Calendar in one date setup, the Calendar fields in all date setup pages applied to the instrument default to the same values. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. A.2.193 FX Swap on page 807. • Currency information You can specify the currencies of the FX swap either in the instrument setup or at deal entry. See A.2.192 FX Setup on page 806. • Forward points calculation You can specify whether forward points are taken from the market or calculated. If you do not define a method for obtaining or calculating forward points, the FX spot rate is taken from the market and the forward points need to be input manually. See A.2.175 FX Forward on page 797. • FX cross rate calculation For an FX swap where neither currency is the portfolio base currency, you need to define how the FX rates (Base Spot FX and Base FX Rate) are calculated. See A.2.171 FX Cross Method on page 796. For an FX swap, it is also possible to set up: • Cashflow and transaction charge rules • Manual charges • Branch codes • Competitive Rates (FX Swap) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 417 6 Forex 6.4 FX swap • FX Swap Margin. See Appendix A Features on page 713. 6.4.2 Market information 6.4.2.1 Currencies Some additional parameters need to be defined for the currencies which are relevant to your FX transactions: see the TRM User Guide. 6.4.2.2 Quotations and market information Quotations for currencies can be viewed and modified in Rate Monitor. It is possible to define market information feeds for each currency (for example, from Reuters): see the TRM User Guide. 6.4.3 Deal capture 6.4.3.1 Input data In addition to the standard deal parameters, the following information is needed to enter an FX swap transaction: • FX swap (input forward points) In addition to the standard deal parameters, the following information is required to enter an FX swap transaction where the forward points are input manually: Information Description Base Currency (Currency) Base currency of the transaction. Quote Currency (Currency 2nd) Quote currency of the transaction. Value Date Date of the near leg (spot transaction). Maturity Date Date of the far leg (forward transaction) and maturity of the contract. FX Base Spot Amount Amount of the near leg (spot transaction) in the base currency. FX Quote Spot Amount Amount of the near leg (spot transaction) in the quote currency. Nominal/Spot Rate Exchange rate of the near leg (spot transaction). FX Forward Points Forward points for the transaction. Deal Rate Exchange rate of the far leg = Nominal / Spot Rate + FX Forward Points (+ Margins if applicable) • Uneven FX swap In addition to the standard deal parameters, the following information is required to enter an uneven FX swap transaction, where the input amount of the near leg is different from the input amount of the far leg: 418 Information Description Base Currency (Currency) Base currency of the transaction. © Wall Street Systems IPH AB - Confidential 6 Forex 6.4 FX swap Information Description Quote Currency (Currency 2nd) Quote currency of the transaction. Value Date Date of the near leg (spot transaction). Maturity Date Date of the far leg (forward transaction) and maturity of the contract. FX Base Spot Amount Amount of the near leg (spot transaction) in the base currency. FX Quote Spot Amount Amount of the near leg (spot transaction) in the quote currency. FX Base Amount Amount of the far leg (forward transaction) in the base currency. FX Quote Amount Amount of the far leg (forward transaction) in the quote currency. Nominal/Spot Rate Exchange Rate of the near leg (spot transaction) FX Forward Points Forward points for the transaction. Deal Rate Exchange rate of the far leg = Nominal / Spot Rate + FX Forward Points (+ Margins if applicable) • FX swap (with interest rate) In addition to the standard deal parameters, the following information is required to enter an FX swap transaction with interest rate where the forward points are input manually: Information Description Base Currency (Currency) Base currency of the transaction. Quote Currency (Currency 2nd) Quote currency of the transaction. Value Date Date of the near leg (spot transaction). Maturity Date Date of the far leg (forward transaction) and maturity of the contract. FX Base Spot Amount Amount of the near leg (spot transaction) in the base currency. FX Quote Spot Amount Amount of the near leg (spot transaction) in the quote currency. Nominal/Spot Rate Exchange Rate of the near leg (spot transaction) FX Finance Rate Implied borrowing rate for an FX swap transaction. FX Forward Points Forward points for the transaction. Deal Rate Exchange rate of the far leg = Nominal / Spot Rate + FX Forward Points (+ Margins if applicable) 6.4.3.2 Generated data • Cashflows Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 419 6 Forex 6.4 FX swap The figure below illustrates the cashflows which are established in TRM for an FX swap transaction. The figure below illustrates the cashflows which are established in TRM for a forward FX swap transaction. 6.4.4 Processing This section describes the actions that can be done throughout the life of an FX swap. 6.4.4.1 Early expiration You can force the forward leg of an FX swap to mature earlier using the action Early Expiration. • Execution The following information is needed to process the early expiration: Information Description Early Expiration Date Date when the early expiration is executed. By default, this is today’s date unless a Fixing/Action Date is specified at transaction level. Opening Date must be after the near leg of the initial FX swap. Value Date Date when the early expiration is settled. This cannot be later than the maturity date of the initial transaction. Amount Amount to be early-expired. This defaults to the amount left and is expressed in the same currency (base or quote) as the input amount of the initial transaction. You can enter any amount between 0 and the remaining amount of the initial transaction. Deal Rate Deal rate for the early expiration transaction. Deal Rate = Original Spot Rate - Forward Points Forward Points Forward points of the early expiration transaction. This defaults to the number of forward points between the early expiration date and the maturity date of the initial transaction. The execution generates an early expiration transaction with the following attributes: 420 © Wall Street Systems IPH AB - Confidential 6 Forex 6.4 FX swap If the original input amount was Base Amount: FX Base amount = amount to expire If the original input amount was Quote Amount: FX Quote amount = amount to expire Deal Rate = early expiration deal rate Opening date = date when the early expiration is done Value date = date when the early expiration is settled Kind = Early Expiration The remaining attributes are inherited from the initial transaction. • Cancellation You can undo the early expiration by canceling the early expiration transaction. 6.4.4.2 Roll over You can defer the maturity of the forward leg of an FX swap to a later date. This process is referred to as roll-over. See A.2.11 Allow Roll Over (FX) on page 717. • Execution If the Spot Rate for the roll-over equals the Original Deal Rate, the following information is needed to process the roll over: Information Description Roll Over Date Date when the roll over is done. Maturity Date New maturity date of the FX deal. This must be later than the maturity date of the initial transaction. Amount Amount to roll over defaults to the amount left and is expressed in the same currency (base or quote) as the input amount of the initial transaction. You can enter any amount between 0 and the remaining amount of the initial transaction. Forward Points Forward points of the roll over transaction. This defaults to the number of forward points from the roll over date to the maturity date. Deal Rate Deal rate for the roll over. Deal Rate = Original Spot Rate + Forward Points The execution generates a roll over transaction with the following attributes: If the original input amount was FX Base Amount: FX Base amount = amount to roll over If the original input amount was FX Quote Amount: FX Quote amount = amount to roll over Deal Rate = roll over deal rate Opening Date = date when the roll over is done Maturity Date = new maturity date Kind = Roll Over The remaining attributes are inherited from the initial transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 421 6 Forex 6.5 Cost-of-funding FX swap If the Spot Rate for the roll-over is different from the Original Deal Rate, the following additional information is needed to process the roll over and settle the subsequent difference: Information Description Settle Differential Switch on if the Spot Rate for the roll-over is different from the Original Deal Rate. By default, this switch is off. Spot Rate If Settle Differential is activated, this field becomes available. Spot Rate defaults to the spot rate of the market but this value can be modified. The Forward Points and Deal rate are adjusted automatically. Base CCY Interest % Interest rate of the base currency for the period from the original settlement date to the new settlement date. Quote CCY Interest % Interest rate of the quote currency for the period from the original settlement date to the new settlement date. Deal Rate Deal rate for the roll over. Deal Rate = Spot Rate + Forward Points The execution generates a roll over transaction as before with an additional cashflow as follows: A netting cashflow is created to handle the settlement of the difference Value Date = Roll over value date Currency = Roll over currency 2 Amount = Base Amount * Original Deal Rate - (-Base Amount * Spot Rate) • Cancellation You can undo the roll over by canceling the roll over transaction. 6.4.4.3 Currency pair shift It is possible to split a position from one underlying currency pair into two new positions, each of which contains one of the currencies with a third currency (usually, the portfolio currency). This process is called an FX Pair Shift. • Setup The FX Pair Shift action is available on an FX swap transaction if the Allow FX Currency Pair Shift feature is included in the instrument definition: see A.2.7 Allow FX Currency Pair Shift on page 716. • Execution See the TRM User Guide for information about this action. 6.4.5 Position monitoring Figures for FX swaps are calculated in the same way as the figures for FX forwards: see 6.1.5 Position monitoring on page 393. 6.5 Cost-of-funding FX swap Cost-of-funding FX swaps are a special case of FX swap, where the nominal amount for the far leg is based on the nominal amount of the near leg and an interest rate component. This instrument enables you to set up defaulting for the interest rate/spread value. Then, at deal entry, the base amount of the far leg will be defaulted to the base amount of the near leg with the interest computed between the value date and the maturity date of the FX swap. 422 © Wall Street Systems IPH AB - Confidential 6 Forex 6.5 Cost-of-funding FX swap This interest is computed based on the interest rate and the spread value according to date basis of the base currency. FX quote amounts are defaulted as usual from base amounts by using FX rate/forward points. 6.5.1 Instrument setup The set up is the same as for a standard FX swap except that you need to attach the trading feature FX Swap Cost-of-Funding. • cost-of-funding characteristics Information Description Active from/to Set active from and to dates if you want the defaulting to be used only for a given period. Currency Currency you want to specify. C-o-F Curve The default curve from which the interest rate will be defaulted. Note: Only IR quotes (i.e. curve with fixing/interest calculation usage) defined with the Bootstrap Yield Curve feature are available. C-o-F Spread Curve The default spread curve from which the spread will be defaulted. Scenario The default scenario from which the values will be retrieved. Method Defaulting method: Ask, Bid, Bid/Ask (Spread Against), Bid/Ask (Spread in Favor), or Mid. • If you select Bid/Ask (Spread Against): if you are buying the base currency of the quoted currency pair, the Ask price is used; if you are selling the base currency of the quoted currency pair, the Bid price is used. • If you select Bid/Ask (Spread in Favor): if you are buying the base currency of the quoted currency pair, the Bid price is used; if you are selling the base currency of the quoted currency pair, the Ask price is used. See A.2.194 FX Swap Cost-of-Funding on page 807. 6.5.2 Deal capture 6.5.2.1 Input data In addition to the standard FX swap deal parameters, the following information is needed to enter a cost-of-funding FX swap: Hint: You will need to display the following columns in the Transaction view: C-o-F Curve, C-o-F Rate, C-o-F Spread %, C-o-F Spread Curve, C-o-F Subscenario, and C-o-F Tenor. Label Value C-o-F curve ID of the curve to be used to default the cost-of-funding rate. Editable Mandatory Y N Defaults to the curve specified at instrument level for the base currency, otherwise, it is empty. C-o-F Subscenario Subscenario to be used to compute the cost-of-funding rate. By default, it is empty. Y N C-o-F Tenor Fixing period to be used to retrieve the cost-of-funding rate. By default, it is empty. Y N Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 423 6 Forex 6.5 Cost-of-funding FX swap Label Value Editable C-o-F Rate Defaults to the rate defined at the curve level for the specific tenor, otherwise, defaults to the interpolated rate between the transaction value date and the maturity date according to the date basis and rate type set up at the curve level. Mandatory Y Y Note: For a forward-forward FX swap, the forward FX rate computed between the value and maturity dates. C-o-F Spread Curve Defaults to the spread curve defined at instrument level, otherwise, it is left empty. Y N C-o-F Spread % If the C-o-F Spread Curve is populated then the displayed value for the tenor is equal to the maturity date, otherwise, it is left empty. Y N FX Finance Rate(*) Computed from C-o-F Rate and C-o-F Spread: N Y N Y FX Finance Rate = C-o-F Rate + C-o-F Spread Quote Currency Yield Yield computed from quote amounts of the FX swap as follows: QuoteCurrencyYield = (FXQuoteAmount-FXQuoteSpotAmount)* B / MaturityDate - ValueDate * 1 / FXQuoteSpotAmount where • B is the date basis defined at the currency level for the quote currency (Currency Editor - Journal page). 6.5.3 Processing The actions you can perform on a cost-of-funding swap are the same as for a standard FX swap, see 6.4.4 Processing on page 420. 6.5.4 Position monitoring Figures for cost-of-funding swaps are calculated in the same way as for FX swaps: see 6.4.5 Position monitoring on page 422. 424 © Wall Street Systems IPH AB - Confidential Chapter 7 Index 7.1 Index types TRM supports the following index types: • Simple index A simple index does not contain information on composition; it is a simple instrument to which a price can be input. It can be used as an underlying for derivatives, and the price is used for valuation and payoff calculations. It is also used in performance measurement for return comparison. • Composite index A composite index is an index defined in the product as a basket of several equities, discount papers, or bonds, for example, CAC-40. If you do not want to manage the composition in TRM, the composite index is treated as a simple index. • Derived index A derived index is an index derived from several simple indexes. They can be composites, but are treated as simple: their internal composition is not considered. A derived index can be re-balanced. It can be used in performance measurement whenever internal performance (allocation) is not needed • Performance index A performance index is a special type of composite index, used to compute the payback of a specific issue. TRM implements the following two index performance formulae to compute the index value. – Performance averaging index This is calculated as follows: N 1--Index i N∑ i=1 ------------------------------ –1 1 --P P ∑ Indexj j=1 where: 1 Index i = ----------------------NbComp NbComp ∑ w k Comp i, k k=1 P = number of observation dates for the denominator N = number of observation dates for the numerator NbComp = number of components of the index Wk = weight of kst component of the index Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 425 7 Index 7.2 Instrument setup Compi,k = value of the kst component at time i – Performance Totaling Index This is calculated as follows: N Index j – Index j – 1 -⎞ ⎞ ∑ Max ⎛⎝ Floor ;Min ⎛⎝ Cap ;--------------------------------------------⎠⎠ Index j – 1 j=1 where: 1 Index i = ----------------------NbComp NbComp ∑ W k Comp i, k k=1 N = number of observation dates for the numerator Floor = predefined constant floor value Cap = predefined constant cap value NbComp = number of components of the index Wk = weight of kst component of the index Compi,k = value of the kst component at time i 7.2 Instrument setup Index instruments must be set up in the following order: 7.2.1 Simple Index Index instruments are based on an instrument type derived from the class INDEX. • Main characteristics (Quoted page): This information enables you to either enter the quotation manually in Rate Monitor, or to retrieve it automatically in real-time. Information Description Price Type information Index. Quote Handling Index. Currency Currency of the index. Note: Real-time market information is set up for the instrument in the Market Info page. See A.2.203 Index on page 813. It is also possible to set up: • 426 Branch codes. See Appendix A Features on page 713. © Wall Street Systems IPH AB - Confidential 7 Index 7.2 Instrument setup 7.2.2 Composite Index Composite Index instruments are based on an instrument type derived from the class INDEX. • Main characteristics Features INDEX-COMPOSITE (primary) and QUOTED must be used. See A.2.205 Index Composite on page 814. This feature allows you to define the information in the instrument setup tabs as described in the following sections. 7.2.2.1 Structure Defines the principal characteristics of the index. Information Description Currency Reference currency for the index, used as the basis of index calculations. Composition Type Defines the component types used in this index: DEBT-SECURITY (bond, quoted Discount Paper), EQUITY, and COMPOSITE (other composite index). Weight Cap The max % of the market value a single component can attain. Calculation Method Defines how Composite Indexes are calculated. The following methods can be used to take the outflows (coupons, dividends and bond accrued interest) into account: • Clean Price: Used mainly for bonds. Only takes into account price return, not accrued interest or cashflows. Unlike the other methods, this method discards the accrued interest from the calculations of bond indices. • Hold Cash On Security: Cashflows are held under security until the index is revised, but not reinvested. In which case, the field amount contains the amount of the cashflow, and is populated when the cashflow is detached from the security (in security currency). The amounts between two rebalancings are added to the security amount (price * units) and eventually, accrued interest before being converted to index currency. • Hold Cash On Index: Cashflows are held under index until the index is revised, but not reinvested. In which case, the field amount contains the amount of the cashflow converted to the index currency, and is populated when cashflow is detached from the security. The amounts between two rebalancings are added to the market value of the index. • Reinvest Cash On Security: The amount of the cashflow is reinvested on the security from which it is detached. TRM calculates a factor to simulate reinvestment of the cash in the security itself (stored in the Rebalance page). • Reinvest Cash On Index: The amount of the cashflow is reinvested in the index. TRM calculates a factor which is applied to the whole index (stored in the Rebase page). Rounding Precision Rounding precision to be applied in calculations. Rounding Method Rounding method to be applied in calculations. Input Method Defines how weightings are input (see 7.2.2.3 Composition on page 429). Available methods are: • Units/Nominal: the absolute units for the component • Market Value: the market value of the component in index currency • Weight %: the % of the total market value of the component • Outstanding: number of times the outstanding units/nominal (typically 1). Available for Bond and Equity • Free Float: same as above but with the units available for trading. Available only for Equity. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 427 7 Index 7.2 Instrument setup 7.2.2.2 Base Periodically models the revisions of the index including the initial definition Information Description From Date of the revision To Read-only. Date up to which this revision is valid. Index Value • For the initial base the default is 100. This can be changed if you want to start the index with another value. For example, to manage the CAC-40 today, you would use the CAC-40’s current value. • For revision bases this is defaulted to the last known frozen base (from the previous day). It can be changed (if incorrect in the database for example) but should normally not be changed: it will be used as the base for index calculations for every date until the next revision. Market Value The total market value of the index in the index currency. It is automatically set with Calculate (see Actions). It can also be forced, and then Calculate will adjust composition to match it. Last Market Value Read-only. Attributes • Error: calculation of the base is impossible (incorrect base/component attributes and/or inputs/market value) • Keep Market Value: affects Calculate button behavior (see below); always on • Modified: composition has been modified for this base and calculation must be when input method is Weight %. done before saving Actions • Copy composition from template Initializes an index from one or more template indexes, available only for the initial base. The template must be selected for this action to be visible. A factor can be used to scale template composition. The action can be executed several times to combine several templates. • Duplicate previous composition Duplicates composition which can be manually revised: when using outstanding and free float methods this does automatic revision without requiring manual intervention (it re-fetches new market information at revision time). Only on revision bases (when you have more than one base). • Update composition attributes Automatically sets or resets the Keep Input flag for all the components of the base, so component flags need not be set or reset manually (see 7.2.2.3 Composition on page 429). • Calculate... This button is used to recalculate the specified base when Components are added, removed, or modified. The calculation makes sure that the setup of the base is consistent: that the sum of all the components amount matches the market value of the base and, if input method is weight %, that the inputs sum to 100%. The calculation is affected by the Keep Market Value switch of the base and the Keep Inputs flags of the components. When Keep Market Value is switched on, the system adjusts component inputs that are not marked with Keep Input. Otherwise the market value can be re-calculated. When the input method is Weight %, the Keep Market Value flag is forced to True. Note: If the flags are set in a way that makes resolution of the equation impossible, Calculate... flags the base with the attribute Error, and the instrument cannot be saved. It is possible to 428 © Wall Street Systems IPH AB - Confidential 7 Index 7.2 Instrument setup temporarily save an index with an inconsistent base by unswitching the attributes manually, but the user must fix the problem before using the index. 7.2.2.3 Composition Defines the composition of the index for a given base Information Description Base Date Reference of the base (corresponds to Base "From"). Component Id of the component; available components are filtered according to index type. Currency Read-only. Currency of the component, retrieved from component characteristics. Calendar Calendar of the component, retrieved from component characteristics. FX Rate Cross-rate between Component currency and index currency, defaulted from fixing scenario. Can be changed by the user. It is the base rate used in calculation relative to this base for this component. Component Value Price of the component. This is defaulted from the fixing scenario and can be changed by the user. It is the base price used in calculations relative to this base for this component. Input It is the base weight for this component. The significance of this weight depends on the input method defined in the index structure (see 7.2.2.1 Structure on page 427). Units/Nominal Read-only. This is the absolute weight in units (for equities) or in nominal (for bonds) which is calculated for the component depending on the input method. Accrued Interest For bond index, amount of accrued interest for the component at base date. Amount Read-only. Shows the amount of the component for the base in index currency. The sum of the amount of all components for a base gives the base market value of the index. Attributes Keep Input forces the Calculate action to keep the input for this component. 7.2.2.4 Rebase Stores the impact of cashflows, depending on the method of calculation. This is used when cashflows are impacted at index level. Information Description Date Date of the market value shift Old Value Market value of the index before the external event was taken into account New Value Market value of the index including the impact of the external event. Cash Amount to be added to index MV from the specified date onwards. Source Read-only. Shows what event triggers the rebasing. Manual means that the user can enter it manually, and in which case, it is modifiable in the editor. Other choices are: Amortization, Cash Dividend, Coupon, Split. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 429 7 Index 7.2 Instrument setup 7.2.2.5 Rebalance Stores the impact of cashflows, depending on the method of calculation. This is used when cashflows are impacted at component level. It is also used to compensate for the effect of equity splits. Information Description Date Date of the CA to be balanced. Component Id of the component; available components are filtered according to index type. Old Units/Nominal Number of units before rebalancing New Units/Nominal Number of units after rebalancing Cash Amount to be added to component MV from the specified date onwards. Source Read-only. Shows what event triggers the rebasing. Manual means that the user can enter it manually, and in which case, it is modifiable in the editor. 7.2.3 Derived Index Features INDEX-DERIVED (primary) and QUOTED must be used. 7.2.3.1 Structure Defines the currency, index type, and maximum weight for any component for the corresponding index composition. Information Description Currency Reference currency for the index, used as the basis of index calculations. Composition Type Index is the only available type. Weight Cap The max % of the market value a single component can attain. Input Method Defines how weightings are input (see 7.2.3.3 Composition on page 431). Available methods are: • Units/Nominal: the absolute units for the component • Weight %: the % of the total market value of the component. Rounding Precision Rounding precision to be applied in calculations. Rounding Method Rounding method to be applied in calculations. Calculation Method Not used for a derived index. 7.2.3.2 Base Periodically models the revisions of the index including the initial definition 430 Information Description From Date of the revision To Read-only. Date up to which this revision is valid. Index Value • For the initial base the default is 100. This can be changed if you want to start the index with another value. • For revision bases this is defaulted to the last known frozen base (from the previous day). It can be changed (if incorrect in the database for example) but should normally not be changed: it will be used as the base for index calculations for every date until the next revision. © Wall Street Systems IPH AB - Confidential 7 Index 7.2 Instrument setup Information Description Market Value The total market value of the index in the index currency. It is automatically set with the Calculate... button (see Actions). It can also be forced, and then calculate will adjust composition to match it. Last Market Value Read-only. Attributes • Error: calculation of the base is impossible (incorrect base/component attributes and/or inputs/market value) • Keep Market Value: affects Calculate button behavior (see below); always on when method is %. • Modified: composition has been modified for this base and calculation must be done before saving Actions • Copy composition from template Initializes an index from one or more template indexes, available only for the initial base. The template must be selected for the action to be visible. A factor can be used to scale template composition. The action can be executed several times to combine several templates. • Duplicate previous composition Duplicates composition which can be then manually revised. Only on revision bases (when there is more than one base). • Update composition attributes Automatically sets or resets the Keep Input flag for all the components of the base: this is a shortcut (see 7.2.3.3 Composition on page 431). • Calculate... This button recalculates the specified base when Components are added, removed, or modified. The calculation makes sure that the setup of the base is consistent: that the sum of all the components amount matches the market value of the base and, if input method is Weight %, that the inputs sum to 100%. The calculation is affected by the Keep Market Value switch of the base and the Keep Inputs flags of the components. When Keep Market Value is switched on, the system adjusts component inputs that are not marked with Keep Input. Otherwise the market value can be re-calculated. When the input method is Weight %, the Keep Market Value flag is forced to True. Note: If the flags are set in a way that makes resolution of the equation impossible, Calculate... flags the base with the attribute Error, and the instrument cannot be saved. It is possible to temporarily save an index with an inconsistent base by unswitching the attributes manually, but the user must fix the problem before using the index. 7.2.3.3 Composition Defines the composition of the index for a given base. Information Description Base Date Reference of the base (corresponds to Base "From"). Component Id of the component; available components are indexes. Currency Read-only. Currency of the component, retrieved from component characteristics. Calendar Read-only. Calendar of the component, retrieved from component characteristics. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 431 7 Index 7.2 Instrument setup Information Description FX Rate Cross-rate between Component currency and index currency, defaulted from fixing scenario. Can be changed by the user. It is the base rate used in calculation relative to this base for this component. Component Value Price of the component. This is defaulted from the fixing scenario and can be changed by the user. It is the base price used in calculations relative to this base for this component. Input It is the base weight for this component. The significance of this weight depends on the input method defined in the index structure (see above). Units/Nominal Read-only. This is the absolute weight in units which is calculated for the component depending on the input method. Amount Read-only. Shows the amount of the component for the base in index currency. The sum of the amount of all components for a base gives the base market value of the index. Attributes Keep Input forces the Calculate action to keep the input for this component. 7.2.3.4 Schedule Defines rebalance schedules, which will be used to generate rebalance dates. Information Description Start Date Date from when rebalancing starts. End Date Date when rebalancing stops (if you do not know if it will stop, just use a distant future date). Method Specifies how the rebalancing dates are calculated. Frequency A function of the Method selected. For example, if method is Months, entering 3 here gives a frequency of 3 months. Convention Business convention to be followed. Roll from Start Yes or No. Date Type Select Re-balance. 7.2.3.5 Rebalance Date Shows rebalance dates. Information Description Date Date when rebalancing is executed. Actions • Generate Generates a set of rebalance dates according to the schedules. If Method is "Days" or "Business Days" and Frequency is 1, only the first rebalance date is generated; next rebalance dates are generated by clicking Rebalance (see below). • Rebalance Performs index rebalancing. The input method for the index must be Weight %. The system creates rows in the Rebalance page for the components of the index to adjust their units so that the percentages match the definition of the base. It is possible to trigger this action automatically via an activity (see 7.4 Processing on page 440). 432 © Wall Street Systems IPH AB - Confidential 7 Index 7.2 Instrument setup 7.2.3.6 Rebalance Stores the impact of re-balancing. Information Description Date Date of rebalancing. Component Id of the component. Old Units/Nominal Number of units before rebalancing. New Units/Nominal Number of units after rebalancing. Cash Amount to be added to component MV from the specified date onwards. Source Read-only. Shows what event triggers the rebasing. Manual means that the user can enter it manually, and in which case, it is modifiable in the editor. 7.2.4 Performance averaging index • Main characteristics Features INDEX-AVERAGING (primary) and QUOTED must be used. See A.2.204 Index Averaging on page 813. This feature allows you to define the following information in the instrument setup tabs: 7.2.4.1 Structure Defines the currency, index type, and maximum weight for any component for the corresponding index composition. Information Description Currency Reference currency for the index, used as the basis of index calculations. Composition Type Defines the component types used in this index: equities, bonds or indexes. Weight Cap The max % of the market value a single component can attain. Calculation Method Clean Price is the only method supported. Rounding Precision Rounding precision to be applied in calculations. Rounding Method Rounding method to be applied in calculations. Input Method Defines how weightings are input (see 7.2.4.3 Composition on page 435). Available methods are: • Units/Nominal: the absolute units for the component • Market value: the market value of the component in index currency • Weight %: the % of the total market value of the component • Outstanding: the number of times the outstanding units/nominal (typically 1). Available for Bond and Equity. • Free Float: same as above, but with the units available for trading. Available only for Equity. 7.2.4.2 Base Periodically models the revisions of the index including the initial definition Information Description From Date of the revision Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 433 7 Index 7.2 Instrument setup Information Description To Read-only. Date up to which this revision is valid. Index Value • For the initial base the default is 100. • For revision bases this is defaulted to the last known frozen base (from the previous day). It can be changed (if incorrect in the database for example) but should normally not be changed: it will be used as the base for index calculations for every date until the next revision. Market Value The total market value of the index in the index currency. It is automatically set with Calculate (see Actions). It can also be forced and then Calculate will adjust composition to match it. Last Market Value Read-only. Attributes • Error: calculation of the base is impossible (incorrect base/component attributes and/or inputs/market value) • Keep Market Value: affects Calculate button behavior (see below); always on when method is %. • Modified: composition has been modified for this base and calculation must be done before saving Actions • Copy composition from template Initializes an index from one or more template indexes, available only for the initial base. The template must be selected for the action to be visible. A factor can be used to scale template composition. This action can be repeated to combine several templates. • Duplicate previous composition Duplicates composition which can then be manually revised: when using outstanding and free-float methods, this does automatic revision without manual intervention (it re-fetches new market information at revision time). Only on revision bases. • Update composition attributes Automatically sets or resets the Keep Input flag for all the components of the base: this is a short cut (see 7.2.4.3 Composition on page 435). 434 © Wall Street Systems IPH AB - Confidential 7 Index 7.2 Instrument setup • Calculate... This button recalculates the specified base when Components are added, removed, or modified. The calculation makes sure that the setup of the base is consistent: that the sum of all the components amount matches the market value of the base, and if the input method is Weight %, that the inputs sum to 100%. The calculation is affected by the Keep Market Value switch of the base, and the Keep Inputs flags of the components. When Keep Market Value is switched on, the system adjusts component inputs that are not marked with Keep Input. Otherwise the market value can be re-calculated. When input method is Weight %, the Keep Market Value flag is forced to True; when the input method is Outstanding or Free Float, it is forced to False. Note: If the flags are set in a way that makes resolution of the equation impossible, Calculate... flags the base with attribute Error, and the instrument cannot be saved. It is possible to temporarily save an index with an inconsistent base by unswitching the attributes manually, but the user must fix this problem before using the index. 7.2.4.3 Composition Defines the composition of the index for a given base. Information Description Base Date Reference of the base (corresponds to Base "From"). Component Id of the component; available components are filtered according to index type. Currency Read-only. Currency of the component, retrieved from component characteristics. Calendar Read-only. Calendar of the component, retrieved from component characteristics. FX Rate Cross-rate between Component currency and index currency, defaulted from fixing scenario. Can be changed by the user. It is the base rate used in calculation relative to this base for this component. Component Value Price of the component. This is defaulted from the fixing scenario and can be changed by the user. It is the base price used in calculations relative to this base for this component. Input It is the base weight for this component. The significance of this weight depends on the input method defined in the index structure (see above). Units/Nominal Read-only. This is the absolute weight in units (for equities) or in nominal (for bonds) which is calculated for the component depending on the input method. Amount Read-only. Shows the amount of the component for the base in index currency. The sum of the amount of all components for a base gives the base market value of the index. Attributes Keep Input forces the Calculate action to keep the input for this component. 7.2.4.4 Rebalance Balances the impact of any equity splits. Information Description Date Date of the CA to be balanced. Component Id of the component; available components are filtered according to index type. Old Units/Nominal Number of units before split. New Units/Nominal Number of units after split. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 435 7 Index 7.2 Instrument setup Information Description Cash Amount to be added to component MV from the specified date onwards. Source Read-only. Shows what event triggers the rebasing. Manual means that the user can enter it manually, and in which case, it is modifiable in the editor. 7.2.4.5 Schedule Defines schedules, used to generate numerator and denominator dates. Information Description Start Date Date from when generation starts. End Date Date when generation stops (if you do not know when generation will stop, just use a distant future date). Method Defines how the generation dates are calculated. Frequency A function of the Method selected. For example, if method is Months, entering 3 here gives a frequency of 3 months. Convention Business convention to be used. Roll from Start Yes or No. Date Type Use Avg. Numerator and Avg. Denominator. 7.2.4.6 Denominator Date and Numerator Date These pages show the dates when performance calculations are performed Information Description Date Input Date of the calculation. Observation Date Date when the price is retrieved for the components following the given calendar. Calendar For each Date Input there must be as many records as distinct calendars in the components. Observation date might be different for each calendar. Actions • Generate Generates a set of Numerator and Denominator dates according to the schedules and individual calendars of the components. 7.2.5 Performance totaling index • Main characteristics Features INDEX-TOTALING (primary) and QUOTED must be used. See A.2.215 Index Totaling on page 821. This feature allows you to define the information in the instrument setup tabs described in the following sections. 436 © Wall Street Systems IPH AB - Confidential 7 Index 7.2 Instrument setup 7.2.5.1 Structure Defines the currency, index type, and maximum weight for any component for the corresponding index composition. Information Description Currency Reference currency for the index, used as the basis of index calculations. Composition Type Defines the component types used in this index: equities, bonds or indexes. Weight Cap The max % of the market value a single component can attain. Calculation Method Clean Price is the only supported method. Rounding Precision Rounding precision to be applied in calculations. Rounding Method Rounding method to be applied in calculations. Input Method Defines how weightings are input (see 7.2.5.3 Composition on page 438). Available methods are: • Units/Nominal: the absolute units for the component • Market value: the market value of the component in index currency • Weight %: the % of the total market value of the component • Outstanding: the number of times the outstanding units/nominal (typically 1). Available for Bond and Equity. • Free Float: same as above but with the units available for trading. Available only for Equity. 7.2.5.2 Base Periodically models the revisions of the index including the initial definition Information Description From Date of the revision To Read-only. Date up to which this revision is valid. Index Value • For the initial base the default is 100. • For revision bases this is defaulted to the last known frozen base (from the previous day). It can be changed (if incorrect in the database for example) but should normally not be changed: it will be used as the base for index calculations for every date until the next revision. Market Value The total market value of the index in the index currency. It is automatically set with Calculate (see Actions). It can also be forced and then calculate will adjust composition to match it. Last Market Value Read-only. Attributes • Error: calculation of the base is impossible (incorrect base/component attributes and/or inputs/market value) • Keep Market Value: affects Calculate button behavior (see below); always on • Modified: composition has been modified for this base and calculation must be when method is %. done before saving Actions • Copy composition from template Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 437 7 Index 7.2 Instrument setup Initializes an index from one or more template indexes, available only for the initial base. The template must be selected for the action to be visible. A factor can be used to scale template composition. This action can be repeated to combine several templates. • Duplicate previous composition Duplicates composition which can be then manually revised: when using outstanding and free float methods this does automatic revision without requiring manual intervention (it re-fetches new market information at revision time). Only on revision bases. • Update composition attributes Automatically sets or resets the Keep Input flag for all the components of the base: this is a short cut (see 7.2.5.3 Composition on page 438). • Calculate... This button recalculates the specified base when Components are added, removed, or modified. The calculation makes sure that the setup of the base is consistent: that the sum of all the components amount matches the market value of the base and, if input method is Weight %, that the inputs sum to 100%. The calculation is affected by the Keep Market Value switch of the base and the Keep Inputs flags of the components. When Keep Market Value is switched on, the system adjusts component inputs that are not flagged with Keep Input. Otherwise the Market Value can be re-calculated. When input method is Weight %, the Keep Market Value flag is forced to True; when method is Outstanding or Free Float it is forced to False. Note: If the flags are set in a way that makes resolution of the equation impossible, Calculate... marks the base with attribute Error, and the instrument cannot be saved. It is possible to temporarily save an index with an inconsistent base by unswitching the attributes manually, but the user must fix this problem before using the index. 7.2.5.3 Composition Defines the composition of the index for a given base 438 Information Description Base Date Reference of the base (corresponds to Base "From"). Component Id of the component; available components are filtered according to index type. Currency Read-only. Currency of the component, retrieved from component characteristics. Calendar Read-only. Calendar of the component, retrieved from component characteristics. FX Rate Cross-rate between Component currency and index currency, defaulted from fixing scenario. Can be changed by the user. It is the base rate used in calculation relative to this base for this component. Component Value Price of the component. This is defaulted from the fixing scenario and can be changed by the user. It is the base price used in calculations relative to this base for this component. Input It is the base weight for this component. The significance of this weight depends on the input method defined in the index structure (see above). Units/Nominal Read-only. This is the absolute weight in units (for equities) or in nominal (for bonds) which is calculated for the component depending on the input method. Amount Read-only. Shows the amount of the component for the base in index currency. The sum of the amount of all components for a base gives the base market value of the index. © Wall Street Systems IPH AB - Confidential 7 Index 7.2 Instrument setup Information Description Attributes Keep Input forces the Calculate action to keep the input for this component. 7.2.5.4 Rebalance Balances the impact of any equity splits Information Description Date Date of the CA to be balanced. Component Id of the component; available components are filtered according to index type. Old Units/Nominal Number of units before rebalancing New Units/Nominal Number of units after rebalancing Cash Amount to be added to component MV from the specified date onwards. Source Read-only. Shows what event triggers the rebasing. Manual means that the user can enter it manually, and in which case, it is modifiable in the editor. 7.2.5.5 Totaling Defines cap and floor to use in totaling formula (see – Performance Totaling Index on page 426). Information Description Floor The floor to use in the totaling formulae. Cap The cap to use in the totaling formulae. 7.2.5.6 Schedule Defines schedules, used to generate totaling dates. Information Description Start Date Date from when generation starts. End Date Date when generation stops (if you do not know if it will stop, just use a date very far in the future). Method Defines how the generation dates are calculated. Frequency A function of the Method selected. For example, if method is Months, entering 3 here gives a frequency of 3 months. Convention Business convention to be used. Roll from Start Yes or No. Date Type Use average numerator and denominator for date types. 7.2.5.7 Totaling Date This page shows the dates when performance calculation is done. Information Description Date Input Date of the calculation. Observation Date The date when the price will be retrieved for the components following the given calendar. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 439 7 Index 7.3 Market information Information Description Calendar For each Date Input there must be as many records as there are distinct calendars in the components. The Observation Dates for each calendar can be different. Actions • Generate Generates a set of totaling dates according to the schedules and individual calendars of the components. 7.3 Market information Rate Monitor is used to visualize and maintain index prices. See the TRM User Guide for more information. 7.4 Processing This section describes the processing that you can perform, either manually in the relevant application, or automatically, as an activity, in Activity Monitor. 7.4.1 Revision Revision is a manual process which consists of updating an index to reflect the market more accurately. This operation is done in the Instrument Editor by creating a new base and a new composition. Note: It is also possible to import revisions using one of the TRM connectivity tools. 7.4.2 Freezing Index Values Rate Monitor enables you to view both calculated and quoted (Q) values, but only the quoted values are used by the rest of the system. Values of composite, derived and performance indexes are calculated automatically in real time according to market data changes (FX rates or component values). It is nevertheless important to be able to freeze these results at any time. In Rate Monitor, use the command Command - Freeze to freeze these values; the current content of the calculated cells are copied to the Quoted (Q) cells. When you have frozen these values, use the Save button to store them in the database like any other standard price. Both index values and detailed composition information are stored. Note: You can import Quoted (Q) values directly from an external data feed, either as a replacement or in parallel, by using another scenario and/or subscenario. You can also use the Index Freeze activity in Activity Manager to perform the freeze. Note: See the TRM User Guide for general information on running activities, and also specific information on the activity parameters. 440 © Wall Street Systems IPH AB - Confidential 7 Index 7.4 Processing 7.4.3 Updating Factors and Cash Use the activity Index Adjustment in Activity Manager to automatically update factors and cash. This activity reads the characteristics of the underlyings, and depending on the Index Type and the Calculation Method, inserts the relevant information into the Rebase and Rebalance pages. Note: See the TRM User Guide for general information on running activities, and also specific information on the activity parameters. 7.4.4 Rebalancing A common use for a derived index is to rebalance the index periodically, so that each component weight is readjusted to the original percentage weighting. After the setup of rebalancing dates is done, (see setup above), you can execute rebalancing for an index directly in the editor, by clicking Rebalance. You can also use the Index Rebalance activity in Activity Manager to perform this task. Note: See the TRM User Guide for general information on running activities, and also specific information on the activity parameters. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 441 7 Index 7.4 Processing 442 © Wall Street Systems IPH AB - Confidential Chapter 8 Cash 8.1 Bank account Bank account balances and any interest accrued on a bank account are displayed in the system as transactions. Bank accounts can be used either: to track your own bank balance by checking your current position adjusted by the existing balance, and to calculate the estimated accrued interest on the bank account; or, if you represent an In-house Bank (that is, you hold accounts for your subsidiaries), you can calculate end-of-day balances and provide your subsidiaries with the appropriate information, as well as calculating any accrued interest on the accounts. You need to set up one instrument to calculate bank balances, and another which is specifically used to calculate accrued interest. Both instruments are assigned to accounts in the Accounts page of Client Editor: see the TRM User Guide for more information. It is recommended that a separate Balance portfolio is defined for the balance and interest-calculation transactions. One reason is that you can restrict update access to the balance information to people in the back office, while the trading portfolios can only be updated by people in the front office and middle office. If you operate as an In-house Bank, you may also find it useful to have a Balance portfolio for each of the bank accounts of your subsidiaries. Note: Information about how to assign balance instruments to accounts and how to create Balance portfolios is described in the TRM User Guide. Bank account balances and interest-calculation instruments belong to the instrument class BANK-ACCOUNT. 8.1.1 Instrument setup Both bank account balance and bank account interest instruments share the same primary feature. 8.1.1.1 Bank account balance Bank account balance instruments are assigned to the accounts for which you want to calculate the balance. The balance can either be derived from payable cashflows in the system, or from paid cashflows. It is also possible to define in how much detail you want the balance to be calculated, for example, if you need one balance transaction per counterparty. Balance instruments do not require any specific set up. They are simply recognized by the following features in the Bank-Account instrument class: • The primary feature Bank Account Balance (see A.2.45 Bank Account Balance on page 729) • The valuation feature Bank Account Method (see A.2.47 Bank Account Valuation on page 732). 8.1.1.2 Bank account interest-calculation Interest-calculation instruments are assigned to the accounts for which you want to calculate the accrual of interest. • Main characteristics Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 443 8 Cash 8.1 Bank account The bank account interest instrument uses the same primary feature as the bank account balance instrument (see 8.1.1.1 Bank account balance on page 443). • Trading information – Interest accrual parameters For bank balances, you can specify the interest rates used, and the method and frequency that interest is accrued. Information Description Date Basis Date basis used to calculate accrued interest for this instrument. Interest Rate Curve Underlying yield curve (set up in IR Quote and Yield Curve Editor) used for interest calculation. Note: If you specify a yield curve (and/or Period, Positive Spread, or Negative Spread), you do not need to specify any Ladder values (see Ladder Rule and Ladder). – Period Period of the underlying yield curve to be used for interest calculation (for example, O/N). Scenario Rate scenario to be used for calculating interest for this instrument. Interest realization parameters You can specify how the accrued interest is realized on the balance. Information Description Frequency Frequency of interest realization (if Method = Periodically). Frequency Unit Method Unit of time to use for interest realization: Business Days, Days, Months, Weeks, or Years. Method of realizing interest: • At Withdrawal - not applicable. • Periodically - interest is realized at regular intervals (see Frequency field). • Settlement Method At Expiration - not applicable. Interest payment method: Capitalize to compound interest or Settle to receive or pay interest. See A.2.46 Bank Account Interest on page 730. 8.1.2 Deal capture Bank account balances and interest transactions are system-generated transactions, performed by scheduled activities (see the TRM User Guide for more information). Once the activity has run, the transactions are generated in the Bank Account Balances application. 8.1.2.1 Generated data • Transaction Transaction Type = Balance Counterparty = Bank that holds the balance, unless the balances are calculated by counterparty • Cashflows – 444 One cashflow per balance (only if the balance has changed) © Wall Street Systems IPH AB - Confidential 8 Cash 8.1 Bank account – If the interest is unrealized: daily accrued interest – If the interest is realized: realized interest cashflows or the capitalizing balance cashflow. 8.1.3 Processing This section describes the processing that you can perform, either manually in the relevant application, or automatically, as an activity, in Activity Manager. See the TRM User Guide for information about these activities and how to set up activities in general. 8.1.3.1 Calculating bank account balance and interest Bank account balance and accrued interest-calculation transactions are generated by the activity Bank Account Balances which you can schedule to run as often as required (see the TRM User Guide for more information). 8.1.3.2 Realize AI Bank account accrued interest can be realized automatically or manually (for automatic realization, see the TRM User Guide). You can realize interest manually, by right-clicking on the transaction in the Transaction view of the Bank Account Balances application and selecting the Realize AI action. • Execution The following information is needed to process the realization: Information Description Date Date of the action i.e. the realization date. Opening Date The opening date of the transaction. Payment Date By default, the Payment Date is the realization date. However, you can change the default. Amount Amount of the realized interest cashflow. By default, this is the total amount of accrued interest, but it can be changed to a lesser amount if you do not want to realize the total amount. Interest Sign Positive: To receive interest. Negative: To pay interest. Settlement Method Capitalize or Settle. The accrued interest is either settled or capitalized. Note: By default, the settlement method will be the one defined in the Interest Realization page of Instrument Editor. Interest Bank ID of a bank if you want to settle the interest realization in a specific bank, which differs from the default bank. Interest Account ID of a bank account if you want to settle the interest realization in a specific account, which differs from the default bank account. Update Realization Date Switch on to allow the next interest realization date to be automatically updated. Note: It is not possible to realize accrued interest for future dates using the Realize AI action. • Cancellation Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 445 8 Cash 8.2 Call account You can cancel interest manually by right-clicking on the transaction in the Transaction view of the Bank Account Balances application and selecting the Undo Realize AI action. The following information is needed to process the cancellation: Information Description Date Date of the action i.e. the undo realization date. By default the date is today's date. 8.2 Call account Call Account is similar to a normal bank account. The client can withdraw and deposit funds (lend or borrow) from the account whenever it is necessary. The funds earn interest on the account at a rate that is fixed daily. The interest is accrued and paid or capitalized at regular intervals. The client can withdraw all or part of the interest from the account when interest is payable (without first having to capitalize the interest). The main difference between Call Money and Call Account is the presumed length of the transaction. Call Money is assumed to mature on a daily basis, while Call Account is automatically rolled over every day. In TRM, call account instruments belong to the instrument class CALL-ACCOUNT. 8.2.1 Instrument setup Call accounts are based on an instrument type derived from the instrument class CALL-ACCOUNT. • Main characteristics The following basic information may be captured when defining a call account instrument. Information Description Currency Currency of the call account. Balance information Minimum and maximum balance allowed on the call account. Notice period information Required notice period for calling the money. – Interest accrual parameters For call accounts, you can specify the interest rates used, and the method and frequency that interest is accrued on the call account. – Interest realization parameters You can also specify how the accrued interest is realized on the call account. See A.2.82 Call Account on page 747. For a call account instrument, it is also possible to set up: • Spot date calculation • Cashflow and transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 446 © Wall Street Systems IPH AB - Confidential 8 Cash 8.2 Call account 8.2.2 Deal capture Call account transactions are entered in the Call Account trading mode of Transaction Manager’s Call Manager layout. Note: See the TRM User Guide for more information about this Transaction Manager layout. 8.2.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a call account transaction: • Transaction view Information Description Movement/Initial Balance Initial movement (inflow or outflow) on the call account. Interest Rate At contract level, this is the last roll over rate. Roll Over Date Date of the next roll over. Capitalize Account Transaction number of an alternative call account on which to realize the capitalized interest. This amount can be zero if the initial movement is intended to open the account only, and does not involve a deposit or withdrawal of funds. Interest rate and balance information defined at instrument level default to the date in the Roll Over Date field. If the Roll Over Date field is empty, then today’s date is used. If no interest rate is available for today, then the rate applied yesterday is used. Similarly, if no balance is available, then the closing balance from the previous day is shown. 8.2.2.2 Generated data Movements on call accounts can be viewed in the Movement view of Call Manager. • Movement view Information Description Movement ID Log number for each movement carried out on a transaction. This number is used to identify individual movements when multiple identical movements are performed on the same transaction on the same day. Interest Rate At movement level, this is the interest rate of the movement. If the transaction has not yet been rolled over, the previous interest rate is displayed. Once the transaction has been rolled over, the rate is updated from the underlying yield curve. If no underlying curve has been defined and a rate change has been agreed with the counterparty, this rate needs to be updated manually. 8.2.3 Processing This section describes the actions that can be done throughout the life of a call account transaction. 8.2.3.1 Update account A call account instrument needs to be updated each day. • Execution – Automatic updating of a call account is done using the Call Money Account Update activity. This activity should be scheduled to run on a daily basis to ensure that the call account instrument is updated each day. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 447 8 Cash 8.2 Call account The following information is needed to process the activity: Parameter Description Minimum Transaction State Minimum transaction state the call account transaction needs to have to be included in the process Portfolio Portfolio containing the call account transaction. Owner Client (portfolio owner) of the portfolio. Counterparty Counterparty of the call account transaction. Counterparty Main Group Counterparty main group of the call account transaction. Counterparty Group Counterparty group of the call account transaction. Instrument ID of the call account instrument. Instrument Group Instrument group to which the call account instrument belongs. Currency Currency of the call account transaction. Interest Rate Curve Yield curve attached to the call money or call account instrument. Note: See the TRM User Guide for information about these activities and how to set up activities in general. 8.2.3.2 New movement It is possible to make a deposit or withdrawal (movement) on a call account. • Execution To include new movements on call account transactions, execute the New Movement processing action on the transaction for which you want to include additional lending or borrowing. In the new row that is added in the Movement view, the following data is required. Information Description Interest Rate Interest rate for the new movement. Amount Amount of the movement. 8.2.3.3 Change interest It is possible to change the interest rate but not create a new movement on a call account using the Change Interest processing action. • 448 Execution Information Description Date Date from when the new interest rate applies. Rate New interest rate. © Wall Street Systems IPH AB - Confidential 8 Cash 8.2 Call account 8.2.3.4 Expire A call account with no outstanding balance can be closed by selecting the Expire right-click action on the call account transaction. • Execution Information Description Closing Date Date when the call account expires. Note that call accounts can have a zero balance and still remain active in the system for future transactions if required; they are not automatically closed when the balance is zero. 8.2.3.5 Update balance You can update the balance using the Update Balance right-click action. • Execution Information Description From Start and end dates of the period for which you want to update the balance. To 8.2.3.6 Update AI You can update accrued interest on call account transactions using the Update AI action. • Execution Information Description Date Date on which you want to recalculate the accrued interest. Rate New interest rate you want to use to recalculate the accrued interest. 8.2.3.7 Realize interest You can realize accrued interest on call account transactions using the Realize AI action. • Execution Information Description Date Date of the action. Opening Date Opening date of the realized interest cashflow. Payment Date By default, the Payment Date is the realize date + payment offset. However, you can change the given default date. Amount Amount of the realized interest cashflow. By default, this is the total amount of accrued interest, but it can be changed to a lesser amount if you do not want to realize the total. Settlement Method Capitalize or Settle. The accrued interest is then either settled or capitalized with the nominal amount of the transaction, depending on the Settlement Method. Note that it is not possible to realize AI for future dates using this action. • Cancellation You can cancel the action using Undo Realize AI. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 449 8 Cash 8.3 Call money 8.2.3.8 Dormant/Pledged You can mark call accounts as being dormant (no transactions allowed) or pledged (restricted movements). • Execution Use the Dormant/Pledged processing action. You are then prompted for new minimum/maximum values: for a dormant account, the minimum and maximum values are both zero. 8.3 Call money Call Money is an overnight deposit used in the wholesale banking market. Although such transactions are normally expired the following day, they can also be rolled over and the interest rate changed. It is possible to increase/decrease the principal of the original deal. In addition, the interest can be paid, capitalized, or simply accrued. The main difference between Call Money and Call Account is the presumed length of the transaction. Call Money is assumed to mature on a daily basis, while Call Account is automatically rolled over every day. In TRM, call money instruments belong to the instrument class CALL-MONEY. 8.3.1 Instrument setup Call Money instruments are based on an instrument type derived from the class CALL-MONEY. • Main characteristics The following basic information may be captured when defining a call money instrument. Information Description Currency Currency of the call money. Balance information Minimum and maximum balance allowed on the call money. Notice period information Required notice period for calling the money. – Interest accrual parameters For call money, you can specify the interest rates used, and the method and frequency that interest is accrued on the call money. – Interest realization parameters You can also specify how the accrued interest is realized on the call money. – Roll over parameters You can define the frequency of the roll over and the convention used. See A.2.84 Call Money on page 750. • Valuation approach See A.2.85 Call Money Valuation on page 750. For a call money instrument, it is also possible to set up: • Spot date calculation • Cashflow and transaction charge rules 450 © Wall Street Systems IPH AB - Confidential 8 Cash 8.3 Call money • Manual charges • Branch codes. See Appendix A Features on page 713. 8.3.2 Deal capture Call money transactions are entered in the Call Money trading mode of Transaction Manager’s Call Manager layout. Note: See the TRM User Guide for more information about this Transaction Manager layout. 8.3.2.1 Input data • Transaction view In addition to the standard deal parameters, the following information is required to enter a call money transaction: Information Description Movement/Initial Balance Change in amount (inflow or outflow) that occurs. Interest Rate Interest rate of the movement. If the transaction has not yet been rolled over, the previous interest rate is displayed. Once the transaction has been rolled over, the rate is updated from the underlying yield curve. If no underlying curve has been defined and a rate change has been agreed with the counterparty, this rate needs to be updated manually. Roll Over Date Date of the next roll over. Capitalize Account Transaction number of an alternative call money instrument on which to realize the capitalized interest. Interest rate and balance information defined at instrument level default to the date in the Roll Over Date field. If the Roll Over Date field is empty, then today’s date is used. If no interest rate is available for today, then the rate applied yesterday is used. Similarly, if no balance is available, then the closing balance from the previous day is shown. 8.3.2.2 Generated data Movements of call money can be viewed in the Movement view of Call Manager. • Movement view Information Description Movement ID Log number for each movement carried out on a transaction. Settlement instructions are also displayed in this view. 8.3.3 Processing This section describes the actions that can be done throughout the life of a call money transaction. 8.3.3.1 Roll over Call money is assumed to mature on a daily basis, unless it is prolonged through roll over. Roll over of call money can be done either manually or automatically using an activity. Normally, the roll over of call instruments should be done as soon as the relevant fixing rates are available. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 451 8 Cash 8.3 Call money • Setup The frequency and conventions for the roll over are determined in the instrument definition. • Execution – Manual roll over of call money instruments is done using the Roll Over action in the Transaction view of Call Manager. If you want to change the amount or interest rate for a call money transaction during roll over, you can enter the changes directly in the following fields: Interest %, Movement, or Closing Amount). If you enter changes in any of these fields, the selected transaction is automatically rolled over. You can enter changes in the fields even after you have selected the Roll Over command. – Automatic roll over is done using the Call Money Roll Over activity. This activity ensures that any unrolled transactions are prolonged automatically at the end of the business day instead of the system creating expiry instruments. The Call Money Account Update activity is then used to update the balances after the roll over. Note: See the TRM User Guide for information on the activity parameters for these activities and how to set up activities in general. • Undo Roll Over You can also undo this action by selecting Undo Roll Over. 8.3.3.2 New movement When rolling over call money transactions, it is possible to include additional lending or borrowing (movements). It is also possible to include new movements after the roll over has been carried out. • Execution To include new movements in call money transactions, execute the New Movement action on the transaction for which you want to include additional lending or borrowing. This command is only available for transactions that have been rolled over and applied. In the new row that is added in the Movement view, the following data is required. Information Description Interest Rate Interest rate for the new movement. Amount Amount of the movement. 8.3.3.3 Expire Call money transactions are expired when there is no longer any lending or borrowing (balance is zero). Note: TRM will not allow you to expire the transaction before the current roll over date. 452 © Wall Street Systems IPH AB - Confidential 8 Cash 8.3 Call money • Execution – Call money transactions are manually expired using the Expire action in Call Money Manager. Information Description Opening Date Date on which the call money transaction is expired. Value Date Value date for the call money transaction. This date defaults from the Roll Over Date. (Interest) Payment Date By default, it is the expiry date. However, you can change this date to a later date at which you want interest to be paid. When the transaction is expired, the interest is realized and a payable cashflow is created for the realized interest. 8.3.3.4 Update balance To update the balance, use the Update Balance right-click action. • Execution Information Description From Start and end dates of the period for which you want to update the balance. To 8.3.3.5 Update AI You can update accrued interest on call money transactions using the Update AI action. • Execution Information Description Date Date on which you want to recalculate the accrued interest. Rate New interest rate you want to use to recalculate the accrued interest. 8.3.3.6 Realize interest • Execution You can realize accrued interest on call money transactions using the Realize AI action. Information Description Date Date of the action. Opening Date Opening date of the realized interest cashflow. Payment Date By default, the Payment Date is the realize date + payment offset. However, you can change the given default date. Amount Amount of the realized interest cashflow. By default, this is the total amount of accrued interest, but it can be changed to a lesser amount if you do not want to realize the total. Settlement Method Capitalize or Settle. The accrued interest is then either settled or capitalized with the nominal amount of the transaction, depending on the Settlement Method. Note that it is not possible to realize AI for future dates using this action: you cannot enter a date that is equal to or later than the transaction’s roll over date. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 453 8 Cash 8.4 Cash • Cancellation You can cancel the action using Undo Realize AI. 8.3.4 Position monitoring 8.3.4.1 Setup Call money transactions are valued by discounting the future cashflows from the maturity date of the roll-over. 8.4 Cash Movements in cash, be it payments or receipts, or transfers, that are not generated directly from a transaction need to be defined as individual instruments. They can then be entered in Transaction Manager as deals in the same way as any other type of instrument. Payment cash instruments are based on an instrument type derived from the class CASH. Note: It is also possible to define cash forecast instruments: see 8.5 Forecast on page 459. 8.4.1 Payment Payment cash instruments represent stand-alone movements of cash, and can be either a negative flow (payment) or a positive flow (receipt). 8.4.1.1 Instrument setup The following basic information may be captured when defining the instrument. This information is relevant to any kind of payment (or receipt). • Main characteristics Information Description Transaction Sign Sign of the payment. If the sign is not defined at instrument level, it needs to be specified separately for each payment transaction. Currency Currency of the payment. Leave this field blank if you want to specify the currency when you enter the payment in Transaction Manager. Rounding parameters Method and precision used to round cashflow amounts. Cashflow Type details Type and subtype assigned to a cashflow. For a generic payment instrument: select Payment. Attribute parameters Attributes of the cashflow: Nominal Amount, Not Bookable, Not Payable, or Pseudo. Client and bank account details The client (portfolio-owner) making the payment, and the client’s bank account information. Counterparty and bank account details The counterparty of the payment, and the counterparty’s bank account information. See A.2.91 Cash Payment on page 754. 454 © Wall Street Systems IPH AB - Confidential 8 Cash 8.4 Cash For a payment instrument it is also possible to set up: • Spot date and value date calculations • Cashflow and transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 8.4.1.2 Deal capture 8.4.1.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a payment instrument: Information Description Currency Currency of the payment. Nominal Amount Amount of the payment. Value Date Date when the payment is made. This defaults to the spot date of the transaction if the value date has not been specified in the instrument definition. Value Date Code If the Value Date Setup feature is applied at instrument level, you can enter the value date period you want to use to calculate the value date for the transaction, for example, 3M (3 months). Note: If you specify a value date period in the instrument setup, this is used by default and cannot be modified. 8.4.1.2.2 Generated data • Cashflows – One cashflow per payment transaction. 8.4.1.3 Processing Apart from the standard processing actions which are common to all transactions (such as Duplicate and Package), there are no other actions in Transaction Manager that are specific to payment instruments. Settlement of cashflows and reconciliation of payments and receipts with the bank account are managed in Settlement Processing and Settlement Reconciliation: see the TRM User Guide for more information. 8.4.2 Transfer Transfers are also set up as cash instruments. Transfers differ from a payment transaction in that they have two cashflows rather than one: one to debit the account making the payment, and the other to credit the account receiving the payment. Transfer instruments are based on an instrument type derived from the class CASH. 8.4.2.1 Instrument setup The following basic information may be captured when defining the instrument. This information is relevant to any kind of cash transfer. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 455 8 Cash 8.4 Cash Main characteristics • Information Description Transaction Sign Sign of the transfer. If the sign is not defined at instrument level, it needs to be specified separately for each transfer transaction. Currency Currency of the transfer. Leave this field blank if you want to specify the currency when you enter the transfer in Transaction Manager. Rounding parameters Method and precision used to round cashflow amounts. Cashflow Type details Type and subtype assigned to a cashflow. For a generic transfer instrument: select Payment. Attribute parameters Attributes of the cashflow: Nominal Amount, Not Bookable, Not Payable, or Pseudo. Client and bank account details The client (portfolio-owner) making the transfer, and the client’s bank account information. Counterparty and bank account details The counterparty of the transfer, and the counterparty’s bank account information. See A.2.326 Transfer (cash) on page 874. For a transfer instrument it is also possible to set up: • Spot date and value date calculations • Cashflow and transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 8.4.2.2 Deal capture 8.4.2.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a transfer instrument: Information Description Currency Currency of the transfer. Nominal Amount Amount of the transfer. Value Date Date when the transfer is made. This defaults to the spot date of the transaction. Value Date Code If the Value Date Setup feature is applied at instrument level, you can enter the value date period you want to use to calculate the value date for the transaction, for example, 3M (3 months). Note: If you specify a value date period in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.339 Value Date Setup on page 879. 8.4.2.2.2 Generated data • 456 Cashflows © Wall Street Systems IPH AB - Confidential 8 Cash 8.4 Cash – A transfer generates two cashflows: one negative cashflow for the source account and one positive cashflow for the target account. – If Counterparty = Owner, then the cash instructions are reversed. 8.4.2.3 Processing Apart from the standard processing actions which are common to all transactions (such as Duplicate and Package), there are no other actions in Transaction Manager that are specific to transfer instruments. Settlement of cashflows and reconciliation of transfers with the bank account are managed in Settlement Processing and Settlement Reconciliation: see the TRM User Guide for more information. 8.4.3 Complex payment A complex payment instrument allows you to define a payment instrument with multiple cashflows in the same currency. The direction (transaction sign) and cashflow type of each individual cashflow within the one payment instrument can be configured separately. Note that if you need to define a complex payment instrument consisting of different currencies, you should use an FX deal instead. Complex payment instruments are based on an instrument type derived from the class CASH. 8.4.3.1 Instrument setup The following basic information may be captured when defining the instrument. This information is relevant to any kind of complex payment. • Main characteristics Information Description Transaction Sign Sign of the initial payment transaction. If the sign is not defined at instrument level, it needs to be specified separately for each payment transaction at deal entry. The parameters of the initial payment are defined in the Movement Leg page. • Cashflow Leg characteristics Information Description ID Number representing the order in which the payment is made. The ID of the initial transaction = 0. The ID is displayed in the Origin column in Transaction Manager’s Cashflow view. Payment Sign Select from: Any, Negative, or Positive. The payment sign for the cashflow leg is relative to the transaction sign of the initial payment transaction. Currency Currency of the payment. Leave this field blank if you want to specify the currency when you enter the payment in Transaction Manager. Rounding parameters Method and precision used to round cashflow amounts. Cashflow Type details Type and subtype assigned to a cashflow. For a generic transfer instrument: select Payment. Attribute parameters Attributes of the cashflow: Nominal Amount, Not Bookable, Not Payable, or Pseudo. Client and bank account details The client (portfolio-owner) making the transfer, and the client’s bank account information. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 457 8 Cash 8.4 Cash Information Description Counterparty and bank account details The counterparty of the transfer, and the counterparty’s bank account information. See A.2.102 Complex Payment (cash) on page 757. For a complex payment instrument it is also possible to set up: • Spot date and value date calculations • Cashflow and transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 8.4.3.2 Deal capture 8.4.3.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a complex payment instrument: Information Description Currency Currency of the payment. Nominal Amount Amount of the payment. Value Date Date when the payment is made. This defaults to the spot date of the transaction. Value Date Code If the Value Date Setup feature is applied at instrument level, you can enter the value date period you want to use to calculate the value date for the transaction, for example, 3M (3 months). Note: If you specify a value date period in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.339 Value Date Setup on page 879. 8.4.3.2.2 Generated data • Cashflows – A complex payment generates multiple cashflows – All cashflows are in the same currency – The sign and type of each cashflow can be different. 8.4.3.3 Processing Apart from the standard processing actions which are common to all transactions (such as Duplicate and Package), there are no other actions in Transaction Manager that are specific to complex payment instruments. Settlement of cashflows and reconciliation of payments and receipts with the bank account are managed in Settlement Processing and Settlement Reconciliation: see the TRM User Guide for more information. 458 © Wall Street Systems IPH AB - Confidential 8 Cash 8.5 Forecast 8.5 Forecast A cash forecast instrument can be defined to record cashflow forecasts in the system. Using a dual-currency forecast instrument, it is possible to view cash exposures in two different currencies. Forecast instruments are based on an instrument type derived from the class FORECAST. 8.5.1 Instrument setup The following basic information may be captured when defining a forecast instrument. • Main characteristics Information Description Currency Currency of the cashflow forecast. Rounding parameters Method and precision used to round cashflow amounts. Price Type Price type for the quotation used to determine which FX rate is used in risk calculations. See A.2.153 Forecast on page 784. For a forecast instrument it is also possible to set up: • Spot date and value date calculations • Cashflow and transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 8.5.1.1 Dual-currency forecast Using a dual-currency forecast instrument, it is possible to view forecast exposures in two different currencies. Dual-currency cashflow forecast instruments are set up in the same way as single currency forecasts, except that they are set up with a different primary feature. See A.2.126 Dual Currency Forecast on page 772. 8.5.2 Deal capture Forecast exposures are imported into TRM using the Forecast Exposures from CMM activity which you can schedule to run as often as required (for example, nightly). These forecasts can then be retrieved in the Forecast Exposure Board for further monitoring or processing. Note: See the TRM User Guide for more information about importing cashflow forecasts into TRM and managing cashflow forecasts in general. 8.5.3 Processing This section describes the actions that can be done throughout the life of a forecast exposure. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 459 8 Cash 8.6 Cost-of-carry 8.5.3.1 Adjust In some rare cases, it may be necessary to adjust the amount of a forecast. This can be done using the Adjust right-click action on the selected forecast. • Execution Information Description Active From Date from when the adjustment applies. Adjustment Amount Amount of the adjustment. Active Until Method Date until when the adjustment applies: Active Until • Until Next Import – the adjustment applies until the next time the activity to import the forecasts from CMM is run, at which time the adjustment is deactivated (but not deleted). • Until Specific Date – the adjustment applies until the date defined in the Active Until field, at which time the adjustment is deactivated (but not deleted). • Always – the adjustment applies indefinitely. Date until when the adjustment applies when Active Until Method = Until Specific Date. An Adjustment flow is added to the forecast exposure. 8.5.3.2 Calculate figures The Calculate Figures right-click action calculates the figures for forecast exposures and displays the results in Forecast Exposure Board’s Figures view. 8.5.3.3 Drill Down The Drill Down action on a retrieved forecast exposure allows you to drill down further into the forecast exposure’s underlying details, for example, to see the underlying component cashflow forecasts of a global forecast amount at a specific date. The underlying components are displayed in Forecast Exposure Board’s Exposure Drilldown view. 8.6 Cost-of-carry Cost-of-carry is used to capture the internal funding cost of outstanding cash. The cost-of-carry balance can be used to monitor how much cash is outstanding for a position and to calculate the accrued interest on the balance. Cost-of-carry can be calculated automatically for any portfolios with a position. Cost-of-carry balances and any accrued interest are displayed in the system as transactions: there is one cost-of-carry transaction per currency dealt in the portfolio. In order to calculate the cost-of-carry of a position, a cost-of-carry instrument needs to be defined and assigned to the portfolio. Only one cost-of-carry instrument needs to be set up to calculate both the balances and the accrued interest. Note: Information about how to assign cost-of-carry instruments to portfolios is described in the TRM User Guide. Cost-of-carry instruments are based on an instrument type derived from the class COST-OF-CARRY. 460 © Wall Street Systems IPH AB - Confidential 8 Cash 8.6 Cost-of-carry 8.6.1 Instrument setup Cost-of-carry instruments are assigned to the portfolios for which you want to calculate the cost associated with funding a position. The balance can either be derived from payable cashflows in the system, or from paid cashflows. Cost-of-carry balance instruments are assigned to portfolios in the Cost of Carry page of Portfolio Editor: see the TRM User Guide for more information. • Main characteristics Cost-of-carry instruments (that do not have accrued interest calculated on the balance) do not require any specific setup. They are simply recognized by the following features in the Cost of Carry instrument class: • – The primary feature COST-OF-CARRY-BALANCE (see A.2.106 Cost of Carry Balance on page 760) – The valuation feature COST-OF-CARRY-METHOD (see A.2.108 Cost of Carry Valuation on page 761). Interest information Cost-of-carry instruments that have accrued interest calculated on the balance use the feature COST-OF-CARRY-INTEREST and require the following setup: – Interest accrual parameters There are some additional parameters that must be defined to calculate the accrual of interest on the cost-of-carry balance. You can specify the interest rates used, and the method and frequency that interest is accrued. Note that if the feature COST-OF-CARRY-INTEREST is not defined in the instrument setup, interest will not be calculated on the cost-of-carry balance. Information Description Date Basis Date basis used to calculate accrued interest for this instrument. Interest Rate Curve Underlying yield curve used for interest calculation. Note: If you specify a yield curve, you do not need to specify any Ladder values (see Ladder Rule and Ladder). – Period Period of the underlying yield curve to be used for interest calculation (for example, O/N). Scenario Rate scenario to be used for calculating interest for this instrument. Interest realization parameters You can specify how the accrued interest is realized on the balance. Information Description Frequency Frequency of interest realization (if Method = Periodically). Frequency Unit Method Unit of time to use for interest realization: Business Days, Days, Months, Weeks, or Years. Method of realizing interest: • At Withdrawal - not applicable. • Periodically - interest is realized at regular intervals (see Frequency field). • Settlement Method At Expiration - not applicable. Interest payment method: Only Capitalize is used for cost-of-carry. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 461 8 Cash 8.6 Cost-of-carry See A.2.107 Cost of Carry Interest on page 760. 8.6.2 Deal capture Cost-of-carry transactions are system-generated transactions, performed by scheduled activities (see the TRM User Guide for more information). When an activity has run, you can view the transactions in the Cost of Carry application. 8.6.2.1 Generated data • Transaction – One transaction per currency: Transaction Type = Balance Counterparty = Portfolio-owner • Cashflows – One cashflow per balance (only if the balance has changed) – Daily accrued interest (if the Cost of Carry Interest feature is assigned to the instrument). – If the interest is realized: realized interest cashflows. – If zero-balancing is used: another balance cashflow with the opposite sign. A zero balance cashflow is also generated the next day. 8.6.3 Processing This section describes the processing that you can perform, either manually in the relevant application, or automatically, as an activity, in Activity Manager. 8.6.3.1 Calculating cost-of-carry balance and interest Cost-of-carry balance and accrued interest-calculation transactions are generated by the activity Cost of Carry which you can schedule to run as often as required (see the TRM User Guide for more information). 8.6.3.2 Realizing cost-of-carry interest Cost-of-carry accrued interest can be realized automatically or manually (for automatic realization, see the TRM User Guide). You can realize interest manually, by right-clicking on the transaction in the Transaction view of the Cost of Carry application and selecting the Realize AI action. • 462 Execution © Wall Street Systems IPH AB - Confidential 8 Cash 8.6 Cost-of-carry The following information is needed to process the realization: Information Description Date Date of the action i.e. the realization date. Opening Date The opening date of the transaction. Payment Date By default, the Payment Date is the realization date. However, you can change the default. Amount Amount of the realized cost-of-carry interest cashflow. By default, this is the total amount of accrued interest, but it can be changed to a lesser amount if you do not want to realize the total amount. Zero Balancing Yes or No (default). Update Realization Date • Yes - the accrued cost-of-carry interest and the cost-of-carry balance are closed out, so that the next day, the starting cost-of-carry balance is zero when the cost-of-carry activity is run. • No - the accrued cost-of-carry interest is realized today, and the next day, the starting cost-of-carry balance is today's balance. Switch on to allow the next interest realization date to be automatically updated. Note: It is not possible to realize accrued interest for future dates using the Realize AI action. • Cancellation You can cancel interest manually by right-clicking on the transaction in the Transaction view of the Cost of Carry application and selecting the Undo Realize AI action. The following information is needed to process the cancellation:. Information Description Date Date of the action i.e. the undo realization date. By default the date is today's date. 8.6.3.3 Setting the cost-of-carry balance to zero It is possible to close out the outstanding cost-of-carry balance without realizing any interest using the activity Cost of Carry Zero Balancing. See the TRM User Guide for more information. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 463 8 Cash 8.6 Cost-of-carry 464 © Wall Street Systems IPH AB - Confidential Chapter 9 Futures 9.1 Forward rate agreement A Forward Rate Agreement (FRA) is an obligation between two parties to enter into a deposit or discount contract in the future at a predefined interest rate. An FRA is an off-balance sheet instrument where the underlying contract is not entered at expiry, but the difference between the pre-agreed rate and the actual rate at expiry is settled between the two parties. The date on which the comparison is made is known as the fixing date. Payment of the interest differential is made up-front, at the start of the future period. The amount is therefore calculated on a discounted basis since it is settled in advance. FRA contracts are traded in reversed sign (the market convention). This means that the purchase of an FRA creates a negative position and a negative interest rate risk, whereas the sale of an FRA produces a positive position and a positive interest rate risk. The most common maturities for FRAs are between 1 and 12 months and the US dollar is the major currency used. FRAs are labeled by period (for example, 3M/6M means a contract that starts in three months and ends in six). 9.1.1 FRA deposit and FRA discount The following basic information may be captured when defining the instrument. This information is relevant to any kind of FRA contract (discount paper or deposit). For more information relating to the setup and structure of specific types of FRA, see 9.1.2 Australian FRA on page 476. 9.1.1.1 Instrument setup Forward rate agreements are based on an instrument type derived from the class FRA. • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of FRA contract (discount paper or deposit). Information Description Currency Currency of the FRA (that is, if it is a listed forward rate agreement). Leave this field blank if you want to specify the currency at deal entry (if you are defining an OTC forward rate agreement). Date Basis Date basis of the instrument. If the date basis is not defined at instrument level, it needs to be specified separately for each transaction. Rounding parameters Method and precision used to round cashflow amounts. Yield Type Yield type of the forward rate agreement. Principal Subtype Type of principal or interest cashflows, if you want to override the default settings. Interest Subtype Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 465 9 Futures 9.1 Forward rate agreement • Netting parameters Information Description Fixing Offset Minimum number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Leave this field blank if you want to specify the fixing offset when you enter the deal. Fixing Subscenario Prices scenario from which the floating rate is retrieved (for example, EUR/USD Spot 9:00 London, or EUR/USD Spot 9:00 Tokyo). Leave this field blank if you want to specify it when you enter the deal. Calendar Calendar to use when calculating the fixing date. Switches Activate the switches that apply to the instrument. • Settlement Currency Settlement Currency - switch on if the P/L cashflow is paid in a different currency. Currency in which the P/L cashflow is paid (if the switch Settlement Currency is switched on). Leave this field blank if you want to specify the settlement currency when you enter the deal. Payment Offset Number of business days after which effective payment of the P/L is made Fixing Rate ID of the yield curve used to calculate the closing price of the forward contract. The forward contract is fixed with the price and TRM calculates the profit/loss using this closing price and the deal rate. Leave this field blank if you want to specify it when you enter the deal. Fixing Period Length of time for which fixing is to be executed (for example, 3M, 6M, 1Y, and so on). Leave this field blank if you want to specify the fixing period when you enter the deal. See A.2.157 Forward Rate Agreement (Deposit) on page 786 and A.2.158 Forward Rate Agreement (Discount) on page 787. • Date information For listed FRA contracts, you must specify the fixing, settlement, and maturity information. See A.2.156 FRA Dates on page 785. For OTC FRA contracts, you need to set up the FRA period information. The maturity date and value date of the contract is calculated using these values. Information Description Calendar parameters Calendars used to calculate the dates. Gap Set Gap set used for supplying the available value/maturity periods for an OTC FRA contract; these in turn are used to define exact dates. Gap Specific gap (within the gap set) defined for the FRA period. This value is used to calculate the value date and maturity date for an OTC FRA contract at deal entry. If you specify the gap period in the instrument setup, this is used as the default in the transaction and cannot be modified. If you leave this field blank, you need to select the gap period in the Maturity Code field at deal entry. The system will then calculate the FRA periods automatically. See A.2.163 FRA Periods on page 790. • 466 Quotation information © Wall Street Systems IPH AB - Confidential 9 Futures 9.1 Forward rate agreement For listed FRA discount contracts, specify the quote information as Yield. See A.2.274 Quoted on page 849. It is also possible to set up: • Branch codes • Cashflow and transaction charge rules • Manual charges • Spot date calculation. See Appendix A Features on page 713. 9.1.1.2 Deal capture 9.1.1.2.1 Input data In addition to the standard deal parameters, the following information is required to enter an FRA contract: Information Description Currency Currency of the transaction. If you specified the currency in the instrument setup (for example, for a US T-Bill), this is used as the default currency in the transaction and cannot be modified. Maturity Code Maturity code used to calculate the FRA periods. From this code, the date for the maturity of the underlying contract and the official date when money is transferred (expiry of the FRA) are calculated. If you defined the specific FRA periods in the instrument setup, these are used as the default in the transaction and cannot be modified. Maturity Date Date when the transaction matures. If you enter a maturity code, the date is calculated automatically; otherwise you can enter the date manually. If the maturity definition parameters are defined at instrument level, these are used by default and cannot be modified. Value Date Date when the transaction starts. This defaults to the spot date of the transaction. Nominal Amount Amount of the forward rate agreement. This is equal to the principal (the amount on which the interest is calculated). FRAs are traded in reversed sign. This means that the nominal amount is negative for the purchase of an FRA, whereas the sale of an FRA is denoted by a positive nominal amount. Deal Rate Rate of return of the underlying forward contract. Fixing Rate Yield curve used when fixing the cashflow. Fixing Period Interest period from which the quotation is retrieved when fixing the interest rate of the transaction, for example, 1M, 3M, or 1Y. Fixing (Max) Offset (Maximum) number of business days before the interest date. Fixing Offset The fixing of the interest occurs on this date. Fixing Subscenario Rate scenario from which the interest rate is retrieved (for example, EUR/USD Spot 9:00 London or EUR/USD Spot 9:00 Tokyo). Fixing Calendar Calendar used for fixing. 9.1.1.2.2 Generated data • Transaction Book Value (discount style): Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 467 9 Futures 9.1 Forward rate agreement BV = rounder (A*D) where: D = discount factor A = nominal amount rounder depends on instrument rounding parameters • Cashflows An FRA is an off-balance sheet instrument, meaning that the principal cashflows never change hands and are therefore marked as pseudo. When an FRA contract is entered into TRM, the pseudo cashflows are established in order to calculate market values and interest rate risks. At the settlement date (when the market interest rate is known and can be compared to the contractual interest rate), the pseudo cashflows are netted with the settled cashflows, and the buyer or seller of the FRA either receives or pays the net amount, instead of the full settlement amount (see 1.8 Processing on page 28 for more information about the netting process). The figure below illustrates the cashflows which are established in TRM for a purchased FRA deposit: Nominal Opening date Netting Maturity period Interest Value date Forward period Maturity date Nominal where the interest amount is calculated as follows: rounder (A*(1/D-1)) where: D = discount factor A = nominal amount rounder depends on the instrument’s rounding parameters The figure below illustrates the cashflows which are established in TRM for a purchased FRA discount paper: Opening date Netting Forward period Book value Maturity period Maturity date Value date Nominal 9.1.1.3 Processing This section describes the actions that can be done throughout the life of an FRA. 468 © Wall Street Systems IPH AB - Confidential 9 Futures 9.1 Forward rate agreement 9.1.1.3.1 Netting FRAs are not subject to a physical delivery of the underlying at expiry but simply result in the difference (positive or negative) between the predefined interest rate and the fixing rate of the underlying at expiry. At the fixing date, the interest rate of the FRA period is known and the profit or loss for that FRA can be calculated. For a purchased FRA, if the fixed market rate is higher than the one originally agreed upon, a settlement amount is received (the profit); but if the fixed interest rate is lower than the contractual rate, the difference must be paid (the loss). • Setup The fixing parameters for FRAs can be defined either at instrument level or at deal entry. Where the fixing parameters are defined depends on how narrow or open the instrument definition needs to be: Information Description Closing price parameters Yield curve and period, rate scenario, and offset between value date and observation period for the rate can be defined either at instrument level or when entering the deal. Settlement Parameters It is possible to define if the netting of the deal is to be paid in a different currency. In this case, the currency can be defined either at instrument level, or when entering the deal. If there is a payment offset it must also be defined here. See A.2.157 Forward Rate Agreement (Deposit) on page 786 and A.2.158 Forward Rate Agreement (Discount) on page 787. • Execution The following information is needed to process the netting: Information Description Netting Date Day of netting (Fixing Date of the FRA). Netting Currency Currency of settlement. (Information only.) Netting Price Netting (market) interest rate. This is defaulted by the system and can be changed by the user. Netting Amount Settlement amount (profit/loss) from the FRA netting. This is calculated automatically by TRM and can be changed by the user. Retrieving of the Netting Price: FP = evaluate(expression, date, scenario, ref curve, period) Calculation of the Netting Amount: PL = BV-(A + I)*D where: BV = book value of the transaction (A for discount and A *D for depo) A = Nominal Amount I = Interest Amount (0 for discount and A*(1/D-1) for depo) D = discount factor for the fixing rate at fixing date As a result of the Netting action, the netting cashflow’s Not Fixed attribute is unset and the P/L amount is set. • Cancellation Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 469 9 Futures 9.1 Forward rate agreement On a fixed netting cashflow there is an Undo Netting action available. Executing this action resets the cashflow’s Not Fixed flag and the P/L amount reverts to 0. 9.1.1.3.2 Early expiration FRAs can be matured earlier than their agreed maturity date by executing the action Early Expiration. This action is only enabled for transactions that have reached a certain state in the transaction flow. • Execution The following information is needed to process the early-expiration: Information Description Opening Date Date when the early expiration is executed. By default, this is today’s date. Settlement Date Date when the early expiration is settled. This must be earlier than the value date of the FRA being expired. Amount to Expire Amount to be early expired. This defaults to the amount still available to be early expired, taking into account previous partial early expirations. Expiration Rate Agreed early expiration rate applied over the FRA period to calculate the forward settlement amount (settlement amount on the original value date). Discount Rate Rate used to discount the forward settlement amount from FRA value date to the early expiration settlement date (rate type Interest Rate) to calculate the Net Amount. Date Basis Date basis used to discount the forward settlement amount from FRA value date to the early expiration settlement date to calculate the Net Amount. The execution generates an early expiration transaction with the following attributes: Transaction sign = opposite of initial transaction Nominal amount = amount to expire Rate = early expiration rate Opening date = date when the early expiration is done Value date = date when the early expiration is settled Kind = Early Expiration The remaining attributes are inherited from the initial transaction. • Cancellation You can undo the early expiration by canceling the early expiration transaction. 9.1.1.4 Position monitoring There are two basic methods for valuation of FRA instruments: Quoted or Theoretical. 9.1.1.4.1 Setup The valuation approach used for an FRA contract is activated by the presence of the appropriate feature in the instrument definition: see A.2.160 FRA Valuation on page 789. • Theoretical valuation method By default, risk calculation is based on the IR exposure settings defined at the FRA instrument level, otherwise, it is based on the interpolation settings defined at the yield curve level (IR Quote and Yield Curve Editor - Interpolation page). See A.2.48 Base IR Exposure Setup on page 732. For more information about risk calculations, see 2.3 Key-figures on page 112. 470 © Wall Street Systems IPH AB - Confidential 9 Futures 9.1 Forward rate agreement • Quoted valuation method By default, with the Quoted valuation method, the discount factor used to compute the market value of the Payback flows is calculated as follows: Equation 9-1 FRA: Quoted valuation method D1 ( r q, d v, d mat ) × D2 ( r, d vlt, d v ) where – rq is the market quote of the FRA on the figure valuation date – D1 is the discount factor computed from the rate type and the data basis of the FRA – r is the market rate retrieved from the valuation default curve between the valuation date and the value date of the FRA – D2 is the discount factor computed from the setup of the valuation default curve. 9.1.1.4.2 Calculations The numerical examples in this section demonstrate how the different figures are calculated for a FRA contract. This example shows a 6M/9M EUR FRA deposit with a 3% Periodic Rate, with the following deal data • Setup Data Symbol Example Instrument Date Basis B Act/360 Instrument Yield Type Periodic Valuation Method Theoretical Valuation Date Figure Date Risk Yield Type Continuous Risk Date Basis • • B_r 365 Result IR: AI Method Linear Result IR: Accrual Method Linear Accrual Accrual Yield: Interest Type Periodic Rate Accrual Yield: Date Basis Actual/360 Portfolio data Data Symbol Example IR Risk Rate e_ir 0.0001 Data Symbol Example Opening Date dt_o 2002-06-07 Nominal Amount A 1,000,000.00 Book Rate r_b 3% Transaction data Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 471 9 Futures 9.1 Forward rate agreement Data Symbol Example Base Book FX Rate S_b 1.000000 Maturity Date d_m 2003-03-11 Value Date d_p 2002-12-11 Data Symbol Example Formula Interest Cashflow c_I -7,500 = -1,000,000*0.03* 0.25 = -A*r_b*t_p Period t_p 0.25 = (2003-03-11 - 2002-12-11)/360 =(d_m-d_p)/B Discount Factor D_b 0.992555831 = 1/(1 + 0.25*0.03) =1/(1+t_p*r_b) Data Symbol Example Formula Figure Date d_f 2002-08-15 Calculated transaction data • Market data on Figure Date • Market data specific to Short Leg • Data Symbol Example Formula Value Date dt_vs 2002-12-11 Time to Value Date t_vs 0.323287671 = (2002-12-11 2002-08-15)/365 = (dt_vs-d_f)/B_r Formula Market data specific to Long Leg • Data Symbol Example Value Date dt_vl 2003-03-11 Time to Value Date t_vl 0.569863014 = (2003-03-11 2002-08-15)/365 = (dt_vl-d_f)/B_r Formula Market data specific to interest flow • Data Symbol Example Value Date dt_vi 2003-03-11 Time to Value Date t_vi 0.569863014 = (2003-03-11 2002-08-15)/365 = (dt_vi-d_f)/B_r Valuation figures specific to Short Leg • Data Symbol Example Formula Amount A_p.s 1,000,000.00 =A 472 © Wall Street Systems IPH AB - Confidential 9 Futures 9.1 Forward rate agreement • Data Symbol Example Formula Market Value V_s 989,103.63 = 1,000,000.00* 0.989103631365 =A*D_V.s Clean Market Value V_c.s 0.00 =P_ms Result Value V_result.s 989,439.34 = 1,000,000.00* 0.989103631365/ 0.999660710305 = A*D_V.s/D_s Market Value Discount Factor D_V.s 0.989103631365 Present Value Discount Factor D_p.s 0.989103631365 Market Value Spot Discount Factor D_s 0.999660710305 Risk Value V_r.s 1,000,000.00 =A IR Exposure 1bp E_ip -31.98 = -1,000,000.00* 0.989103631365* 0.323287671* 0.0001 = -V_r.s*D_p.s*t_vs*0.0001 Effective Duration 0.32328767 = -(-31.98)/ 989,103.63/0.0001 =-E_ip/V_s/0.0001 Modified Duration (total) 0.24560530 = 24.277053/(0.5* (989,103.63(-979,793.24)(-7,348.45)) *0.0001)* 0.999660710305 =E_1p.t/(0.5*(V_s-V_l-V_i) *0.0001)*D_s Valuation figures specific to Long Leg Data Symbol Example Formula Amount A_p.l -990,587.04 = -979,793.24/ 0.989103631365 = V_l/D_V.l Market Value V_l -979,793.24 = 1,000,000.00* 0.979793242655 = -A*D_V.l Clean Market Value V_c.l 9,313.55 =P_ml Result Value V_result.l -989,439.34 = -1,000,000.00* 0.989103631365/ 0.999660710305 = -A*D_V.s/D_s Market Value Discount Factor D_V.l 0.979793242655 Present Value Discount Factor D_p.l 0.979793242655 Risk Value V_r.l -1,000,000.00 =-A IR Exposure 1bp E_ipl 55.83 = -(-1,000,000.00)* 0.979793242655* 0.569863014* 0.0001 = -V_r.l*D_p.l*t_vl*0.0001 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 473 9 Futures 9.1 Forward rate agreement Data Symbol Effective Duration Example Formula 0.56986301 = -55.83/-979,793.24 /0.0001 =-E_ipl/V_l/0.0001 Valuation figures specific to interest flow • Data Symbol Example Formula Amount A_p.i -7,429.40 = -7,348.45 /0.989103631365 =V_i/D_V.s Market Value V_i -7,348.45 = -7,500.00* 0.9797932427 =c_I*D_V.i Clean Market Value V_c.i -7,350.94 =P_mi Result Value V_result.i 0 Market Value Discount Factor D_V.i 0.9797932427 Present Value Discount Factor D_p.i 0.9797932427 Risk Value V_r.i -7,500.00 =c_I IR Exposure 1bp E_ipi 0.42 = -7,500.00* 0.9797932427* 0.569863014* 0.0001 =-V_r.i*D_p.i*t_vi*0.0001 0.56986301 = -0.42/-7,348.45/ 0.0001 = -E_ipi/V_i/0.0001 Effective Duration Valuation figures specific to transaction • Data Symbol Example Formula Market Value V 1,961.94 = 989,103.63+ (-979,793.24)+ (-7,348.45) =V_s+V_l+V_i Clean Market Value V_c.t 1,962.61 = 0.00+9,313.55+ (-7,350.94) =V_c.s+V_c.l+V_c.i IR Exposure 1bp E_1p.t 24.277053 = -31.98 + 55.83 + 0.42 =E_ip + E_ipl + E_ipi -123.7400764 = -(24.277053 / 1,961.91) / 0.0001 =-(E_1p.t/V)/0.0001 Effective Duration 474 © Wall Street Systems IPH AB - Confidential 9 Futures 9.1 Forward rate agreement • Result figures specific to Short Leg Note: The way the result is set for the instrument impacts the way result figures are computed. In this case, the Book Value Method has been set to None. • Data Symbol Example Formula Total Profit P_ts -335.71 = 989,103.63 989,439.34 = V_s - V_result.s MtoM Profit P_ms 0.00 Other Profit P_os -335.71 = -335.71 0.00 =P_ts - P_ms Result figures specific to Long Leg Note: The way the result is set for the instrument impacts the way result figures are computed. In this case, the Book Value Method has been set to None. • Data Symbol Example Formula Total Profit P_tl 9,646.10 = -979,793.24 (-989,439.34) = V_l - V_result.l MtoM Profit P_ml 9,313.55 = 1,000,000.00 * (0.989103631365 0.979793242655)/ 0.999660710305 = A * (D_V.s - D_V.l) /D_s Other Profit P_ol 332.55 = 9,646.10 - 9,313.55 =P_tl - P_ml Result figures specific to interest flow Note: The way the result is set for the instrument impacts the way result figures are computed. In this case, the Book Value Method has been set to None. Data Symbol Example Formula Total Profit P_ti -7,348.45 =V_i MtoM Profit P_mi -7,350.94 = -7,500 *0.9797932427/ 0.999660710305 =c_I*D_V.i/D_s Other Profit P_oi 2.49 = -7,348.45 (-7,350.94) =P_ti-P_mi Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 475 9 Futures 9.1 Forward rate agreement Result figures specific to the transaction • Note: The way the result is set for the instrument impacts the way result figures are computed. In this case, the Book Value Method has been set to None. Data Symbol Example Formula Total Profit 1,961.94 = -335.71 + 9,646.10 + -7,348.45 = P_ts + P_tl + P_ti MtoM Profit 1,962.61 = 0.00 + 9,313.55 + -7,350.94 = P_ms + P_ml + P_mi Other Profit -0.67 = -335.71 + 332.55 + 2.49 = P_os + P_ol + P_oi 9.1.2 Australian FRA The following section describes the characteristics that are specific to Australian FRA contracts. 9.1.2.1 Instrument setup • Main characteristics Note that Australian FRAs must be set up using the FRA (Discount) primary feature. Information Description Currency Currency of the Australian FRA-AUD. Date Basis Date basis of the Australian FRA-Act/365. Interest Type Interest rate type of the Australian FRA-Periodic Rate. See A.2.158 Forward Rate Agreement (Discount) on page 787. 9.1.2.2 Deal capture 9.1.2.2.1 Input data A deal involving an Australian FRA is entered in the same way as a standard FRA: see 9.1.1.2 Deal capture on page 467. 9.1.2.2.2 Generated data For a purchased Australian FRA, the principal cashflows are calculated as follows: • At value date: N × r c × t ⁄ 365 N – ----------------------------------1 + r c × t ⁄ 365 where: rc = contract rate t = number of days between value date and maturity date N = nominal amount • At maturity date: Principal flow = -N 476 © Wall Street Systems IPH AB - Confidential 9 Futures 9.1 Forward rate agreement Therefore, at value date, the settlement amount (A) is calculated by discounting these cashflows to the value date: N × ( r c – r ) × t ⁄ 365 A = -----------------------------------------------------------------------------------( 1 + r c × t ⁄ 365 ) × ( 1 + r × t ⁄ 365 ) where: r = the fixed market interest rate from value date to maturity date 9.1.3 Swedish FRA In Sweden, FRA and bond forwards are traded on the Nasdaq/OMX exchange. These contracts are fixed every month-end and settled shortly after, up until the last fixing, which is settled on the third Wednesday of March, June, September, or December. Settlement of month-end fixings is three business days after fixing. For the final fixing, i.e. on the underlying value date, the settlement date equals fixing date. The underlying value date is the 3rd Wednesday of March, June, September, or December, and the underlying maturity date is the 3rd Wednesday three months later. 9.1.3.1 Instrument setup Swedish FRA instruments must be based on an instrument type derived from the class FRA. • Main characteristics The setup of Swedish FRA is similar to standard FRAs except for the following: Information Description Currency SEK Date Basis Date basis of the Swedish FRA: Actual/360. Interest Type Interest rate type of the Swedish FRA: Periodic Rate. See A.2.159 Forward Rate Agreement (Swedish) on page 788. 9.1.3.2 Deal capture 9.1.3.2.1 Input data A deal involving an Swedish FRA is entered in the same way as a standard FRA except that fields related to fixing rate at the transaction level (Fixing Rate/Period) are not mandatory: see 9.1.1.2.1 Input data on page 467. 9.1.3.2.2 Generated data The generated data for a Swedish FRA are similar to those of a standard FRA. For Swedish FRA, netting cashflows that are fixed every end of month until the last fixing date (i.e. the value date) are created at deal entry and set to Not Fixed. 9.1.3.3 Processing This section describes the actions that can be done throughout the life of an FRA. 9.1.3.3.1 Netting • Execution Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 477 9 Futures 9.1 Forward rate agreement Right-click a Not Fixed netting cashflow and select Execute Netting. The following window is displayed: Information Description Netting Date Day of netting (Fixing Date of the FRA). Netting Currency Currency of settlement. (Information only.) Netting Rate Defaults to the quotation of the FRA instrument on the netting date. Discount Rate Defaults to the rate between netting date and value date of the FRA. This rate is taken from the discount yield curve specified in the netting setup. If no curve is specified, the curve defined at the currency level is used. Netting Amount Settlement amount (profit/loss) from the FRA netting. This is calculated automatically by TRM and can be changed by the user. First Time Fee Rate First time fee percentage defaults to the value specified at the instrument level (Instrument Editor’s Netting page). This is only editable on the first netting flow. As with standard FRAs, the netting cashflow’s Not Fixed attribute is unset and the P/L amount is set as follows: Equation 9-2 Swedish FRA: Netting - BookReferenceValue calculation BookReferenceValue = PaybackCF i ∑ -----------------------------------------------------------------------------------d mat, i – d v, i i 1 + NettingPrice × ⎛⎝ -----------------------------⎞⎠ 360 Equation 9-3 Swedish FRA: Netting - Amount calculation Value – PreviousValue Amount = ----------------------------------------------------------------------------------d v – d pay⎞ ⎞ ⎛ 1 + DiscountRate × ⎛ ------------------⎝ ⎝ 360 ⎠ ⎠ where PreviousValue is the value of the previous netting flow, if it exists, otherwise the PreviousValue is the sum of the Payback flow amounts (i.e. book value + contractual interest). At the first month end fixing of a transaction, the exchange fee cashflow is generated as follows: Equation 9-4 Swedish FRA: Netting - Exchange fee cashflow – Abs ( A ) × FirstTimeFeePercent Amount = -------------------------------------------------------------------------------------v – d pay⎞ ⎞ ⎛ 1 + DiscountRate × ⎛ d------------------⎝ ⎝ 360 ⎠ ⎠ • Cancellation You can cancel the netting either by using the Undo Netting action, or by using the Netting - Undo activity. 9.1.3.4 Position monitoring The valuation of Swedish FRA is similar to the valuation of standard FRAs except that Swedish FRAs use the Quoted valuation method. See 9.1.1.4 Position monitoring on page 470. 478 © Wall Street Systems IPH AB - Confidential 9 Futures 9.2 Bond forward 9.2 Bond forward Forward bonds are normally traded over-the-counter and are agreements that fix the yield or price on a specified bond for a specific date in the future. When the deal is made, the type of bond, the amount, maturity and the value date are agreed upon. In some capital markets, forward bonds have become instruments in their own right, so-called synthetic bonds. Synthetic bonds are usually constructed with special features, but commonly there are underlying instruments, such as Treasury Bonds. These synthetic bonds are quoted at the market and they can be traded until a particular date. When the contract/issue expires, the difference between the contractual price and the market price is settled and the settlement amount is paid or received. For more information relating to the setup and structure of specific types of bond forwards, see: • 9.2.1 Bond forward on page 479 • 9.2.2 Swedish Bond forward on page 482 9.2.1 Bond forward Bond forward instruments must be based on an instrument type derived from the class BOND-FORWARD. 9.2.1.1 Instrument setup The following basic information may be captured when defining the instrument. This information is relevant to any kind of bond forward instrument. • • Main characteristics Information Description Issuer Client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty Client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Underlying Underlying bond instrument. Currency Currency in which the instrument is traded. Netting information Information Description Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max Offset Maximum number of days’ offset allowed. Fixing Subscenario Subscenario from which the rate is retrieved. Calendar Calendar to use when calculating the fixing date. Payment Offset Number of business days between value date and payment date. Method Frequency Choose when you want the netting to occur. For example, for daily netting, select Business Days as method and 1 as frequency. See A.2.61 Bond Forward on page 739. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 479 9 Futures 9.2 Bond forward Last fixing and settlement dates • Information Description Last Trading Day Last day the instrument can be traded. Settlement Date Last day on which the cash settlement can take place. See A.2.63 Bond Forward Dates on page 741 It is also possible to set up • Trading yield convention (used to convert price/rate at transaction level) • dates. 9.2.1.2 Deal capture 9.2.1.2.1 Input data In addition to standard deal parameters, the following information is required to enter a bond future transaction: Note: When you enter the deal rate or deal price, the other is computed according to the trading yield convention defined at the instrument level. Information Description Deal Rate The interest rate at which the deal is made (contract rate). Deal Price The market price of the underlying bond, expressed as a % of the nominal amount. Note: The secondary instrument is defaulted with underlying instrument entered at bond forward instrument level. 9.2.1.2.2 Generated data The following cashflows are generated: • Cashflows (pseudo) of underlying bond (interest + redemption) • Netting flow according to Netting setup and the value date of the transaction. • Principal cashflow (pseudo) computed as Nominal Amount * Deal Rate in %. 480 © Wall Street Systems IPH AB - Confidential 9 Futures 9.2 Bond forward The following cashflow structure is generated for a bond forward: 9.2.1.3 Processing This section describes the actions that can be done throughout the life of a bond forward. 9.2.1.3.1 Netting • Setup The netting parameters for bond forwards are defined at instrument level. • Execution Right-click a Not Fixed netting cashflow and select Execute Netting. The resulting dialog displays the following information: Information Description Netting Date Day of netting (Fixing Date of the bond forward). Netting Currency Currency of settlement. (Information only.) Netting Rate Netting Price When updating one of these fields, the other is computed according to bond forward trading yield convention. Netting Amount Settlement amount (profit/loss) from the bond forward netting parameters. Click OK. The Not Fixed attribute is removed and the netting amount is computed as follows: NettingAmount = NominalAmount*(Netting Price%-DealPrice%)/100 • Cancellation On a fixed netting cashflow there is an Undo Netting action available. Executing this action resets the cashflow’s Not Fixed flag and the P/L amount reverts to 0. 9.2.1.4 Position monitoring There are two basic methods for the valuation of Bond forward instruments: Quoted or Theoretical. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 481 9 Futures 9.2 Bond forward 9.2.1.4.1 Setup The valuation approach is activated by attaching the Bond Forward Valuation (BOND-FORWARD-METHOD) feature to the instrument, see A.2.64 Bond Forward Valuation on page 741. • Theoretical: Uses the zero coupon approach, i.e. the interest rate corresponding to the maturity of the cashflow is used to discount from the cashflow date to the figure date and to compute market value. – Quoted: If the bond forward is quoted, then the market quote is used to discount the underlying cashflows from their value date to the bond forward value date (according to the trading yield convention), then the valuation interest rate is used to discount from the value date to the figure date. Each cashflow of bond forward is discounted by: Equation 9-5 Bond forward: Quoted method - Discount factor D1 ( r q, d v, d mat ) × D2 ( r, d vlt, d v ) Where – rq is the market quote of the bond forward on figure date – D1 is the discount factor computed according to the rate type and date basis of the trading yield convention – r is the market rate retrieved from the valuation default curve – D2 is the discount factor computed according to the setup of valuation default curve. 9.2.2 Swedish Bond forward Swedish Bond forwards are cash settled on a periodic basis. In practice, this means that all future positions are marked-to-market for monthly cash settlement using a market yield determined on the final business day of each month. The accumulated profit and loss are settled on the third business day after. Swedish bond forward instruments must be based on an instrument type derived from the class BOND-FORWARD. 9.2.2.1 Instrument setup The instrument setup is similar to standard bond forwards except that you select the Bond Forward (Swedish) primary feature and except for the following: • • 482 Main characteristics Information Description Currency Currency in which the instrument is traded. Netting parameters Information Description Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max Offset Maximum number of days’ offset allowed. Fixing Subscenario Subscenario from which the rate is retrieved. © Wall Street Systems IPH AB - Confidential 9 Futures 9.2 Bond forward Information Description Calendar Calendar to use when calculating the fixing date. Switches Activate the switches that apply to the instrument. • Settlement Currency Settlement Currency - switch on if the P/L cashflow is paid in a different currency. Currency in which the P/L cashflow is paid (if the switch Settlement Currency is switched on). Leave this field blank if you want to specify the settlement currency when you enter the deal. Payment Offset Number of business days between the value date and the payment date (should be 3 for a Swedish Bond forward). Discount Rate Rate used to discount settlements between the value date and the netting date (used to default the discount rate when performing netting). Leave this field blank if you want to specify the discount rate when performing netting. Method (Read-only.) Defaults to Last of Month. First Time Fee Rate Fixed percentage of the nominal amount, which will be discounted back from the underlying value date to the payment date with the discount rate. This fee amount is settled on the first netting flow. Leave this field blank if you want to specify the first time fee rate when performing netting. See A.2.62 Bond Forward (Swedish) on page 740. It is also possible to set up • Trading yield convention (used to convert price/rate at transaction level) • dates. 9.2.2.2 Deal capture 9.2.2.2.1 Input data The data required is the same as for a bond forward (see 9.2.1 Bond forward on page 479). 9.2.2.2.2 Generated data Netting cashflows that are fixed every month-end up until the last fixing date (i.e. the value date) are created at deal entry and set to Not Fixed. 9.2.2.3 Processing 9.2.2.3.1 Netting • Setup The netting parameters for bond forwards are defined at instrument level. • Execution Right-click a Not Fixed netting cashflow and select Execute Netting. The resulting dialog displays the following information: Information Description Netting Date Day of netting (Fixing Date of the bond forward). Netting Currency Currency of settlement. (Information only.) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 483 9 Futures 9.2 Bond forward Information Description Netting Price Defaulted to the quotation of the instrument on the netting date. Discount Rate Defaulted to the rate between netting date and value date of the transaction. This rate is taken from the discount yield curve specified in netting setup. If empty, the default curve from currency editor is used instead. First Time Fee Expressed as a percentage, and editable for the first netting flow, otherwise it is not modifiable and defaults to the value specified in the netting setup (Netting page) at the instrument level. Click OK. The Not Fixed attribute is removed and the P/L amount is computed as follows: Equation 9-6 Swedish bond forward: P/L amount calculation ( V book – V Prev ) × D ( r, d pay, d v ) Where V book ∑ PaybackCF i × D ( r net, d v, di v ) i Where discount factor (D) is computed according to the rate type/date basis of the trading yield convention defined at the underlying instrument level. Where Previous value is the value of the previous netting flow, if it exists, otherwise, the deal price of the transaction is used DealPrice%*NominalAmount/100 The first time you perform the Netting action on a transaction, the exchange fee cashflow is computed as follows: Equation 9-7 Swedish bond forward: Exchange Fee calculation – Abs ( A ) × FirstTimeFee percent × D ( r, d pay, d v ) • Cancellation On a fixed netting cashflow there is an Undo Netting action available. Executing this action resets the cashflow’s Not Fixed flag and the P/L amount reverts to 0. 9.2.2.4 Position monitoring The valuation setup for Swedish bond forwards is the same as for standard bond forwards, see 9.2.1.4 Position monitoring on page 481. 484 © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future 9.3 Money market future A money market (MM) futures contract is an agreement to buy or sell a standard quantity of a specific financial instrument or deposit, on an Exchange, at a price agreed between two parties, and with delivery to be executed on a standard future date. The size and direction of the settlement amount depends on a given short-term interest rate on the settlement date, a few days before the value date. An MM futures contract is based on an interbank deposit rate. Its value rises and falls inversely to changes in interest rates. The contract amount is expressed in trading units (contract size), where the size of the unit depends on the type of the contract. For example, the unit size of the three month sterling (Short Sterling) money market future is £500,000. Typically there is an initial margin requirement (entered as a payment in TRM) when buying or selling futures contracts but no principal is paid. The principal amount is notional. The changes in market value are often settled daily (netted) during the period between the transaction date and the value date. This means that the market rate underlying the calculation of the settlement amount must be fixed for the future contracts every day (daily settlement). Quotations for MM future prices are given as 100-r, where r is the underlying forward interest rate. There is a minimum price movement (tick size) and the associated value. For example, for Short Sterling the tick size is 0.01 and the tick value £12.50. There are several reasons why you would take a position in futures: • Hedging exposures A futures contract can be used to fix a price for a transaction to be carried out on a specific future date, for example to set a price for the purchase of a commodity or the sale of a financial instrument. If the hedger suffers a loss in the underlying cash market (either pays more than expected when purchasing or receives less than expected when selling), then the futures contract will compensate the hedger for the loss suffered in the cash market. • Speculating on price movements Commonly referred to as ‘Trading’, traders can use futures contracts to back up their views on price movements. Futures prices vary with the underlying cash market. If the speculator correctly predicts the direction and magnitude of price changes, the speculator will make a profit in the futures market. An incorrect view on price movements will however result in a loss in the futures market. • Arbitraging Traders use futures to exploit price anomalies to make risk-free profits. 9.3.1 Money market future (single contract) Money market future (single contract) include the following money market future instruments: • 9.3.1.1 MM future on page 485 • 9.3.1.2 Australian bank bill future on page 494 • 9.3.1.3 Fed fund future on page 496. 9.3.1.1 MM future MM future instruments must be based on an instrument type derived from the class MM-FUTURE. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 485 9 Futures 9.3 Money market future 9.3.1.1.1 Instrument setup • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of MM future instrument. • • Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Currency The currency in which the instrument is traded. Trading units definition Information Description Contract Size Standard size of the futures contract (for example, 1,000,000). Minimum Bid Size Smallest allowed bid size. This is typically 1.0 (meaning 1 contract). Tick Size Minimum price movement (tick size and value), for example, 0.005 / 12.50. Tick Value Tick Size * Point Value = Tick Value Rounding Method Rounding method used in the calculations: Up, Down, or Nearest. Allow Trading in Half of Tick Size Allows trading this instrument at a price with a precision of half the tick size (used for eurodollar Future contracts and options for nearest expiring month). Netting information The daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or it expires. Information Description Fixing parameters Leave these fields blank if you want to define the fixing parameters at deal entry. Calendar Calendar used to calculate the dates. Switches Switch on Settlement Currency if settlement is made in a different currency. Settlement Currency If the Settlement Currency switch is on, the currency in which settlement is made. Payment Offset Number of business days between value date and payment date. This must be the same as the value for Spot Days on the page Spot Date Setup. Method Frequency Choose when you want netting to occur. For example, for daily netting, select Business Days as method and 1 as frequency. See A.2.231 MM Future on page 827. • Future dates definition Information Description Last Trading Day Last day when the futures contract can be traded. The final day during which trading may take place in a futures contract, after which it must be settled. 486 © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future Information Description Settlement Date Last day on which delivery (cash settlement) of the underlying instrument can take place. Maturity Date Underlying maturity (last trade date plus contract period length). See A.2.238 MM Future Dates on page 832. • Quotation information Information Description Active From Period within which the quotation information is valid. Active To Leave these fields blank if you want the quotation information to apply indefinitely. Price Type Standard method for quoting the price. For an MM future, usually, the quotation is 100 minus the forward rate. Quote Handling Select Generic (which means that you will be able to enter the bid and ask quotes for this instrument). Currency Currency of the future instrument. See A.2.274 Quoted on page 849. It will then be possible to either enter the quotation manually in Rate Monitor, or get it automatically in real time. See the TRM User Guide for information about Rate Monitor. • Valuation of money market futures It is possible to specify that another MtoM instrument’s direct market quotation is used to value the future instrument. See A.2.246 MtoM Instrument Setup on page 836. It is also possible to set up • Spot date calculation • Cashflow or transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 9.3.1.1.2 Market information One future contract corresponds to a given nominal value, known as the contract size (trading unit). The market quotation is given in terms of percentage, which moves by ticks, the minimum possible movement. The tick value is the change in settlement price corresponding to a movement of one tick (assumed to be one basis point, 0.01%) in the quote. This variable is derived from the length of the period of the MM future. For example, Short Sterling has a tick value of £500,000 * 0.25 * 0.0001 = £12.50 The risk and profit/loss valuation of all outstanding futures contracts are recalculated using the most recent market data. Each instrument is revalued according to its real-time market quote. These real-time market feeds, from Reuters for example, are set up in the Market Info Source Editor: see the TRM User Guide. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 487 9 Futures 9.3 Money market future IR quotes are shown as Bid and Ask in Rate Monitor. TRM uses the average of these two quotes; if the Ask side is empty it is ignored and the Bid rate is used instead, and vice versa. 9.3.1.1.3 Deal capture Input data In addition to the standard deal parameters, the following information is required to enter a money market future contract: Information Description Trading Units Number of futures bought/sold. Deal Price Contractual rate of the deal expressed as a percentage (100 – r) where r is the underlying deal interest rate. Generated data Two cashflows are generated: – One position flow which represents the future position. – The next netting flow (not fixed) which will be the support for the next daily margin once fixed (see Daily netting on page 488). 9.3.1.1.4 Processing This section describes the actions that can be done throughout the life of a money market future. Daily netting This section describes the actions that can be done throughout the life of a money market future. Money market futures are not subject to a physical delivery of the underlying at expiry but are typically fixed every day. If the market quote for the future has changed from the previous day, the difference (multiplied by the point value and the number of units) is settled between the parties of the trade. • Setup The netting parameters for money market futures are defined at instrument level. • Execution The daily netting of money market futures is carried out using the Execute Netting action. The following information is needed to process the netting: Information Description Netting Date (Information only) The value date of the cashflow. Netting Price Fixing market quote. This is defaulted by the system and can be changed by the user. Netting Amount The automatically calculated profit or loss from the future (settlement amount). Automatically adjusts if you modify the netting price. This can be changed by the user. Netting Currency (Information only) Currency of the settlement cashflow. The Execute Netting action automatically generates the next cashflow. 488 © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future Netting of the cashflows can also be performed automatically using the Netting activity: see the TRM User Guide for more information about activities. • Cancellation The netting can be canceled either using the Undo Netting action, or using the Netting - Undo activity. Closing the position Closing out a position means entering a trade that is opposite to the original one. Closing of a futures position takes place when the holder of a short position buys, or a long position sells, new contracts, which are matched with old ones. The transactions may not have been fixed before the matching. If not, matching the trades creates a profit/loss cashflow to account for the price difference between transactions. Note: Netting must be done before the end of day on the day of the sale. Matching • Setup – The selling parameters used to automatically match transactions are specified in the result treatment applied to the instrument definition. – The portfolio must have the Allow Short Selling switch activated. See the TRM User Guide for more information. • Execution Automatic matching of transactions occurs each night with the End of Day Processing activity. Manual matching of futures is done in Transaction Manager’s Matching mode. This option is available if you specified Manual or FIFO as the selling method for the instrument. • Cancellation You can also unmatch transactions in Transaction Manager’s Matching mode if the cashflows resulting from the transactions are not yet paid or booked. See the TRM User Guide for more information about matching and unmatching transactions. 9.3.1.1.5 Position monitoring This section describes the valuation and risk calculations of MM futures. Valuation The market value of MM Futures is calculated as follows: V = n * V_tic * (F - p_d) / s_t * D_s Where n Trading units V_tic Tick Value F Market Quote p_d Deal Price s_t Tick Size (%) D_s Spot Discount Factor Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 489 9 Futures 9.3 Money market future Risk There are two methods for the IR Exposure and Modified Duration calculation of Money Market instruments: Default and Par method. • Default The default valuation setup for a Money Market future instrument uses the valuation feature MM Future Method (A.2.243 Money Market Future Valuation on page 834 on page 593) and the Quoted valuation method. Using the default valuation setup, the Modified Duration key figure is based on IR Exposure 1 bp, which in turn is calculated by estimating the sensitivity of a position's market value to a parallel shift of 1 basis point in the zero curves used for the valuation of the position. See section Calculations - Quoted valuation method on page 492 for examples of these calculations. – Default Method: IR Exposure 1bp E{i1}= E_ir.s + E_ir.e where E_ir.s =IR Exposure 1bp at value Date = dV.dD_s * d_D.s * 0.0001 where dV.dD_s Risk Value at Value Date = -n * V_tic * 100 / (t_p * s_t * D_p.e) where n Trading units V_tic Tick Value t_p Period length from Value date until Maturity Date according to the Date Basis = (d_m - d_v) / B s_t Tick Size (%) s_t entered as a real number, for example, if you enter a bp tick size of 1, it is interpreted as 0.0001 D_p.e PV Discount Factor at Maturity Date. d_D.s Sensitivity of Discount Factor at Value Date = -D_p.s * t_v.s where D_p.s PV Discount Factor at Value Date t_v.s Time to Risk Date at Value Date E_ir.e =IR Exposure 1bp at Maturity Date = dV.dD_e * d_D.e * 0.0001 where 490 dV.dD_e Risk Value at Maturity Date n * V_tic * 100 * D_p.s /(t_p * s_t * D_p.e * D_p.e) where n Trading units V_tic Tick Value D_p.s PV Discount Factor at Value Date t_p Period length from Value Date until Maturity Date relative to the Date Basis = (d_m - d_v) / B © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future s_t Tick Size (%) s_t entered as a real number, for example, if you enter a bp tick size of 1, it is interpreted as 0.0001 D_p.e – PV Discount Factor at Maturity Date d_D.e Sensitivity of Discount Factor at Maturity Date -D_p.e * t_v.e where D_p.e PV Discount Factor at Maturity Date t_v.e Time to Risk Date at Maturity Date Default Method: Modified Duration U_mod = 10000 × E{i1}/ ϕ (V_p.s + V_p.e) where • E{i1} IR Exposure 1bp ϕ The average of the present value components: ϕ 0.5 or 1 depending on the number of present value components. In the case of MM Future, ϕ = 0.5 as the average is between the present value at Value Date, and the present value at Maturity Date V_p.s The present value of the position cashflow at Value Date V_p.e The present value of the position cashflow at Maturity Date Par It is also possible to use the Par method for the valuation of Money Market future instruments. You can use this method by attaching the features MM Future Par Method (A.2.242 Money Market Future Par Valuation on page 834) and Base IR Exposure Setup (A.2.48 Base IR Exposure Setup on page 732) to the MM future instrument and configuring IR Exposure as follows: Information Description Date Basis Actual/365 Yield Type Continuous Yield This method calculates the IR exposure 1bp and Modified Duration figures as follows: – Par method: IR Exposure 1bp Equation 9-8 Par method: IR exposure 1bp 0.0001 E { i1 } = – nS V tic × ---------------st where n Trading units S The FX rate between the currency of the contract and the valuation currency. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 491 9 Futures 9.3 Money market future V_tic s_t Tick Value Tick Size (%) s_t entered as a real number, for example, if you enter a bp tick size of 1, it is interpreted as 0.0001 – Par method: Modified Duration Equation 9-9 Par method: Modified Duration NEW v tic U mod = -------------st × A where V_tic Tick Value s_t Tick Size (%) A Nominal Amount Calculations - Quoted valuation method The numerical examples in this section demonstrate how the different figures are calculated for an MM Future using the Quoted valuation method. This example shows an MM Future, with the following deal data: Instrument data • Data Symbol Example Contract Size u 1,000,000.00 Tick Size s_t 0.005 Tick Value V_tic 12.5 Maturity Date d_m 2007-03-15 Value Date d_v 2006-12-15 Period Length t_p 0.246575342 = (2007-03-15 - 2006-12-15)/365 Valuation Method Formula t_p = (d_m - d_v) / B_y Quoted (Risk) Date Basis B Act/365 Interpolation Date Basis B_y Act/365 (Risk) Yield Type Continuous Transaction data • Data Symbol Opening Date Example 2005-07-13 Trading units n 1.00 Deal Price p_d 94.00 492 Formula © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future • • • • Calculated transaction data Data Symbol Example Formula Nominal Amount A 1,000,000.00 = 1.00 * 1,000,000.00 A=n*u Data Symbols Example Formula Figure Date d_f 2006-06-27 Market Quote F 95.00 Spot Discount Factor D_s 0.9998561266 PV Discount Factor - Start D_p.s 0.9859568019 PV Discount Factor - End D_p.e 0.9777229960 Time to Risk Date - Start t_v.s 0.4684931507 = (2006-12-15 - 2006-06-27)/365 t_v.s = (d_v -d_f) / B Time to Risk Date - End t_v.e 0.7150684932 t_v.e = (d_m - d_f) / B Data Symbol Example Formula Market Value V 2,499.64 = 1.00 * 12.5 * (95.00 – 94.00) / 0.005 * 0.9998561266 V= n * V_tic * (F - p_d) / s_t * D_s Market data Valuation figures Result figures The setup of the instrument impacts the way result figures are computed. Data Symbol Example Formula Total Profit Total_Profit = 2,499.64 Total_Profit = V MtoM Profit MtoM_Profit 2,500.00 = 2,499.64 / 0.9998561266 MtoM_Profit = V / D_s -0.36 = 2,499.64 - 2,500.00 = Total_Profit - MtoM_Profit Other Profit • Risk figures – Start date Data Symbol Example Formula Sensitivity of D d_D.s -0.46 = -0.9859568019 * 0.4684931507 d_D.s = -D_p.s * t_v.s Risk Value dV.dD_s -1,036,989.92 = -1.00 * 12.5 * 100 / (0.246575342 * 0.005 * 0.9777229960) dV.dD_s = -n * V_tic * 100 / (t_p * s_t * D_p.e) IR Exposure 1bp E_ir.s 47.90 = -1,036,989.92 * (-0.46) * 0.0001 E_ir.s = dV.dD_s * d_D.s * 0.0001 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 493 9 Futures 9.3 Money market future – End date Data Symbol Example Formula Sensitivity of D d_D.e -0.70 = -0.9777229960 * 0.7150684932 d_D.e = -D_p.e * t_v.e Risk Value dV.dD_e 1,045,722.83 = 1.00 * 12.5 * 100 * 0.9859568019 / (0.246575342 * 0.005 * 0.9777229960 * 0.9777229960) dV.dD_e = n * V_tic * 100 * D_P.s / (t_p * s_t * D_p.e * D_p.e) IR Exposure 1bp E_ir.e -73.11 = 1,045,722.83 * (-0.70) * 0.0001 E_ir.e = dV.dD_e * d_D.e * 0.0001 Data Symbol Example Formula IR Exposure 1bp E_ir.t -25.21 = 47.90 + -73.11 E_ir.t = E_ir.s + E_ir.e – Total Calculations - Par method The default IR exposure calculations follow the theoretical approach described in Calculations Quoted valuation method on page 492. An alternative is to choose the feature Money Market Future Par Valuation, as described in section Valuation on page 489, in which case, market value is calculated as above, but IR exposure is calculated as follows: Instrument data • Data Symbol Example Contract Size A 1,000,000.00 Tick Size (%) s_t 0.005 Tick Value V_tic 12.5 Data Symbol Example Number of Contracts N 3 Formula Transaction data • Formula Valuation figures • Note: You can view these figures in Transaction Manager and Treasury Monitor. Data Symbol Example Formula IR Exposure 1bp E_i1 = -75.0000 =-N*V_tic*0.0001/s_t Modified Duration U_mod = 0.250 =V_tic/(s_t*A) 9.3.1.2 Australian bank bill future Australian short futures have 90-day Bank Accepted Bills (bank bills) as the underlying. The market in these instruments is the biggest short-term interest rate market in Australia. Quotations for 90-day bank bill futures are given as 100 - yield% per annum. This yield-to-maturity formula discounts the face value (contract size) to earn the correct interest cost. For example, a yield of 6.85% equals a futures price of 93.15. 494 © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future 9.3.1.2.1 Instrument setup Australian bank bill futures must be based on an instrument type derived from the class MM-FUTURE. They are set up in a similar way to MM futures (see 9.3.1.1 MM future on page 485), but require a different primary feature. • Main characteristics See A.2.232 MM Future - Australian Bank Bill Future on page 828. • Future dates definition Information Description Last Trading Day Last day when the futures contract can be traded. The final day during which trading may take place in a futures contract, after which it must be settled. Settlement Date Last day on which delivery (cash settlement) of the underlying instrument can take place. Maturity Date Underlying maturity (last trade date plus contract period length). Note that for the correct management of the instrument (netting amount calculation, valuation, and so on), it is important you select the dates so that the actual number of days is equal to the number of days to maturity, that is: Days to Maturity = Maturity Date - Settlement Date = 90 See A.2.238 MM Future Dates on page 832. • Quotation information Information Description Price Type Method for quoting the price - Ticks. Quote Handling Select Generic (which means that you will be able to enter the bid and ask quotes for this instrument). Currency Currency of the future contract - AUD. See A.2.274 Quoted on page 849. • Netting information The daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or it expires. See A.2.319 Ticks Netting on page 870. 9.3.1.2.2 Market information For an Australian short future, the method used to convert the market quotation into a future price is as follows: First, the corresponding yield is computed as: Yield = 100 - Q where Q is the market quote of the future contract. The future price is then converted using the following formula: ContractSize × 365 P = ------------------------------------------------------------------------------Yield × DaystoMaturity 365 + --------------------------------------------------------------100 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 495 9 Futures 9.3 Money market future Once the market quotation has been converted into the future price, the valuation of the contract is carried out in the same way as for a standard MM future contract. 9.3.1.3 Fed fund future Fed fund futures are similar to money market futures, except that settlement is carried out against the average daily Fed funds overnight rate over the future period. 9.3.1.3.1 Instrument setup Fed fund futures are based on an instrument type derived from the class MM Future. They are set up in the same way as money market futures (see 9.3.1.1 MM future on page 485), but with the following differences. • Fed fund future dates The delivery period needs to be set up in the instrument definition. This is done in the same way as future dates for MM futures. Information Description Last Trading Day Last day when the futures contract can be traded. The final day during which trading may take place in a futures contract, after which it must be settled. Delivery Period Start First day of the delivery period. Delivery Period End Last day of the delivery period. (Maturity Date in Transaction Manager) See A.2.144 Fed Fund Future Dates on page 782: note that you use this feature instead of MM-FUTURE-DATES. 9.3.1.3.2 Market information If tick size is st, tick value is vt, and the average rate over the period is R, then the settlement amount is: vt A s = 100 ---- ( F – F c ) st where: F = (1 - R) and Fc is the contract price (or last fixing price) The average rate is the arithmetic average of overnight rates during the delivery period. For non-business days (such as, public holidays and weekends), the rate of the last business day is used. 9.3.1.3.3 Position monitoring Setup The Fed Fund Future Method valuation feature (see A.2.146 Fed Fund Future Valuation on page 783) is used to calculate the valuation and risk figures for Fed fund futures. The behavior of this feature replicates that of the MM Future valuation method except for some differences in IR exposure calculations. That is, after the netting for a given date has been executed, the risk calculations are computed using the next fixing date as the valuation date for risk figures. See section Calculations on page 497 for examples of these calculations. As for MM futures, it is also possible to use the Par method for the valuation of Fed Fund future instruments. You can use this method by attaching the features Fed Fund Future Par Method 496 © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future (A.2.145 Fed Fund Future Par Valuation on page 782) and Base IR Exposure Setup (A.2.48 Base IR Exposure Setup on page 732) to the instrument and configuring IR exposure as follows: Information Description Date Basis Actual/365 Yield Type Continuous Yield This method calculates IR exposure 1bp and Modified Duration figures as follows: • IR Exposure 1bp for Fed Fund futures Before the start of the delivery period of a Fed Fund future, IR exposure 1bp is calculated the same way as for MM future. During the delivery period, IR exposure will decrease linearly by the same amount each day. If the length of the delivery period is n days, then on day k of the delivery period, IR exposure 1bp is: Equation 9-10 Par method: IR exposure 1bp E { i1 } • v t × 0.0001 n – k = – N S --------------------------- × -----------n st Modified Duration for Fed Fund futures Modified duration of Fed Fund futures follows the same logic as IR Exposure 1bp. Before the start of the delivery period of a Fed Fund future, Modified Duration is calculated the same way as for MM future. During the delivery period, Modified Duration will decrease linearly by the same amount each day. If the length of the delivery period is n days, then on day k of the delivery period, Modified Duration is: Equation 9-11 Par method: Modified Duration See section Calculations - Par method on page 502 for examples of these calculations. Calculations The numerical examples in this section demonstrate how the different figures are calculated for a Fed fund future contract both before and during the delivery period. This example shows a purchase of a Fed fund future contract, with the following deal data: • Instrument data Data Symbol Example Contract Size u 5,000,000.00 Tick Size s_t 0.005 Tick Value v_t 20.835 Delivery Period Start d.s 2006-12-01 Delivery Period End d.e 2006-12-31 Interest Period End d.i 2007-01-02 (Risk) Date Basis B 365 Formula Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 497 9 Futures 9.3 Money market future Data Symbol (Risk) Yield Type Example Formula Continuous Delivery Period Length N.d 31 N.d = d.e - d.s +1 Day Length d.l 0.002777778 d.l = 1 / 360 Symbol Example Transaction data • Data Opening Date 2006-06-27 Trading Units N 7.00 Deal Price F_c 95.00 Calculated transaction data • Data Symbol Example Formula Nominal Amount A 35,000,000.00 = 7.00 * 5,000,000.00 A= N*u Tick Amount A_t 29,169.00 = 35,000,000.00 * 20.835 / 0.005 A_t = N * v_t / s_t Before delivery period • Unless otherwise stated, the figure date used in the calculations is 2006-06-27. On this date, the market data is as follows: – Market data Data Symbol Example Figure Date d.f 2006-06-27 Market Quote F 96.00 Figure Spot Date ds.f 2006-06-29 Spot Discount Factor D.p 0.9998088047 – Calculated market data Data Symbol Example Formula Time to Spot Date t.s 0.0054794521 = (2006/06/29 - 2006/06/27) / 365 t.s = (ds.f - d.f) / B 0.9998088047 = 29,163.42 / 29,169.00 = V / A_t Unit Market Value Remaining averaging period k.d = 31 k.d = MIN(N.d, d.e - d.f + 1) Average discount factor D.a = 0.9999013140 D.a = POWER(D.n / D.1, 1 / k.d) 498 © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future – Calculated market data - start date Data Symbol Example PV Discount Factor D.1 0.9851018295 Time to Risk Date t_v.s 0.4301369863 = (2006-12-01 - 2006-06-27) /365 t_v.s = (d.s - d.f) / B Formula – Formula Calculated market data - end date Data Symbol Example PV Discount Factor D.n 0.9820925982 Time to Risk Date t_v.e 0.5178082192 = (2007-01-02 - 2006-06-27) /365 t_v.e = (d.i - d.f) / B Data Symbol Example Formula Market Value V 29,163.42 = 7.00 * 20.835 * (96.00 - 95.00) / 0.005 * 0.9998088047 V= – – Valuation figures N * v_t * (F - F_c) / s_t * D.p Risk figures - start date Data Symbol Example Formula Sensitivity of D d_D.s -0.04237 = -0.9851018295 * 0.4301369863 d_D.s = -D.1 * t_v.s Sensitivity of D with respect to Spot d_Df.1 -0.4184 = -(0.985101829 / 0.9998088047) * (0.4301369863 0.0054794521) d_Df.1 = -(D.1 / D.p) * (t_v.s - t.s) Risk Value dV.dD.1 -34,382,784.06 = -100 * 0.9998088047 * 29,169.00 / (0.00277778 * 0.999901314 * 0.9851018295 * 31) dV.dD.1 = -100 * D.p * A_t / (d.l * D.a * D.1 * N.d) IR Exposure 1bp E_ir.s 1,456.8973 = -0.4237 * -34,382,784.06 * 0.0001 E_ir.s = d_D.1 * dV.dD.1 * 0.0001 IR Exposure Spot 1 bp E_ir.s.1 1,438.6132 = -34,382,784.06 * -0.4184 * 0.0001 E_ir.s.1 = dV.dD.1 * d_Df.1 * 0.0001 – Risk figures - end date Data Symbol Example Formula Sensitivity of D d_D.n -0.5085 = -0.9820925982 * 0.5178082192 d_D.n = -D.n * t_v.e Sensitivity of D with respect to Spot d_Df.n_1 -0.5033 = -(0.9820925982 / 0.9998088047) * (0.5178082192 - 0.005479452) d_Df.n_1 = -(D.n / D.p) * (t_v.e - t.s) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 499 9 Futures 9.3 Money market future Data Symbol Example Formula Risk Value dV.dD.n 34,488,136.40 = 100 * 0.9998088047 * 29,169.00 / (0.002777778 * 0.999901314 * 0.9820925982 * 31) dV.dD.n = 100 * D.p * A_t / (d.l * D.a * D.n * N.d) IR Exposure 1bp E_ir.e -1,753.8446 = -0.5085 * 34,488,136.40 * 0.0001 E_ir.e = d_D.n * dV.dD.n * 0.0001 IR Exposure Spot 1 bp E_ir.s.n_1 -1,735.6172 = 34,488,136.40 * -0.5033 * 0.0001 E_ir.s.n_1 = dV.dD.n * d_Df.n_1 * 0.0001 Data Symbol Example Formula IR Exposure 1bp E_ir.t -296.9472305 = 1,456.8973 + -1,753.8446 E_ir.t = E_ir.s + E_ir.e IR Exposure Spot 1 bp E_ir.s.t -297.0040163 = 1,438.6132 + -1,735.6172 E_ir.s.t = E_ir.s.1 + E_ir.s.n_1 Modified Duration U_m 0.0876712329 = -297.0040163 / (0.5 * (ABS(-34382784.06 * 0.9851018295 / 0.9998088047) + ABS(34488136.40 * 0.9820925982 / 0.9998088047)) * 0.0001) U_m = -E_ir.s.t / (0.5 * (ABS(dV.dD.1 * D.1 / D.p) + ABS(dV.dD.n * D.n / D.p)) * 0.0001) – Risk figures - total During delivery period • Unless otherwise stated, the figure date used in the calculations is 2006-12-15. On this date, the market data is as follows: – Market data Data Symbol Example Figure Date d.f 2006-12-15 Last Fixing Rate F_x 96.00 Market Quote F 93.00 Spot Discount Factor D.p 0.9997870834 – Calculated market date Data Symbol Unit Market Value Example Formula -1.9995741668 = 29,163.42 / 29,169.00 V / A_t Remaining averaging period k.d = 16 k.d =MIN(N.d, d.e - d.f + 1) Average discount factor D.a = 0.9999428415 D.a = POWER(D.n / D.1, 1 / k.d) 500 © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future – Calculated market data - start date Data Symbol Example PV Discount Factor D.1 1.000000 Time to Risk Date t_v.s 0.000000 = (2006-12-15 * 2006-12-15) / 365 t_v.s = (d.f - d.f) /B Formula – Formula Calculated market data - end date Data Symbol Example PV Discount Factor D.n 0.9990287496 Time to Risk Date t_v.e 0.0493150685 = (2007-01-02 - 2006-12-15) / 365 t_v.e = (d.i - d.f) /B – Valuation figures - Position flow Data Symbol Example Formula Market Value V -58,325.58 = 7.00 * 20.835 * (93.00 - 95.00) / 0.005 * 0.9997870834 V = N * v_t * (F - F_c) / s_t * D.p – Valuation figures - Netting flow Data Symbol Example Formula Market Value V_n -29,169.00 = (95.00 - 96.00) * 29,169.00 V_n = (F_c - F_x) * A_t Data Symbol Example Formula Total Profit Total_Profit = -58,325.58 Total_Profit = V MtoM Profit MtoM_Profit -58,338.00 = (93.00 - 95.00) * 29,169.00 MtoM_Profit = (F - F_c) * A_t 12.42 = -58,325.58 (-58,338.00) = Total_Profit MtoM_Profit – Result figures Other Profit – Risk figures - start date Data Symbol Example Formula Risk Value dV.dD.1 33,875,613.70 = -100 * 29,169.00 / (0.002777778 * 0.9999428415 * 1.000000 * 31 dV.dD.1 = -100 * A_t / (d.l * D.a * D.1 * N.d) Modified Duration U_m 0.03836 = 129.933861 / (ABS(34488136.4 * 0.9990287496 / 0.9997870834) * 0.0001) U_m = -E_ir.s.n / (ABS(dV.dD.n * D.n / D.p) * 0.0001) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 501 9 Futures 9.3 Money market future – Risk figures - end date Data Symbol Example Formula Sensitivity of D d_D.n -0.0492672 = -0.9990287496 * 0.0493150685 d_D.e = -D.n * t_v.e Sensitivity of D with regards to Spot d_Df.n -0.0383271 = -(0.9990287496 * 0.9997870834) * (0.0493150685 - 4/365) d_Df.n = -(D.n / D.p) * (t_v.e - 4/365) Risk Value dV.dD.n 33,901,327.70 = 100 * 0.9997870834 * 29,169.00 / (0.002777778 * 0.9999428415 * 0.9990287496 * 31 dV.dD.n = 100 * D.p * A_t / (d.l * D.a * D.n * N.d) IR Exposure 1bp E_ir.e -167.022252 = -0.0492672 * 33,901,327.70 * 0.0001 E_ir.e = d_D.n * dV.dD.n * 0.0001 IR Exposure Spot 1bp E_ir.s.n -129.933861 = -0.0383271 * 33,901,327.70 * 0.0001 E_ir.s.n = d_Df.n * dV.dD.n * 0.0001 Data Symbol Example Formula IR Exposure 1bp E_ir.t -167.02 = 0.00 + -167.022252 E_ir.t = E_ir.s + E_ir.e – Risk figures - total Calculations - Par method The default IR exposure calculations follow the theoretical approach described in Calculations on page 497. An alternative is to choose the feature Fed Fund Future Par Valuation, as described in section Setup on page 496, in which case, market value is calculated as above, but IR exposure is calculated as follows: Instrument data • Data Symbol Example Formula Contract Size A.f 1,000,000.00 Tick Size (%) s_t.f 0.005 Tick Value v_t.f 12.5 Delivery Period Start dt.s 2006-12-01 Delivery Period End dt.e 2006-12-29 Delivery Period Length n.p 29 n.p = dt.e - dt.s +1 Data Symbol Example Formula Number of Contracts N.f 7 Transaction data • 502 © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future • Valuation figures Note: You can view these figures in Transaction Manager and Treasury Monitor. Data Symbol Example Formula Figure Date dt.f 2006-12-15 Remaining Averaging Period k 14 =dt.f-dt.s f = 0.517241379 =(n.p-k)/n.p IR Exposure 1bp E_i1 = -150.87414 =-n.f*f*v_t.f*0.0001/s_t.f Modified Duration U_mod = 0.0431069 =f*v_t.f/(s_t.f*A.f) 9.3.2 Money market future chain Money Market Future chain allows users to define the whole MM future chain as one instrument, instead of having to define each contract as a separate instrument (MM-FUTURE class). Important: MM future chain instruments should only be used in the bootstrapping of zero coupon yield curves. The 'old-style' MM future instruments (see 9.3.1.1 MM future on page 485) should still be used for trading. 9.3.2.1 Instrument setup MM future chain must be based on an instrument type derived from the class MM-FUTURE-CHAIN. • Main characteristics: The following basic information can be captured when defining the instrument: • Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Currency The currency in which the instrument is traded. Netting information The daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or expires. Information Description Fixing Subscenario Subscenario from which the price is retrieved. Calendar Calendar used to calculate the dates. Settlement Offset Number of business days between fixing date and settlement date of the fixing amount (variation margin). Also, profit/loss realized from the closing of a position will have their value date assigned based on this offset. An offset of 0 will realize profits/losses on the date the position is closed (Opening Date of the closing transaction), and an offset of 1 will realize profits losses on the next business day (i.e. in line with the settlement of the fixings). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 503 9 Futures 9.3 Money market future Information Description Method Frequency Choose when you want netting to occur. For example, for daily netting, select Business Days as method and 1 as frequency. See A.2.234 MM Future - Money Market Future Chain on page 830. • Contract characteristics Information Description Calendar Holiday Calendar The calendars used to determine the business days when calculating the trading, delivery, and underlying dates. Root Symbol The root exchange symbol of the chain, for example, enter 'I' for LIFFE Euribor future chain. Quarterly Contracts The number of quarterly contracts available for trading with an expiry in March, June, September and December. Monthly Contracts The number of monthly contracts (nearest months, excluding the quarterly months) available for trading. Trading Offset The number of business days of the last trading day before the third Wednesday of the month. Formatter The display formatting for the contracts: • Default: MMM YY displays as SEP 10. • Symbol: Root Symbol + Month Code + Single Digit Year using the same example as above, displays as EDU0 (ED is the root symbol, U is the month code for September, and 0 is the last digit of the year 2010.) Month Codes: Jan = F, Feb = G, Mar = H, Apr = J, May = K, Jun = M, Jul = N, Aug = Q, Sep = U, Oct = V, Nov = X, Dec = Z Note: The default formatter is always used in Rate Monitor. In other applications, the formatting depends on the selected formatter. • Trading Units definition Information Description Contract Size Standard size of the futures contract (for example, 1,000,000). Minimum Bid Size Smallest allowed bid size. This is typically 1.0 (meaning 1 contract). Tick Size Minimum price movement (tick size and value). Tick Value Rounding Method Rounding method used in the calculations: Up, Down, or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum bid size, the amount is rounded up, down, or to the nearest corresponding amount. Allow Trading in Half of Tick Size Allows trading this instrument at a price with a precision of half the tick size (used for eurodollar Future contracts and options for nearest expiring month). These contract characteristics and trading units are specific to the type of the future being defined, each being selectable via dedicated instrument feature. The system supports the following: – One Month Money Market future (with feature Money Market 1M Future Chain) These are futures on one month deposits, with monthly contracts expiring on or just before the third Wednesday of the month. 504 © Wall Street Systems IPH AB - Confidential 9 Futures 9.3 Money market future See A.2.235 MM Future - Money Market 1M Future Chain on page 831. – Three Month Money Market future (with feature Money Market 3M Future Chain) These are futures on three month deposits, with quarterly contracts expiring in Mar, Jun, Sep and Dec and monthly (serial) contracts, all expiring on or just before the third Wednesday of the month. See A.2.236 MM Future - Money Market 3M Future Chain on page 831. – Fed Fund future (with feature Fed Fund Future Chain) These are futures on the average daily Fed Funds overnight rate for a calendar month, expiring on the last business day of that month. See A.2.143 Fed Fund Future Chain on page 781. – Australian 90-Day Bank Bill future (with feature Australian 90-Day Bank Bill Future Chain) These are Australian futures on (approximately) 90 day bank bills or CDs, with quarterly contracts expiring in Mar, Jun, Sep and Dec, one business day before the second Friday of the month. The Australian 90 Day Bank Bills have a variable tick value, thus Tick Size and Value fields are not available in the trading units definition. See A.2.233 MM Future - Australian 90-Day Bank Bill Future Chain on page 829. • Quotation information Define how these contracts are to be quoted on the market. Information Description Price Type Select Ticks. Quote Handling Select MM Future Chain. See A.2.275 Quoted Chain on page 851. 9.3.2.2 Market information • Live market feed To set up market information for MM future chain instruments, open the Market Info Source Editor, select type as CHAIN and item to the market information provider’s root symbol, for example, FEI for LIFFE Euribor future chain for the Reuters' feed. For more information about using this editor, see TRM User Guide. If you set up the market info at the instrument level, the type CHAIN is defaulted by the system. Based on this setup, the live market feed is able to ask for prices for all the outstanding contracts. Note: Currently, Reuters' is the only live feed that can be used with future chains. • Displaying quotes You can view future chain quotes in the Instrument page of the Rate Monitor. You can expand the chain to display all active contracts by selecting Periods on one of the axes. For more information about using Rate Monitor, see TRM User Guide. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 505 9 Futures 9.4 Bond future 9.4 Bond future A bond future is an agreement to buy or sell a bond at a future date and with a given price. At the time when the deal is made, the type of bond, amount, maturity, and value date are agreed upon. Unlike forward contracts, futures are traded on an exchange and have daily settlement. A bond future is marked to market and settled daily, instead of once when the contract expires. The investor’s gain/loss is added to/taken from the margin account daily, essentially bringing the value of the future to zero. This can be viewed as the future contract being closed out and re-written at a new price, every day. The daily settlement price is calculated as the average of the prices at which the contract traded just before the end of trading for the day. Bond futures are long-term interest rate instruments which allow the buyer to lock into an interest rate for a future lending period, and the seller to lock into an interest rate for a future borrowing period. Bond futures prices represent arbitrage rates implied by the current market rates rather than individual forecasting or expectations about future yields. In some capital markets, bond futures have become instruments on their own, so-called synthetic bonds. Synthetic bonds are usually constructed with special features but they generally have underlying instruments, Treasury Bonds for example. These synthetic bonds are quoted at the market and they can be traded until a predefined date. If the coupon interest earned on the bond is less than the interest cost of funding a long position in it, then the market is said to have a negative carry; if the coupon interest earned on the bond is greater than the funding cost, the market has a positive carry. Under normal circumstances bond markets tend to have a positive carry; the yield curve slopes upwards. The implication is that if there is a positive carry, then bond futures should be lower in price than cash futures. The greater the carry, either as a result of a marked yield differential and/or a lengthy carry period, the lower the price of the futures contract will be. 9.4.1 Bond future Bond future instruments must be based on an instrument type derived from the class BOND-FUTURE. The following basic information may be captured when defining the instrument. This information is relevant to any kind of bond future. For more information relating to the setup and structure of specific types of bond futures, see: • 9.4.2 CTD future on page 509 • 9.4.3 Australian bond future on page 518. 9.4.1.1 Instrument setup • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of bond future instrument. 506 Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Underlying The underlying bond instrument. Currency The currency in which the instrument is traded. © Wall Street Systems IPH AB - Confidential 9 Futures 9.4 Bond future • • Trading units definition Information Description Contract Size Standard size of the futures contract (for example, 3,000,000). Minimum Bid Size Smallest allowed bid size (for example, 1.0000). Tick Size Minimum price movement (tick size and value), for example, 0.005 / 12.50 Tick Value Tick Size * Point Value = Tick Value Rounding Method Rounding method used in the calculations: Up, Down, or Nearest. Allow Trading in Half of Tick Size Allows trading this instrument at a price with a precision of half the tick size (used for eurodollar Future contracts and options for nearest expiring month). Netting information The daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or it expires. Information Description Fixing parameters Leave these fields blank if you want to define the Fixing parameters at deal entry. Calendar Calendar used to calculate the dates. Switches Switch on Settlement Currency if settlement is made in a different currency. Settlement Currency If the Settlement Currency switch is on, the Currency in which settlement is made. Payment Offset Number of business days between value date and payment date. Method Select Business Days for daily netting. Frequency For daily netting, enter 1 when Method = Business Days. See A.2.67 Bond Future on page 742. • Future dates definition Information Last Trading Day Description Last day when the futures contract can be traded. The final day during which trading may take place in a futures contract, after which it must be settled. Settlement Date Last day on which delivery (cash settlement) of the underlying instrument can take place. See A.2.168 Future Dates on page 795. • Quotation information Information Description Active From Period within which the quotation information is valid. Active To Leave these fields blank if you want the quotation information to apply indefinitely. Price Type Standard method for quoting the price: Price/Underlying Unit. Quote Handling Select Generic. Currency Currency of the future instrument. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 507 9 Futures 9.4 Bond future See A.2.274 Quoted on page 849. Valuation of bond futures • It is possible to specify that another MtoM instrument’s direct market quotation is used to value the future instrument. See A.2.246 MtoM Instrument Setup on page 836. It is also possible to set up • Spot date calculation • Cashflow or transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 9.4.1.2 Deal capture 9.4.1.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a bond future contract: Information Description Trading Units Number of futures bought/sold. Deal Price The market price of the bond future, expressed as a percentage of its nominal value. 9.4.1.2.2 Generated data Two cashflows are generated: – One position flow which represents the future position. – The next netting flow (not fixed) which will be the support for the next daily margin once fixed (see 9.4.1.3.1 Daily netting on page 508). 9.4.1.3 Processing This section describes the actions that can be done throughout the life of a bond future. 9.4.1.3.1 Daily netting Bond futures are fixed (settled) daily at the exchange. If the market quote for the future has changed from the previous day, the difference (multiplied by the point value and the number of units) is settled between the parties of the trade. • Setup The netting parameters for bond futures are defined at instrument level. • Execution The daily netting of bond futures is carried out using the Execute Netting action. The following information is needed to process the netting: Information Description Netting Date Day the cashflow is fixed. Netting Price Fixing market quote. This is defaulted by the system and can be changed by the user. 508 © Wall Street Systems IPH AB - Confidential 9 Futures 9.4 Bond future Information Description Netting Amount Profit or loss (settlement amount) from the future. This is calculated automatically by TRM and can be changed by the user. Netting Currency (Information only) Currency of the settlement cashflow. The Execute Netting action automatically generates the next cashflow. Netting of the cashflows can also be performed automatically using the Netting activity: see the TRM User Guide for more information. • Cancellation The netting can be canceled either using the Undo Netting action, or using the Netting - Undo activity. 9.4.1.3.2 Closing the position Closing out a position means entering into a trade that is opposite to the original one. Closing of a futures position takes place when the holder of a short position buys, or a long position sells, new contracts which are matched with old ones. The transactions may not have been fixed before the matching. If not, matching the trades creates a profit/loss cashflow to account for the price difference between transactions. 9.4.1.3.3 Matching • Setup – The selling parameters used to automatically match transactions are specified in the result treatment applied to the instrument definition – The portfolio must have the Allow Short Selling switch activated. See the TRM User Guide for more information. • Execution Automatic matching of transactions occurs each night with the End of Day Processing activity. Manual matching of futures is done in Transaction Manager’s Matching mode. This option is available if you specified Manual or FIFO as the selling method for the instrument. See the TRM User Guide for more information about matching transactions. • Cancellation You can also unmatch transactions in Transaction Manager’s Matching mode if the cashflows resulting from the transactions are not yet paid or booked. 9.4.2 CTD future Some bond futures (CTD futures) are settled when the contract expires by delivery of an underlying bond. The bond to be delivered (Cheapest To Deliver (CTD) bond) is chosen by the party with the short position from the deliverable basket. The conversion factor defines the price of this bond. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 509 9 Futures 9.4 Bond future 9.4.2.1 Instrument setup CTD futures are set up in a similar way to bond futures (see 9.4.1 Bond future on page 506), but require a different primary feature. • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of CTD future instrument. Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Currency The currency in which the instrument is traded. First and Last Delivery Date Delivery period of the future. Date Basis Date basis used to calculate the implied repo rate used to determine the cheapest to deliver. You can see the implied repo rate in the following TRM applications: • Transaction Manager: In Transaction Figure view, you can see the implied repo rate (column Implied Repo Rate) for one bond i.e. the cheapest (CTD) bond at the time of valuation (column Delivery Instrument). • Rate Monitor: You can display the implied repo rate for each bond in a CTD future's basket of deliverable bonds, by selecting Period as one of the axes, usually the vertical one, and figure Implied Repo Rate. See TRM User Guide for more information. • • Delivery basket Information Description Instrument Bond instrument to include in the basket. Conversion Factor Conversion factor of the instrument. This is used to determine the exact price of the underlying bond. Trading units definition Information Description Contract Size Nominal value of one future contract. Minimum Bid Size Minimum number of contracts that can be traded (usually one). Tick Size Minimum price movement (tick size and value). Tick Value Rounding Method Up, Down or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum contract size, the amount is rounded up, down, or to the nearest corresponding amount. See A.2.116 CTD Future on page 765. 510 © Wall Street Systems IPH AB - Confidential 9 Futures 9.4 Bond future • Quotation information Information Description Active From Period within which the quotation information is valid. Active To Leave these fields blank if you want the quotation information to apply indefinitely. Price Type Standard method for quoting the price: Price %. Quote Handling Select CTD. Currency Currency of the future instrument. See A.2.274 Quoted on page 849. • Netting information Information Description Fixing parameters Leave these fields blank if you want to define the Fixing parameters at deal entry. Calendar Calendar used to calculate the dates. Switches Switch on Settlement Currency if settlement is made in a different currency. Settlement Currency If the Settlement Currency switch is on, the Currency in which settlement is made. Payment Offset Number of business days between value date and payment date. Method Select Business Days or Bullet. Frequency Enter 1 when Method = Business Days, or 0 when Method = Bullet. See A.2.319 Ticks Netting on page 870. 9.4.2.2 Processing This section describes the actions that can be done throughout the life of a CTD future. 9.4.2.2.1 Delivery Sometimes bond futures (CTD futures) are settled by delivery of an underlying bond. The delivery transaction has to be entered as a separate transaction in TRM. The nominal amount of the bond to be delivered is given by the nominal amount of the future (contract size * number of contracts), and the delivery price is the last fixing price * conversion factor. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 511 9 Futures 9.4 Bond future 9.4.2.3 Position monitoring 9.4.2.3.1 Setup The risk calculation is based on the cashflows of the underlying cheapest to deliver bond, and the setup taken partially from the future and from the underlying bond. For more information about risk calculations, see 2.3 Key-figures on page 112. • The risk setup (feature Risk Setup (BOND)) of the future determines which method (Yield to Maturity, Z-Spread, or Zero-Coupon) is used to discount the underlying bond cashflows to delivery date. See A.2.288 Risk Setup (BOND) on page 858. Note: The yield type and date basis used in the risk yield to maturity and Z-Spread calculation are taken from the underlying bond (Risk Yield or Discount Margin setup, respectively), as well as from the risk free rate in the Z-Spread calculation. If these are not specified for the underlying bond, then the following defaults are used: Yield to Maturity: Continuous Yield, Actual/365 Date Basis Z-Spread: Annually Continuous Yield, Actual/365 Date Basis, the risk-free curve of the currency. Both Risk Yield and Discount Margin are calculated on the delivery date using the invoice amount. That is, they will differ from the Risk Yield or Discount Margin of the underlying bond, which is based on the spot date and on the bond's market price. See A.2.291 Risk Yield on page 859 or A.2.343 Z-DM/Spread Setup on page 882. • Discounting from the delivery date to the spot date of the future and from the spot date to the figure date use the valuation curve and discount curve of the future respectively. If either of these is not defined, the default curve of the currency is used. Figure Interest Rate shows the interest rate for the period from spot date to risk date of the cashflow, as usual. When the risk method Yield to Maturity is used, Figure Base Interest Rate shows the rate for the period from the delivery date to the risk date, i.e. Yield to Maturity. • The IR exposure setup is taken from the future (feature Base IR Exposure Setup, see A.2.48 Base IR Exposure Setup on page 732), if defined, except for the Yield Type and Date Basis, which depend on the risk setup: – Yield-to-Maturity Use Yield Type and Date Basis of the risk yield setup of the underlying bond, or corresponding defaults. – Z-Spread Use Yield Type and Date Basis of the Discount Margin setup of the underlying bond, or corresponding defaults. – Zero-Coupon Use Yield Type and Date Basis specified in the IR Exposure setup of the future. If these are not defined, use the defaults from the valuation curve's interpolation setup. 9.4.2.3.2 Calculations In this section, numerical examples demonstrate how the different figures are calculated for a CTD bond future. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. This example shows a CTD bond future, with the following deal data: 512 © Wall Street Systems IPH AB - Confidential 9 Futures 9.4 Bond future Setup data Valuation Method Quoted Risk Date Basis B Act/365 Trading unit u 100 Tick Size 1.00 Tick Value tv 1.00 Delivery Date dt_p.d 2006-10-10 Conversion Factor c_f 1.05 Cashflow data Amount per unit (A.*) Value date (dt_v.*) Coupon start date (dt_s.*) Payment date (dt_p.*) Current Coupon (*.c0) 0.02 2006-01-01 2005-07-01 2006-01-02 Next Coupon (*.n) 0.02 2006-07-01 2006-01-01 2006-07-03 Coupon 1 (*.c1) 0.02 2007-01-01 2006-07-01 2007-01-01 Coupon 2 (*.c2) 0.02 2007-07-01 2007-01-01 2007-07-02 Coupon 3 (*.c3) 0.02 2008-01-01 2007-07-01 2008-01-01 Coupon 4 (*.c4) 0.02 2008-07-01 2008-01-01 2008-07-01 Coupon 5 (*.c5) 0.02 2009-01-01 2008-07-01 2009-01-01 Coupon 6 (*.c6) 0.02 2009-07-01 2009-01-01 2009-07-01 Coupon 7 (*.c7) 0.02 2010-01-01 2009-07-04 2010-01-01 Redemption (*.p) 1.00 2010-01-01 2010-01-01 Transaction data Trading Units N 100,000.00 Trading Price (last fixed price) F_c 95.00 Opening Date dt_o 2005-06-01 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 513 9 Futures 9.4 Bond future Other important transaction data is calculated by the system as follows: • Accrued Interest of CTD Bond at delivery Accrued_Interest = (dt_p.d - dt_s.c1) / (dt_v.c1 - dt_s.c1) * A.c1 0.0109782609 = (2006/10/10 – 2006/07/01) / (2007/01/01 - 2006/07/01) * 0.02 • Nominal Amount A=N*u 10,000,000.00 = 100,000.00 * 100 • Hedging Amount Hedging_Amount = A / c_f 9,523,809.52 = 10,000,000.00 / 1.05 • Book Value V_b.p = 0.00 Unless otherwise stated, the figure date used in the calculations is 2005-07-06. On this date, the market data is as follows: Market data on 2005-07-06 Figure Date d_f 2005-07-06 Days to Spot d_fs 2 Figure Spot Date dt_s.f = d_f + d_fs 2005-07-08 Future Price F 90.00 Price of the CTD Bond P_ctd 90.00 Discount Rate r_d 2.0277215% Yield to Maturity ytm 5.80146169% Other market data is calculated by the system as follows: • 514 Time to Payment Cashflow Time to payment Fixing t_p.f = (dt_s.f - d_f) / B 0.005479452 Delivery t_p.p = (dt_p.d - d_f) /B 1.26301370 Current Coupon t_p.c0 = (dt_p.c0 - d_f) /B 0.49315068 Next Coupon t_p.n = (dt_p.c0 - d_f) /B 0.49315068 Coupon 1 t_p.c1 = (dt_p.c1 - d_f) /B 1.49041096 Coupon 2 t_p.c2 = (dt_p.c2 - d_f) /B 1.98904110 Coupon 3 t_p.c3 = (dt_p.c3 - d_f) /B 2.49041096 Coupon 4 t_p.c4 = (dt_p.c4 - d_f) /B 2.98904110 Coupon 5 t_p.c5 = (dt_p.c5 - d_f) /B 3.49315068 Coupon 6 t_p.c6 = (dt_p.c6 - d_f) /B 3.98904110 Coupon 7 t_p.c7 = (dt_p.c7 - d_f) /B 4.49315068 Redemption t_p.r = (dt_p.p - d_f) /B 4.49315068 © Wall Street Systems IPH AB - Confidential 9 Futures 9.4 Bond future • Accrued Interest of the CTD I_ctd = (dt_s.f - dt_s.c0) / (dt_v.c0 - dt_s.c0) * A.c0 0.000760870 = (2005/07/08 – 2005/07/01) / (2006/01/01 - 2005/07/01) * 0.02 • Time to Spot (Implied Repo Rate) t_s = (dt_s.f - d_f) / 365 0.005479452 = (2005/07/08 - 2005/07/06) / 365 • PV Discount Factor • Cashflow PV discount factor Fixing D_pv.s = EXP(-r_d * t_s) 0.99988890 Delivery D_pv.f (taken from the valuation curve) 0.90268161 Coupon 1 D_pv.c1 = D_pv.f * EXP(-ytm * (t_p.c1 - t_p.p)) 0.89085131 Coupon 2 D_pv.c2 = D_pv.f * EXP(-ytm * (t_p.c2 - t_p.p)) 0.86545008 Coupon 3 D_pv.c3 = D_pv.f * EXP(-ytm * (t_p.c3 - t_p.p)) 0.84063951 Coupon 4 D_pv.c4 = D_pv.f * EXP(-ytm * (t_p.c4 - t_p.p)) 0.81666999 Coupon 5 D_pv.c5 = D_pv.f * EXP(-ytm * (t_p.c5 - t_p.p)) 0.79313176 Coupon 6 D_pv.c6 = D_pv.f * EXP(-ytm * (t_p.c6 - t_p.p)) 0.77063933 Coupon 7 D_pv.c7 = D_pv.f * EXP(-ytm * (t_p.c7 - t_p.p)) 0.74842780 Redemption D_pv.r = D_pv.f * EXP(-ytm * (t_p.r - t_p.p)) 0.74842780 MV Spot Discount Factor D_s = EXP(-r_d * t_s) 0.99988890 = EXP(-0.020277215 * 0.005479452) 9.4.2.3.3 Valuation figures The valuation method used in this example is the Quoted method. • Market Value V = N * tv * (F - F_c) * D_s -499,944.45 = 100,000.00 * 1.00 * (90.00 – 95.00) * 0.99988890 • Implied Repo Rate irr = (F/100 * 1.05+ Accrued_Interest - (P_ctd / 100 + I_ctd) + (A.c0 + A.n)) / ((P_ctd / 100 + I_ctd) * ((dt_p.d - dt_s.f) / 365) - (A.c0 * ((dt_p.d - dt_p.c0) / 365) + A.n * ((dt_p.d -dt_p.n) / 365))) = 8.56336405% • Risk Value Cashflow Risk value Fixing V_r.f = N * tv * (F - F_c) = 100,000.00 * 1.00 * (90.00 – 95.00) -500,000.00 Delivery V_r.d = -A * (F / 100 + Accrued_Interest / c_f ) = -10,000,000 * (90.00 / 100 + 0.0109782609 / 1.05) -9,104,554.87 Coupon 1 V_r.c1 = Hedging_Amount * A.c1 = 9,523,809.52 * 0.02 190,476.19 Coupon 2 V_r.c2 = Hedging_Amount * A.c2 190,476.19 Coupon 3 V_r.c3 = Hedging_Amount * A.c3 190,476.19 Coupon 4 V_r.c4 = Hedging_Amount * A.c4 190,476.19 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 515 9 Futures 9.4 Bond future • 516 Cashflow Risk value Coupon 5 V_r.c5 = Hedging_Amount * A.c5 190,476.19 Coupon 6 V_r.c6 = Hedging_Amount * A.c6 190,476.19 Coupon 7 V_r.c7 = Hedging_Amount * A.c7 190,476.19 Redemption V_r.p = Hedging_Amount 9,523,809.52 Present Value Cashflow Present value Fixing V_p.f = V_r.f * D_pv.s = -500,000.00 * 0.99988890 -499,944.45 Delivery V_p.d = V_r.d * D_pv.f = -9,104,554.87 * 0.90268161 -8,218,514.25 Coupon 1 V_p.c1 = V_r.c1 * D_pv.1 = 190,476.19 * 0.89085131 169,685.96 Coupon 2 V_p.c2 = V_r.c2 * D_pv.2 = 190,476.19 * 0.86545008 164,847.63 Coupon 3 V_p.c3 = V_r.c3 * D_pv.3 = 190,476.19 * 0.84063951 160,121.81 Coupon 4 V_p.c4 = V_r.c4 * D_pv.4 = 190,476.19 * 0.81666999 155,556.19 Coupon 5 V_p.5 = V_r.c5 * D_pv.5 = 190,476.19 * 0.79313176 151,072.72 Coupon 6 V_p.6 = V_r.c6 * D_pv.6 = 190,476.19 * 0.77063933 146,788.44 Coupon 7 V_p.7 = V_r.c7 * D_pv.7 = 190,476.19 * 0.74842780 142,557.68 Redemption V_p.r = V_r.p * D_pv.7 = 9,523,809.52 * 0.74842780 7,127,883.82 Total V_p.total 499,944.45 © Wall Street Systems IPH AB - Confidential 9 Futures 9.4 Bond future 9.4.2.3.4 Result figures The setup of the instrument impacts the way result figures are computed. • Total Profit Total_Profit = V = -499,944.45 • MtoM Profit MtoM_Profit = A * (F - F_c) / 100 -500,000.00 = 10,000,000 * (90.00 - 95.00) / 100 • Accrued Interest Accrued_Interest = 0.00 • Accrued Profit Accrued_Profit = 0.00 • Other Profit Other_Profit = Total_Profit.p - MtoM_Profit.p 55.55 = -499,944.45 - (-500,000.00)> 9.4.2.3.5 Risk figures • IR Exposure 1bp Cashflow IR exposure 1bp Fixing E_i.f =-V_r.f * D_pv.s * t_p.f * 0.0001 = -(-500,000.00) * 0.99988890 * 0.005479452 * 0.0001 0.27 Delivery E_i.d = -V_r.d * D_pv.f * t_p.p * 0.0001 = -(-9,104,554.87) * 0.90268161 * 1.26301370 * 0.0001 1,038.01 Coupon 1 E_i.c1 = -V_r.c1 * D_pv.1 * t_p.c1* 0.0001 = -190,476.19 * 0.89085131 * 1.49041096 * 0.0001 -25.29 Coupon 2 E_i.c2 = -V_r.c2 * D_pv.2 * t_p.c2 * 0.0001 = -190,476.19 * 0.86545008 * 1.98904110 * 0.0001 -32.79 Coupon 3 E_i.c3 = -V_r.c3 * D_pv.3 * t_p.c3 * 0.0001 = -190,476.19 * 0.84063951 * 2.49041096 * 0.0001 -39.88 Coupon 4 E_i.c4 = -V_r.c4 * D_pv.4 * t_p.c4 * 0.0001 = -190,476.19 * 0.81666999 * 2.98904110 * 0.0001 -46.50 Coupon 5 E_i.c5 = -V_r.c5 * D_pv.5 * t_p.c5 * 0.0001 = -190,476.19 * 0.79313176 * 3.49315068 * 0.0001 -52.77 Coupon 6 E_i.c6 = -V_r.c6 * D_pv.6 * t_p.c6 * 0.0001 = -190,476.19 * 0.77063933 * 3.98904110 * 0.0001 -58.55 Coupon 7 E_i.c7 = -V_r.c7 * D_pv.7 * t_p.c7 * 0.0001 = -190,476.19 * 0.74842780 * 4.49315068 * 0.0001 -64.05 Redemption E_i.r = -V_r.p * D_pv.r * t_p.r * 0.0001 = -9,523,809.52 * 0.74842780 * 4.49315068 * 0.0001 -3,202.67 Total E_i.total -2,484.21 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 517 9 Futures 9.4 Bond future • Effective Duration U_eff = -E_i.total / V_P.total / 0.0001 -49.69 = -(-2,484.21) / 499,944.45 / 0.0001 9.4.3 Australian bond future Australian bond futures have 3-year and 10-year Commonwealth Treasury Bonds issued by the Federal Government as the underlying. These bonds are fixed interest securities that are issued with a set term to maturity and have a semi-annual coupon rate which is fixed for the life of the bond. They are considered as the benchmarks of long and medium term interest rates in Australia and are actively traded by both Australian and international investors and traders. Australian bond futures are quoted as 100 - yield% per annum in multiples of 0.01%. The Australian convention quotes Treasury bonds on the basis of their yield-to-maturity, and not by the clean price. This means that the value of one tick move (0.01%) does not remain constant but moves in line with changes in the underlying yield. 9.4.3.1 Instrument setup Australian bond futures are set up in a similar way to standard bond futures (see 9.4.1 Bond future on page 506), but require a different primary feature. • Main characteristics See A.2.68 Bond Future - Australian on page 743. • Quotation information Information Description Price Type Method for quoting the price - Ticks. Quote Handling Select Generic (which means that you will be able to enter the bid and ask quotes for this instrument). Currency Currency of the future contract - AUD. See A.2.274 Quoted on page 849. • Netting information The daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or it expires. See A.2.319 Ticks Netting on page 870. 9.4.3.2 Market information For an Australian bond future, the Reserve Bank of Australia bond pricing formula is used to convert the market quotation into a future price. First, the corresponding yield is computed as: Yield = 100 - Q where Q is the market quote of the future contract. The future price is then converted using the following formula: Equation 9-12 Australian bond future: future price conversion n n c(1 – v ) P = ContractSize × ⎛⎝ ----------------------- + v ) i where: – 518 i = yield% p.a. divided by 200 © Wall Street Systems IPH AB - Confidential 9 Futures 9.5 Equity future – v = 1 / (1 + i) – n = total number of coupons (20 for 10Y bond, 6 for 3Y bond) as defined at the underlying instrument level (Bond Future page - underlying instrument) – c = coupon rate / 2 (expressed as %) as defined at the underlying instrument level (Bond Future page - underlying instrument) Once the market quotation has been converted into the future price, the valuation of the contract is carried out in the same way as for a standard bond future contract. Note: It is possible to set up 3Y /10Y Treasury Bond future instruments with as underlying a synthetic bond, which will be defined as follows: Coupon rate = 6%, issue date = settlement date of the future and a term to maturity of 3Y or 10Y depending on the type of the future. 9.5 Equity future A future is an agreement (obligation) to buy or sell a given quantity of a particular asset, at a specified future date, at a pre-agreed price. Futures contracts have standard delivery dates, trading units, terms and conditions. You can "open" a futures position by either buying or selling a future. You can "close" your futures position by doing the opposite - either selling or buying the same future. In practice, most futures contract positions are "closed out" before they expire. If you hold a view that the underlying asset will rise you could buy futures - known as a long futures position - which commits you to take delivery of the underlying assets, or equivalent cash value, at a pre-arranged price and by a certain date. If your view is that the share prices for the underlying asset will fall, you could sell futures - known as a short futures position - which commits you to deliver the underlying assets, or equivalent cash value, at a prearranged price and by a certain date. An equity future is an exchange traded derivative instrument where the underlying is stock. Equity futures are usually fixed daily. Typically there is an initial margin requirement (entered as a payment in TRM) when buying or selling futures contracts but no principal is paid. When the market quote for the future changes, the variation margin (daily change in market value) is settled every day (netted) until the contract is closed or it expires. The variation margin is calculated by multiplying the change in the quote by the point value and the number of contracts. When the equity future expires, the difference between the last fixing price and the closing price is settled. Dividends are taken into account for the market valuation. They can be entered in Rate Monitor and TRM will then use this information in the calculations. 9.5.1 Instrument setup Equity future instruments must be based on an instrument type derived from the class EQUITY-FUTURE. • Main characteristics Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 519 9 Futures 9.5 Equity future The following basic information may be captured when defining the instrument. This information is relevant to any kind of equity future instrument. • Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Underlying The underlying equity instrument or equity index. Currency The currency in which the instrument is traded. Netting information The daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or it expires. Information Description Fixing parameters Leave these fields blank if you want to define the Fixing parameters at deal entry. Calendar Calendar used to calculate the dates. Switches Switch on Settlement Currency if settlement is made in a different currency. Settlement Currency If the Settlement Currency switch is on, the Currency in which settlement is made. Payment Offset Number of business days between value date and payment date. Method Select Business Days for daily netting. Frequency For daily netting, enter 1 when Method = Business Days. See A.2.131 Equity Future on page 775. • Future dates definition Information Description Last Trading Day Last day when the futures contract can be traded. The final day during which trading may take place in a futures contract, after which it must be settled. Settlement Date Last day on which delivery (cash settlement) of the underlying instrument can take place. See A.2.168 Future Dates on page 795. • Trading units definition Information Description Point Value Unit of trading of the contract: one future normally represents 100 shares. Minimum Bid Size Smallest allowed bid size (for example, 100). Tick Size Minimum price movement (tick size and value). Tick Value Tick Size * Point Value = Tick Value Note: The tick value needs to be entered in the main currency units (e.g. pounds), even when the underlying equity is traded in fractional units (e.g. pence). Rounding Method 520 Rounding method used in the calculations: Up, Down, or Nearest. © Wall Street Systems IPH AB - Confidential 9 Futures 9.5 Equity future Information Description Allow Trading in Half of Tick Size Allows trading this instrument at a price with a precision of half the tick size (used for eurodollar Future contracts and options for nearest expiring month). See A.2.320 Trading Unit (Derivative) on page 871. • Quotation information Information Description Active From Period within which the quotation information is valid. Active To Leave these fields blank if you want the quotation information to apply indefinitely. Price Type Standard method for quoting the price: Price/Underlying Unit. Quote Handling Generic Currency Currency in which the quotation is expressed. See A.2.274 Quoted on page 849. It is also possible to set up • Spot date calculation • Cashflow or transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 9.5.2 Deal capture 9.5.2.1 Input data In addition to the standard deal parameters, the following information is required to enter an equity future contract: Information Description Trading Units Number of futures bought/sold. Deal Price Transaction price. 9.5.2.2 Generated data Two cashflows are generated: – One position flow which represents the future position. – The next netting flow (not fixed) which will be the support for the next daily margin once fixed (see 9.5.3.1 Daily netting on page 521). 9.5.3 Processing This section describes the actions that can be done throughout the life of an equity future. 9.5.3.1 Daily netting Equity futures are not subject to a physical delivery of the underlying at expiry but are typically fixed every day. If the market quote for the future has changed from the previous day, the difference (multiplied by the point value and the number of units) is settled between the parties of the trade. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 521 9 Futures 9.5 Equity future • Setup The netting parameters for equity futures are defined at instrument level. • Execution The daily netting of equity futures is carried out using the Execute Netting action. The following information is needed to process the netting: Information Description Netting Date Day the cashflow is fixed. Netting Price Fixing market quote. This is defaulted by the system and can be changed by the user. Netting Amount Profit or loss (settlement amount) from the equity future. This is calculated automatically by TRM and can be changed by the user. Netting Currency (Information only) Currency of the settlement cashflow. The Execute Netting action automatically generates the next cashflow. Netting of the cashflows can also be performed automatically using the Netting activity: see the TRM User Guide for more information. • Cancellation The netting can be canceled either using the Undo Netting action, or using the Netting - Undo activity. 9.5.3.2 Closing the position Closing out a position means entering into a trade that is opposite to the original one. Closing of a futures position takes place when the holder of a short position buys, or a long position sells, new contracts which are matched with old ones. The transactions may not have been fixed before the matching. If not, matching the trades creates a profit/loss cashflow to account for the price difference between transactions. 9.5.3.2.1 Matching • Setup – The selling parameters used to automatically match transactions are specified in the result treatment applied to the instrument definition. – The portfolio must have the Allow Short Selling switch activated. See the TRM User Guide for more information. • Execution – Automatic matching of transactions occurs each night with the End of Day Processing activity. – Manual matching of futures is done in Transaction Manager’s Matching mode. This option is available if you specified Manual or FIFO as the selling method for the instrument. See the TRM User Guide for more information about matching transactions. • Cancellation You can also unmatch transactions in Transaction Manager’s Matching mode if the cashflows resulting from the transactions are not yet paid or booked. 522 © Wall Street Systems IPH AB - Confidential 9 Futures 9.6 FX future 9.6 FX future Forex futures serve two primary purposes as financial instruments: • They can be used by companies or sole proprietors to remove the exchange-rate risk inherent in cross-border transactions. • They can be used by investors to speculate and profit from currency exchange-rate fluctuations. An FX future is an exchange-traded contract to buy or sell a specified amount of a given currency at a predetermined price on a set date in the future. With a foreign exchange futures contract, the participants do not actually buy or sell anything: they simply agree to buy or sell the currencies on the pre-agreed terms if the contract reaches maturity. However, in reality, the majority of FX future contracts rarely reach maturity: this means that only a small proportion of FX Futures contracts result in actual delivery of the currencies. Both FX and traditional futures operate in the same basic manner. There is, however, one key difference between the two: FX futures are not traded on a centralized exchange; rather, the deal flow is available through several different exchanges in the U.S. or elsewhere. The vast majority of FX futures are traded through the Chicago Mercantile Exchange (CME) and its partners. However, this is not to say that FX futures contracts are OTC; they are still bound to a designated "size per contract", and they are offered only in whole numbers (unlike forward contracts). An FX futures contract is conceptually similar to a forward FX contract, in that both are agreements to buy or sell a certain amount of a certain currency for another at a certain price on a certain date. However, the fundamental difference between futures and forwards is the fact that futures are traded on exchanges, whereas forwards trade "over-the-counter". This has three practical implications: • Futures are standardized instruments. You can only trade the specific contracts supported by the exchange. Forwards are entirely flexible. Because they are privately negotiated between parties, they can be for any conceivable underlying and for any settlement date. • Forwards entail both market risk and credit risk. A counterparty may fail to perform on a forward. With futures, there is only market risk. This is because exchanges employ a system whereby counterparties exchange daily payments of profits or losses on the days they occur. Through these margin payments, a futures contract's market value is effectively reset to zero at the end of each trading day. This all but eliminates credit risk. • The daily cash flows associated with margining can skew futures prices, causing them to diverge from corresponding forward prices. 9.6.1 Instrument setup FX future instruments must be based on an instrument type derived from the class FX-FUTURE. • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of FX future instrument. Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Base Currency The currency pair: Base Currency/Settlement Currency. Settlement Currency See A.2.176 FX Future on page 798. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 523 9 Futures 9.6 FX future • Future dates definition Most currency contracts are traded on the March quarterly cycle and go through a physical delivery process four times a year on the third Wednesday of March, June, September, and December. However, the Mexican peso and the South African rand are traded on all twelve calendar months. There are two "cash-settled" contracts — the Brazilian real, traded on all twelve calendar months; and the Russian ruble, traded on the March quarterly cycle. Information Last Trading Day Description Last day when the futures contract can be traded after which it must be settled. After this date, the contract cannot be traded. Settlement Date Last day on which delivery (or cash settlement) of the underlying instrument can take place. The final contract value is determined on this date and settlement is made. See A.2.168 Future Dates on page 795. • Trading units definition Information Description Contract Size Amount of base currency. Minimum Bid Size Smallest allowed bid size: 1. Tick Size Minimum fluctuation on the currency contract. Tick Value Tick Size * Contract Size = Tick Value Rounding Method Rounding method used in the calculations: Up, Down, or Nearest. Allow Trading in Half of Tick Size Allows trading this instrument at a price with a precision of half the tick size (used for eurodollar Future contracts and options for nearest expiring month). See A.2.320 Trading Unit (Derivative) on page 871. • Quotation information Information Description Active From Period within which the quotation information is valid. Active To Leave these fields blank if you want the quotation information to apply indefinitely. Price Type Standard method for quoting the price: Price/Unit. Quote Handling Generic Currency Currency in which the quotation is expressed. Note that all dollar-based FX futures prices are quoted in direct terms against the US dollar, unlike the spot forex market. The price represents the number of US dollars it would take to buy one unit of foreign currency. See A.2.274 Quoted on page 849. • 524 Netting information © Wall Street Systems IPH AB - Confidential 9 Futures 9.6 FX future The daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or it expires. Information Description Fixing parameters Leave these fields blank if you want to define the Fixing parameters at deal entry. Calendar Calendar used to calculate the dates. Switches Switch on Settlement Currency if settlement is made in a different currency. Payment Offset Number of business days between value date and payment date. Method Select Business Days for daily netting. Frequency For daily netting, enter 1 when Method = Business Days. See A.2.177 FX Future Netting on page 798. • Valuation of FX futures It is possible to specify that another MtoM instrument’s direct market quotation is used to value the future contract. See A.2.246 MtoM Instrument Setup on page 836. It is also possible to set up: • Spot date calculation • Cashflow or transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 9.6.2 Deal capture 9.6.2.1 Input data In addition to the standard deal parameters, the following information is required to enter an FX future contract: Information Description Trading Units Number of futures bought/sold. Deal Price Transaction price. If the quotation information is defined in the instrument setup, the deal price defaults to the price of the market feed provided by the Price Manager: see A.2.266 Quote Default on page 845. 9.6.2.2 Generated data • Cashflows The following cashflows are generated: – One position flow which represents the future position – The netting flow(s). 9.6.3 Processing This section describes the actions that can be done throughout the life of an FX future. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 525 9 Futures 9.6 FX future 9.6.3.1 Daily netting As for other futures, there are initial and maintenance margins and daily cash settlements. The initial margin is the minimum amount required to enter into a new futures contract, but the maintenance margin is the lowest amount an account can reach before needing to be replenished. If the market quote for the future has changed from the previous day, the daily change in market value is settled every day (netted) until the contract is closed or expires. • Setup The netting parameters for FX futures are defined at instrument level: see A.2.177 FX Future Netting on page 798. • Execution The daily netting of FX futures is carried out using the Execute Netting action. The following information is needed to process the netting: Information Description Netting Date Day the cashflow is fixed. Netting Price Fixing market quote. This is defaulted by the system and can be changed by the user. Netting Amount Profit or loss (settlement amount) from the FX future. This is calculated automatically by TRM and can be changed by the user. Netting Currency (Information only) Currency of the settlement cashflow. The Execute Netting action automatically generates the next cashflow. Netting of the cashflows can also be performed automatically using the Netting activity: see the TRM User Guide for more information about activities. • Cancellation The netting can be canceled either using the Undo Netting action, or using the Netting - Undo activity. 9.6.3.2 Closing the position Closing out a position means entering into a trade that is opposite to the original one. Closing of a futures position takes place when the holder of a short position buys, or a long position sells, new contracts which are matched with old ones. The transactions may not have been fixed before the matching. If not, matching the trades creates a profit/loss cashflow to account for the price difference between transactions. 9.6.3.2.1 Matching • Setup – The selling parameters used to automatically match transactions are specified in the result treatment applied to the instrument definition. – The portfolio must have the Allow Short Selling switch switched on. See the TRM User Guide for more information. • 526 Execution – Automatic matching of transactions according to the FIFO method occurs each night with the End of Day Processing activity. – Manual matching of futures is done in Transaction Manager’s Matching mode. This option is available if you specified Manual or FIFO as the selling method for the instrument. © Wall Street Systems IPH AB - Confidential 9 Futures 9.6 FX future • Cancellation You can also unmatch transactions in Transaction Manager’s Matching mode if the cashflows resulting from the transactions are not yet paid or booked. See the TRM User Guide for more information about matching and unmatching transactions. 9.6.4 Position monitoring The numerical examples in this section demonstrate how the figures are calculated for an FX future contract. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. 9.6.4.1 Calculations This example shows an FX Future, with the following deal data: • Setup data Data • Symbol Valuation Method Quoted Risk Yield Type Continuous Risk Date Basis B.r 360 Contract Size u 125,000.00 Base CCY EUR Settlement CCY USD Portfolio data Data Symbol Example FX Exposure e_fx 0.01 Figure Currency • • Example USD Transaction data Data Symbol Example Opening Date dt_o 2006-10-08 Trading Units N 100 Fixing Rate Before Last F_1 1.260000 Last Fixing Rate F_0 1.275000 Deal Rate F_d 1.270500 Value Date dt_m 2007-03-21 Data Symbol Example Nominal Amount A=N*u 12,500,000 Calculated Transaction data Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 527 9 Futures 9.6 FX future Market Data on the Figure Date • Data Symbol Example Figure Date dt.f 2006-10-12 Market Quote F 1.280000 FX Convert: Base CCY S 1.270000 Calculated Data on Figure Date • Data Symbol Example Formula Time to Maturity t_m 0.44444444 = (2007/03/21 -2006/10/12) / 360 = (dt.m-dt.f) / B.r Present Value Discount Factor: Base CCY D_P.b 0.994494278 Present Value Discount Factor: Quote CCY D_P.q 0.991695620 Valuation figures - Netting Flow • Data Symbol Amount Market Value V.n Example Formula 187,500 = 12,500,000 * (1.275 - 1.260) = A * (F_0 - F_1) 187,500 = 12,500,000 * (1.275 - 1.260) = A * (F_0 - F_1) Valuation figures - Position Flow • Data Symbol Example Formula Market Value V.p 118,750 = 12,500,000 * (1.28 - 1.2705) = A * (F - F_d) Valuation figures - Variation Flow • Data Symbol Example Formula Market Value V.v -56,250.00 = 12,500,000 * (1.2705 1.2750) = A * (F_d - F_0) Example Formula 250,000 = 187,500 + 118,750 + -56,250 = V.n + V.p + V.v Valuation figures - Total • Data Symbol Market Value Risk figures - Base CCY • Data Symbol Example Formula Present Value V_P.b 15,787,596.67 = 1.27 * 12,500,000 * D_P.b = S * V_r.b * D_P.b Risk Value V_r.b 12,500,000 =A IR Exposure 1bp E_ip -701.67 = -1.27 * 12,500,000 * 0.994494278 * 0.44444444 * 0.0001 = -S * V_r.b * D_P.b * t_m * 0.0001 528 © Wall Street Systems IPH AB - Confidential 9 Futures 9.7 Index future • • Data Symbol Example Formula FX Exposure e_fx 157,875.97 = 0.01 * 15,787,596.67 = e_fx_1 * V_P.b Risk figures - Quoted CCY Data Symbol Example Formula Present Value V_l.q -15,749,366.06 = 15,881,250 * 0.991695620 = V_r.q * D_P.q Risk Value V_r.q -15,881,250 = -12,500,000 * 1.2705 = -A * F_d IR Exposure 1bp E_ipq 699.97 = 15,881,250 * 0.991695620 * 0.44444444 * 0.0001 = -V_r.q * D_P.q * t_m * 0.0001 Symbol Example Formula 38,230.61 = 15,787,596.67 + -15,749,366.06 = V_P.b + V_l.q_1 Example Formula 187,500 = V.n Risk figures - Total Data Present Value • Profit Data MtoM Symbol 9.7 Index future A future is an agreement (obligation) to buy or sell a given quantity of a particular asset, at a specified future date, at a pre-agreed price. Futures contracts have standard delivery dates, trading units, terms and conditions. You can open a futures position by either buying or selling a future. You can close your futures position by doing the opposite, either selling or buying the same future. In practice, most futures contract positions are closed out before they expire. If you hold a view that the underlying asset will rise you could buy futures, known as a long futures position, which commits you to take delivery of the underlying assets, or equivalent cash value, at a pre-arranged price and by a certain date. If your view is that the share prices for the underlying asset will fall, you could sell futures, known as a short futures position, which commits you to deliver the underlying assets, or equivalent cash value, at a prearranged price and by a certain date. An index future is an exchange traded derivative instrument where the underlying is an index. Typically, index futures are fixed daily. As the underlying is an index there is no physical settlement at the end. Typically there is an initial margin requirement (entered as a payment in TRM) when buying or selling futures contracts but no principal is paid. When the market quote for the future changes, the variation margin (daily change in market value) is settled every day (netted) until the contract is closed or it expires. The variation margin is calculated by multiplying the change in the quote by the point value and the number of contracts. When the index future expires, the difference between the last fixing price and the closing price is settled. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 529 9 Futures 9.7 Index future 9.7.1 Instrument setup Index future instruments are based on an instrument type derived from the class INDEX-FUTURE. • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of index future contract. • Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Underlying The underlying index instrument. Currency The currency in which the instrument is traded. Netting information The daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or it expires. Information Description Fixing parameters Leave these fields blank if you want to define the Fixing parameters at deal entry. Calendar Calendar used to calculate the dates. Switches Switch on Settlement Currency if settlement is made in a different currency. Settlement Currency If the Settlement Currency switch is on, the Currency in which settlement is made. Payment Offset Number of business days between value date and payment date. Method Select Business Days for daily netting. Frequency For daily netting, enter 1 when Method = Business Days. See A.2.208 Index Future on page 818. • Future dates definition Information Description Last Trading Day Last day when the futures contract can be traded. The final day during which trading may take place in a futures contract, after which it must be settled. Settlement Date Last day on which delivery (cash settlement) of the underlying instrument can take place. See A.2.168 Future Dates on page 795. • 530 Trading units Information Description Point Value Unit of trading of the contract: value of 1 point of the index. Minimum Bid Size Smallest allowed bid size (for example, 1.00000). © Wall Street Systems IPH AB - Confidential 9 Futures 9.7 Index future Information Description Tick Size Minimum price movement (tick size and value), for example, 0.5 / €5. Tick Value Tick Size*Point Value = Tick Value Rounding Method Rounding method used in the calculations: Up, Down, or Nearest. Allow Trading in Half of Tick Size Allows trading this instrument at a price with a precision of half the tick size (used for eurodollar Future contracts and options for nearest expiring month). See A.2.322 Trading Unit (Index) on page 872. • Quotation information Information Description Active From Period within which the quotation information is valid. Active To Leave these fields blank if you want the quotation information to apply indefinitely. Price Type Standard method for quoting the price: Price/Underlying Unit. Quote Handling Generic Currency Currency in which the quotation is expressed. See A.2.274 Quoted on page 849. It is also possible to set up: • Spot date calculation • Cashflow or transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 9.7.2 Deal capture 9.7.2.1 Input data In addition to the standard deal parameters, the following information is required to enter an index future contract: Information Description Trading Units Number of futures bought/sold. Deal Price Transaction price. 9.7.3 Processing This section describes the actions that can be done throughout the life of an index future. 9.7.3.1 Daily netting Index futures are not subject to a physical delivery of the underlying at expiry but are typically fixed every day. If the market quote for the future has changed from the previous day, the difference (multiplied by the point value and the number of units) is settled between the parties of the trade. • Setup Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 531 9 Futures 9.7 Index future The netting parameters for index futures are defined at instrument level: see 9.7.1 Instrument setup on page 530. • Execution The daily netting of index futures is carried out using the Execute Netting action. The following information is needed to process the netting: Information Description Netting Date Day the cashflow is fixed. Netting Price Fixing market quote. This is defaulted by the system and can be changed by the user. Netting Amount Profit or loss (settlement amount) from the index future. This is calculated automatically by TRM and can be changed by the user. Netting Currency (Information only) Currency of the settlement cashflow. The Execute Netting action automatically generates the next cashflow. Netting of the cashflows can also be performed automatically using the Netting activity: see the TRM User Guide for more information. • Cancellation The netting can be canceled either using the Undo Netting action, or using the Netting - Undo activity. 9.7.3.2 Closing the position Closing out a position means entering into a trade that is opposite to the original one. Closing of a futures position takes place when the holder of a short position buys, or a long position sells, new contracts which are matched with old ones. The transactions may not have been fixed before the matching. If not, matching the trades creates a profit/loss cashflow to account for the price difference between transactions. 9.7.3.3 Matching • Setup – The selling parameters used to automatically match transactions are specified in the result treatment applied to the instrument definition. – The portfolio must have the Allow Short Selling switch activated. See the TRM User Guide for more information. • Execution Automatic matching of transactions occurs each night with the End of Day Processing activity. Manual matching of futures is done in Transaction Manager’s Matching mode. This option is available if you specified Manual or FIFO as the selling method for the instrument. See the TRM User Guide for more information about matching transactions. • Cancellation You can also unmatch transactions in Transaction Manager’s Matching mode if the cashflows resulting from the transactions are not yet paid or booked. 532 © Wall Street Systems IPH AB - Confidential Chapter 10 Options 10.1 Cap/floor/collar Cap, Floors, and Collars are OTC option instruments that are commonly used to hedge a position. • Interest Rate Cap: buying a cap protects against a rise in the money market interest rate. • Interest Rate Floor: buying a floor protects against a fall in the money market interest rate. • Interest Rate Collar: purchasing a collar consists of buying a cap and selling a floor. With these option agreements, the buyer has the right to be compensated by the seller for the difference between the contract interest and the reference interest in exchange for an option premium. This comparison of interest takes place periodically according to a number of predetermined data. The settlement of any difference takes place at the end of the interest period on the fixing date. For these types of option instrument, the nominal cashflow is pseudo: only the premium is paid at deal entry. 10.1.1 Vanilla cap/floor/collar • Cap A Cap instrument is an option contract which puts an upper limit on a floating exchange rate. The owner of a cap has an insurance against rising interest rates. At the fixing date, if the money market interest rate is higher than the contract interest rate, the seller of an interest rate cap is obliged to compensate the buyer with the difference. In the case of a lower money market interest rate, no settlement takes place. For this insurance, the buyer must pay a premium. For example, the issuer of a floating rate debt (such as LIBOR3M) wants to insure against having to refund more than 4% a year. To do so, the issuer buys a Cap that pays (LIBOR3M - 4%) if LIBOR3M increases to 4%. The Cap instrument will have the same period, nominal, and fixing dates as the issue. • Floor A Floor instrument is the opposite of a cap: if the money market interest rate is lower than the contract interest rate, the seller of an interest rate floor is obliged to compensate the difference to the buyer. In the case of a higher money market interest rate no settlement takes place. For example, the buyer of a floating rate debt (such as EURIBOR6M) wants to insure against interest rates falling below 2%. The buyer can purchase a Floor that pays (EURIBOR6M - 2%). If EURIBOR6M falls below 2%, the holder of the floor will be compensated for the loss with the floor’s payoff. • Collar A Collar instrument is the combination of a bought Cap and a paid Floor. This means that the premium can be positive/negative if the Cap is worth more/less than the Floor. For example, the issuer of a floating rate debt wants to ensure a relative stability of interest flows for a reduced cost. To do so the issuer can buy a Collar. – If the interest rates go above the Cap, the holder of the collar is paid the difference. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 533 10 Options 10.1 Cap/floor/collar – If interest rates go below the Floor, the holder of the collar pays the difference. This means that in either case, the issuer can ensure that interest rates remain within a narrow corridor in exchange for a premium. The same strategy can be employed by a lender if a Collar is sold. • Cap and Floor A Cap and Floor instrument consists of buying a cap and a floor at the same time. In exchange for the premium, the holder of the cap and floor will always be compensated if the interest rates go outside the interest rate corridor. A purchased cap and floor instrument hedges against interest rate volatility, whereas a sold cap and floor is a bet on interest rate stability. 10.1.1.1 Instrument setup Cap, Floor, Collar, and Cap and Floor instruments must be based on an instrument type derived from the class CAP-FLOOR-COLLAR. • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of Cap/Floor/Collar. Information Currency Description Currency of the instrument. Leave this field blank if you want to specify the currency when you enter the transaction in Transaction Manager. Transaction Sign Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow: • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal in Transaction Manager. • Select either Buy/Lend or Sell/Borrow if you want this to be the default direction of the transaction, that is, the direction cannot be modified in Transaction Manager. AI Method Method used to calculate settlement accrued interest. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Structure Schedule Template to be applied on the instrument. If you specify the schedule in the instrument setup, this is used as the default in the transaction and cannot be modified. Leave this field blank if you want to apply a schedule to the instrument when you enter the deal in Transaction Manager. Transaction Type Cap, Floor, Collar, or Cap & Floor. See A.2.87 Cap/Floor/Collar on page 751. • Maturity definition It is possible to set up maturity information at instrument level. 534 Information Description Calendar parameters Calendars used to calculate the maturity date of an instrument. If you enter both a Calendar and a Holiday Calendar, the maturity date calculation takes both calendars into account. © Wall Street Systems IPH AB - Confidential 10 Options 10.1 Cap/floor/collar Information Description Gap Set Gap set used for supplying the maturity periods for an instrument; these in turn are used to define exact dates. This is a mandatory field. Maturity Date Period Maturity period used to calculate the maturity date for an instrument in Transaction Manager, for example, 6M or 1Y. If you specify the maturity date period in the instrument setup, this is used as the default in the transaction and cannot be modified. See A.2.230 Maturity Date Setup on page 827. • Premium definition The main characteristics of a premium are: premium date, premium type, premium currency, and premium price. The premium amount can then be determined. For the premium date, it is possible to set up some information at instrument level. Information Description Calendar parameters Calendars used to calculate the premium date. Date Type Type of date on which the settlement of the premium takes place (Premium Date). This is the spot date by default. Offset Offset between the date defined previously and the premium date. See A.2.263 Premium Date Setup on page 844. Further information relating to the characteristics of the premium can also be set up at instrument level. Information Description Type Determines how the premium amount is calculated. If defined, the premium type is applied to each transaction. Leave this field blank if you want to specify the premium type when you enter the deal. Currency Currency of the premium. If defined, the premium currency is applied to each transaction. Leave this field blank if you want to specify the premium currency when you enter the deal. See A.2.262 Premium on page 844. For a cap/floor/collar, it is also possible to set up: • Spot date calculation to define the date when the premium is paid • Value date calculation • Quotation information • Branch codes • Cashflow and transaction charge rules • Manual charges. See Appendix A Features on page 713. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 535 10 Options 10.1 Cap/floor/collar 10.1.1.2 Deal capture 10.1.1.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a Cap/Floor contract. • Transaction view Information Description Option Type Cap, Floor, Collar, or Cap and Floor. (Transaction Type in Transaction Manager) Nominal Amount The notional principal of the underlying loan. Value Date Date when the deal starts, and from which interest starts to accrue. This defaults to the spot date of the transaction. Maturity Date Date when the transaction matures. If you enter a maturity code, the date is calculated automatically; otherwise you can enter the date manually. Premium Type • Type of premium. Select from: • Price % - the premium amount is calculated as a percentage of the nominal amount. • Amount • Price Points - the premium amount is calculated based on points, where 1 point is nominal amount/1000. Premium Price Depends on the premium type: this could be specified in amount, percent, or points. Premium Amount Amount of the premium. The premium amount can be entered directly. Premium Currency Currency of the premium amount. Schedule view If you did not specify the schedule in the instrument setup, you need to apply a schedule to the instrument when you enter the deal in Transaction Manager. TRM provides pre-defined primary templates for this instrument class: see B.2.1.1.9 Cap on page 891, B.2.1.1.10 Cap and Floor on page 891, and B.2.1.1.11 Collar on page 892. In each template, the principal schedule represents the Nominal Amount and generates pseudo cashflows as no principal is paid. The interest schedule is used to generate the caplets or floorlets. The expression fields contain the formula, and the cap and/or floor value should be entered in the Cap or Floor fields. For each set of cashflows, the following information must be supplied at deal entry: Information Description Frequency Method and Period The frequency method/period for the interest cashflows (for example, Years/4 generates four interest flows per year). Fixing Rate The yield curve used for the fixing calculations. Fixing Period The period of the yield curve that is used for the fixing. Cap/Up The cap and/or floor value must be entered in the appropriate field. Floor/Down 536 © Wall Street Systems IPH AB - Confidential 10 Options 10.1 Cap/floor/collar 10.1.1.2.2 Generated data • Cashflows – One settlement flow for the premium – The nominal cashflows are pseudo. For a bought cap, the cashflows generated are as follows: Interest flows (not fixed) Nominal Opening date Spot days Premium Maturity Maturity date Nominal 10.1.1.3 Processing The processing actions that are typically linked to caps, floors, and collars are fixing and execution of the trigger. It is also possible to early expire a cap/floor/collar transaction. 10.1.1.3.1 Fixing For a cap/floor/collar, the amount of each interest flow has to be determined before it is paid. The buyer has the right to be compensated by the seller for the difference between the contract interest and the reference interest. The settlement of any difference takes place at the end of the interest period: this process is known as fixing. • Execution The fixing process is performed directly on an individual cashflow in the Cashflow view and requires the following parameters: Information Description Fixing Date Date of the fixing. Fixing Quote Fixing quote is the market variable quote taken from Rate Monitor, and is used to calculate the cashflow fixing price and amount. Nominal Rate Nominal rate used in the fixing calculations. Amount Amount of the cashflow. It is possible to modify the fixing values. When the fixing quote is modified, this updates both the nominal rate and the amount accordingly. Similarly, if the nominal rate is modified, the amount is affected (but not the fixing quote). It is also possible to modify the amount independently from the other fixing values. This may be necessary when rounding differences arise, for example. Executing the fixing modifies the cashflow as follows: Marks it as being fixed Sets the fixing date Stores the rate of the market reference used for fixing Stores the effective interest rate (nominal rate) on the cashflow Sets the amount of the cashflow Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 537 10 Options 10.1 Cap/floor/collar • Cancellation It is possible to cancel the fixing using the Undo Fixing action. 10.1.1.3.2 Early expiration Caps, Floors, and Collars can be closed-out earlier than their agreed maturity date. This process is referred to as early expiration. • Execution Early expiration of a the transaction requires the following information: Information Description Opening Date Date when the early expiration is done. Premium Date Date on which the settlement of the premium takes place. Amount Left Remaining amount of the initial transaction. Premium Type Determines how the premium amount is calculated (from the initial transaction). Premium Currency Currency of the premium (from the initial transaction). Premium Price New premium price relative to the early expiration. Premium Amount Premium amount of the early expiration. The execution generates an early expiration transaction with the following attributes: Sign = Opposite sign of the initial option transaction Opening date = date when the early expiration is done Premium = new premium price Kind = Early Expiration The remaining attributes are inherited from the initial transaction. The early expiration transaction generates closing cashflows for the initial transaction. • Cancellation You can undo the early expiration by canceling the early expiration transaction. 10.1.1.4 Position monitoring - Caplet The Theoretical method is the only valuation method used for the valuation of cap/floor/collar and cap and floor instruments. 10.1.1.4.1 Setup The valuation approach feature Cap/Floor/Collar Valuation in the instrument definition determines that the instrument is valuated as a Cap/Floor/Collar. See A.2.88 Cap/Floor/Collar Valuation on page 751. Note: Depending on your needs, other approaches can be used such as NumeriX Valuation (A.2.253 NumeriX Valuation on page 841), External Valuation (A.2.142 External Valuation on page 781). 10.1.1.4.2 Calculations The numerical examples in this section demonstrate how the different figures are calculated for a Caplet using the Theoretical method and the valuation approach Cap/Floor/Collar Valuation. This example shows a Caplet, with the following deal data: 538 © Wall Street Systems IPH AB - Confidential 10 Options 10.1 Cap/floor/collar • • • Setup Data Symbol Example Instrument Date Basis (Act/360) B 360 Instrument Yield Type Periodic Valuation Method Theoretical Valuation Date Figure Date Risk Date Figure date Risk Yield Type Continuous Risk Date Basis (Act/365) B_r 365 Expiry Date Basis (Act/360) B_e 360 Data Symbol Example Opening Date dt_o 2006-03-03 Nominal Amount A 100,000,000.00 Cap/Up r_b 3.00% Fixing To dt_e 2007-11-29 From When dt_s 2007-12-03 Until When dt_l 2008-03-03 Value Date dt_v 2008-03-03 Payment Date dt_p 2008-03-03 Transaction data Market data on Figure Date Note: Unless otherwise stated, the figure date used in the calculations is 2006-04-15: • Data Symbol Example Formula Figure Date dt_f 2006-04-15 Sigma sigma 0.180000000000 Days in Period p_d 91.00000 = 2008-03-03 – 2007-12-03 =dt_vl - dt_vs Period Length p_t 0.25277778 = 91.00000 / 360 = p_d/B Time to Expiry t_e 1.647222 = (2007-11-29 – 2006-04-15) / 360 = (dt_e - dt_f) / B_e Market data specific to Caplet Start Data Symbol Example Formula Risk Date dt_vs 2007-12-03 = dt_s Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 539 10 Options 10.1 Cap/floor/collar Data Symbol Example Formula Risk Time to Value Date t_vs 1.63561644= (2007-12-03 – 2006-04-15) / 365 = (dt_vs-dt_f) / B_r Discount Factor D_s 0.954334399291 Market data specific to Caplet End • Data Symbol Example Formula Risk Date dt_vl 2008-03-03 = dt_l Risk Time to Value Date t_ve 1.884931507 = (2008-03-03 – 2006-04-15) / 365 = (dt_vl - dt_f) / B_r Discount Factor D_e 0.947737432916 Market data specific to Payment Date • Data Symbol Risk Date Example Formula 2008-03-03 = dt_p = (dt_p - dt_f) / B_r Risk Time to Value Date t_vp 1.884931507 = (2008-03-03 – 2006-04-15) / 365 Discount Factor D_p 0.947737432916 Data Symbol Example Formula Forward Price r_f 0.027537046 =(D_s / D_e -1) / p_t Black D1 d_1 -0.255303877 = (LN(r_f/r_b) + 0.5 * sigma * sigma * t_e) / (sigma * SQRT(t_e)) Black D2 d_2 -0.486323357 = d_1 - sigma * SQRT(t_e) F-factor f_F 0.399244203 =NORMSDIST(d_1) X-factor f_X -0.313368961 =-NORMSDIST(d_2) Caplet Price price 0.000381615 = (r_f * f_F + r_b * f_X) * p_t * D_e Intrinsic Value v.i 0 = (r_f - r_b) * p_t * D_e * 0.5 * (SIGN(LN(r_f / r_b)) + 1) Delta (Caplet Start) delta.s 0.399244203 =f_F Delta (Caplet End) delta.e -0.313368961 =f_X Data Symbol Example Formula Market Value V_m 38,161.51 = A * price Intrinsic Value V_i.t 0.00 = A * v.i Option figures • Transaction figures • 540 © Wall Street Systems IPH AB - Confidential 10 Options 10.1 Cap/floor/collar Data Symbol Time Value • • • • Example Formula 38,161.51 = V_m - V_i.t Transaction figures (Caplet Start) Data Symbol Example Formula Market Value V.s 38,101,247.64 = A * f_F * D_s Payment Amount A_P.s 40,202,324.31 = V_r.s * D_s / D_p Risk Value V_r.s 39,924,420.27 = A * delta.s IR Exposure 1bp E_1.s -6,231.90 = -V_r.s * D_s * t_vs * 0.0001 Transaction figures (Caplet End) Data Symbol Example Formula Market Value V.e 38,101,247.64 = A * f_F * D_s Payment Amount A_p.e 40,202,324.31 = V_r.s * D_s / D_p Risk Value V_r.e 39,924,420.27 = A * delta.s IR Exposure 1bp E_1.e -6,231.90 = -V_r.s * D_s * t_vs * 0.0001 Transaction figures (Payment Date) Data Symbol Example Formula Market Value V.p -225,218.55 = A * (r_b * p_t * f_X) * D_p Payment Amount A_p.p -237,638.13 = V_r.s * D_s / D_p Risk Value V_r.p -237,638.13 = A * (r_b * p_t * f_X) IR Exposure 1bp E_1.p 42.45 = -V_r.p * D_e * t_vp * 0.0001 Transaction figures (Total Caplet) Data Symbol Example Formula Market Value (Total) V.total 38,161.51 = V.s + V.e + V.p 40,265.91 = A_P.s + A_p.e + A_p.p 942.73 = E_1.s + E_1.e + E_1.p Payment Amount IR Exposure 1bp E_1.t 10.1.1.5 Position monitoring - Floorlet The Theoretical method is the only valuation method used for the valuation of cap/floor/collar and cap and floor instruments. 10.1.1.5.1 Setup The valuation approach feature Cap/Floor/Collar Valuation in the instrument definition determines that the instrument is valuated as a Cap/Floor/Collar. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 541 10 Options 10.1 Cap/floor/collar See A.2.88 Cap/Floor/Collar Valuation on page 751. Note: Depending on your needs, other approaches can be used such as NumeriX Valuation (A.2.253 NumeriX Valuation on page 841), External Valuation (A.2.142 External Valuation on page 781). 10.1.1.5.2 Calculations The numerical examples in this section demonstrate how the different figures are calculated for a Floorlet using the Theoretical method and the valuation approach Cap/Floor/Collar Valuation. This example shows a Floorlet, with the following deal data: Setup • Data Symbol Example Instrument Date Basis (Act/360) B 360 Instrument Yield Type Periodic Valuation Method Theoretical Valuation Date Figure Date Risk Date Figure date Risk Yield Type Continuous Risk Date Basis (Act/365) B_r 365 Expiry Date Basis (Act/360) B_e 360 Data Symbol Example Opening Date dt_o 2006-03-03 Transaction data • Nominal Amount 100,000,000.00 Cap/Up r_b 3.00% Fixing To dt_e 2007-11-29 From When dt_s 2007-12-03 Until When dt_l 2008-03-03 Value Date dt_v 2008-03-03 Payment Date dt_p 2008-03-03 Market data on Figure Date • Note: Unless otherwise stated, the figure date used in the calculations is 2006-04-15. Data Symbol Example Figure Date dt_f 2006-04-15 Sigma sigma 0.180000000000 Days in Period p_d 91.00000000 = 2008-03-03 2007-12-03 542 Formula = dt_vl-dt_vs © Wall Street Systems IPH AB - Confidential 10 Options 10.1 Cap/floor/collar • • • Data Symbol Example Formula Period Length p_t 0.25277778 = 91.00000000 / 360 = p_d/B Time to Expiry t_e 1.647222 = (2007-11-29 2006-04-15) / 360 = (dt_e - dt_f) / B_e Market data specific to Floorlet Start Data Symbol Example Formula Risk Date dt_vs 2007-12-03 =dt_s Risk Time to Value Date t_vs 1.63561644 = (2007-12-03 – 2006-04-15) / 365 = (dt_vs-dt_f) / B_r Discount Factor D_s 0.95457016202929 Market data specific to Floorlet End Data Symbol Example Formula Risk Date dt_vl 2007-03-03 =dt_l Risk Time to Value Date t_ve 1.884931507 = (2008-03-03 – 2006-04-15) / 365 = (dt_vl - dt_f) / B_r Discount Factor D_e 0.947828995799391 Market data specific to Payment Date Data Symbol Risk Date • Example Formula 2007-03-03 =dt_p = (dt_p - dt_f) / B_r Risk Time to Value Date t_vp 1.884931507 = (2008-03-03 – 2006-04-15) / 365 Discount Factor D_p 0.947828995799391 Data Symbol Example Formula Forward Price r_f 0.028136246 =(D_s / D_e -1) / p_t d_1 d_1 -0.162123724 = (LN(r_f/r_b) + 0.5 * sigma * sigma * t_e) / (sigma * SQRT(t_e)) d_2 d_2 -0.393143204 = d_1 - sigma * SQRT(t_e) F-factor f_F 0.564395788 = NORMSDIST(-d_1) X-factor f_X 0.652893142 = NORMSDIST(-d_2) Floorlet Price price 0.000888116 = -(r_f * f_F - r_b * f_X) * p_t * D_e Option figures Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 543 10 Options 10.1 Cap/floor/collar Data Symbol Example Formula Intrinsic Value v.i -0.000446537 = (r_f - r_b) * p_t * D_e * 0.5 * (-SIGN(LN(r_f / r_b)) + 1) Transaction figures • Data Symbol Example Formula Market Value V_m 88,811.63 = A * price Intrinsic Value V_i.t -44,653.70 = A * v.i 133,465.33 = V_m - V_i.t Time Value Transaction figures (Floorlet Start) • Data Symbol Example Formula Market Value V_f.s -53,875,537.88 = -A * f_F * D_s Risk Value A_rf.s -56,439,578.80 = -A * f_F IR Exposure 1bp E_1.s 8,811.97 = -A_rf.s * D_s * t_vs * 0.0001 Transaction figures (Floorlet End) • Data Symbol Example Formula Market Value V_f.e 53,495,069.30 = A * (f_F) * D_e Risk Value A_rf.e 56,439,578.80 = A * (f_F) IR Exposure 1bp E_1.e -10,083.45 = -A_rf.e * D_e * t_ve * 0.0001 Transaction figures (Payment Date) • Data Symbol Example Formula Market Value V_f.p 469,280.21 = A * (r_b * p_t * f_X) * D_p Risk Value A_rf.p 495,110.63 = A * (r_b * p_t * f_X) IR Exposure 1bp E_1.p -88.46 = -A_rf.p * D_p * t_vp * 0.0001 Example Formula 88,811.63 = V_f.s+V_f.e+V_f.p -1,359.94 = E_1.s+E_1.e+E_1.p Transaction figures (Total Floorlet) • Data Symbol Market Value (Total) IR Exposure 1bp E_1.t 10.1.2 Exotic cap/floor/collar The Cap/Floor/Collar family of instruments can include some exotic features as with any other kind of option contract. • 544 Barrier © Wall Street Systems IPH AB - Confidential 10 Options 10.1 Cap/floor/collar A barrier cap/floor/collar can knock in/out a caplet/floret using a trigger. The execution of the trigger activates/de-activates the payment. – Double barrier A double barrier cap/floor/collar is the association of two barriers below and above the rate using two triggers. – Rebate barrier If the knock-in is not activated (or if the knock-out is activated), the buyer receives compensation known as the rebate. • Amortizing cap/floor The cap/floor or barrier level can change from one period to one other. This can be managed using the schedule offset, manually at cashflow level, or with the use of several schedules. • Quanto cap/floor In a quanto cap/floor, the payment currency of the cashflows is different than the fixing rate currency. • Digital cap/floor The interest amount is fixed if the cap/floor is reached. This is embedded in the expression. 10.1.2.1 Instrument setup Instrument setup for exotic cap/floor/collar instruments is similar to that of vanilla cap/floor/collar instruments, see 10.1.1.1 Instrument setup on page 534. 10.1.2.2 Deal capture Deal capture for exotic cap/floor/collar instruments is similar to that of vanilla cap/floor/collar instruments (see 10.1.1.2 Deal capture on page 536) with the following additional requirements. • Schedule view As with a vanilla cap/floor/collar instrument, if you did not specify the schedule in the instrument setup, you need to apply a schedule to the instrument when you enter the deal in Transaction Manager. For a cap/floor/collar instrument with exotic features, in addition to the primary schedule, a secondary Trigger schedule must be used to generate triggers and barriers. TRM provides pre-defined secondary templates for this purpose, See B.2.1.2 Secondary templates on page 900. 10.1.2.3 Processing 10.1.2.3.1 Execute trigger A barrier cap/floor/collar can knock in/out a caplet/floret using a trigger. The execution of the trigger in Transaction Manager’s Event view activates/de-activates the payment. • Execution The following table describes the action parameters: Information Description Fixing Date Date when the trigger is evaluated. Fixing Quote Interest rate at fixing date. When the trigger is activated from the transaction, it defaults to the transaction’s fixing date and cannot be modified. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 545 10 Options 10.2 Swaption When the trigger is activated from the event, it defaults to the Fixing From date of the event but can be modified as long as it stays within the Fixing From/Fixing To interval. • Cancellation It is possible to cancel the generated transaction. 10.1.2.3.2 Rebate barrier A rebate is a compensation which is paid to the buyer of the cap/floor/collar in one of the following cases: either when a Knock-In barrier is never activated; or when a Knock-Out barrier is activated. At deal entry, rebate cashflows are generated as follows (according to the schedule templates): • A Knock-In barrier generates a cashflow with the following attributes: Cashflow = Out-Triggerable, P/L, Rebate Value date = value date of the interest cashflow linked to the barrier (reference of the rebate = referee of the barrier). • A Knock-Out barrier generates a cashflow with the following attributes: Cashflow = Inactive, In-Triggerable, P/L, Rebate c Value date = value date of the interest cashflow linked to the barrier (reference of the rebate = referee of the barrier). 10.2 Swaption A swaption is the option to enter into an interest rate swap. In exchange for an option premium, the buyer gains the right but not the obligation to enter into a specified IR swap agreement with the issuer on a specified future date. The agreement specifies whether the buyer of the swaption will be a fixed-rate receiver (like a Call option on a bond) or a fixed-rate payer (like a Put option on a bond). In return for this flexibility, the option holder must pay the option premium up-front to compensate the other party for the additional risk. A cash-settled option gives its owner the right to receive a cash payment based on the difference between a determined value of the underlying swap at the time the option is exercised and the fixed exercise price of the option. A cash-settled Call conveys the right to receive a cash payment if the determined value of the underlying swap at exercise exceeds the exercise price of the option. The style of the option refers to when that option can be exercised: European, American, and Bermudan. There are three categories of swaptions: however, note that only the first category is supported in TRM: • Category 1 - the dates of the underlying swap are fixed, and the expiry date of the option is before the start date of the swap. This is usually a European-style option and is supported in TRM. • Category 2 - the dates of the underlying swap are fixed and the expiry date of the option is between the start and end dates of the underlying swap. This is usually an American or Bermudan-style option and is not supported in TRM. • Category 3 - the dates of the underlying swap are not fixed: the swap starts when the option is exercised. This is usually an American or Bermudan-style option and is not supported in TRM. Swaption instruments must be based on an instrument type derived from the class SWAPTION. 546 © Wall Street Systems IPH AB - Confidential 10 Options 10.2 Swaption 10.2.1 Instrument setup • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of swaption instrument. Information Description Underlying Underlying swap instrument of the swaption. Type Type of option: Call or Put Exercise Type European or American. Delivery Type Cash-Settlement or Physical Delivery. Structure Schedule template to be used for the swaption. If a structure is not defined at instrument level, a schedule needs to be specified for each transaction. See A.2.315 Swaption on page 869. • Expiry definition You can set up expiry information at instrument level. Information Description Calendar parameters Calendars used to calculate the expiry date. Gap Set Gap set used for supplying the available expiry periods. Expiry Date Period If defined, this expiry period is applied to each transaction. See A.2.141 Expiry Date Setup on page 781. • Premium definition The main characteristics of a premium are: premium date, premium type, premium currency, and premium price. The premium amount can then be determined. For the premium date, it is possible to set up some information at instrument level. Information Description Calendar parameters Calendars used to calculate the premium date. Date Type Type of date on which the settlement of the premium takes place (Premium Date). This is the spot date by default. Offset Offset between the date defined previously and the premium date. See A.2.263 Premium Date Setup on page 844. Further information relating to the characteristics of the premium can also be set up at instrument level. Information Description Type Determines how the premium amount is calculated. If defined, the premium type is applied to each transaction. Leave this field blank if you want to specify the premium type when you enter the deal. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 547 10 Options 10.2 Swaption Information Description Currency Currency of the premium. If defined, the premium currency is applied to each transaction. Leave this field blank if you want to specify the premium currency when you enter the deal. See A.2.255 Option Premium on page 842. • IR Pricer (Swaption) definition To characterize the swaption in terms amortization type (bullet or amortizing), exercise type (European or American), leg type (fixed or floating) and swap type (single currency or cross currency). This feature identifies the swaption instrument to be used in the IR Pricing tool. See A.2.223 IR Pricer (Swaption) on page 824 and see TRM User Guide for more general information about IR Pricing. For a swaption, it is also possible to set up: • Cashflow and transaction charge rules • Manual charges • Branch codes • Spot date calculation. See Appendix A Features on page 713. 10.2.2 Deal capture 10.2.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a swaption. • Transaction view Information Description Option Type Type of option: Call or Put. (Transaction Type in Transaction Manager) Note: If Type is defined in the instrument setup, this is used as the default in the transaction and cannot be changed at deal entry. Currency Currency of the swaption. Value Date Date when the swaption starts, and from which interest starts to accrue. This defaults to the spot date of the transaction. Maturity Date Date when the transaction matures. If you enter a maturity code, the date is calculated automatically; otherwise you can enter the date manually. Expiry Date Final date when the option can be exercised. Nominal Amount Notional amount of the swaption. Deal Price Price used for the first leg of the swaption (100 in the case of a vanilla swap). If you want to have an up-front premium/discount, enter a price <> 100: this will apply on the first leg. (In this case, Pseudo Settlement should not be activated.) 548 © Wall Street Systems IPH AB - Confidential 10 Options 10.2 Swaption In addition, the following optional information can be captured: Information Description Expiry Code If the Expiry Date Setup feature is applied at instrument level, you can enter the expiry date period you want to use to calculate the expiry date for the transaction, for example, 3M (3 months). If you specify an expiry date period in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.141 Expiry Date Setup on page 781. Secondary Instrument Underlying swap instrument. Currency 2nd Other currency involved in the transaction. Premium Type Type and currency of the premium. Premium Currency If these values are defined using the Option Premium feature at instrument setup, these values are used as the default in the transaction and cannot be modified: see A.2.255 Option Premium on page 842. Premium Price Depends on the premium type: this could be specified in amount, percent, or points. Premium Date Settlement date of the premium. If this value is specified at instrument setup, it is used as the default in the transaction and cannot be modified at deal entry. For the premium date, it is possible to set up some information at instrument level: see A.2.263 Premium Date Setup on page 844. • Leg view The legs of the underlying IR swap instrument are displayed in this view. If the legs are not defined on the swap instrument they must be selected here. The relevant instruments for legs are generic loans. It is also possible to choose a bond as one of the legs. • Schedule view The cashflow structure of each leg should also be selected (when the leg is a generic loan without a predefined cashflow structure). Schedule information must be provided for each leg, see 3.10 Loan on page 326. 10.2.2.2 Generated data • Cashflows The following cashflows are generated: – One position flow which represents the option – One settlement flow for the premium – Plus the cashflows of the underlying IR swap (see 11.1 Interest rate swap on page 629). 10.2.3 Processing This section describes the actions that can be done throughout the life of a swaption. 10.2.3.1 Interest fixing When one of the legs of the underlying swap involves a floating-rate instrument, the amount of each interest flow has to be determined before it is paid. This process is known as fixing. • Execution Each interest cashflow of a floating-rate deal contains some parameters that define how its amount is fixed. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 549 10 Options 10.2 Swaption – The fixing period determined by a from/to date value pair indicates when the amount of the flow has to be fixed; it can be before the interest starts accruing (in-advance fixing), or before the payment of the interest (in-arrears fixing). – The fixing parameters (expression, rate, spread, and so on) that define how the fixing rate is calculated. – An "expression value" which is informative and gives the current value of the expression. Executing the fixing modifies the cashflow as follows: Marks it as being fixed Sets the fixing date Stores the rate of the market reference used for fixing Stores the effective interest rate (nominal rate) on the cashflow Sets the amount of the cashflow • Cancellation/Amendment It is possible to manually update the fixing quote on a fixed cashflow, which consequently affects the interest rate and the amount. 10.2.3.2 Exercise/no exercise The holder of the option has a right to exercise the option at a predetermined date or dates. • • Execution – If the holder of a swaption with physical delivery exercises an option, an exercise transaction is created. This transaction closes out the option transaction and buys (or sells) the appropriate amount of the underlying security at the strike price. – If the holder of a swaption with cash settlement exercises an option, an exercise transaction is created. This transaction closes out the option transaction and settles the difference of the strike price and current market price of the underlying. No exercise If the holder of the option allows the option to expire without exercising it, a "no exercise" transaction is created. This transaction closes out the option. • Information Description Exercise Date Date of the exercise. For a European option, this must be the expiry date. Delivery Type Physical Delivery or Cash Settlement. Scenario For cash settlement, this is the scenario from which the market price of the underlying is retrieved. Price/Spot Rate Market price of the underlying instrument (for cash settlement). No Exercise If the option is not exercised, select No Exercise. Cancellation The exercise or no exercise transaction can be canceled. A new exercise/no exercise transaction can be created as described above. 10.2.4 Position monitoring In this section, numerical examples demonstrate how the different figures are calculated for a swaption. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. 550 © Wall Street Systems IPH AB - Confidential 10 Options 10.2 Swaption 10.2.4.1 Calculations This example shows a Buy 1,000,000 EUR swaption (Call) European style transaction, with the following deal data: • Setup Data Symbol Example Instrument Date Basis B Act/360 Instrument Yield Type Periodic Valuation Method Theoretical Valuation Date Figure Date Risk Date Figure Date Risk Yield Type Continuous Risk Date Basis B_r AI Method Linear Accrual Method Linear Accrual Fixed Leg Coupon Rate r_c Floating Leg Risk Profile • Act/365 2.30% Simple risk Transaction data Data Symbol Example Opening Date dt_o 2005-11-14 Nominal Amount A -1,000,000.00 Spread r_s 0.05% Expiry Date d_e 2005-12-14 Maturity Date d_m 2010-12-14 Date Basis B 360 Risk Date Basis B_r 365 Spot Date ds 2005-11-16 Unless otherwise stated, the figure date used in the calculations is 2005-11-25. On this date, the market data is as follows: • Market data on 2005-11-25 Data Symbol Example Figure Date dt_f 2005-11-25 Days to Spot d_fs 4 Time to Spot t_s 0.011111111 = 4 / 360 Risk Time to Spot t_r 0.010958904 = 4 / 365 Spot Discount Factor D_s 0.999444695 Volatility sg 0.13 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 551 10 Options 10.2 Swaption Other market data and figures are calculated by the system as follows: • Data Symbol Example Formula Time to Expiry t_e 0.052777778 = (2005/12/14 – 2005/11/25) / 360 = (d_e – dt_f) / 360 10.2.4.2 Fixed leg Transaction data specific to the opening flow of the fixed leg is as follows: • Data Symbol Example Value Date dv.p 2005-12-14 Amount A = c_m -1,000,000.00 Transaction data specific to the coupon flows of the fixed leg is as follows: • Data - Coupon 1 Symbol Example Value Date dv.c1 2006-12-14 Data - Coupon 2 Symbol Example Value Date dv.c2 2007-12-14 Calculated transaction data specific to the coupon flows of the fixed leg is as follows: Data - Coupon 1 Symbol Example Formula Period p.c1 1.0138889 = (2006/12/14 – 2005/12/14) / 360 = (dv.c1 -dv.p) / B Amount A.c1 = -23,319.44 = ROUND(c_m * p.c1 * r_c, 2) Data - Coupon 2 Symbol Example Formula Period p.c2 1.0138889 = (2007/12/14 2006/12/14) / 360 = (dv.c2 – dv.c1) / B Amount A.c2 = -23,319.44 = ROUND(c_m * p.c2 * r_c, 2) On the figure date, the market data specific to the coupon flows of the fixed leg is as follows: • Data - Coupon 1 Symbol Example MV Discount Factor D_V.c1 0.97770415 Data - Coupon 2 Symbol Example MV Discount Factor D_V.c2 0.953564819 552 © Wall Street Systems IPH AB - Confidential 10 Options 10.2 Swaption Other market data and figures specific to the coupon flows of the fixed leg are calculated by the system as follows: Data - Coupon 1 Symbol Example Formula Time to Value Date tv.c 1.06666667 = (2006/12/14 – 2005/11/25) / 360 = (dv.c1 - dt_f) / B Risk Time to Value Date tv_r.c 1.05205479 = (2006/12/14 – 2005/11/25) / 365 = (dv.c1 - dt_f) / B_r Data - Coupon 2 Symbol Example Formula Time to Value Date tv.c2 2.080555556 = (2007/12/14 – 2005/11/25) / 360 = (dv.c2 - dt_f) / B Risk Time to Value Date tv_r.c2 2.052054795 = (2007/12/14 – 2005/11/25) / 365 = (dv.c2 - dt_f) / B_r 10.2.4.3 Floating leg • • Transaction data specific to the opening flow of the floating leg is as follows: Data Symbol Example Formula Value Date dt_v 2005-12-14 = dt_x.f1 Transaction data specific to the coupons of the floating leg is as follows: Data – Coupon 1 Symbol Example Formula Value Date dt_v.f1 2006-03-14 Coupon Period p.f1 0.250000000 = (dt_v.f1 - dt_x.f1) / B Data – Coupon 2 Symbol Example Formula Value Date dt_v.f2 2006-06-14 Coupon Period p.f2 0.255555556 = (dt_v.f2 - dt_v.f1) / B Data – Coupon 3 Symbol Example Formula Value Date dt_v.f3 2006-09-14 Coupon Period p.f3 0.255555556 = (dt_v.f3 - dt_v.f2) / B Data – Coupon 4 Symbol Example Formula Value Date dt_v.f4 2006-12-14 Coupon Period p.f4 0.252777778 = (dt_v.f4 - dt_v.f3) / B Data – Coupon 5 Symbol Example Formula Value Date dt_v.f5 2007-03-14 Coupon Period p.f5 0.250000000 = (dt_v.f5 - dt_v.f4) / B Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 553 10 Options 10.2 Swaption Data – Coupon 6 Symbol Example Formula Value Date dt_v.f6 2007-06-14 Coupon Period p.f6 0.255555556 = (dt_v.f6 - dt_v.f5) / B Data – Coupon 7 Symbol Example Formula Value Date dt_v.f7 2007-09-14 Coupon Period p.f7 0.255555556 Data – Coupon 8 Symbol Example Value Date dt_v.f8 2007-12-14 Coupon Period p.f7 0.252777778 = (dt_v.f7 - dt_v.f6) / B Formula = (dt_v.f8 - dt_v.f7) / B On the figure date, the market data specific to the opening flow of the floating leg is as follows: Market data on 2005-11-25 • Data Symbol Example Formula Time to Value Date tv.vp 0.052054795 = (dt_x.f1 - dt_f) / B_r MV Discount Factor D_V.fp 0.998911966 Other market data specific to coupons of the floating leg is calculated by the system as follows: • Data – Coupon 1 Symbol Example Formula Time to Value Date tv.f 0.298630137 = (dt_v.f1 - dt_f) / B_r MV Discount Factor D_V.f 0.993714881 Fixing Rate r_x.f 2.091983% = (D_V.fp / D_V.f1 - 1) / (p.f1) Data – Coupon 2 Symbol Example Formula Time to Value Date tv.f2 0.550684932 = (dt_v.f2 - dt_f) / B_r MV Discount Factor D_V.f2 0.988458384 Fixing Rate r_x.f2 2.080907% = (D_V.f1 / D_V.f2 - 1) / (p.f2) Data – Coupon 3 Symbol Example Formula Time to Value Date tv.f3 0.802739726 = (dt_v.f3 - dt_f) / B_r MV Discount Factor D_V.f3 0.983156734 Fixing Rate r_x.f3 2.110100% = (D_V.f2 / (D_V.f3) - 1) / (p.f3) Data – Coupon 4 Symbol Example Formula Time to Value Date tv.f4 1.052054795 = (dt_v.f4 - dt_f) / B_r MV Discount Factor D_V.f4 0.97770415 Fixing Rate r_x.f4 2.206257% 554 = (D_V.f3 / (D_V.f4) - 1) / (p.f4) © Wall Street Systems IPH AB - Confidential 10 Options 10.2 Swaption Data – Coupon 5 Symbol Example Formula Time to Value Date tv.f5 1.298630137 = (dt_v.f5 - dt_f) / B_r MV Discount Factor D_V.f5 0.972001731 Fixing Rate r_x.f5 2.346670% = (D_V.f4 / D_V.f5 - 1) / (p.f5) Data – Coupon 6 Symbol Example Formula Time to Value Date tv.f6 1.550684932 = (dt_v.f6 - dt_f) / B_r MV Discount Factor D_V.f6 0.965999527 Fixing Rate r_x.f6 2.431356% = (D_V.f5 / D_V.f6 - 1) / (p.f6) Data – Coupon 7 Symbol Example Formula Time to Value Date tv.f7 1.802739726 = (dt_v.f7 - dt_f) / B_r MV Discount Factor D_V.f7 0.959830039 Fixing Rate r_x.f7 2.515182% = (D_V.f6 / D_V.f7 - 1) / (p.f7) Data – Coupon 8 Symbol Example Formula Time to Value Date tv.f8 2.052054795 = (dt_v.f8 - dt_f) / B_r MV Discount Factor D_V.f8 0.953564819 Fixing Rate r_x.f8 2.599245% = (D_V.f7 / D_V.f8 - 1) / (p.f8) 10.2.4.4 Key-figures The key figures on the figure date are calculated as follows: Data Symbol Example Formula Figure Forward Rate (Swap Rate) r_s = 0.023480493 = (D_V.fp - D_V.f8) / (1 * D_V.c1 + 1 * D_V.c2) 10.2.4.4.1 Option figures Data Symbol Example Formula Present Value of Floating Flows PVF = 0.0453471475 = - (Total Floating Leg Market Value Underlying) / A Present Value of Fixed Flows PVX = 0.0450361108 = (Total Fixing Leg Market Value Underlying) / A F F 0.0231588468 = PVF / PVX * r_c d1 d_1 = 0.2306972587 = (LN(F / r_c) + 0.5 * sg * sg * t_e) / (sg * SQRT(t_e)) d2 d_2 = 0.1986351837 = d_1 - sg * SQRT(t_e) Fixed Leg Factor f_x = 0.5787259353 = NORMSDIST(d_2) Floating Leg Factor f_f = 0.5912249983 = NORMSDIST(d_1) price p = 0.0007468019 = PVF * NORMSDIST(d_1) - PVX * NORMSDIST(d_2) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 555 10 Options 10.2 Swaption 10.2.4.4.2 Fixed leg - Valuation figures Data - Coupon 1 Symbol Example Formula Market Value Underlying V_u.c1 -22,799.51 = -23,319.44 * 0.97770415 = A.c1 * D_V.c1 Market Value V.c1 -13,194.67 = Fixed Leg Factor * -22,799.51 = f_x * V_u.c1 Data - Coupon 2 Symbol Example Formula Market Value Underlying V_u.c2 -22,236.60 = -23,319.44 * 0.953564819 = A.c2 * D_V.c2 Market Value V.c2 -12,868.90 = Fixed Leg Factor * -22,236.60 = f_x * V_u.c2 Data - Total Fixed Leg Symbol Example Formula Market Value V.fixed = -26,063.57 10.2.4.4.3 Fixed leg - Risk figures Data - Coupon 1 Symbol Example Formula IR Exposure Underlying E_u.c1 = -23,980.87 = A.c1 * (D_s * D_V.c1 * (tv_r.c1 - tr.s) + D_s * D_V.c1 * tr.s) IR Exposure 1bp E_i.c1 = 1.39 = -E_u.c1 * f_x * 0.0001 Data - Coupon 2 Symbol Example Formula IR Exposure Underlying E_u.c2 = -45,620.32 = A.c2 * (D_s * D_V.c2 * (tv_r.c2 - tr.s) + D_s * D_V.c2 * tr.s) IR Exposure 1bp E_i.c1 = 2.64 = -E_u.c2 * f_x * 0.0001 Data - Total fixed leg Symbol Example Formula IR Exposure 1bp E_i.fixed = 4.03 10.2.4.4.4 Floating leg - Valuation figures Data - Opening flow Symbol Example Formula Fixed Amount A_x.p = 1,000,000.00 = -A Data - Coupon 1 Symbol Example Formula Estimated Amount A_e.f1 5,229.96 = 1,000,000 * 0.02091983 * 0.250000000 = -A * r_x.f1 * p.f1 Market Value Underlying V_u.f1 5,197.09 = 5,229.96 * 0.993714881 = A_e.f1 * D_V.f1 Market Value V.f1 3,072.65 = Floating Leg Factor * 5,197.09 = f_f * V_u.f1 556 © Wall Street Systems IPH AB - Confidential 10 Options 10.2 Swaption Data - Coupon 2 Symbol Example Formula Estimated Amount A_e.f2 5,317.87 = -1,000,000.00 * 0.02080907 * 0.255555556 = -A * r_x.f2 * p.f2 Market Value Underlying V_u.f2 5,256.50 = 5,317.87 * 0.988458384 =A_e.f2 * D_V.f2 Market Value V.f2 3,107.77 = Floating Leg Factor * 5,256.50 = f_f * V_u.f2 Data - Coupon 3 Symbol Example Formula Estimated Amount A_e.f3 5,392.48 = 1,000,000 * 0.02110100 * 0.255555556 = -A * r_x.f3 * p.f3 Market Value Underlying V_u.f3 5,301.65 = 5,392.48 * 0.983156734 = A_e.f3 * D_V.f3 Market Value V.f3 3,134.47 = Floating Leg Factor * 5,301.65 = f_f * V_u.f3 Data - Coupon 4 Symbol Example Formula Estimated Amount A_e.f4 5,576.93 = 1,000,000 * 0.02206257 * 0.252777778 = -A * r_x.f4 * p.f4 Market Value Underlying V_u.f4 5,452.58 = 5,576.93 * 0.97770415 = A_e.f4 * D_V.f4 Market Value V.f4 3,223.70 = Floating Leg Factor * 5,452.58 = f_f * V_u.f4 Data - Coupon 5 Symbol Example Formula Estimated Amount A_e.f5 5,866.67 = 1,000,000 * 0.02346670 * 0.250000000 = -A * r_x.f5 * p.f5 Market Value Underlying V_u.f5 5,702.42 = 5,866.67 * 0.972001731 = A_e.f5 * D_V.f5 Market Value V.f5 3,371.41 = Floating Leg Factor * 5,702.42 = f_f * V_u.f5 Data - Coupon 6 Symbol Example Formula Estimated Amount A_e.f6 6,213.47 = 1,000,000 * 0.02431356 * 0.255555556 = -A * r_x.f6 * p.f6 Market Value Underlying V_u.f6 6,002.20 = 6,213.47 * 0.965999527 = A_e.f6 * D_V.f6 Market Value V.f6 3,548.65 = Floating Leg Factor * 6,002.20 = f_f * V_u.f6 Data - Coupon 7 Symbol Example Formula Estimated Amount A_e.f7 6,427.69 = 1,000,000 * 0.02515182 * 0.255555556 = -A * r_x.f7 * p.f7 Market Value Underlying V_u.f7 6,169.49 = 6,427.69 * 0.959830039 = A_e.f7 * D_V.f7 Market Value V.f7 3,647.56 = Floating Leg Factor * 6,169.49 = f_f * V_u.f7 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 557 10 Options 10.2 Swaption Data - Coupon 8 Symbol Example Formula Estimated Amount A_e.f8 6,570.31 = 1,000,000 * 0.02599245 * 0.252777778 = -A * r_x.f8 * p.f8 Market Value Underlying V_u.f8 6,265.22 = 6,570.31 * 0.953564819 = A_e.f8 * D_V.f8 Market Value V.f8 3,704.15 = Floating Leg Factor * 6,265.22 = f_f * V_u.f8 Data - Total floating leg Symbol Example Formula Market Value V.floating = 26,810.37 10.2.4.4.5 Floating leg - Risk figures Data - Coupon 1 Symbol Example Formula IR Exposure Underlying Short E_s.f1 = -51,998.16 = A * (D_V.fp * (tv.fp - tr.s) + D_V.fp * tr.s) IR Exposure Underlying Long E_l.f1 = 296,753.21 = -A * (D_V.f1 * (tv.f1 - tr.s) + D_V.f1 * tr.s) IR Exposure 1bp Short E_is.f1 = -3.07 = E_s.f1 * f_f * 0.0001 IR Exposure 1bp Long E_il.f1 = 17.54 = E_l.f1 * f_f * 0.0001 Data - Coupon 2 Symbol Example Formula IR Exposure Underlying Short E_s.f2 = -296,753.21 = A * (D_V.f1 * (tv.f1 - tr.s) + D_V.f1 * tr.s) IR Exposure Underlying Long E_l.f2 = 544,329.14 = -A * (D_V.f2 * (tv.f2 - tr.s) + D_V.f2 * tr.s) IR Exposure 1bp Short E_is.f2 = -17.54 = E_s.f2 * f_f * 0.0001 IR Exposure 1bp Long E_il.f2 = 32.18 = E_l.f2 * f_f * 0.0001 Data - Coupon 3 Symbol Example Formula IR Exposure Underlying Short E_s.f3 = -544,329.14 = A * (D_V.f2 * (tv.f2 - tr.s) + D_V.f2 * tr.s) IR Exposure Underlying Long E_l.f3 = 789,218.97 = -A * (D_V.f3 * (tv.f3 - tr.s) + D_V.f3 * tr.s) IR Exposure 1bp Short E_is.f3 = -32.18 = E_s.f3 * f_f * 0.0001 IR Exposure 1bp Long E_il.f3 = 46.66 = E_l.f3 * f_f * 0.0001 Data - Coupon 4 Symbol Example Formula IR Exposure Underlying Short E_s.f4 = -789,218.97 IR Exposure Underlying Long E_l.f4 = 1,028,598.34 = -A * (D_V.f4 * (tv.f4 - tr.s) + D_V.f4 * tr.s) IR Exposure 1bp Short E_is.f4 = -46.66 = E_s.f4 * f_f * 0.0001 IR Exposure 1bp Long E_il.f4 = 60.81 = E_l.f4 * f_f * 0.0001 Data - Coupon 5 Symbol Example Formula IR Exposure Underlying Short E_s.f5 = -1,028,598.34 = A * (D_V.f4 * (tv.f4 - tr.s) + D_V.f4 * tr.s) IR Exposure Underlying Long E_l.f5 = 1,262,270.74 = -A * (D_V.f5 * (tv.f5 - tr.s) + D_V.f5 * tr.s) IR Exposure 1bp Short E_is.f5 = -60.81 = E_s.f5 * f_f * 0.0001 558 A * (D_V.f3 * (tv.f3 - tr.s) + D_V.f3 * tr.s) © Wall Street Systems IPH AB - Confidential 10 Options 10.3 Option on MM future Data - Coupon 5 Symbol Example Formula IR Exposure 1bp Long E_il.f5 = 74.63 = E_l.f5 * f_f * 0.0001 Data - Coupon 6 Symbol Example Formula IR Exposure Underlying Short E_s.f6 = -1,262,270.74 = A * (D_V.f5 * (tv.f5 - tr.s) + D_V.f5 * tr.s) IR Exposure Underlying Long E_l.f6 = 1,497,960.91 = -A * (D_V.f6 * (tv.f6 - tr.s) + D_V.f6 * tr.s) IR Exposure 1bp Short E_is.f6 = -74.63 = E_s.f6 * f_f * 0.0001 IR Exposure 1bp Long E_il.f6 = 88.56 = E_l.f6 * f_f * 0.0001 Data - Coupon 7 Symbol Example Formula IR Exposure Underlying Short E_s.f7 = -1,497,960.91 = A * (D_V.f6 * (tv.f6 - tr.s) + D_V.f6 * tr.s) IR Exposure Underlying Long E_l.f7 = 1,730,323.74 = -A * (D_V.f7 * (tv.f7 - tr.s) + D_V.f7 * tr.s) IR Exposure 1bp Short E_is.f7 = -88.56 E_s.f7 * f_f * 0.0001 IR Exposure 1bp Long E_il.f7 = 102.3 = E_l.f7 * f_f * 0.0001 Data - Coupon 8 Symbol Example Formula IR Exposure Underlying Short E_s.f8 = -1,730,323.74 = A * (D_V.f7 * (tv.f7 - tr.s) + D_V.f7 * tr.s) IR Exposure Underlying Long E_l.f8 = 1,956,767.26 = -A * (D_V.f8 * (tv.f8 - tr.s) + D_V.f8 * tr.s) IR Exposure 1bp Short E_is.f8 = -102.30 = E_s.f8 * f_f * 0.0001 IR Exposure 1bp Long E_il.f8 = 115.69 = E_l.f8 * f_f * 0.0001 Data - Total floating Leg Symbol Example IR Exposure 1bp E_i.floating = 112.61 Formula 10.2.4.4.6 Total Valuation figures Data Symbol Example Formula Market Value V.transaction = 746.80 = V.fixed + V.floating 10.2.4.4.7 Total Risk Figures Data Symbol Example Formula IR Exposure 1bp E_i.transaction = 116.64 = E_i.fixed + E_i.floating = -1,561.90 = -E_i.transaction / V.transaction / 0.0001 Effective Duration 10.3 Option on MM future Money market future options, for example, options on IMM Eurodollar futures, are standardized, exchange-traded instruments. At exercise, the owner of the contract will receive the difference between the strike price and the underlying future’s market price. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 559 10 Options 10.3 Option on MM future In addition, each party will receive a future’s position, short or long, which they may liquidate immediately. In some markets, the premium is not paid when the deal is made. Instead, there is a futures-style marking to market process, where cashflows corresponding to daily changes in the option quote change hands. 10.3.1 Instrument setup MM future option instruments must be based on an instrument type derived from the class MM-FUTURE-OPTION. • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of MM future option instrument. Information Description Issuer Issuer (writer) of the future option. Underlying Underlying future contract. Strike price details Strike price of the option. Rounding parameters Method and precision used to round cashflow amounts. Currency Currency of the option. Type Type of option: Call or Put. Exercise and Delivery parameters Defines when the option can be exercised, and whether there is a physical delivery or a cash settlement. Future Style Premium Defines type of settlement as Future Style: premium is not paid upfront but netted daily. See 10.3.4 Processing on page 563 for more information. See A.2.239 MM Future Option on page 833. • Option expiry definition You can set up option date information at instrument level. Information Description Calendar parameters Calendars used to calculate the expiry date. Expiry Date Final date when the option can be exercised. Delivery Offset Number of days offset allowed in which to deliver the underlying after the option is exercised. See A.2.254 Option Dates on page 841. • Netting information In the futures-style marking to market process, the daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or it expires. 560 Information Description Fixing parameters Leave these fields blank if you want to define the Fixing parameters at deal entry. © Wall Street Systems IPH AB - Confidential 10 Options 10.3 Option on MM future Information Description Calendar Calendar used to calculate the dates. Switches Switch on Settlement Currency if settlement is made in a different currency. Settlement Currency If the Settlement Currency switch is on, the Currency in which settlement is made. Payment Offset Number of business days between value date and payment date. Method Select Business Days for daily netting. Frequency For daily netting, enter 1 when Method = Business Days. See A.2.319 Ticks Netting on page 870. • Trading units definition Information Description Contract Size Number of future contracts for 1 option (usually, this is 1). Minimum Bid Size Smallest allowed bid size (usually, this is 1). Tick Size Minimum price movement (tick size and value), for example, 0.005 / 12.50. Tick Value Rounding Method Rounding method used in the calculations: Up, Down, or Nearest. See A.2.320 Trading Unit (Derivative) on page 871. • Quotation information Information Description Active From Period within which the quotation information is valid. Active To Leave these fields blank if you want the quotation information to apply indefinitely. Price Type Standard method for quoting the price. For an MM future option, select Price %. Quote Handling Select Generic (which means that you will be able to enter the bid and ask quotes for this instrument. Currency Currency of the future instrument. It will then be possible to either enter the quotation manually in Rate Monitor, or get it automatically in real time: see 10.3.2 Market information on page 562. See A.2.274 Quoted on page 849. • Valuation of money market futures It is possible to specify that another MtoM instrument’s direct market quotation is used to value the future instrument. See A.2.246 MtoM Instrument Setup on page 836. For a MM future options, it is also possible to set up: • Spot date calculation • Cashflow or transaction charge rules • Manual charges Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 561 10 Options 10.3 Option on MM future Branch codes. • See Appendix A Features on page 713. 10.3.2 Market information One future contract corresponds to a given nominal value, known as the contract size (trading unit). The market quotation is given in terms of percentage, which moves by ticks, the minimum possible movement. Tick value is defined as the change in the market value of one contract corresponding to a movement of one tick in the quote. The point value is the change in settlement price corresponding to a movement of one tick (assumed to be one basis point, 0.01%) in the quote. This variable is derived from the length of the period of the IR future. For example, Short Sterling has a point value of £500,000 * 0.25 * 0.0001 = £12.50. The risk and profit/loss valuation of all outstanding futures contracts are recalculated using the most recent market data. Each instrument is revalued according to its real-time market quote. These real-time market feeds, from Reuters for example, are set up in the Market Info Source Editor: see the TRM User Guide. IR quotes are shown as Bid and Ask in Rate Monitor. TRM uses the average of these two quotes; if the Ask side is empty it is ignored and the Bid rate is used instead, and vice versa. 10.3.3 Deal capture 10.3.3.1 Input data In addition to the standard deal parameters, the following information is required to enter an MM future option: Information Description Trading Units Number of futures bought/sold. If the trading units for the instrument are specified at instrument setup using the Derivative Trading Unit feature, the deal can be input in units and the Nominal Amount will be computed by the system. See A.2.320 Trading Unit (Derivative) on page 871. Deal Price Contractual rate of the deal expressed as a percentage (100 – r) where r is the underlying deal interest rate. Premium Amount Amount of the premium if the type of settlement is not defined as Future Style. Strike Strike value of the option. If Strike is defined at instrument level, this is used by default and cannot be modified. (Nominal/Spot Rate in Transaction Manager) Expiry Date Final date when the option can be exercised. If the Expiry Date for the instrument is specified at instrument setup using the Option Dates feature, this is used as the default in the transaction and cannot be modified at deal entry. See A.2.254 Option Dates on page 841. Transaction Type Type of option: Call or Put. If this is specified at instrument setup, this is used as the default in the transaction and cannot be modified at deal entry. Issuer Issuer of the instrument. If this value is specified at instrument setup, this is used as the default in the transaction and cannot be modified at deal entry. 562 © Wall Street Systems IPH AB - Confidential 10 Options 10.3 Option on MM future 10.3.3.2 Generated data • Cashflows The following cashflows are generated: – One position flow which represents the future position – One settlement flow for the premium – For future style, the next netting flow (not fixed) which will be the support for the next daily margin once it has been fixed (see 10.3.4.2 Daily netting on page 563). 10.3.4 Processing This section describes the actions that can be done throughout the life of a money market future option. 10.3.4.1 Exercise/No Exercise The holder of the option has a right to exercise the option at a predetermined date or dates. Note: The Exercise action for netted options is not supported. • • Execution – If the holder of an MM future option with physical delivery exercises an option, an Exercise transaction is created. This transaction closes out the option transaction and buys (or sells) the appropriate amount of the underlying future at the strike price. – If the holder of an MM future option with cash settlement exercises an option, an Exercise transaction is created. This transaction closes out the option transaction and settles the difference of the strike price and current market price of the underlying (multiplied by the appropriate number of units of the underlying). No exercise If the holder of the option allows the option to expire without exercising it, a No Exercise transaction is created. This transaction closes out the option. • Information Description Exercise Date Date of exercise. For a European option, this must be the expiry date. Delivery Type Physical Delivery or Cash Settlement. Scenario For cash settlement, this is the scenario from which the market price of the underlying is retrieved. Price/spot rate Market price of the underlying instrument (for cash settlement). No Exercise If the option is not exercised, select No Exercise. Cancellation The Exercise or No Exercise transaction can be canceled. A new Exercise/No Exercise transaction can be created as described above. 10.3.4.2 Daily netting Money market future options with a future style settlement are typically fixed every day. If the market quote for the underlying future has changed from the previous day, the difference is settled between the parties of the trade. • Setup Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 563 10 Options 10.3 Option on MM future The netting parameters for money market future options are defined at instrument level: see 10.3.1 Instrument setup on page 560. • Execution The daily netting of money market future options is carried out using the Execute Netting action. The following information is needed to process the netting: Information Description Netting Date Day the cashflow is fixed. Netting Price Fixing market quote. This is defaulted by the system and can be changed by the user. Netting Amount Netting Currency Profit or loss (settlement amount) from the future. This is calculated automatically by TRM and can be changed by the user. (Information only) Currency of the settlement cashflow. The Execute Netting action automatically generates the next cashflow. Netting of the cashflows can also be performed automatically using the Netting activity: see the TRM User Guide for more information. • Cancellation The netting can be canceled either by the Undo Netting action, or with the Netting - Undo activity. 10.3.4.3 Matching • Setup The selling parameters used to automatically match transactions are specified in the result treatment applied to the instrument definition. – The portfolio must have the Allow Short Selling switch activated. See the TRM User Guide for more information. • Execution – Automatic matching of transactions occurs each night with the End of Day Processing activity. – Manual matching of futures is done in Transaction Manager’s Matching mode. This option is available if you specified Manual or FIFO as the selling method for the instrument. See the TRM User Guide for more information about matching transactions. • Cancellation You can also unmatch transactions in Transaction Manager’s Matching mode if the cashflows resulting from the transactions are not yet paid or booked. 10.3.5 Position monitoring 10.3.5.1 Calculations In this section, numerical examples demonstrate how the different figures are calculated for an MM future option. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. 564 © Wall Street Systems IPH AB - Confidential 10 Options 10.3 Option on MM future This example shows an MM future option, with the following deal data: Setup data Symbol Example Tick Size s_t 0.005 Tick Value v_t 12.5 Next Fixing Date dt_f 2006-12-15 Expiry Date dt_x 2006-12-15 Risk Yield Type Continuous Yield Risk Date Basis B_r Act/365 Start Date dt_s 2006-12-15 End Date dt_e 2007-03-15 Period t_p = (dt_e – dt_s) / B_r 0.246575 Transaction data Symbol Example Underlying contract data Opening Date 2006-06-02 Trading Units N 1.00 Nominal/Spot Rate (strike) F_c 96.50 Deal Price p_c 5.00 Previous fixing price (Nominal Rate) p.xp 6.00 Last fixing price (Nominal Rate) p.xl 7.00 Other important deal data is calculated (but not displayed) by the system as follows: • Tick Amount A_x = 100 * N * (v_t / s_t) 250,000.00 = 100 * 1.00 * (12.5 / 0.005) Unless otherwise stated, the figure date used in the calculations is 2006-06-15. On this date, the market data is as follows: • • Market data on 2006-06-15 Data Symbol Example Figure Date dt_f 2006-06-15 Market Quote P 8.00 Underlying Future Quote F 99.00 MV Discount Factor D.s 0.999679 Other market data is calculated by the system as follows: Data Symbol Example Formula Time to Expiry (Risk) t_e 0.501370 = (2006/12/15 – 2006/06/15) / 365 = (dt_x – dt_f) / B_r Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 565 10 Options 10.3 Option on MM future On the figure date, market data specific to the start date of the underlying contract is as follows: • Data Symbol Example Formula PV Discount Factor D_P.s = 0.9855442220 Time to Value Date (risk) t_v.s 0.501369863 = (2006/12/15 2006/06/15) / 365 = (dt_s – dt_f) / B_r On the figure date, market data specific to the end date of the underlying contract is as follows: • Data Symbol Example Formula PV Discount Factor D_P.e = 0.9785870561 Time to Value Date (risk) t_v.e 0.747945205 = (2007/03/15 2006/06/15) / 365 = (dt_e – dt_f) / B_r On the figure date, market data specific to the fixing date of the underlying contract is as follows: • Data Symbol Example PV Discount Factor D_P.fD_P.f = 1.00 Time to Value Date (risk) t_v.i = 0.00 Formula 10.3.5.1.1 Valuation figures Balance flow • Data Symbol Example Formula Market Value V 7,497.60 = 1.00 * 12.5 / 0.005 * (8.00 – 5.00) * 0.999679 = N * v_t / s_t * (P - p_c) * D.s Unit Option Value V_o 0.08 = 8.00 / 100 = P / 100 Intrinsic Value V.i 6,250.00 = 0.025000 * 250,000 = p_i * A_x Time Value V.t 13,750.00 = 20,000 – 6,250.00 = V_P – V.i Present Value V_P 20,000.00 = 0.08 * 250,000 = p_u * A_x Data Symbol Example Formula Market Value V.n 2,500.00 = 1.00 * 12.5 / 0.005 * (7.00 – 6.00) = N * v_t / s_t * (p.xl - p.xp) Data Symbol Example Formula Market Value V.v -5,000.00 = 1.00 * 12.5 / 0.005 (5.00 – 7.00) = N * v_t / s_t * (p_c - p.xl) Netting flow • Variance • 566 © Wall Street Systems IPH AB - Confidential 10 Options 10.3 Option on MM future • Total Data Symbol Example Formula Market Value V.t = 4,997.60 = V + V.n + V.v 10.3.5.1.2 Result figures • Balance flow Data Symbol Example Formula MtoM Profit MtoM_Profit 7,500.00 = 7,497.60 / 0.999679 = V / D.s Other Profit Other_Profit -2.40 = 7,497.60 – 7,500.00 = V - MtoM_Profit 10.3.5.1.3 Risk figures • • • • Start Date Data Symbol Example Formula Risk Value V_r.s -614,252.42 = 250,000.00 * -2.4570096895 = A_x * d_o.s IR Exposure 1bp E_ir.s 30.35 = -614,252.42 * -0.49 * 0.0001 = V_r.s * d_D.s * 0.0001 Price Sensitivity Against D d_o.s = -2.4570096895 = delta * dF.dD_s Start Date (underlying sensitivities) Data Symbol Example Formula Sensitivity of D against r d_D.s -0.49 = -0.9855442220 * 0.501369863 = -D_P.s * t_V.s Sensitivity of Underlying Price dF.dD_s -4.14 = -1 / (0.246575 * 0.9785870561) = - 1 / (t_p * D_P.e) Data Symbol Example Formula Risk Value V_r.e 618,619.39 = 250,000 * 2.474478 = A_x * d_o.e IR Exposure 1bp E_ir.e -45.28 = 618,619.39 * -0.73 *0.0001 = V_r.e * d_D.e * 0.0001 Price Sensitivity Against D d_o.e = 2.474478 = delta * dF.dD_e End Date End Date (underlying sensitivities) Data Symbol Example Formula Sensitivity of D against r d_D.e -0.73 = -0.9785870561 * 0.747945205 = -D_P.e * t_V.e Sensitivity of Underlying Price dF.dD_e 4.17 = 0.9855442220 / (0.246575 * 0.9785870561 * 0.9785870561) = D_P.s / (t_p * D_P.e * D_P.e) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 567 10 Options 10.3 Option on MM future 10.3.5.1.4 Option pricing – price volatility Balance flow • Data Symbol Example Formula Implied Volatility sigma = 0.242070385 Unit Strike X 0.96500 = 96.50 / 100 = F_c / 100 Unit Underlying Price F.u 0.99000 = 99.00 / 100 = F / 100 d_1 d_1 = 0.234921658 = (LN(F.u/X) + 0.5 * sigma * sigma * t_e) / (sigma * SQRT(t_e)) d_2 d_2 = 0.063517729= 0.063517729 = d_1 - sigma * SQRT(t_e) Unit Price p_u = 0.08 = (F.u * NORMSDIST(d_1) - X * NORMSDIST(d_2)) * D_P.f Delta delta = 0.59286523 = NORMSDIST(d_1) * D_P.f Gamma gamma = 0.022870209 = NORMDIST(d_1,0,1,0) * D_P.f / (F * sigma * SQRT(t_e)) Intrinsic Value p_i = 0.025000000 = 0.5*(1+SIGN(LN(F.u/X)))*(F.u-X)* D_P.f Symbol Example Formula Netting flow • Data Implied Volatility -0.000002 = 10000000 * (p_u - V_o) 10.3.6 Australian MM Future option 10.3.6.1 Instrument setup Australian short future options will be based on an instrument type derived from the class MM-FUTURE-OPTION. To take into account characteristics of Australian short futures options, the feature MM-FUTURE-AU-BB-OPTION embeds the method of computing tick value regarding the level of the strike. Tick value and tick size are not visible to the user, but will be used as usual in the management of the instrument. Australian bank bill futures must be based on an instrument type derived from the class MM-FUTURE-OPTION. They are set up in a similar way to MM futures (see 9.3 Money market future on page 485) but require a different primary feature. • Main characteristics See A.2.232 MM Future - Australian Bank Bill Future on page 828. • Quotation information Information Description Price Type Method for quoting the price - Ticks. Quote Handling Select Generic (which means that you will be able to enter the bid and ask quotes for this instrument). Currency Currency of the future contract - AUD. See A.2.274 Quoted on page 849. 568 © Wall Street Systems IPH AB - Confidential 10 Options 10.4 Bond option • Netting information The daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or it expires. See A.2.319 Ticks Netting on page 870. 10.3.6.2 Market information For an Australian short future option, premiums for such instruments are quoted in terms of annual percentage yield with the value of a single point of premium (i.e. 0.01% p.a.) calculated by comparing its contract value at the exercise price (expressed as 100 minus annual yield) and its value at that same exercise price less one point (0.01%). For an option with a particular exercise price, the value of 0.01% of premium is the tick value. Tick value for these instruments is computed as follows: 1. Compute the value of the future contract at strike price using the formula in Australian Money market Futures. 2. Compute the value of the future contract at strike price-0.01%. 3. Compute the difference between these two contracts: this is the tick value. The premium of an option on 90 Day Bank Bill future with a strike K is computed as follows, where q% is the quotation of the option: q*Tick_value/Tick_size, where q*Tick_value is rounded to 4 decimals and Tick_value = 0.01. 10.4 Bond option Bond options allow investors the ability to hedge the risk of their bond portfolios or speculate on the direction of bond prices with limited risk. A buyer of a bond call option is expecting a decline in interest rates and an increase in bond prices. A bond call option gives the holder of the option a right (but not an obligation) to buy the specified amount of the underlying bond at the specified strike price. The buyer of a put bond option is expecting an increase in interest rates and a decrease in bond prices. A bond put option gives the holder of the option a right (but not an obligation) to sell the specified amount of the underlying bond at the specified strike price. In return for this flexibility, the option holder must pay a premium up-front to compensate the other party for the additional risk. There are two settlement methods when exercising a bond option. The first method is to deliver the underlying bond (physical delivery). The party receiving the bond pays the strike plus the accrued interest, unless the strike price refers to the dirty price. The second method is to pay the difference between the market price of the underlying and the strike price (cash delivery). The method used depends on the terms of the contract. In TRM, the following bond option instruments are supported: • European type options where the option can be exercised only at the expiry date • American type options where the option can be exercised any time on or before the expiry date. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 569 10 Options 10.4 Bond option 10.4.1 Instrument setup Bond option instruments must be based on an instrument type derived from the class BOND-OPTION. • 10.4.1.1 Option on bond on page 570 • 10.4.1.2 Option on bond future on page 571. Note: For exchange-traded bond options, the strike price, expiry date, and option type (Call or Put) must be defined in the instrument setup. 10.4.1.1 Option on bond • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of bond option instrument. Information Description Issuer Issuer (writer) of the option. Underlying Underlying bond instrument. This is the bond that will be delivered in the case of physical delivery. Strike price details Strike price of the option. Rounding parameters Method and precision used to round cashflow amounts. Currency Currency of the bond option. Type Type of option: Call or Put. Price Type information Price %. Exercise and Delivery parameters Defines when the option can be exercised, and whether there is a physical delivery or a cash settlement. Future Style Premium Defines type of settlement as Future Style. See A.2.77 Bond Option on page 745. • Option expiry definition You can set up option date information at instrument level. Information Description Calendar parameters Calendars used to calculate the expiry date. Expiry Date Final date when the option can be exercised. Delivery Offset Number of days offset allowed in which to deliver the underlying after the option is exercised. See A.2.254 Option Dates on page 841 570 © Wall Street Systems IPH AB - Confidential 10 Options 10.4 Bond option • Trading units definition Information Description Point Value Unit of trading of the contract. Minimum Bid Size Smallest allowed bid size (for example, 100). Tick Size Minimum price movement (tick size and value). Tick Value Rounding parameters Rounding method used in the calculations. See A.2.320 Trading Unit (Derivative) on page 871. • Netting parameters If daily netting is required, the netting parameters need to be defined at instrument level. Information Description Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max Offset Maximum number of days’ offset allowed. Fixing Subscenario Subscenario from which the rate is retrieved. Calendar Calendar to use when calculating the fixing date. Settlement information Settlement currency if the P/L cashflow is paid in a different currency. Payment Offset Number of business days between the value date and the payment date. Method Select Business Days for daily netting. Frequency For daily netting, enter 1 when Method = Business Days. See A.2.247 Netted Instrument on page 837. • Valuation of bond options It is possible to specify that another MtoM instrument’s direct market quotation is used to value the bond option. See A.2.246 MtoM Instrument Setup on page 836. For a bond option, it is also possible to set up: • Spot date calculation to define the date when the premium is paid • Quotation information • Branch codes • Cashflow and transaction charge rules • Manual charges. See Appendix A Features on page 713. 10.4.1.2 Option on bond future At the exercise of a bond future option, the underlying contract is marked to market, and the receiving party receives the difference between the strike price and the market price from the paying party. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 571 10 Options 10.4 Bond option In addition, both parties receive a futures position, short or long, which they may liquidate immediately. Bond future options are set up in the same way as an option on a bond (see 10.4.1.1 Option on bond on page 570) except that the underlying instrument is a bond future. Main characteristics • Information Description Underlying Underlying future contract. 10.4.2 Deal capture 10.4.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a bond option. Information Option Type Description Call or Put (Transaction Type in Transaction Manager). Note: If you specify Type in the instrument setup, this is used as the default in the transaction and cannot be modified at deal entry. Trading Units Number of options bought/sold. If the trading units for the instrument are specified at instrument setup using the Derivative Trading Unit feature, the deal can be input in units and the Nominal Amount will be computed by the system. See A.2.320 Trading Unit (Derivative) on page 871. Deal Price Amount of the option premium (per unit). Strike Strike price of the option. If Strike is defined at instrument level, this is used by default and cannot be modified. (Nominal/Spot Rate in Transaction Manager) Expiry Date Final date when the option can be exercised. If the Expiry Date for the instrument is specified at instrument setup using the Option Dates feature, this is used as the default in the transaction and cannot be modified at deal entry. See A.2.254 Option Dates on page 841. Nominal Amount Amount of the transaction. In addition, the following optional information can be captured: Information Description Issuer Issuer of the instrument and underlying bond instrument. Secondary Instrument If these values are specified at instrument setup they are used as the default in the transaction and cannot be modified at deal entry. 10.4.2.2 Generated data • Cashflows The following cashflows are generated: 572 – One position flow which represents the option – One settlement flow for the premium © Wall Street Systems IPH AB - Confidential 10 Options 10.4 Bond option – With daily netting, the next netting flow (not fixed) which will be the support for the next daily margin once fixed (see 10.4.3.2 Daily netting on page 573). 10.4.3 Processing This section describes the actions that can be done throughout the life of a bond option. 10.4.3.1 Exercise/No Exercise The holder of the option has a right to exercise the option at a predetermined date or dates. Note: The Exercise action for netted options is not supported. • Execution – If the holder of a bond option with physical delivery exercises an option, an exercise transaction is created. This transaction closes out the option transaction and buys (or sells) the appropriate amount of the underlying bond at the strike price. – If the holder of a bond option with cash settlement exercises an option, an exercise transaction is created. This transaction closes out the option transaction and settles the difference of the strike price and current market price of the underlying (multiplied by the appropriate number of units of the underlying). • No exercise If the holder of the option allows the option to expire without exercising it, a "no exercise" transaction is created. This transaction closes out the option. • Information Description Exercise Date Date of exercise. For a European option, this must be the expiry date. Delivery Type Physical Delivery or Cash Settlement. Scenario For cash settlement, this is the scenario from which the market price of the underlying is retrieved. Price/spot rate Market price of the underlying instrument (for cash settlement). No Exercise If the option is not exercised, select No Exercise. Cancellation The exercise or no exercise transaction can be canceled. A new exercise/no exercise transaction can be created as described above. 10.4.3.2 Daily netting If the market quote for the underlying bond has changed from the previous day, the difference (multiplied by the point value and the number of units) may be settled between the parties of the trade. • Setup The netting parameters for bond options are defined at instrument level. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 573 10 Options 10.5 Bond Future Option • Execution The netting of a bond option is carried out using the Execute Netting action. The following information is needed to process the netting: Information Description Netting Date Day the cashflow is fixed. Netting Price Fixing market quote. This is defaulted by the system and can be changed by the user. Netting Amount Profit or loss (settlement amount) from the future. This is calculated automatically by TRM and can be changed by the user. Netting Currency (Information only) Currency of the settlement cashflow. The Execute Netting action automatically generates the next cashflow. Netting of the cashflows can also be performed automatically using the Netting activity: see the TRM User Guide for more information. • Cancellation The netting can be canceled either using the Undo Netting action, or using the Netting - Undo activity. 10.5 Bond Future Option At the exercise of a bond future option, the underlying contract is marked to market, and the receiving party receives the difference between the strike price and the market price from the paying party. In addition, both parties receive a futures position, short or long, which they may liquidate immediately. 10.5.1 Instrument setup Bond future options are set up in the same way as an option on a bond (see 10.4.1.1 Option on bond on page 570) except that the underlying instrument is a bond future. • Main characteristics Information Description Underlying Underlying future contract. 10.5.2 Australian Bond Future Option 10.5.2.1 Instrument setup Australian bond future options are set up in the same as standard bond future options, but require a different primary feature. • Main characteristics See A.2.28 Australian Bond Future Option on page 724. 574 © Wall Street Systems IPH AB - Confidential 10 Options 10.6 Equity option • Quotation information Information Description Price Type Method for quoting the price - Ticks. Quote Handling Select Generic (which means that you will be able to enter the bid and ask quotes for this instrument). Currency Currency of the future contract - AUD. See A.2.274 Quoted on page 849. • Netting information The daily change in market value (pseudo cashflows) is settled every day (netted) until the contract is closed or it expires. See A.2.319 Ticks Netting on page 870. 10.5.2.2 Market information Options on Australian futures are quoted in terms of annual percentage yield with the value of a single point of premium (0.01% p.a.) calculated by comparing its contract value at the exercise price (expressed as 100 minus annual yield) and its value at that same exercise price less one point (0.01%). As a consequence, for an option with a particular exercise price, the value of 0.01% of premium is constant, while the tick value of the underlying future is not. Tick value for corresponding instruments is computed as follows: 1. Compute the value of the future contract at strike price using the Australian Bond Future price 2. Compute the value of the future contract at strike price-0.01% 3. Compute the difference between these two contracts, which is the value of 0.01% of premium Once the market quotation has been converted into the future option price, the valuation of the contract is carried out in the same way as for a standard bond option contract. 10.6 Equity option An equity call option gives the holder of the option a right (but not an obligation) to buy the specified amount of the underlying security at the specified strike price. An equity put option gives the holder of the option a right (but not an obligation) to sell the specified amount of the underlying security at the specified strike price. There are two different kinds of options: physical delivery options, and cash-settled options. A physical delivery option gives the holder the right to receive delivery (if it is a call), or the right to make delivery (if it is a put) of the underlying equity. A cash-settled option gives the holder the right to receive a cash payment based on the difference between the value of the underlying at the time the option is exercised and the fixed exercise price of the option. In return for this flexibility, the option holder must pay a premium up-front to compensate the other party for the additional risk. In TRM, the strike price, expiry date, and option type (call/put) can either be defined at instrument level, or completed at deal capture. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 575 10 Options 10.6 Equity option In TRM, the following equity option instruments are supported: • European type options, where the option can be exercised only at the expiry date • American type options, where the option can be exercised any time on or before the expiry date. 10.6.1 Instrument setup Equity option instruments must be based on an instrument type derived from the class EQUITY-OPTION. • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of equity option instrument. Information Description Issuer details Issuer (writer) of the option. Underlying Underlying equity instrument. Strike price details Strike price of the option. Leave this field blank if you want to specify the strike price details when you enter the deal in Transaction Manager. Rounding parameters Method and precision used to round cashflow amounts. Currency Currency of the equity option. Type Type of option: Call or Put. Leave this field blank if you want to specify the option type when you enter the deal in Transaction Manager. Price Type information Amount/Unit. Exercise and Delivery parameters Defines when the option can be exercised, and whether there is a physical delivery or a cash settlement. Further contract information Further information concerning the relationship between the option and the underlying, for example, the equity conversion factor. See A.2.133 Equity Option on page 776. • Option expiry definition You can set up option date information at instrument level. Information Description Calendar parameters Calendars used to calculate the expiry date. Expiry Date Final date when the option can be exercised. Leave this field blank if you want to specify the expiry date when you enter the deal in Transaction Manager. Delivery Offset Number of days offset allowed in which to deliver the underlying after the option is exercised. See A.2.254 Option Dates on page 841. For an equity option, it is also possible to set up: • 576 Spot date calculation to define the date when the premium is paid © Wall Street Systems IPH AB - Confidential 10 Options 10.6 Equity option • Quotation information • Netting information • Branch codes • Cashflow and transaction charge rules • Manual charges. See Appendix A Features on page 713. 10.6.2 Deal capture 10.6.2.1 Input data In addition to the standard deal parameters, the following information is required to enter an equity option: Information Description Trading Units Number of options bought/sold. Trading units for the instrument are specified at instrument setup using the Equity Trading Unit feature. See A.2.321 Trading Unit (Equity) on page 871. Deal Price Strike Amount of the option premium (per unit). Strike price of the equity option. If Strike is defined at instrument level, this is used by default and cannot be modified. (Nominal/Spot Rate in Transaction Manager) Expiry Date Final date when the option can be exercised. If the Expiry Date for the instrument is specified at instrument setup using the Option Dates feature, this is used as the default in the transaction and cannot be modified at deal entry. See A.2.254 Option Dates on page 841. Option Type Call or Put (Transaction Type in Transaction Manager). If you specify Type in the instrument setup, this is used as the default in the transaction and cannot be modified at deal entry. Issuer Issuer of the instrument. If this value is specified at instrument setup, it is used as the default in the transaction and cannot be modified at deal entry. 10.6.2.2 Generated data • Cashflows For an equity option, the cashflows generated are as follows: Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 577 10 Options 10.6 Equity option 10.6.3 Processing This section describes the actions that can be done throughout the life of an equity option. 10.6.3.1 Pricing Pricing of equity option transactions can be performed using a right-click processing action. • Setup The Pricing action is available on the transaction if the Equity Option Pricing feature is associated with the instrument. See A.2.134 Equity Option Pricing on page 777. • Execution The Pricing action allows you to find the premium price, as well as the theoretical price and the Greeks, by manually changing the volatility while keeping the other parameters constant. Information Description Trading Units Trading units of the equity option. Deal Price By default, this is the Theoretical Price. Book Value (Information only) Book Value = Trading Units * Deal Price. Theoretical Price (Information only) Theoretical price of the equity option. Theoretical Amount (Information only) Intrinsic Value Intrinsic value of the equity option. Time Value Time value of the equity option. Volatility Volatility of the equity option. Delta (Information only) Gamma Delta, Gamma, Theta, and Vega of the equity option. Theoretical price of the equity option weighted by the Book Value. Theta Vega 10.6.3.2 Exercise/no exercise The holder of the option has a right to exercise the option at a predetermined date or dates. • 578 Execution – If the holder of an equity option with physical delivery exercises an option, an exercise transaction is created. This transaction closes out the option transaction and buys (or sells) the appropriate amount of the underlying security at the strike price. – If the holder of an equity option with cash settlement exercises an option, an exercise transaction is created. This transaction closes out the option transaction and settles the difference of the strike price and current market price of the underlying (multiplied by the appropriate number of units of the underlying). © Wall Street Systems IPH AB - Confidential 10 Options 10.6 Equity option • No exercise If the holder of the option allows the option to expire without exercising it, a “no exercise” transaction is created. This transaction closes out the option. • Information Description Exercise Date Date of the exercise. For a European option, this must be the expiry date. Delivery Type Physical Delivery or Cash Settlement. Scenario For cash settlement, this is the scenario from which the market price of the underlying is retrieved. Price/spot rate Market price of the underlying instrument (for cash settlement). No Exercise If the option is not exercised, select No Exercise. Cancellation The exercise or no exercise transaction can be canceled. A new exercise/no exercise transaction can be created as described above. 10.6.4 Position monitoring 10.6.4.1 Calculations In this section, numerical examples demonstrate how the different figures are calculated for an Equity Option. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. This example shows an Equity Option, with the following deal data: Setup data Date Basis B 360 Risk Date Basis B_r 365 Trading Unit Size L 100 FX Exposure Offset e_fx 0.01 Price Exposure Offset e_p 5.00% Annual Dividend (compound) r_y 10.00% Asset Rate (continuous) r_a = LN(1 +r_y) 0.095310180 Trading Units N 5 Option Type (call = 1, put = -1) type 1 Underlying instrument data Transaction data Opening Date 2005-03-17 Spot Date dt_s 2005-03-19 Maturity Date dt_m 2005-06-20 Expiry Date dt_e 2005-06-17 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 579 10 Options 10.6 Equity option Transaction data Nominal Rate X 35.000000 Premium pr 125.00 Other important deal data is calculated by the system as follows: • Nominal Amount A = type * N * L 500.00 = 1 * 5 * 100 • Book Value (local) V_bl = pr = 125.00 • Book Value V_b = V_bl = 125.00 • Period t_p = (dt_m – dt_s) / B 0.258333333 = (2005/06/20 – 2005/03/19) / 360 Unless otherwise stated, the figure date used in the calculations is 2005-04-15. On this date, the market data is as follows: Market data on 2005-04-15 Figure Date dt_f 2005-04-15 Interest Rate r_f 2.380071% Days to Spot d_fs 4 Discount Rate r_d 2.000000% Asset Spot Price S 35.000000 Quoted Price p_q 0.2500000 Other market data is calculated by the system as follows: • Days to Expiry = dt_m – dt_f = 66 • Time to Maturity t_m = (dt_m –dt_f) / B = 0.18333333 • Time to Expiry t_e = (dt_e – dt_f) / B = 0.17500000 • Time to Maturity (risk) t_m.r = (dt_m –dt_f) / B_r = 0.18082192 • Time to Expiry (risk) t_e.r = (dt_e – dt_f) / B_r = 0.17260274 • Time to Spot t_s = d_fs / B = 0.011111111 • Time to Spot (risk) t_s.r = d_fs / B_r = 0.010958904 • PV Discount Factor D_Pb = EXP (-r_f * t_m.r) = 0.995705557 • Discount Factor Spot D_sb = EXP (-r_d * t_s.r) = 0.999780846 580 © Wall Street Systems IPH AB - Confidential 10 Options 10.6 Equity option 10.6.4.1.1 Option figures The option figures on the figure date are as follows: • Implied Volatility sg = 7.44225979% • rc r_c = LN(D_Pb) / t_m = 0.023474677 • ds ds = D_sb * EXP(t_s * r_a) = 1.000840177 • Asset Today Price S_t = S * ds = 35.02940618 • d1 d_1 = (LN(S_t / X) + (r_c - r_a) * t_m + (sg * sg / 2) * t_e) / (sg * SQRT(t_e)) = -0.380474145 • d2 d_2 = d_1 - sg * SQRT(t_e) = -0.411607351 • price p = type * ((S_t) * EXP(-r_a * t_m) * NORMSDIST(type * d_1)) - type * ((X) * EXP(-r_c * t_m) * NORMSDIST(type * d_2)) = 0.249945260 • delta delta = type * EXP(-r_a * t_m) * NORMSDIST(type * d_1) * ds = 0.345993457 • Asset Rho rho.b =-type * t_m * NORMSDIST(type * d_1) * (S_t) * EXP(-r_a * t_m) = -2.220124682 • Cash Rho rho.q = type * t_m * NORMSDIST(type * d_2) * (X) * EXP(-r_c * t_m) = 2.174301384 • Intrinsic Value v.i=type * ((S_t)*EXP(-r_a*t_m)* 0.5 * (SIGN(type * (LN(ds * S_t / X)+(r_c-r_a)*t_m))+1)) - type * ((X)*EXP(-r_c*t_m)*0.5 * (SIGN(type * (LN(ds * S_t / X)+(r_c-r_a)*t_m))+1)) =0.00 10.6.4.1.2 Valuation figures • Market Value V = type * p_q * A * D_sb =124.97 • Present Value V_p= type * p * A = 124.97 • Intrinsic Value V_i=v.i*A =0.00 10.6.4.1.3 Risk figures • Price Exposure E_p = type * A * delta * S * e_p = 302.74 • IR Exposure 1bp E_i = type * A * rho.q * 0.0001 = 0.108715 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 581 10 Options 10.7 Index option 10.7 Index option An index call option gives the holder of the option a right (but not an obligation) to buy the specified amount of the underlying index at the specified strike price. An index put option gives the holder of the option a right (but not an obligation) to sell the specified amount of the underlying index at the specified strike price. As it is not practical to buy or sell the index, the index options are settled with cash when they expire. The holder of the in-the-money option receives the difference between the current index value and the strike (multiplied by the number of options and the point value). In return for this potential gain, the option holder must pay a premium up-front to compensate the other party for the additional risk. In TRM the index options must be exchange traded, that is, the strike price, expiry date, and option type (call/put), need to be defined for the instrument. In TRM the following index option instruments are supported: • European type options, where the option can be exercised only at the expiry date • American type options, where the option can be exercised any time on or before the expiry date. 10.7.1 Instrument setup Index option instruments must be based on an instrument type derived from the class INDEX-OPTION. • Main characteristics The following basic information may be captured when defining the instrument. This information is relevant to any kind of index option instrument. Information Description Issuer details Issuer (writer) of the option. Underlying Underlying index instrument. Strike price details Strike price of the option. Rounding parameters Method and precision used to round cashflow amounts. Currency Currency of the index option. Type Type of option: Call or Put. Price Type information Amount/Unit. Exercise and Delivery parameters Defines when the option can be exercised, and whether there is a physical delivery or a cash settlement. Further contract information Further information concerning the relationship between the option and the underlying. For an index option there must always be cash settlement. See A.2.211 Index Option on page 818. • 582 Option expiry definition © Wall Street Systems IPH AB - Confidential 10 Options 10.7 Index option You can set up option date information at instrument level. Information Description Calendar parameters Calendars used to calculate the expiry date. Expiry Date Final date when the option can be exercised. Delivery Offset Number of days offset allowed in which to deliver the underlying after the option is exercised. See A.2.254 Option Dates on page 841. • Trading units It is possible to specify the point and tick values of the index option instrument. See A.2.322 Trading Unit (Index) on page 872. For an index option, it is also possible to set up: • Spot date calculation to define the date when the premium is paid • Quotation information • Netting information • Branch codes • Cashflow and transaction charge rules • Manual charges. See Appendix A Features on page 713. 10.7.2 Deal capture 10.7.2.1 Input data In addition to the standard deal parameters, the following information is required to enter an index option: Information Description Trading Units Number of options bought/sold. Deal Price Amount of the option premium (per unit). Issuer Issuer of the option. If Issuer is defined at instrument level, this is used by default and cannot be modified. Strike Strike index value of the option. If Strike is defined at instrument level, this is used by default and cannot be modified. (Nominal/Spot Rate in Transaction Manager) Option Type Type of option: Call or Put. If Type is defined at instrument level, this is used by default and cannot be modified. (Transaction Type in Transaction Manager) Expiry Date Final date when the option can be exercised. If date information is defined at instrument level, this is used by default and cannot be modified. Value Date Date when the exercise is settled. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 583 10 Options 10.7 Index option 10.7.2.2 Generated data • Cashflows For an index option, the cashflows generated are as follows: Opening date Spot date Expiry date Spot days Premium 10.7.3 Processing This section describes the actions that can be done throughout the life of an index option. 10.7.3.1 Exercise/no exercise The holder of the option has a right to exercise the option at a predetermined date or dates. Note: The Exercise action for netted options is not supported. • Execution – • No exercise – • If the holder of an index option exercises an option, an exercise transaction is created. This transaction closes out the option transaction and settles the difference of the strike index value and current underlying index value (multiplied by the number of options and point value). If the holder of the option allows the option to expire without exercising it, a “no exercise” transaction is created. This transaction closes out the option transaction. Information Description Exercise Date Date of exercise. For a European option, this must be the expiry date. Delivery Type Cash Settlement. Scenario For cash settlement, this is the scenario from which the value of the underlying index is retrieved. Price/Spot Rate Value of the underlying index No Exercise If the option is not exercised, select No Exercise. Cancellation The exercise or no exercise transaction can be canceled. A new exercise/no exercise transaction can be created as described above. 584 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option 10.8 FX option This section describes the different types of FX options supported in TRM: plain vanilla, digital, barrier and compound FX options. It provides instructions for setting up these instruments, capturing deals, processing and generated data, and calculations. See 10.8.6 Position monitoring on page 610 for more information about the calculations of FX options. Additionally, it provides information about valuation settings, for example, to customize the default valuation settings; and describes the valuation models that are used according to the type of FX option. Default valuation settings are determined by the feature FX Option Valuation (See feature A.2.189 FX Option Valuation on page 805). To customize these default settings, use the feature FX Option Setup (A.2.188 FX Option Setup on page 804). For more information about the valuation models, see 10.8.6.2.2 Option valuation models on page 611. 10.8.1 Vanilla FX option An FX Option is the right either to buy or to sell a specified amount of one currency at a price denominated in another currency. The price of one currency in terms of another currency is known as an exchange rate. The exercise price (or strike) of a FX Option thus represents an exchange rate. An option that gives a right to buy is a call option, and an option that gives a right to sell is a put option. In addition, there are two different kinds of options: physical delivery options and cash-settled options. A physical delivery option gives the owner the right to receive the physical delivery (if it is a call), or to make physical delivery (if it is a put), of the underlying currencies when the option is exercised. A cash-settled option gives its owner the right to receive a cash payment based on the difference between a determined value of the underlying at the time the option is exercised (spot rate from the market) and the fixed exercise price of the option. A cash-settled Call conveys the right to receive a cash payment if the determined value of the underlying at exercise exceeds the exercise price of the option. And a cash-settled Put conveys the right to receive a cash payment if the determined value of the underlying at exercise is less than the exercise price. The style of the option refers to when that option is exercisable. With a European exercise style option, the holder can only exercise the option at expiry. With an American exercise style option, however, the holder can choose to exercise at any time between the purchase date of the option and the expiry. In return for this flexibility, the option holder must pay a premium up-front to compensate the other party for the additional risk. 10.8.1.1 Instrument setup FX OTC Options are based on a type derived from the FX-OPTION instrument class. • Main characteristics The following basic information may be captured when defining the instrument. Information Description Exercise Instrument Underlying FX instrument. Type Type of option: Call or Put. Exercise Type European or American or Templatized (for Bermudan). Delivery Type Cash Settlement or Physical Delivery. If defined, this underlying instrument is applied to each transaction. Leave this field blank if you want to specify the underlying instrument when you enter the deal. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 585 10 Options 10.8 FX option – Dates definition You can set up expiry and premium date information at instrument level. Information Description Gap Set Gap set used for supplying the expiry periods for the option; these in turn are used to define exact dates. This is a mandatory field. Expiry Date Period Expiry period used to calculate the expiry date for the option at deal entry, for example, 6M or 1Y. If you specify the expiry date period in the instrument setup, this is used as the default in the transaction and cannot be modified. Premium Offset Number of days offset between the applied date defined in the Applied On field and the premium date. Applied On Date on which the settlement of the premium takes place (Premium Date). This is the spot date by default. Calendar Calendars used to calculate the expiry date and premium date of an option instrument. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the expiry date and premium date calculation takes both calendars into account. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. See A.2.182 FX Option on page 800. • Premium definition Further information relating to the characteristics of the premium can also be set up at instrument level. Information Description (Premium) Type Determines how the premium amount is calculated. If defined, the FX Premium Type is applied to each transaction. Leave this field blank if you want to specify the premium type when you enter the deal. (Premium) Currency Currency of the premium. If defined, the premium currency is applied to each transaction. Leave this field blank if you want to specify the premium currency when you enter the deal. See A.2.186 FX Option Premium on page 803. • Pricing The system can provide the theoretical premium (option value) before the actual premium is captured. This action becomes available on the transaction when the FX-Option-Pricing feature has been applied to the instrument. See A.2.187 FX Option Pricing on page 803. For an FX OTC Option, it is also possible to set up: • Cashflow and transaction charge rules • Manual charges • Branch codes. 586 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option See Appendix A Features on page 713. 10.8.1.2 Deal capture 10.8.1.2.1 Input data In addition to the standard deal parameters, the following information is required to enter an FX OTC Option: Information Description Transaction Type Call or Put. (Type) Secondary Instrument The underlying instrument of the FX option. (Exercise Instrument) Currency (Base Currency) Currency 2nd (Quote Currency) Corresponds to the currency that is bought/sold if the Call/Put FX option is exercised. Corresponds to the currency that is sold/bought if the Call/Put FX option is exercised. Expiry Date Date on which the FX Option expires. Deal Rate Fixed exercise price of the FX option. (Strike) FX Base Amount Amount that is bought/sold if the Call/Put FX option is exercised. (Base Amount) FX Quote Amount Amount that is sold/bought if the Call/Put FX option is exercised. (Quote Amount) FX Premium Type Determines how the premium amount is calculated. Premium Price Depends on the premium type: This could be specified in amount, percent, or points. Fixing Subscenario Subscenario from which the FX spot rate is retrieved. 10.8.1.2.2 Generated data • Cashflows When dealing a Vanilla FX option, four cashflows are generated: – Option position at opening date: this contains all the relevant information of the option – Option premium settlement at premium date Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 587 10 Options 10.8 FX option – Two cashflows for the potential delivered currencies at value date: these cashflows will only be generated if the option is exercised with physical delivery. Base currency Option position Opening date Expiry date Premium date Spot days Premium Expiry Value date Quote currency The asset currency is displayed in the transaction column Asset CCY. The cashflow kind Reversed Asset CCY informs valuation that asset currency is the quote currency, and valuation does the required reversals. For more information about asset and cash currencies, see 2.3.3.1 Asset and cash currencies on page 116. 10.8.1.3 Processing This section describes the actions that can be done throughout the life of an FX option. 10.8.1.3.1 Pricing Pricing of FX option transactions can be performed using a right-click processing action. • Setup The Pricing action is available on the transaction if the FX Option Pricing feature is associated with the instrument, see A.2.187 FX Option Pricing on page 803. Note: Before running the Pricing action, you need to set up the pricing configuration in Transaction Manager, Option - Pricing Configuration. For more information about setting up pricing at the transaction level, see TRM User Guide. • Execution The Pricing action allows you to find the premium price, as well as the theoretical price and the Greeks, by manually changing the volatility while keeping the other parameters constant. Information Description Premium Currency Currency of the Premium cashflow. Premium Type Premium type: Percentage or Points. Premium Amount Premium Amount = Premium Price * Base Amount of the transaction. Theoretical Price (Information only) Theoretical price of the FX option. 588 Theoretical Amount (Information only) Intrinsic Value Intrinsic value of the FX option. Time Value Time value of the FX option. Volatility Volatility of the FX option. Theoretical price of the FX option multiplied by the Base Amount of the transaction. © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option Information Description Delta (Information only) Gamma Delta, Gamma, Theta, and Vega of the FX option. Theta Vega 10.8.1.3.2 Exercise/no exercise (single option) The principle is to allow the user to exercise the option: • If the holder of a physical delivery option wishes to buy (in case of a call) or sell (in the case of a put) the underlying at the exercise price (strike) • In the case of a cash-settled option, to receive the cash settlement amount (price of the underlying at exercise - exercise price of the option). There are three styles of exercise: • European: option can be exercised at expiry date • American: option can be exercised between the opening date and the expiry date. • Templatized (for Bermudan): option can be exercised at dates specified in the exercise schedule attached to the transaction. See Appendix C Option schedules on page 911. If the current spot rate of the exchange rate of the underlying is above the exercise price of the FX Option, the Call option is considered in-the-money (below for a Put Option). Then, the user will be able to exercise the FX option. Conversely, if the current spot rate of the exchange rate of the underlying is below the exercise price of the FX Option, the Call option is considered out-of-the-money (above for a Put Option). In this case, a No Exercise is suggested (No Exercise switch selected). • Execution - Physical Delivery In the case of exercise with physical delivery, the agreed amount of underlying currencies is delivered at the agreed exchange rate (strike). The following table describes the exercise parameters: Information Description Exercise Date Date when the exercise is done. Value Date Shows value date of the delivery transaction. This date can be modified if the exercise date is before or later than the expiry date of the initial transaction (American or Bermudan style). Note: Read-only for a partial exercise. Delivery Type Physical Delivery. Click Next to complete the exercise parameters for a physical delivery: Information Description Delivery Instrument (Read-only.) Exercise FX Instrument. Base Currency (Read-only.) Shows the base currency of the transaction Base Amount (Read-only except for a partial exercise.) Shows the base amount of the transaction. Quote Currency (Read-only.) Shows the quote currency of the transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 589 10 Options 10.8 FX option Information Description Quote Amount (Read-only except for a partial exercise.) Shows the quote amount of the transaction. Strike (Read-only.) Shows the deal rate of the option. Spot Rate Shows the FX spot rate between base and quote currencies. No Exercise Indicates whether the option should be exercised based on entered Spot Rate. • Selected if the option is out-of-the-money. • Not selected if option is in-the-money. Click Finish. An Exercise transaction is generated based on each underlying currency with the following attributes. Depending on the option type and the sign of the option transaction, the sign of the exercise transaction is as follows: Option Exercise Buy/Call Buy Sell/Call Sell Buy/Put Sell Sell/Put Buy where: Buy/Sell is relative to the Base currency Instrument = Exercise Instrument (Secondary Instrument) of the option transaction FX Base amount = FX Base Amount of the option transaction FX Quote amount = FX Quote Amount of the option transaction Exchange Rate (Deal Rate) = strike (deal rate) of the option Opening date = date when the exercise is done Value date = date when the exercise is settled Kind = Exercise The remaining attributes are inherited from the initial transaction. With physical delivery, it is also possible to do a partial exercise of the option contract at expiry. This will close the full original option position. After a partial exercise, it will not be possible to exercise the amount left of the original option. • Execution - Cash Settlement In the case of exercise of a cash-settled option, the underlying currencies are not delivered but a settlement amount is received (or paid) instead. The following table describes the exercise parameters: 590 Information Description Exercise Date Date when the exercise is done. Value Date Date when the exercise is settled. This cannot be later than the maturity date of the initial transaction. © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option Information Description Delivery Type Cash Settlement. Click Next to complete the exercise parameters for a cash settlement: Information Description Base Currency (Read-only.) Shows the base currency of the transaction Base Amount (Read-only except for a partial exercise.) Shows the base amount of the transaction. Quote Currency (Read-only.) Shows the quote currency of the transaction. Quote Amount (Read-only except for a partial exercise.) Shows the quote amount of the transaction. Strike (Read-only.) Shows the deal rate of the initial transaction. Fixing Subscenario Subscenario from which the FX spot rate is retrieved. Typically, use the FIXING scenario. Read-only when defined at the transaction level, otherwise editable. Spot Rate Shows FX spot rate between base and quote currencies based on the selected subscenario. The spot rate is recalculated when the exercise date changes. Settlement Currency Currency of the net settlement amount. Defaults to the premium currency. Settlement Amount No Exercise Amount to be settled. This amount is recalculated when the spot rate changes. Indicates whether the option should be exercised based on the spot rate. • Selected if the option is out-of-the-money. • Not selected if option is in-the-money. No exercise is recalculated when the spot rate changes. Click Finish. An Exercise transaction is generated based on each underlying currency with the following attributes: Opening date = date when the exercise is done Value date = date when the exercise is settled Kind = Exercise A Net settlement cashflow is generated with Amount = Net settlement Amount The remaining attributes are inherited from the initial transaction. In the case where the option is out-of-the-money, the user has to execute a No Exercise. A No Exercise transaction is generated based on the option with the following attributes: Opening date = date when the No exercise is done Kind = No Exercise The remaining attributes are inherited from the initial transaction. • Cancellation It is possible to cancel the generated transaction (Exercise, No Exercise). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 591 10 Options 10.8 FX option 10.8.1.3.3 Exercise/no exercise (multiple options) TRM allows you to exercise multiple options at the same time assuming that certain conditions are met. In which case, the exercising follows a similar logic to exercising single options though the action is simplified. • Execution To exercise multiple options at the same time, the following conditions must be met: – All transactions must have the same Fixing/Action Date. If there is no Fixing/Action Date then the current date is used. For example, as well as other criteria, your query criteria may include a given Fixing/Action Date. (The Fixing/Action Date column must be visible in the Query and Transaction views.) – All transactions must be exercisable, i.e. the Exercise action is available. Among the resulting transactions, you might have transactions using an instrument set up for cash settlement or physical delivery. Depending on your needs you can choose the following options: – Default: Exercises the options according to the contract setting (cash settlement or physical delivery) at the instrument level. – Cash Settlement: Allows you to force all options to be exercised as cash settlement. – Physical Delivery: Allows you to force all options to be exercised as physical delivery. In this case only, you can choose to exercise or not exercise the options. Note: For Default and Cash Settlement, the options are exercised according to whether they are at-the-money or not. When you click OK, one exercise (no exercise) transaction is generated for each selected option. You need to apply these transactions. 10.8.1.3.4 Early expiration (close out) For an OTC FX Option, early expiration will close out the option contract. • Execution The following table describes the early expiration parameters: Information Description Opening Date Date when the early expiration is done. Premium Date Date on which the settlement of the premium takes place. Amount to Expire Amount to be early expired. This defaults to the amount still available to be early expired, taking into account previous partial early expirations. Amount Left Remaining amount of the initial transaction. FX Premium Type Determines how the premium amount is calculated (from the initial transaction). Premium Currency Currency of the premium (from the initial transaction). Premium Price New option premium price relative to the early expiration. Premium Amount Premium amount of the early expiration. The execution generates an early expiration transaction with the following attributes: Sign = Opposite sign of the initial option transaction Opening date = date when the early expiration is done 592 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option Premium = new premium price Kind = Early Expiration The remaining attributes are inherited from the initial transaction. • Cancellation It is possible to cancel the generated transaction (Early Expiration). 10.8.2 Digital FX option A Digital Option (also known as a binary option) is designed specifically for traders who believe that the market will be above or below a certain level at a specified time, and is a good way to profit from a rally or a correction in the market. The digital option pays a fixed amount if the spot price is above (call) or below (put) the target level that you have chosen. As long as the spot price is above or below the barrier level at expiration, you receive the payoff. The payoff of a digital option is only governed by the spot price prevailing at expiration. If the spot price is not above (in the case of a Call) or below (in the case of a Put) the specified barrier at the end of the option period, the option expires worthless. A One Touch Option is an American style digital option. As long as the spot level hits the barrier level at least once prior to expiration, the payoff amount is received at expiry. If the barrier is not reached during the option period, the option expires worthless. 10.8.2.1 Instrument setup FX digital options are based on a type derived from the FX-OPTION instrument class. • FX Option Digital main characteristics The following basic information may be captured when defining the instrument. Information Description Type Type of option: Call or Put. Exercise Type European or American or Templatized (for Bermudan). – Date definition You can set up expiry and premium date information at instrument level. Information Description Gap Set Gap set used for supplying the expiry periods for the option; these in turn are used to define exact dates. This is a mandatory field. Expiry Date Period Expiry period used to calculate the expiry date for the option at deal entry, for example, 6M or 1Y. If you specify the expiry date period in the instrument setup, this is used as the default in the transaction and cannot be modified. Premium Offset Number of days offset between the applied date defined in the Applied On field and the premium date. Applied On Date on which the settlement of the premium takes place (Premium Date). This is the spot date by default. Calendar Calendars used to calculate the expiry date and premium date of an option instrument. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the expiry date and premium date calculation takes both calendars into account. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 593 10 Options 10.8 FX option Information Description Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. See A.2.184 FX Option Digital on page 801. Premium definition • For the remaining characteristics of the premium, you can also set up some information at instrument level. Information Description Type Premium type: Determines how the premium amount is calculated. If defined, this is used as the default premium type and cannot be modified when dealing the instrument. Currency Currency of the premium. If defined, this is used as the default premium currency and cannot be modified when dealing the instrument. See A.2.186 FX Option Premium on page 803. For an FX digital option, it is also possible to set up: • Cashflow and transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 10.8.2.2 Deal capture 10.8.2.2.1 Input data In addition to the standard deal parameters, the following information is required to enter an FX digital option: Information Description Transaction Type Call or Put. (Type) Currency Corresponds to the base currency of the currency pair. (Base Currency) Currency 2nd Corresponds to the quote currency of the currency pair. (Quote Currency) Expiry Date Date on which the FX Option expires. Deal Rate Strike of the digital FX option. (Strike) FX Base Amount (*) Payoff amount if entered in base currency. (Base Amount) 594 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option Information Description FX Quote Amount (*) Payoff amount if entered in quote currency. (Quote Amount) FX Premium Type Determines how the premium amount is calculated. Premium Price Depends on the premium type: This could be specified in amount, percent, or points. Fixing Subscenario Subscenario from which the Exchange spot rate is retrieved. (*) The payoff is either input in base amount or quote amount depending on the currency. In addition, the following optional information can be captured: Information Premium Date Description Date on which the payment of the premium occurs. Note: If you specify the date type in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.184 FX Option Digital on page 801. Premium Currency Currency of the premium. The premium currency corresponds to the payoff currency. Note: If you specify the premium currency in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.186 FX Option Premium on page 803. Expiry Code If the Expiry Date Setup feature is applied at instrument level, you can enter the expiry date period you want to use to calculate the expiry date for the transaction, for example, 3M (3 months). Note: If you specify an expiry date period in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.184 FX Option Digital on page 801. 10.8.2.2.2 Generated data • Cashflows The structure of the generated cashflow is as for a FX vanilla standard case (apart from the pseudo cashflows relative to the underlying): – Option position at opening date: this contains all the relevant information of the option (payoff definition in the Expression field). – Option premium settlement at premium date. 10.8.2.3 Processing 10.8.2.3.1 Exercise/no exercise For European FX digital options, at expiry, the user is able to exercise the option. If the current spot rate of the exchange rate of the underlying is above the exercise price of the FX option, the Call option is considered in-the-money (below for a Put Option). Then, when exercising the FX digital option, the buyer will receive the payoff (seller/pay). Conversely, if the current spot rate of the exchange rate of the underlying is below the exercise price of the FX option, the Call option is considered out-of-the-money (above for a Put Option). In this case, when exercising the FX digital option, the buyer will not receive anything. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 595 10 Options 10.8 FX option • Execution The following table describes the exercise parameters: Information Description Exercise Date Date when the exercise is done. Value Date Date when the exercise is settled. This cannot be later than the maturity date of the initial transaction. Editable if the exercise date is before the expiry date for American and Bermudan options). Base Currency (Read-only.) Shows the base currency of the transaction Quote Currency (Read-only.) Shows the quote currency of the transaction. Strike (Read-only.) Shows the deal rate of the initial transaction. Fixing Subscenario Subscenario of the option position flow (exercise event in case of a Bermudan). Typically, use the fixing scenario. Read-only when defined at transaction level, otherwise editable. Spot Rate Shows FX spot rate between base and quote currencies based on the selected subscenario. The spot rate is recalculated when the exercise date changes. Settlement Currency Currency of the net settlement amount. Defaulted to the premium currency. Settlement Amount Amount to be settled (payoff amount). This amount is recalculated when the spot rate changes. If the option is out-of-the-money, a null amount (0) is diplayed, otherwise either the base amount or quote amount is displayed depending on which one was entered at transaction level. No Exercise Indicates whether the option should be exercised based on the spot rate. • Selected if the option is out-of-the-money. • Not selected if option is in-the-money. No exercise is recalculated when the spot rate changes. An Exercise transaction is generated based on the option, with the following attributes: Opening date = date when the exercise is done Value date = date when the exercise is settled Kind = Exercise A Net settlement cashflow is generated with Amount = Payoff The remaining attributes are inherited from the initial transaction. The payoff is represented by a Net settlement cashflow. • Cancellation It is possible to cancel the generated transaction (Exercise, No Exercise). 10.8.2.3.2 Early expiration (close out) See 10.8.1.3.4 Early expiration (close out) on page 592. 10.8.3 Barrier FX option A barrier option is similar to a plain vanilla option but with one exception: the presence of one or two trigger prices or barriers. If the barrier is touched at any time before maturity, it causes an option 596 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option with pre-determined characteristics to come into existence (in the case of a knock-in option) or it will cause an existing option to cease to exist (in the case of a knock-out option). If a knock-out option has been knocked out, or if a knock-in option fails to knock in, the option’s value is zero at expiration date, no matter what the value of the underlying. There are single barrier options and double barrier options: • Single barrier options which have one barrier. • Double barrier options which have barriers on either side of the strike (that is, one trigger price is greater than the strike, and the other trigger price is less than the strike). Touching either of them will knock the option. Intuitively, barrier options should be cheaper than their plain vanilla counterparts because they run the risk of either not being knocked in or being knocked out. In total, there are eight types of single barrier options, comprising puts or calls which have barriers. System schedule templates are provided for each of these types. These are described in C.2.1 System-defined templates on page 913. • Up-and-in For an up-and-in call or put, the payout at expiration is zero unless, at some time during the option’s life time, the underlying breaches the barrier to go above the current spot rate. If this happens the option becomes a vanilla put option. • Up-and-out For an up-and-out call or put, if the underlying breaches the barrier level to go above the current spot rate, the option ceases to exist. • Down-and-in For a down and in call or put, the payout is zero unless the underlying goes below the barrier level, in which case the option becomes a vanilla call option. • Down-and-out For a down and out call or put, if the underlying goes below the barrier level, the option ceases to exist. Otherwise, the payout is a call option. • Option with Rebate Rebates are pre-defined payoffs which are sometimes given when a barrier expires worthless. With a knock-out option, at the breach of the barrier, the owner of the contract receives the rebate. With a knock-in option, the rebate is paid at expiry date if the option was not knocked in. 10.8.3.1 Instrument setup FX barrier options are based on a type derived from the FX-OPTION instrument class. • FX Option main characteristics The following basic information may be captured when defining the instrument. Information Description Exercise Instrument Underlying FX instrument. Option Type Call or Put. Exercise Style European or American. Delivery Style Physical Delivery or Cash-Settlement. See A.2.182 FX Option on page 800. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 597 10 Options 10.8 FX option • Barrier definition Information Description Option Schedule Option Schedule template to be used for the barrier definition. See Appendix C Option schedules on page 911 for more information about these templates. If this is not defined at instrument level it must be specified for each transaction. Note: It is also possible to associate one or several option schedule template groups to the instrument (see below). See A.2.140 Exotic Structure (Option) on page 780. • Expiry definition You can set up expiry information at instrument level. Information Description Calendar Holiday Calendar Calendars used to calculate the expiry date. Gap Set Gap set used for supplying the available expiry periods. Expiry Date Period If defined, this expiry period is applied to each transaction and cannot be changed at deal entry. See A.2.141 Expiry Date Setup on page 781. • Premium definition The main characteristics of a premium are: premium date, premium type, premium currency, and premium price. The premium amount can then be determined. For the premium date, it is possible to set up some information at instrument level: Information Description Calendar Holiday Calendar Calendars used to calculate the premium date. Date Type Type of date on which the payment of the premium occurs (Premium Date). This is spot date by default. Offset Offset between the date defined as the premium date type and the premium date. See A.2.263 Premium Date Setup on page 844. For the remaining characteristics of the premium, you can also set up some information at instrument level: Information Premium Type Description Determines how the premium amount is calculated. If defined, this is used as the default premium type and cannot be modified when dealing the instrument. Premium Currency Currency of the premium. If defined, this is used as the default premium currency and cannot be modified when dealing the instrument. See A.2.186 FX Option Premium on page 803. 598 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option • Option schedule groups You can limit the choice of schedules available to assign to a FX barrier option in Transaction Manager by associating one or several option schedule template groups to the instrument. When this feature is selected, it is possible to assign one or several option schedule template groups to the instrument and, at deal entry, only the templates belonging to these groups will be available for selection. Note: If a barrier structure is already defined, this will override the option schedule groups setup. See A.2.256 Option Template Setup on page 842. For an FX barrier option, it is also possible to set up: • Cashflow and transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 10.8.3.2 Deal capture 10.8.3.2.1 Input data • General information An FX barrier option will be dealt using the same standard deal parameters as an FX vanilla option. To define the barrier part of the option, you must specify the barrier characteristics. An option schedule template must be applied on the deal (see Appendix C Option schedules on page 911), which will generate the barrier structure on the option deal. • Knock In An option schedule template needs to be selected that contains a Knock-In schedule (with which a Knock event is generated with In as Subcategory). Then, in the Option Schedule view, the following information must be supplied: – For up-and-in, Expression (fx > cap) and Cap for the barrier – For down-and-in, Expression (fx < floor) and Floor for the barrier Many other parameters in an option schedule can be adjusted in order to modify the barrier (for example, in the case of a discontinuity barrier). • Knock Out You need to select an option schedule template that contains a Knock-Out schedule (with which a Knock event is generated with Out as the Subcategory). Then, in the Option Schedule view, the following information must be supplied: – For up-and-out, Expression (fx > cap) and Cap for the barrier – For down-and-out, Expression (fx < floor) and Floor for the barrier Many other parameters in an option schedule can be adjusted in order to modify the barrier (for example, in the case of a discontinuity barrier). • With Rebate An option schedule template, which contains a Rebate schedule (with which a Rebate cashflow is generated), needs to be selected. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 599 10 Options 10.8 FX option Then, in the Option Schedule view, the rebate amount needs to be input (as a Rate value). Many other parameters in an option schedule can be adjusted in order to modify the rebate (for example, value date). 10.8.3.2.2 Generated data • Cashflows The structure of the generated cashflow is identical to the FX vanilla standard case. Concerning the barrier structure, there is in addition: • Option Schedule When an option template is selected, one option schedule is created for each item in the template. Some of the fields are automatically defaulted from the transaction parameters. See Appendix C Option schedules on page 911. • Event A knock event will be generated from the option schedule. 10.8.3.3 Processing 10.8.3.3.1 Execute Barrier The Knock-In option consists of a standard option (call or put) and a trigger. It is activated if the spot rate touches the trigger during the term: if the option is knocked-in, it becomes a standard option. The Knock-Out option consists of a standard option (call or put) and a trigger. The option expires if the spot rate touches the trigger during the term. For the European style, the term is at expiry date, and for the American style, the standard active period of the trigger is between the opening date and the expiry date. This first step is to evaluate the trigger in Transaction Manager’s Event view. • Execution If an FX option has a barrier, you must evaluate the barrier each time it is defined in the option contract to either enable (in case of a knock-in) or disable (in case of a knock-out) the option. If a barrier exists on the option, you can use the right-click Execute Barrier menu option to evaluate the barrier. The following table describes the action parameters: Information Description Execution Date Date when the trigger is evaluated. If today is within the barrier window, the date defaults to the current date (today) or to the last day of the past barrier window. You can modify the date as long as the date is still within the barrier window. Note: If the date of the fixing action was set on the deal prior to barrier execution, you will not be able to modify the date. Fixing Subscenario The subscenario used to retrieve spot rate. Spot Rate The FX spot rate at execution date defaulted from fixing scenario/subscenario. You can modify this rate. Touched Barrier Type When available, displays the barrier that has been touched. This is especially useful for multiple barrier options. Note: When both an in and an out barrier are touched the out barrier takes precedence. 600 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option • Information Description Touched Barrier Expression Displays which Boolean expression activated the touched barrier. Rebate Currency Rebate Amount When available, displays the rebate information associated with touched barrier. No Exercise Shows that the system will automatically perform a no exercise of the deal. This switch is switched on in the following cases: • An out barrier is touched, i.e. the spot rate is equal to or higher the rate defined in the expression. • None of the in barriers have been touched and there are no more in barriers to evaluate in the future. – For touched in barriers, inactive and in-triggerable attributes are removed from the option. – For touched out barriers or when the option had in barriers that have not been touched and do not have any in barriers in the future, a no exercise transaction is generated in order to close the position of the option. – For all other cases, no action. Cancellation It is possible to cancel the generated transaction. 10.8.3.3.2 Exercise/no exercise When the barrier option becomes a plain vanilla option, the normal processing is applicable to the option. See 10.8.2.3.1 Exercise/no exercise on page 595. 10.8.3.3.3 Early expiration (close out) Barrier options can be early expired in a similar way to standard FX options. See 10.8.1.3.4 Early expiration (close out) on page 592. 10.8.4 Compound FX option A compound option is an option to buy or sell another option: it gives the right to buy or sell (for a pre-agreed amount at a set future date) a second option of predetermined specification. This second option is known as the underlying option. The purchaser of the compound option pays an initial premium (the front premium). If the purchaser chooses to exercise the right to buy the underlying option, an exercise premium (the back premium) is paid. There are four possible types of compound options: – Call on Call – Call on Put – Put on Call – Put on Put. An example of a FX compound option would be a call-on-call option giving the owner the right to buy, in 1 month's time, a 6 month 1.55 US Dollar call/Canadian Dollar call expiring 7 months from today (or 6 months from the expiry of the compound). The strike price on the compound is the premium that would be paid in 1 month's time if the compound for the option expiring 6 months from that point in time is exercised. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 601 10 Options 10.8 FX option 10.8.4.1 Instrument setup FX compound options are based on a type derived from the FX-OPTION instrument class. • FX Compound Option main characteristics The following basic information may be captured when defining the instrument. Information Description Exercise Instrument Underlying Option. Type Option type: Call on Call, Call on Put, Put on Call, or Put on Put. Exercise Type European or American Option Schedule Option Schedule template to be used for the compound exercise definition. The selected Option Schedule template should create a Compound Exercise transaction event. – Date definition You can set up expiry and premium date information at instrument level. Information Description Gap Set Gap set used for supplying the expiry periods for the option; these in turn are used to define exact dates. This is a mandatory field. Expiry Date Period Expiry period used to calculate the expiry date for the option at deal entry, for example, 6M or 1Y. If you specify the expiry date period in the instrument setup, this is used as the default in the transaction and cannot be modified. Premium Offset Number of days offset between the applied date defined in the Applied On field and the premium date. Applied On Date on which the settlement of the premium takes place (Premium Date). This is the spot date by default. Calendar Calendars used to calculate the expiry date and premium date of an option instrument. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the expiry date and premium date calculation takes both calendars into account. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. See A.2.183 FX Option Compound on page 801. • Premium definition Further information relating to the characteristics of the premium can also be set up at instrument level. Information Description Premium Type Determines how the premium amount is calculated. If defined, this premium type is applied to each transaction. Leave this field blank if you want to specify the premium type when you enter the deal. 602 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option Information Description Premium Currency Currency of the premium. If defined, the premium currency is applied to each transaction. Leave this field blank if you want to specify the premium currency when you enter the deal. See A.2.186 FX Option Premium on page 803. For an FX compound option, it is also possible to set up: • Cashflow and transaction charge rules • Manual charges • Branch codes. See Appendix A Features on page 713. 10.8.4.2 Deal capture 10.8.4.2.1 Input data The capture of an FX compound option deal requires the following input: – Characteristics of the compound option – Characteristics of the underlying FX option. Depending on the type of deal information required, these characteristics can be defined either at transaction level or at option schedule level. • Transaction view In addition to the standard deal parameters, the following information is required to enter an FX compound option: Information Description Option Type Call on Call, Call on Put, Put on Call, or Put on Put. (Transaction Type in Transaction Manager) Underlying Option Corresponds to the underlying option which is bought/sold if the compound option is exercised. (Secondary Instrument in Transaction Manager) Base Currency Corresponds to the currency that is bought/sold if the Call/Put underlying FX option is exercised. (Currency in Transaction Manager) Quote Currency Corresponds to the currency that is sold/bought if the Call/Put underlying FX option is exercised. (Currency 2nd in Transaction Manager) Expiry Date Date on which the underlying FX option expires. Strike Fixed exercise price of the underlying FX option. (Deal Rate in Transaction Manager) Base Amount Amount that is bought/sold if the Call/Put underlying FX option is exercised. (FX Base Amount in Transaction Manager) Quote Amount Amount that is sold/bought if the Call/Put underlying FX option is exercised. (FX Quote Amount in Transaction Manager) FX Premium Type Determines how the premium amount of the compound option is calculated. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 603 10 Options 10.8 FX option Information Description Premium Price Premium price of the Compound option. Depends on the premium type: this could be in amount or percent. – Option Schedule view In order to build a compound option, an Option Schedule template that contains a Compound Exercise schedule (with which a Compound Exercise transaction event is generated) needs to be selected. The schedule can be defined either at instrument level when setting up the FX compound option instrument, or at transaction level by adding an Option Schedule. Then, in the Option Schedule view, the following information must be supplied: Information Description End date Expiry date of the compound option. Rate Strike price of compound option (which is equal to the premium of the underlying option). Many other parameters in an option schedule can be adjusted in order to modify the compound. See Appendix C Option schedules on page 911. 10.8.4.2.2 Generated data • Cashflows The structure of the generated cashflows is composed of: • – Option position at opening date: this contains all the relevant information of the compound option – Compound Option premium settlement at premium date – Pseudo Option position cashflow relative to the underlying option. Option Schedule When the option template relative to the compound exercise is selected, an option schedule is created. Some of the values are automatically defaulted from the transaction parameters (see Appendix C Option schedules on page 911), while others can be modified at deal entry (see above). • Event A compound exercise event will be generated from the option schedule. 10.8.4.3 Processing 10.8.4.3.1 Compound exercise/no exercise The principle is to allow the user to exercise the compound option: only physical delivery is handled. If the premium price of the underlying option is above the strike price of the FX compound option, the Call option is considered in-the-money (below for a Put Option). Then, the user will be able to exercise the FX compound option: the underlying option is bought/sold. Conversely, if the premium price of the underlying option is below the strike price of the FX compound option, the Call option is considered out-of-the-money (above for a Put Option). In this case, a No Exercise will be suggested. 604 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option • Execution The following table describes the exercise parameters: Information Description Exercise Date Date when the exercise is done. Option Underlying option which will be bought/sold. No Exercise By default, the system suggests the exercise of the option. For a No Exercise, the switch has to be turned on. Delivery Type (Used for the future exercise of the underlying option) Delivery type of the exercise of the underlying option. In the case of a Physical Delivery, the underlying FX instrument has to be specified in the Underlying Instrument field. A Compound Exercise transaction is generated based on the underlying option, with the following attributes: Opening date = date when the exercise is done Value date = date when the exercise is settled Kind = Compound Exercise The cashflow structure is similar to the buy/sell of the underlying option, plus the closing cashflows. • Cancellation It is possible to cancel the generated transaction (Compound Exercise, No Exercise). 10.8.4.3.2 Early expiration (close out) The close-out of the compound option can only take place between the opening date of the deal and the expiry date of the compound. See 10.8.1.3.4 Early expiration (close out) on page 592. 10.8.5 Average FX rate option A buyer of an average rate call option buys the right to receive a payment at the option's maturity if certain conditions are met both during the option's life and at maturity. The value of one currency for another at various points during the lifetime of an option determines whether a payment is made and the size of the payment. This option has a specific expiration date and a series of observation periods (a minimum of two) during its life, which determine the value of the option at maturity. The option will be in-the-money and a payment made to the holder only if the spot rate at expiration is less advantageous than the average of currency exchange rates accumulated during its term. Like vanilla options, the buyer of the average rate option knows the option strike from day one. 10.8.5.1 Instrument setup Average FX rate options are based on an instrument type derived from the class FX-OPTION. • Main characteristics Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 605 10 Options 10.8 FX option Average FX rate options are set up in a similar way to standard FX options, except that you can configure the type of average rate option in terms of observation dates and weights: Information Description Observation Method Choices are: Irregular and Business Days. • If you select Business Days, observation dates are defined for all business days (regarding the fixing currency at transaction level) between the spot date and the value date - the fixing offset (specified in the Netting page). • If you select Irregular, you can define the observation dates and weights at deal entry in the views Observation Date and Observation Schedule in Transaction Manager. Choices are: Irregular Weights and Equally Weighted (default). Weighting Method Note: Only editable when the observation method is Irregular. Average Rounding Method Average Rounding Rounding method and precision to be used for the average. See A.2.43 Average FX Rate Option on page 729. 10.8.5.2 Deal capture 10.8.5.2.1 Input data In addition to the standard deal parameters, the following mandatory information is required to enter an average FX rate option transaction. • Transaction view Note: This information defaults to the information defined at the instrument level. Information Description Observation Method Choices are: Irregular and Business Days. Weighting Method • If you select Business Days, observation dates are defined for all business days (regarding the fixing currency at transaction level) between the spot date and the value date - the fixing offset (specified in the Netting page). • If you select Irregular, you can define the observation dates and weights at deal entry in the views Observation Date and Observation Schedule in Transaction Manager. Choices are: Equally Weighted (default) and Irregular Weights. If you select Irregular Weights, you will need to enter the weights manually at the transaction level in the Observation Date view. Note: Only editable when the observation method is Irregular. Average Rounding Method Average Rounding Rounding method and precision to be used for the average. The Fixing Calendar field can be edited at the transaction level to enable the user to specify the calendar to be used to generate the observation dates. The Fixing Subscenario field can be edited to specify the subscenario to be used for FX rates observations. When the observation method is set to Business Days, the observation dates are defined by the business days (according to the fixing calendar specified at the transaction level) between spot date and value date – fixing offset (specified at the instrument level in the Netting page) 606 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option If you selected to use the Irregular method, you need to provide the relevant information in order to generate the observation dates. • Observation Schedule view Information Description Start Date Defaults to the spot date of the transaction. End Date Defaults to the transaction value value - the fixing offset. Method Combined with the specified frequency defines how often the cashflows will be generated. (Used with Frequency.) • Days, Business Days, Weeks, Months or Years: One flow every specified frequency days or business days or weeks or months or years. For example, if you select year and you specify a frequency of 1, you will have one flow every year; a frequency of 2, one flow every two years, and so on. • Times/Year: The specified frequency determines how many times per year. For example, if you specify a frequency of 1, the cashflows will be generated once per year; if you specify 2, the cashflows will be generated twice per year. • Last of Month: One flow the last day of every specified frequency month. • Months (sticky): The same as Last of Month, if the end date falls at month end, otherwise like Months. • ISDA Dates (Q): 15 March, 15 June, 15 Sept. and 15 Dec. • IMM Dates (M): One flow every 3rd Wednesday of every specified frequency month • Manual: Select if you want to be able to enter the dates directly in the Observation Date view. When this method is selected, the dates will no longer be generated from the transaction, and the following fields are cleared and are no longer editable. Frequency Convention Number of time units (to be used with Method). Convention used to adjust the observation dates: • Backward - previous business day • Following - next business day • Modified Backward - previous business day except if not in the same month (next in this case) • Modified Following - next business day except if not in the same month • None - no adjustment. (previous in this case) Holiday Calendar Additional calendar to supplement the calendar specified in the Fixing Calendar column (at the transaction level). Roll from Start Yes or No: When set to Yes, dates are calculated from Start Date rather than from the End Date. Long Stub Yes or No: To change the first coupon period to a long first coupon. By default, it is a short first coupon when the period is broken. For example, selecting Yes in the Roll from Start field causes a long last coupon. Fixed Roll Date Specific date to be used in the schedule each year, without reference to the year: for example, 15 March annually. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 607 10 Options 10.8 FX option • Observation Date Information Description Observation Date If you selected to enter the observation dates manually (Manual method in the Observation Schedule view), enter the dates, otherwise the dates generated from the inputs in the observation schedule are displayed. Weight Enter the weight if you selected the Irregular Weights method. 10.8.5.2.2 Generated data The generated cashflows are the same as for average FX rate forwards, i.e. two pseudo FX settlement flows and one option flow. 10.8.5.3 Processing This section describes the actions that can be done throughout the life of an average FX rate option transaction. See 10.8.1.3 Processing on page 588. 10.8.5.3.1 Early expiration This action is the same as for FX options, see 10.8.5.3.1 Early expiration on page 608. 10.8.5.3.2 Exercise/no exercise For average FX rate options, only cash settlement options are exercised. This action is similar to the exercise of a cash settlement FX option, except that the spot rate at exercise date is replaced by the average value of the observed FX rates, Avg FX rate. See 10.8.1.3.2 Exercise/no exercise (single option) on page 589. 10.8.5.4 Position monitoring Average FX rate options are valuated using the Theoretical valuation method. 10.8.5.4.1 Setup You need to use the specific valuation feature Average FX Rate Option Valuation to support specific Theoretical valuation of this instrument. See A.2.44 Average FX Rate Option Valuation on page 729. 608 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option 10.8.5.4.2 Calculations With the valuation feature Average FX Rate Option Valuation, the Vorst formula is used, which is initially an analytic formula for European Asian option with geometric average. Indeed, when the underlying S is assumed to be log normally distributed, its geometric average is also lognormal. Equation 10-1 FX options - Average FX rate option where – S(t) is the value of the FX rate at the time t – F(t,Ti) is the t-forward price of S(Ti) – w1,...,wi the weight of S(t1),...S(ti) – k is the largest integer such that t k ≤ t – X is the strike of the option – rrf is the risk free rate – σ m is the vanilla option volatility strike X for the mth observation day derived from the FX smile curve. Call Price: Equation 10-2 Average FX Rate Option - Call Price Put Price: Equation 10-3 Average FX Rate Option - Put Price Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 609 10 Options 10.8 FX option 10.8.6 Position monitoring There are two basic methods for valuation of FX option instruments: Quoted or Theoretical. 10.8.6.1 Setup By default, the figures are calculated using the Theoretical valuation method. This method means that both Market Value and Present Value (and Risk figures) are based on the volatility of the underlying currency pair, and the interest rates are taken from the valuation yield curves of each currency. If there is no setup for the valuation approach (FX Option Setup), the default parameters are applied. See feature A.2.189 FX Option Valuation on page 805. This default behavior can be overridden by using the Quoted valuation method in the Base Valuation Setup (see feature A.2.50 Base Valuation Setup on page 734), in which case, the behavior is different: both Market Value and Present Value (and Risk figures) are based on the volatility of the underlying currency pair, and the asset currency interest rate derived from the FX forward and spot rates. For more information about valuation models, see 10.8.6.2.2 Option valuation models on page 611. 10.8.6.2 Calculations This section describes the models and calculations of FX options. 10.8.6.2.1 Volatility smile for FX options Volatility smile is a method of adjusting the Black-Scholes valuation for options that are not at-the-money. Usually, out-of-the-money and in-the-money options are more expensive than the Black-Scholes formula would suggest. The market practice is to adjust the price by using the standard formula, but with a different (higher) volatility. This means that the volatility will be dependent not only on time to expiry of the option, but also on its 'moneyness' (extent to which the option is in/out of the money). The moneyness is measured by the delta (in fact the term of the option). δ = N[ d1 ] Note: The Greek symbol δ is represented by the word delta in numerical examples. You can view the different values of δ is given in Rate Monitor. Note: Delta is calculated using the volatility of the at-the-money option, which is the arithmetic average of the ask and bid 50% quotes. After the smile adjustment the Black Scholes formula is recalculated, and in consequence the value of is not the one corresponding to the that is used in the calculation of the smile adjustment. If δ does not fall exactly on one of the grid points given in Rate Monitor, the value of the volatility σs will be linearly interpolated from the adjacent grid points. If δ is between two grid points δ1 δ2 with δ1 < δ2 610 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option the volatility is: Equation 10-4 where σ1 σ2 are the smile volatility corresponding to the grid points δ1 δ2 respectively. Before the first and outside the last grid point we use extrapolation: Equation 10-5 Equation 10-6 The final value of sigma, used in all subsequent calculations, is σs Note: The possible time interpolation is carried for each node in the smile curve before the smile volatility is made. The volatility is given as a decimal number in the transaction column Figure Sigma. 10.8.6.2.2 Option valuation models The following sections describe the valuation models currently implemented for FX options. Vanilla and European digital options (Black-Scholes variants) This section describes a general Black-Scholes valuation formula, which can be used to valuate vanilla and European digital options. Generic payoff function: Equation 10-7 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 611 10 Options 10.8 FX option where A Asset currency payoff Se Spot FX rate on exercise date X Strike FX rate C Cash currency payoff ω Sign of the option (Call: ω = 1, Put: ω = -1) The following market data is needed: S Spot FX rate on valuation date ra Asset currency continuous rate rc Cash currency continuous rate te Time to expiry date dp Time delay between expiry and payment dates σ ATM Volatility ds Ratio between spot rate and valuation day’s rate Generic formula: Equation 10-8 Generic formula where Equation 10-9 and N is the cumulative normal distribution with zero mean and unit standard distribution. This generic formula (Equation 10-8 on page 612) applies to the following special cases: Vanilla option A = S,C = X Asset-or-nothing A = S,C = 0 Cash-or-nothing A = 0,C < 0 612 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option American options (Bjerksund-Stensland approximation) Consider an American call option with strike X and time to expiry te. If the spot rate is S and cash and asset currency interest rates are rc and ra, respectively, one can approximate the fair value by: Equation 10-10 where the parameters are given by the following formulas: Equation 10-11 Note: Parameter I is the trigger price that determines whether it as optimal to exercise the option immediately. The function φ is defined as: Equation 10-12 where Equation 10-13 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 613 10 Options 10.8 FX option The value of a put is calculated by reversing the asset and cash currencies, and considering the option as a call: Equation 10-14 Barrier FX Options If we assume continuous monitoring and zero spot lag, there exists an analytic solution for European single barrier options (see Haug, E. G. The Complete Guide to Option Pricing Formulas, McGraw-Hill 1997). There is also an infinite series solution for European double barrier options (see Zhang, P.G. Exotic Options, 2nd Ed, World Scientific). Basic functions We start by defining the following functions φ i i, which are solutions to the Black-Scholes partial differential equation: Equation 10-15 Black-Scholes partial differential equation where we use the shorthands and and where 614 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option Spot Adjustment Theoretical formulas are usually given in a framework where the spot rate S is immediate. To make an adjustment for the real world, the term ds = Dc / Da is used where Dc and Da are discount factors between the spot date and the valuation date in cash and asset currency, respectively. The pricing formulas will be linear combinations of the basic functions, such that they will satisfy the barrier conditions at the barrier(s), and the final condition on the exercise day. The option with rebates can be valued in parts. That is the fair value of the option is equal to the value of the option without rebates plus the value of the possible rebates. Double barrier options Double barrier option price is given by an infinite sum of terms, which in normal cases converge fast, so that it is sufficient to use a low number of terms in the approximation of fair value. Summation terms are included as long as the new term contributes more than a millionth part to the previous value of the sum. We define the components that will be used in the summations, first, the components for the asset and cash parts of the option itself. • Call Asset Equation 10-16 Double Barrier component Call Asset • Call Cash Equation 10-17 Double Barrier component Call Cash • Put Asset Equation 10-18 Double Barrier component Put Asset Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 615 10 Options 10.8 FX option • Put Cash Equation 10-19 Double Barrier component Put Cash Then the components used for rebate valuation: • Lower Barrier Rebate Equation 10-20 Lower Barrier Rebate • Upper Barrier Rebate Equation 10-21 Upper Barrier Rebate • No-Knock Rebate Equation 10-22 No-knock rebate Finally, we collect the previously defined components to calculate the fair value of a double barrier option with rebates. • Knock-Out option The fair price for the option is given as the sum: Equation 10-23 Knock-out option fair price 616 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option Where E is the value of the option itself (without rebates), which for a call is: Equation 10-24 Knock-out option Call and for a put: Equation 10-25 Knock-out option Put U Ra is the value of the upper barrier rebate of A U in asset currency: Equation 10-26 Knock-out option upper barrier rebate (asset) L Ra is the value of the lower barrier rebate A L in asset currency: Equation 10-27 Knock-out option lower barrier rebate (asset) U R c is the value of the upper barrier rebate C U in cash currency: Equation 10-28 Knock-out option upper barrier rebate (cash) and R L c is the value of the lower barrier rebate C L in cash currency: Equation 10-29 Knock-out option lower barrier rebate (cash) • Knock-In option Fair price is given as the sum: Equation 10-30 Knock-in option fair price P–E+F where P is the price of the corresponding vanilla option, E is the price of the corresponding knock-out option (without rebates), and F is the value of the no-knock rebate: Equation 10-31 Knock-in option No knock rebate Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 617 10 Options 10.8 FX option if the rebate R is in the asset currency, and Equation 10-32 Knock-in option rebate if the rebate is in the cash currency. Single barrier options If we assume continuous monitoring, there exists a closed form solution for single barrier options. A single barrier option is equivalent to a double barrier option where one of the barriers is either zero or infinity. In these cases, all components with n ≠ 0 will disappear, and the infinite sums described in basic and double barrier options are replaced with simple formulas. • Knock-Out option The fair value is: E + Ra + Rc where E is the value of the pay-off, and R a and R c are the values of the asset and cash currency rebates of amounts A and C, respectively, paid in case the option is knocked out. The formulas for these components are: Down-and-Out Call Equation 10-33 Down-and-out call Down-and-Out Put Equation 10-34 Down-and-out put 618 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option Up-and-Out Call Equation 10-35 Up-and-out call Up-and-Out Put Equation 10-36 Up-and-out put • Knock-In option The fair value is: P–E+F Where P is the value of the corresponding vanilla option, E is the value of the corresponding knock-out option (excluding possible rebates), and F is the value of the rebate of amount E R , given in different cases by: Down-and-in option, rebate in asset currency: Equation 10-37 Down-and-in option, rebate in asset currency Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 619 10 Options 10.8 FX option Down-and-in option, rebate in cash currency: Equation 10-38 Down-and-in option, rebate in cash currency Up-and-in option, rebate in asset currency: Equation 10-39 Up-and-in option, rebate in asset currency Up-and-in option, rebate in cash currency: Equation 10-40 Up-and-in option, rebate in cash currency 10.8.6.2.3 Numerical examples Example 1 - European Vanilla FX option In this section, numerical examples demonstrate how the different figures are calculated for a Vanilla FX option deal. This example shows a Buy 1,000,000 (strike/deal rate of 1.25) Vanilla FX option (Call) European style transaction, with the following deal data: Setup • Data Symbol Example Date Basis (Act / B) B 360 By default, this is the date basis defined for the currency of the option position cashflow (in Currency Editor’s Journals page). Valuation Method Theoretical Valuation Date Figure Date Risk Date Figure Date Asset Risk Date Basis (Act / B) B.a 360 Cash Risk Date Basis (Act / B) B.c 365 Risk Yield Type FX Exposure Offset Continuous e_fx 1% Note: For the risk figures, the IR Exposure setup is taken from the underlying instrument of the option. If the underlying instrument has no IR exposure setup, then the Date Basis and Yield Type defined for the valuation curve(s) are used. 620 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option • • • • • Transaction data Data Symbol Example Opening Date dt_o 2006-05-24 Spot Date dt_s 2006-05-26 Nominal Amount A 1,000,000 Deal Rate F_b 1.250000 Premium Amount premium 47,960 Maturity Date dt_m 2007-05-29 Expiry Date dt_e 2007-05-25 Data Symbol Example Formula Book Value V_b 47,960.00 V_b=premium FX Quote Amount A_q -1,000,000 * 1.25 = -1,250,000.00 V_q=-A * F_b Amount (Asset) A.a -1,250,000.00 A.a=A_q Amount (Cash) A.c 1,000,000.00 A.c=A Data Symbol Example Figure Date dt_f 2006-06-15 Days to Spot d_fs 2 Figure Asset Price S 0.800000000 ATM Volatility sg 13.5% Calculated transaction data Market data on Figure Date Market data specific to the asset currency Data Symbol Example FX Conversion Rate S.a 1.25 Market Value Discount Factor Spot D_s.a 0.999444695109 Present Value Discount Factor D_P.a 0.953883042421 Market data specific to the cash currency Data Symbol Example FX Conversion Rate S.c 1.00 Market Value Discount Factor Spot D_s.c 0.999688530045 Present Value Discount Factor D_P.c 0.973261859544 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 621 10 Options 10.8 FX option Calculated data on Figure Date • Data Symbol Example Formula Time to Maturity t_m (2006-05-29 - 2006-06-15) /360 = 0.966666667 t_m=(dt_m-dt_f)/B Time to Expiry t_e (2006-05-25 - 2006-06-15) /360 = 0.955555556 t_e=(dt_e-dt_f)/B Option pricer input on the figure date • Note: Asset Expiry Rate and Cash Expiry Rate are displayed in Transaction Manager as a percentage (i.e. multiplied by 100). Data Symbol Example Formula Asset Expiry Rate r.a 0.048842288 r.a=-LN(D_P.a)/Time_to_maturity Cash Expiry Rate r.c 0.039777543 r.c =-LN(D_P.c)/Time_to_maturity Sign _sign 1 Spot S 0.8 =S Strike X 0.8 =1/F_b Sigma sg 13.50% =sg Time to Maturity t_m 0.96666667 =Time_to_maturity Time to Expiry t_e 0.95555556 =Time_to_expiry Spot Adjustment ds 1.00000002 ds = (D_s.c/D_s.a) Option figures on the figure date • Data Symbol Example Formula d1 d_1 -0.084572333 =(LN((S*ds)/X)+(r.c-r.a)*t_m+(sg*sg/2)*t_e) / (sg * sqrt (t_e)) d2 d_2 -0.216538237 =d_1-sg*SQRT(t_e) price p 0.048675215 =_sign*((S*ds)*EXP(-r.a*t_m)* Intrinsic Value v.i 0.015316878 =_sign *((ds*S)*EXP(-r.a*t_m)*0.5*(_sign * SIGN(LN(ds*S/X)+(r.c-r.a)*t_m)+1)-((X)*EXP(-r. c*t_m)*0.5*(_sign *SIGN(LN(ds*S)+(r.c-r.a)*t_m)+1))) (Method zero sigma) The Greeks • The Greeks are calculated using numerical differentiation: Equation 10-41 dp / dx = (p (x + eps) - p (x - eps)) / (2 eps) Since the spot rate is inversed, epsilon is added to (1 / S) rather than S. Data Symbol Example epsilon eps 0.000000001 622 Formula © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option Data Symbol Example price (S+/-epsilon) p_up.S 0.0486752143578562 P_dn.S 0.0486752153762781 delta delta.a -0.509210951 price (ra+/-epsilon) p_up.ra 0.0486752152608569 p_dn.ra 0.0486752144732773 p_up.rc 0.0486752144262246 p_dn.rc 0.0486752153079095 Asset Rho rho.a 0.393790 = (p_up.ra-p_dn.ra)/(2*eps) Cash Rho rho.c -0.440842 = (p_up.rc-p_dn.rc)/(2*eps) price (t +/- epsilon) p_up.t 0.048675215 p_dn.t 0.048675215 theta -0.0280628 = (p_dn.t-p_up.t)/(2*eps) price (rc+/-epsilon) Theta • • • = (p_up.S-p_dn.S)/(2*eps) IR Risk Conversion figures Data Symbol Example Formula Risk Value V_r.a 533,829.54 = A /D_P.a * rho.a / t_m * S.a V_r.c -468,572.68 = A /D_P.c * rho.c / t_m / S.c dD_dr.a -0.922086941 = -D_P.a * (dt_m - dt_f) / B.a dD_dr.c -0.927931855 = -D_P.c * (dt_m - dt_f) / B.c Data Symbol Example Formula Market Value V 48,675.21 = S.c * p * A Intrinsic Value V_i 15,316.88 = v.i*A Time Value V_t 33,358.34 = V-V_i Data Symbol Example Formula Present Value V_P.a -407,368.73 = A * _sign * ((S*ds) * EXP (-r.a*t_m) * NORMSDIST(_sign*d_1)) * S.c IR Exposure 1bp E_i.a -39.38 = V_r.a * dD_dr.a * 0.0001 / S.a FX Exposure E_fx -4,073.69 = A.c*delta.a*(e_fx_1/S.a ) Data Symbol Example Formula Present Value V_P.c 456,043.95 = A* _sign * (-X*EXP (-r.c*t_m) * NORMSDIST(_sign*d_2)) * S.c Discount factor sensitivity • Formula Valuation figures Risk figures (Asset) Risk figures (Cash) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 623 10 Options 10.8 FX option Data Symbol Example Formula IR Exposure 1bp E_i.c 43.48 = V_r.c * dD_dr.c * 0.0001 * S.c FX Exposure E_fx.c 0 Example 2 - American option This example shows a Buy 1,000,000 (deal rate of 1.25) Vanilla FX option (Call) American style transaction, with the following deal data: Setup • Data Symbol Example Instrument Date Basis (Act / B) B 360 By default, this is the date basis defined for the currency of the option position cashflow (in Currency Editor’s Journals page). Valuation Method Theoretical Valuation Date Figure Date Risk Date Figure Date Intrinsic Method Spot Asset Risk Date Basis (Act / B) B.a 360 Cash Risk Date Basis (Act / B) B.c 365 Risk Yield Type FX Exposure Continuous e_fx 1.00% Note: For the risk figures, the IR Exposure setup is taken from the underlying instrument of the option. If the underlying instrument has no IR exposure setup, then the Date Basis and Yield Type defined for the valuation curve(s) are used. Transaction data • Data Symbol Example Opening Date dt_o 2006-05-24 Spot Date dt_s 2006-05-26 Nominal Amount A -1,000,000 Deal Rate F_b 1.250000 Premium Amount premium 47,960 Maturity Date dt_m 2006-05-29 Expiry Date dt_e 2006-05-25 Data Symbol Example Formula Book Value V_b 47,960.00 V_b=premium FX Quote Amount A_q -1,000,000 * 1.25 = 1,250,000.00 V_q=-A*F_b Calculated transaction data • 624 © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option • • • • • Data Symbol Example Formula Amount (Asset) A.a 1,250,000.00 A.a=A_q Amount (Cash) A.c -1,000,000.00 A.c=A Data Symbol Example Figure Date dt_f 2006-06-15 Days to Spot d_fs 2 Figure Asset Price S 0.800000000 ATM Volatility sg 13.50% Market data on Figure Date Market data specific to the Asset Currency Data Symbol Example FX Convert (Asset) S.a 1.25 Market Value Discount Factor Spot D_s.a 0.9994446951 Present Value Discount Factor D_P.a 0.9538830424 Market data specific to the Cash Currency Data Symbol Example FX Convert (Cash) S.c 1.00 Market Value Discount Factor Spot D_s.c 0.999444714 Present Value Discount Factor D_P.c 0.962278254 Calculated data on Figure Date Data Symbol Example Formula Time to Maturity t_m (2006-05-29 - 2006-06-15) /360 = 0.966666667 t_m=(dt_m-dt_f)/B Time to Expiry t_e (2006-05-25 - 2006-06-15) /360 = 0.955555556 t_e=(dt_e-dt_f)/B Option pricer input on the figure date Note: Asset Expiry Rate and Cash Expiry Rate are displayed in Transaction Manager as a percentage (i.e. multiplied by 100). Data Symbol Example Formula Asset Expiry Rate r.a 0.048842288 r.a=-LN(D_P.a)/Time_to_maturity Cash Expiry Rate r.c 0.039777543 r.c =-LN(D_P.c)/Time_to_maturity Sign _sign 1 Spot Rate S 0.8 = Asset_Price Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 625 10 Options 10.8 FX option Data Symbol Example Formula Strike X 0.8 =1/F_b Sigma sg 13.50% =sg Time to Maturity t_m 0.96666667 =Time_to_maturity Time to Expiry t_e 0.95555556 =Time_to_expiry Spot Adjustment ds 1.00000002 ds=(D_s.c/D_s.a) Option figures on the figure date • Data Symbol Example Formula beta beta 3.312531702 =(0.5-(r.c-r.a)/(sg*sg)+SQRT(POWER(((r.c-r.a)/(s g*sg)-0.5),2)+2*r.c/(sg*sg))) b_zero b_zero 0.800000000 =MAX(X,X*r.c/r.a) b_inf b_inf 1.145941203 =X*Beta/(Beta-1) ht ht -0.590319833 =-((r.c-r.a)*t_e+2*sg*SQRT(t_e))*B_zero/(B_infB_zero) I I 0.954237878 =B_zero+(B_inf-B_zero)*(1-EXP(ht)) alpha alpha 0.180127088 =(I-X)*POWER(I,-Beta) Part_1 0.086012493 =Alpha*POWER(S,Beta) Part_2 0.063193409 =Alpha *phi(S,t_e,Beta,I,I,r.c,r.c-r.a,sg) Part_3 0.624830099 =phi(S,t_e,1,I,I,r.c,r.c-r.a,sg) Part_4 0.378776110 =phi(S,t_e,1,X,I,r.c,r.c-r.a,sg) Part_5 0.653506387 =X*phi(S,t_e,0,I,I,r.c,r.c-r.a,sg) Part_6 0.422404879 =X*phi(S,t_e,0,X,I,r.c,r.c-r.a,sg) price p 0.037771565 =part_1 -part_2+part_3-part_4-part_5+part_6 Intrinsic Value (method zero sigma) v.i 0.000000000 =_sign *MAX((_sign * (S - X)), 0) The Greeks • The Greeks are calculated using numerical differentiation: Equation 10-42 dp / dx = (p (x + eps) - p (x - eps)) / (2 eps) Data Symbol Example epsilon eps 0.000000010 price (S+/-epsilon) p_up.S 0.0377715699692693 P_dn.S 0.0377715601162298 delta.a 0.492651975 delta 626 Formula = (p_up.S-p_dn.S)/(2*eps) © Wall Street Systems IPH AB - Confidential 10 Options 10.8 FX option Data Symbol Example price (ra+/-epsilon) p_up.ra 0.0377715619439786 p_dn.ra 0.0377715681415203 p_up.rc 0.03777156789416 p_dn.rc 0.0377715621913389 Asset Rho rho.a -0.309877 = (p_up.ra-p_dn.ra)/(2*eps) Cash Rho rho.c 0.285141 = (p_up.rc-p_dn.rc)/(2*eps) price (t +/- epsilon) p_up.t 0.0377715652147856 p_dn.t 0.037771564870713 theta -0.0172036 = (p_dn.t-p_up.t)/(2*eps) price (rc+/-epsilon) Theta • IR Risk Conversion figures Data Symbol Example Formula Risk Value V_r .a -525,094.68 = A.a /D_P.a * rho.a / t_m *S.a V_r.c 383,170.75 = A.a /D_P.c * rho.c / t_m / S.c dD_dr.a -0.922086941 = -D_P.a * (dt_m - dt_f) / B.a dD_dr.c -0.917459814 = -D_P.c * (dt_m - dt_f) / B.c Data Symbol Example Formula Market Value V 47,214.46 =S.c*p*A.a Intrinsic Value V_i 0.00 =v.i*A Time Value V_t 47,214.46 =V-V_i Data Symbol Example Formula Present Value V_P.a 469,932.36 = A.a * _sign * (EXP (-r.a*t_m) * delta.a)*S.a IR Exposure 1bp E_i.a 38.73 = V_r.a * dD_dr.a * 0.0001 / S.a FX Exposure E_fx 4,926.52 = A.a *delta.a*(e_fx_1/S.a ) Data Symbol Example Formula Present Value V_P.c -422,717.91 =V - V_P.a IR Exposure 1bp E_i.c -35.15 = V_r.c * dD_dr.c * 0.0001 * S.c Discount factor sensitivity • • • Formula Valuation figures Risk figures (Asset) Risk figures (Cash) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 627 10 Options 10.9 Exchange traded FX option 10.9 Exchange traded FX option TBC 628 © Wall Street Systems IPH AB - Confidential Chapter 11 Swaps 11.1 Interest rate swap In TRM, a Swap instrument refers to an Interest Rate (IR) Swap. An IR swap is an agreement between two counterparties to exchange interest rate payments on an amount over a pre-defined period: the amount is notional for single-currency swaps. The most common structure is the fixed-for-floating swap in which one counterparty agrees to pay a fixed rate over the term of the swap in exchange for a floating-rate payment payable by the other counterparty. Another structure, usually called Basis Swap, consists of exchanging two floating-rates linked to different market references. Swaps are also used to create Asset Swaps, where one leg is a bond. In addition, swaps can be cross-currency, which means that the legs are denominated in different currencies: see 11.1.3 Cross-currency swap on page 656. IR swap instruments are based on an instrument type derived from the instrument class SWAP. 11.1.1 Single-currency IR swap The following information is relevant to any kind of single-currency swap. For more information relating to the setup and structure of specific types of single-currency swaps, see: • 11.1.1.1.1 Plain vanilla single-currency on page 631 • 11.1.1.1.2 Zero-coupon single-currency on page 631 • 11.1.1.1.3 Single-currency with upfront on page 632. 11.1.1.1 Instrument setup • Main characteristics for single-currency swaps – Legged Information Description Sign Sign of the transaction. If the sign is not defined at instrument level, it needs to be specified separately for each transaction. Leg Structure The leg structure for the swap instrument. Select a two leg swap structure. TRM supports swap structures with multiple legs. Pseudo Settlement Select these options to make the principal notional (no exchange of capital). Pseudo Repayment Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 629 11 Swaps 11.1 Interest rate swap – Legs Typically, you need to specify the leg instrument and the sign of the leg versus the transaction. If this information is not defined at the instrument level, then it must be specified at deal entry. Information Description Instrument The instrument to be used for this leg by default. Sign versus Transaction Choose from: Same, Opposite, or Any. See A.2.307 Swap on page 866. • Maturity definition It is possible to set up maturity information at instrument level. Information Description Calendar parameters Calendars used to calculate the maturity date. Gap Set Gap set used for supplying the available maturity periods. Maturity Date Period If defined, this maturity period is applied to each transaction. See A.2.230 Maturity Date Setup on page 827. • Upfront cashflow definition To create a payable upfront cashflow, use the Swap, Upfront trading feature. See A.2.316 Swap, Upfront on page 869. • Result treatment setup The default method is Swap (Book, FX Rate). See A.2.308 Swap (Book, FX Rate) on page 867. • IR Pricer definition To characterize the swap in terms of callable (yes or no), leg type (fix or floating) and swap type (single currency or cross currency). This feature identifies the swap instrument to be used in the IR Pricing tool. See A.2.222 IR Pricer (Swap) on page 824 and see TRM User Guide for more general information about IR Pricing. 630 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap • Valuation – If the valuation feature Single Swap Valuation or NumeriX Single-Swap Valuation or NumeriX Valuation is set at the instrument level, the valuation setup is retrieved from the swap. See A.2.302 Single Swap Valuation on page 863, A.2.251 NumeriX Single-Swap Valuation on page 840 or A.2.253 NumeriX Valuation on page 841. – If the valuation feature Swap Valuation or Swap Per Leg Valuation is set at the instrument level, the valuation setup is retrieved from the leg instrument. See A.2.310 Swap Valuation on page 867 or A.2.313 Swap Per Leg Valuation on page 868. – If the valuation feature NumeriX Swap Valuation is set up at the instrument level, the set up defaults to the first leg instrument. See A.2.252 NumeriX Swap Valuation on page 841. For more information about the valuation defaulting see 11.1.1.4 Position monitoring on page 640. It is also possible to set up: • Spot day and value date calculations • Manual charges • Cashflow and transaction charge rules • Branch codes. See Appendix A Features on page 713. 11.1.1.1.1 Plain vanilla single-currency A swap where value and maturity date principals are notional (that is, not settled), in the same currency, and their absolute amounts are equal. For a plain vanilla single-currency swap, the structure can be demonstrated as follows: Notional Notional • Instrument setup – Swap characteristics Information Description Leg Structure SWAP-2-LEGS Pseudo Settlement Both these options should be selected. Pseudo Repayment 11.1.1.1.2 Zero-coupon single-currency A swap where one leg pays no interest. Instead, the redemption amount is split into a notional component and a payable component. The other leg pays interest on a notional amount that is equal to the notional component of the zero-coupon leg. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 631 11 Swaps 11.1 Interest rate swap For a zero-coupon single-currency swap, the structure can be demonstrated as follows: Redemption flow = Pseudo Redemption + Payable Redemption Premium • Instrument setup – Swap characteristics Information Description Leg Structure SWAP-2-LEGS-ZERO Pseudo Settlement Both these options should be selected. Pseudo Repayment – Schedule structure for the leg instrument TRM provides a pre-defined system template (see B.2.1.1.47 Zero-Coupon Swap Leg on page 899) designed for this purpose. With this schedule, the redemption flow of the underlying is split into a pseudo Redemption flow and a payable Redemption Premium flow. See Appendix B Schedules on page 883. 11.1.1.1.3 Single-currency with upfront A swap where the value and maturity date principal amounts are notional (that is, not settled), in the same currency, and their (absolute) amounts are equal. A separate settled upfront cashflow is created for the value date, for the leg(s) where Deal Price is more or less than 100, calculated as follows: (100 - Deal Price) / 100 * Nominal Amount The upfront cashflow is booked according to the result treatment definition of the swap instrument. For a single-currency swap with an upfront cashflow, the structure can be demonstrated as follows: Notional Upfront cashflow Notional • Instrument setup – Swap characteristics Information Description Leg Structure SWAP-2-LEGS Pseudo Settlement Both these options should be selected. Pseudo Repayment – 632 Upfront cashflow definition © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap To create a payable upfront cashflow, use the Swap, Upfront trading feature. See A.2.316 Swap, Upfront on page 869. 11.1.1.2 Deal capture Note: To perform pricing of swap transactions, you can use the IR Pricing tool. See TRM User Guide for more information about IR Pricing. 11.1.1.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a swap. • Transaction view You input data for Leg 1 of the swap as this is used as a basis for the calculations on the remaining legs. Information Description Currency Currency of the swap. Value Date Date when the swap starts, and from which interest starts to accrue. This defaults to the spot date of the transaction. Maturity Date Date when the transaction matures. If you enter a maturity code, the date is calculated automatically based on the maturity definition at instrument level; otherwise you can enter the date manually. Nominal Amount Amount of the first leg of the swap. Deal Price Price used for the first leg of the swap (100 in the case of a vanilla swap). Note: If you want to have an up-front premium/discount, enter a price <> 100: this will apply on the first leg. In addition, the following optional information can be captured: Information Description Value Date Code If the Value Date Setup feature is applied at instrument level, you can enter the value date period you want to use to calculate the value date for the transaction, for example, 3M (3 months). This can be used to compute the value date for a forward purchase of an IR swap. Note: If you specify a value date period in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.339 Value Date Setup on page 879. Maturity Code If you enter a maturity code at deal entry, the date is calculated automatically; otherwise you can enter the date manually. Note: If the maturity definition parameters are defined at instrument level, these are used by default and cannot be modified. • Leg view If the legs are not defined on the swap instrument they must be selected here. The relevant instruments for legs are loans. If you want to create an asset swap it is also possible to choose a bond as one of the legs. The cashflow structure of each leg should also be selected (when the leg is a loan without a predefined cashflow structure). • Schedule view Schedule information must be provided for each leg. See A.2.202 Generic Loan on page 812. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 633 11 Swaps 11.1 Interest rate swap 11.1.1.2.2 Generated data • Cashflows For a vanilla single-currency swap the cashflow structure is as follows: Fixed interest Notional Notional Floating interest Spot Opening date Maturity Maturity date Value date 11.1.1.3 Processing This section describes the actions that can be done throughout the life of a swap. 11.1.1.3.1 Pricing Pricing of swap transactions can be performed at transaction level using a right-click processing action. • Setup A choice of three types of Pricing action are available on the transaction if the Swap Pricing feature is associated with the instrument: Goal Seeker, Annuity, or Spread. See A.2.314 Swap Pricing on page 868. • Execution – Goal Seeker Information Description Variable Parameter to use as the variable. Choose from: Spread or Fixed. Context Entity to which the variable belongs. Choose from: Schedule or Leg. Target Key-figure that you want to modify: Market Value. Target Value Value that you want to achieve. Result (Information only) Calculated value of the variable after pricing. – Annuity This Pricing action allows you to convert the Upfront payment into Annuity using the funding rate. 634 Information Description Funding Rate % Funding rate expressed as a percentage. © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Information Description Annuity (Information only) Calculated Annuity amount after pricing. – Spread The Spread Pricing action is carried out in two steps. In the first step, the Upfront amount is converted into Annuity using the funding rate. Information Description Funding Rate % Funding rate expressed as a percentage. Annuity (Information only) Annuity amount calculated from the Upfront and funding rate. In the second step, the Annuity amount and the funding rate are both used to calculate the spread. Information Description Annuity (Information only) Funding Rate Values taken from the first step in the Pricing action. Target Market Value Value that you want to reach. All-In Switch on to take into account any fees which have the All-In attribute. Re-Offer Switch on to take into account any fees which have the Re-Offer attribute. Spread % (Information only) Calculated Spread value expressed as a percentage. 11.1.1.3.2 Early expiration Swaps can be closed-out earlier than their agreed maturity date. This process is referred to as early expiration. Note: Early expiration is also available for forward interest rate swaps. • Execution Early expiration of a swap requires the following information: Information Description Opening Date Date when the early expiration is executed. By default, this is today’s date unless a Fixing/Action Date is specified at transaction level. Value Date Date when the early expiration is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Settlement Date Date when early-expiration price is paid. Can be different for each leg. Amount to Expire Amount to be early expired. This defaults to the amount still available to be early expired, taking into account previous partial early expirations and roll overs. Settlement Amount Method • Clean Price: AI is created as Payable cashflow and P/L flow is the difference between early-expiration price and original deal price. • Dirty Price: AI is created as Not Payable cashflow, and P/L flow is reduced by the AI amount. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 635 11 Swaps 11.1 Interest rate swap Information Description Net Amount Net amount to be settled between the two parties. Options • If Settlement Amount method is Clean, Net Amount = Sell Profit/Loss). • If Settlement Amount method is Dirty, Net Amount = Accrued Interest + Sell Profit/Loss. • Amortize P/L Switch on Amortize P/L to amortize the P/L from the value date until the original maturity date. If this switch is off, the Sell P/L flow created by the early expiration (arising from Net Amount – Accrued Interest) occurs on the early expiration value date. • No Fee Realization Switch on No Fee Realization so that fees keep amortizing to maturity. For example, this can be used in the case of an asset swap, which mirrors the issue fees, to keep the fees amortizing even when the asset swap is fully unwound. If this switch is off, at early expiration, the fees that were amortizing until the maturity date are closed. The execution generates an early expiration transaction with the following attributes: Transaction sign = opposite of initial transaction Nominal amount = amount to expire Opening date = date when the early expiration is done Value date = date when the early expiration is settled Kind = Early Expiration The remaining attributes are inherited from the initial transaction. The early expiration transaction generates closing cashflows for the initial transaction and P/L cashflows if there is a difference between the early expiration price and the original deal price. When there is an amortized upfront cashflow, the accrued portion is realized on the early expiration date. • Cancellation You can undo the early expiration by canceling the early expiration transaction. 11.1.1.3.3 Roll over You can defer the maturity of an a one-leg IR swap acting as a guarantee to a later date. This process is referred to as a roll-over. • Setup This process is available on the transaction if the Allow Roll Over (Guarantee) feature is associated with the instrument. See A.2.18 Allow Roll Over (Guarantee) on page 720. • Execution The following information is needed to process the roll-over: Information Description Roll Over Date Date when the roll-over is executed. Roll Over Method Roll-over method: Settle All. Nominal Amount Amount of the roll-over. This defaults to the amount left of the initial transaction but you can override this if you want to perform a partial roll-over. 636 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Information Description Gap Gap set used for supplying the maturity date. This defaults to the maturity period of the initial transaction but can be modified. Maturity Date New maturity date for the IR swap. This must be later than the maturity date of the initial transaction. The maturity date is calculated automatically from the maturity period of the initial transaction. The initial transaction is paid in its entirety at the initial maturity date. The default nominal amount of the roll-over transaction equals the sum of the interest and principal cashflows of the initial transaction. The execution generates a new transaction with the following attributes: Nominal amount = amount (can be smaller than the initial transaction) Opening date = date when the roll-over is done Value date = maturity date of the initial transaction Maturity date = maturity of the roll-over Kind = Roll-over • Cancellation You can undo the roll-over by canceling the roll-over transaction. 11.1.1.3.4 Trade assignment Trade assignments are changes of ownership of transactions. • Execution Change of ownership during the life of a transaction can be performed in two steps: – Right-click the existing transaction and choose Assignment (sale) action. This action closes the existing transaction, and when required, exchanges settlement amounts between the old and new owners of the transaction. – Right-click the generated transaction and choose Assignment (purchase) action. This action creates the new transaction with the new owner. Assignment (sale) of a transaction to another client requires the following information: Information Description Opening Date Date when the early expiration is executed. By default, this is today’s date unless a Fixing/Action Date was specified at transaction level. Value Date Date when the early expiration is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Settlement Date Date when assign price is paid. Amount Left Read-only. Remaining amount of the initial transaction. Assignee New owner of the transaction. Net Amount Method Clean Amount: AI is created as Payable cashflow. Dirty Amount: AI is created as Not Payable cashflow, and P/L flow is reduced by the AI amount. Net Amount (leg1/leg2) Amount to be settled between old and new owners. Currency (leg1/leg2) Read-only. Currency of the leg. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 637 11 Swaps 11.1 Interest rate swap Information Description Accrued Interest (leg1/leg2) Read-only. Interest accrued on specified date. Switches • Amortize P/L Switch on Amortize P/L to amortize the P/L from the value date until the original maturity date. If this switch is off, the Sell P/L flow created by the assignment (arising from Net Amount – Accrued Interest) occurs on the assign value date. • No Fee Realization Switch on No Fee Realization so that fees keep amortizing to maturity. If this switch is off at assignment, the fees that were amortizing until the maturity date are closed. Execution generates an Assignment transaction with following cashflows: – Cashflows to close the future cashflows of the original transactions (closing of cashflows where payment date is after the assignment value date) – Settlement flows between the assignor and the assignee, reflecting the settlement amounts. The generated transaction has the following attributes: Information Description Transaction Sign Opposite of the original transaction sign. Nominal Amount Amount to assign. Opening Date Opening date of action. Value Date Value date of action. Kind Assignment. The original transaction remains unchanged. On this closing transaction, the assignee can select the Assignment (purchase) action to generate the future flows of its new transactions. A dialog allows the user to select the portfolio. A new transaction is generated, reflecting the future cashflows of the original transaction and settlement flows between assignee and assignor. Note: The Counterparty field is open, to allow Counterparty change if required. Assignment can also be done from an external counterparty. You can capture an IRS by supplying the net amount according to the specified settlement method. In the Action menu, choose Assignment (purchase), see TRM User Guide. • Cancellation You can undo the assignment action by canceling the generated assignment transaction. 11.1.1.3.5 Changing the counterparty of a transaction You can terminate the existing transaction against one counterparty and reopen it against another counterparty. The following information is required: 638 Information Description Opening Date Date when the transfer is executed. By default, this is today’s date unless a Fixing/Action Date was specified at transaction level. © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Information Description Value Date Date when the transfer is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Counterparty New counterparty for the transaction. A transaction will be generated whose Kind is Counterparty Conversion. The characteristics of the new transaction will be the same as the old one, except for Counterparty and opening/value date. This action generates closing cashflows for the future cashflows from the original transaction, and futures cashflows between the original owner and the new counterparty. No settlement/result flows will be affected in the generated transaction, as the assignment is between the counterparties only. The generated transaction can be cancelled to undo the action. 11.1.1.3.6 Transferring transactions between portfolios You can transfer the transaction from one portfolio to another. This is effectively a sale in one portfolio and a purchase in another. Portfolio transfer of an existing transaction can be performed at transaction level by right-clicking and choosing Transfer. Transfer of a transaction to another portfolio requires the following information: Information Description Opening Date Date when the transfer is executed. By default, this is today’s date unless a Fixing/Action Date was specified at transaction level. Value Date Date when the transfer is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Settlement Date Payment date for settlement flows. New Portfolio New portfolio for the transaction No Settlement switch If On, the generated settlement amount is marked as pseudo (i.e. not bookable, not payable). Net Amount Method Clean: AI is created as Payable cashflow. Net Amount (leg1/leg2) Amount to be settled between old and new owners. Currency (leg1/leg2) Read-only. Currency of the leg. Accrued Interest (leg1/leg2) Read-only. Interest accrued on specified date. Options • Amortize P/L • No Fee Realization Dirty: AI is created as Not Payable cashflow, and P/L flow is reduced by the AI amount. Two Transfer transactions are generated: 1. A sale is created in the source portfolio of the transfer, i.e. closing cashflows of the original transaction and settlement flows (real or pseudo, depending on inputs). 2. A purchase is then created in the receiving portfolio, with future flows and settlement flows (real or pseudo, depending on inputs). The original transaction remains unchanged. The user can undo the portfolio transfer action by canceling the generated transactions. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 639 11 Swaps 11.1 Interest rate swap 11.1.1.3.7 Transaction Conversion To allow schedule conversion at predefined dates during transaction's life. • Setup This process is available on the transaction if the Transaction Conversion feature is associated with the instrument. See A.2.325 Transaction Conversion on page 873. Then, the user is allowed to attach the Conversion schedule to the existing schedule and to define conversion events and converted schedules. • Execution When conversion schedules are defined, the user is allowed to execute generated conversion events. The conversion inputs are displayed. See A.2.325 Transaction Conversion on page 873. The execution generates a conversion transaction with following attributes: – Kind: Conversion – Opening Date: Conversion opening date – Value Date: Conversion value date The conversion transaction generates closing cashflows for the initial transaction. If the conversion price is different to the original deal price, then a P/L flow is generated, showing the differences between the conversion price and the original deal price. On a non-converted leg, future cashflows are reopened as a new transaction and remain unchanged. 11.1.1.4 Position monitoring 11.1.1.4.1 Setup Assuming that the relevant valuation features are attached to the instrument (11.1.1.1 Instrument setup on page 629), the valuation setup is defined by the following features depending on the Pricing mode. TRM valuation setup • The estimation curves default in IR Pricing when these are defined at the instrument level (feature Estimation Curve Setup). • The valuation curves default in IR Pricing when these are defined at the instrument level (feature Valuation Curve Setup). • The risk profile defaults in IR Pricing when defined at the instrument level (feature Floating Valuation Setup). • The values defined for FX method and valuation default in IR Pricing when defined at the instrument level (feature Base Valuation Setup). • The volatility surfaces default in IR Pricing when these are defined at the instrument level (feature Volatility Surface Setup) as follows: 640 – The volatility curve in IR Pricing defaults to volatility reference set defined at the instrument level, with the usage Volatility. If not defined, uses the Cap/Floor volatility reference attached to the currency. – The adjust volatility curve in IR Pricing defaults to volatility reference set at instrument level with the usage Adjust Volatility. If not defined, uses the Swaption volatility reference attached to the currency. © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Numerix valuation setup • The estimation curves default in IR Pricing when these are defined at the instrument level (feature Estimation Curve Setup). • The calibration id, model, quality and analytic quality default in IR Pricing when these are defined at the instrument level (feature Numerix Setup). Valuation setup defaulting • If the TRM valuation setup is not defined, then uses the default valuation defined in the currency as it does now. • If the NumeriX valuation (feature Numerix Valuation) is not defined, then it defaults to the Hull and White model. Risk calculation setup The cashflow discounting method (periodic, continuously compounded) used in IR risk calculation depends on the instrument setup: • By default, if no IR exposure is set up at leg- or top instrument level, then TRM uses the valuation curve interpolation settings (IR Quote and Yield Curve Editor - Interpolation page). • If IR exposure is set up at the leg instrument level, then TRM uses these settings, it uses top instrument level. For example, If IR exposure is set up with Yield Type Periodic, then risk calculations use periodic discounting of the cashflows. See A.2.48 Base IR Exposure Setup on page 732. For more information about risk calculations, see 2.3 Key-figures on page 112. 11.1.1.4.2 Calculations In this section, numerical examples demonstrate how the different figures are calculated for a vanilla IR swap. For information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. For information about how modified duration is calculated for IR Swaps, see 2.3.4.9.5 Modified Duration on page 145. This example shows a 2-leg IR swap in EUR, with the following deal data: • Setup Setup data Instrument Date Basis Act/360 Instrument Yield Type Periodic Valuation Method Theoretical Risk Method Theoretical Valuation Date Figure Date Risk Date Figure Date Risk Yield Type Continuous Fixed Leg Coupon Rate 4.00% Floating Leg Risk Profile Plain Vanilla (simple risk) Leg Structure SWAP-2-LEGS Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 641 11 Swaps 11.1 Interest rate swap Transaction data • Transaction data Opening Date dt_o 2002-02-22 Nominal Amount c_m 1,000,000 Spread r_s 0.50% Maturity Date d_m 2005-02-22 Spot Date ds 2002-02-22 Market data • Unless otherwise stated, the figure date used in the calculations is 2002-06-15. On this date, the market data is as follows: Market data on 2005-06-15 Figure date dt_f 2002-06-15 Days to Spot d_fs 3 Discount Rate r_d 3.044986% Other data is calculated by the system as follows: • - Time to Spot t_s = d_fs / B 0.008333333 = 2002/06/15 / 360 - MV Spot Discount Factor D_s = EXP (-t_s * r_d) = 0.9997462834 11.1.1.4.3 Fixed leg Transaction data specific to the principal flow of the fixed leg is as follows: Transaction data Value Date dv.p 2005-02-22 Amount A = c_m 1,000,000 On the figure date, the market data specific to the principal amount of the fixed leg is as follows: Market data on 2002-06-15 Interest Rate r.p 4.585862% Other data, specific to the principal amount of the fixed leg is calculated by the system as follows: • Time to Value Date tv = (dv.p - dt_f) / B 2.730555556 = (200502/22 – 2002/06/15) / 360 • Market Value Discount Factor D_V.p = D_s * D.p = 0.8824165107 • Present Value Discount Factor D_P.p = D_s * D.p = 0.8824165107 • Discount Factor From Spot D.p = EXP( -(tv.p - t_s) * r.p) = 0.8826404512 642 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Transaction data specific to the coupon flows of the fixed leg is as follows: Transaction data Coupon 1 Value Date dv.c1 Coupon 2 2003-02-22 dv.c2 Coupon 3 2004-02-22 dv.c3 2005-02-22 Calculated transaction data specific to the coupon flows of the fixed leg is as follows: • Coupon 1 Period t_p1 = (dv.c1 - ds) / B 1.01 = (2003/02/22 - 2002-02-22) / 360 Amount A.c1 = c_m * t_p1 * r_c 40,555.56 = 1,000,000 * 1.01 * 0.04 • Coupon 2 Period t_p2 = (dv.c2 – dv.c1) / B 1.01 = (2004/02/22 - 2003-02-22) / 360 Amount A.c2 = c_m * t_p2 * r_c 40,555.56 = 1,000,000 * 1.01 * 0.04 • Coupon 3 Period t_p3 = (dv.c3 - dv.c2) / B 1.02 = (2005/02/22 – 2004/02/22) / 360 Amount A.c3 = c_m * t_p3 * r_c 40,666.67 = 1,000,000 * 1.02 * 0.4 On the figure date, the market data specific to the coupons of the fixed leg is as follows: Market data Coupon 1 Interest Rate r.c1 Coupon 2 3.590392% r.c2 Coupon 3 4.177677% r.c3 4.585862% Other data specific to the coupon flows of the fixed leg is calculated by the system as follows: • Coupon 1 Time to Value Date tv.c1 = (dv.c1 - dt_f) / B 0.700000 = (2003/02/22 – 2002/06/15) / 360 Market Value Discount Factor D_V.c1 = D_s * D.c1 = 0.9752247775 Present Value Discount Factor D_P.c1 = D_s * D.c1 = 0.9752247775 Discount Factor From Spot D.c1 = EXP( -(tv.c1 - t_s) * r.c1) = 0.9754722711 • Coupon 2 Time to Value Date tv.c2 = (dv.c2 - dt_f) / B 1.713888889 = (2004/02/22 – 2002/06/15 / 360 Market Value Discount Factor D_V.c2 = D_s * D.c2 = 0.9309903649 Present Value Discount Factor D_P.c2 = = D_s * D.c2 = 0.9309903649 Discount Factor From Spot D.c2 = EXP( -(tv.c2 - t_s) * r.c2) = 0.9312266326 • Coupon 3 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 643 11 Swaps 11.1 Interest rate swap Time to Value Date tv.c3 = (dv.c3 – dt_f) / B 2.730555556 = (2005/02/22 – 2002/06/15) / 360 Market Value Discount Factor D_V.c3 = D_s * D.c3 = 0.8824165079 Present Value Discount Factor D_P.c3 = D_s * D.c3 = 0.8824165079 Discount Factor From Spot D.c3 = EXP( -(tv.c3 - t_s) * r.c3) = 0.8826404485 Valuation figures – fixed leg The valuation method commonly used for a vanilla IR swap is the Theoretical method. • Principal flow Market Value V = c_m * D_V.p 882,416.51 = 1,000,000 * 0.8824165107 • Coupon 1 Market Value V.c1 = A.c1 * D_V.c1 39,550.78 = 40,555.56 * 0.9752247775 • Coupon 2 Market Value V.c2 = A.c2 * D_V.c2 37,756.83 = 40,555.56 * 0.9309903649 • Coupon 3 Market Value V.c2 = A.c3 * D_V.c3 35,884.94 = 40,666.67 * 0.8824165079 • Total Fixed Market Value = V.p + V.c1 + V.c2 + V.c3 = 995,609.06 Result figures – fixed leg The setup of the instrument impacts the way result figures are computed. • Principal flow Total Profit Total_Profit.p = V.p = 882,416.51 MtoM Profit MtoM_Profit.p = A * D.p 882,640.45 = 1,000,000 * 0.88264045.12 Other Profit Other_Profit.p = Total_Profit.p - MtoM_Profit.p -223.94 = 882,416.51 -882,640.45 • Coupon 1 Total Profit Total_Profit.c1 = V.c1 = 39,550.78 Accrued Interest Accrued_Interest.c1 = (dt_f - dt_o) / (dv.c1 - dt_o) * A.c1 12,555.56 = (2002/06/15 – 2002/02/22) / (2003/02/22 – 2002/02/22) * 40,555.56 MtoM Profit MtoM_Profit.c1 = A.c1 * D.c1 - Accrued_Interest.c1 27,005 = 40,555.56 * 0.9754722711 – 12,555.56 644 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Other Profit Other_Profit.c1 = Total_Profit.c1 - Accrued_Interest.c1 - MtoM_Profit.c1 -10.04 = 39,550.78 – 12,555.56 – 27,005.26 • Coupon 2 Total Profit Total_Profit.c2 = V.c2 = 37,756.83 MtoM Profit MtoM_Profit.c2 = A.c2 * D.c2 37,766.41 = 40,555.56 * 0.9312266326 Other Profit Other_Profit.c2 = Total_Profit.c2 - MtoM_Profit.c2 -9.58 = 37,756.83 – 37,766.41 • Coupon 3 Total Profit Total_Profit.c3 = V.c3 = 35,884.94 MtoM Profit MtoM_Profit.c3 = A.c3 * D.c3 35,894.04 = 40,666.67 * 0.8826404485 Other Profit Other_Profit.c3 = Total_Profit.c3 - MtoM_Profit.c3 -9.11 = 35,884.94 – 35,894.04 • Total Fixed Total Profit = Total_Profit.p + Total_Profit.c1 + Total_Profit.c2 + Total_Profit.c3 = 995,609.06 Accrued Interest = Accrued_Interest.c1 = 12,555.56 MtoM Profit = MtoM_Profit.p + MtoM_Profit.c1 + MtoM_Profit.c2 + MtoM_Profit.c3 = 983,306.17 Other Profit = Other_Profit.p + Other_Profit.c1 + Other_Profit.c2 + Other_Profit.c3 = -252.67 Risk figures – fixed leg The risk method commonly used for a vanilla IR swap is the Theoretical method. • Principal flow IR Exposure 1bp E_i.p = (A) * (-(tv.p - t_s) * D.p * D_s - t_s * D.p * D_s) * 0.0001 -240.95 = (1,000,000)*(-(2.730555556-0.008333333)*0.88264045.12*0.9997462834t_s*D.p*D_s)*0.0001 Effective Duration U_eff.p =-E_i.p / V.p / 0.0001 2.730556 = -240.95 / 882,416.51 / 0.0001 • Coupon 1 IR Exposure 1bp E_i.c1 = = (A.c1) * (-(tv.c1-t_s) * D.c1 * D_s - t_s * D.c1 * D_s) * 0.0001 -2.77 = (40,555.56)*(-(0.70000-0.008333333)*0.9754722711*0.9997462834-t_s*D.c1*D_s)*0.0001 Effective Duration U_eff.c1 = -E_i.c1 / V.c1 / 0.0001 0.70000 = -2.77 / 39,550.78 / 0.0001 • Coupon 2 IR Exposure 1bp E_i.c2 = (A.c2) * (-(tv.c2-t_s) * D.c2 * D_s - t_s * D.c2 * D_s) * 0.0001 -6.47 = (40,555.56)*(-(1.713888889-0.008333333)*0.9312266326*0.9997462834-t_s*D.c2*D_s)*0.0001 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 645 11 Swaps 11.1 Interest rate swap Effective Duration U_eff.c2 = -E_i.c2 / V.c2 / 0.0001 1.71389 = -6.47 / 37,756.83 / 0.0001 • Coupon 3 IR Exposure 1bp E_i.c3 = (A.c3) * (-(tv.c3-t_s) * D.c3 * D_s - t_s * D.c3 * D_s) * 0.0001 -9.80 = (40,666.67)*(-(2.730555556-0.0083333333)*0.8826404485*0.9997462834-t_s*D.c3*D_s)*0.0001 • Total Fixed IR Exposure 1bp = E_i.p + E_i.c1 + E_i.c2 + E_i.c3 = 2.611335896 Effective Duration = -E_i.total / V.total / 0.0001 = 2.611335896 11.1.1.4.4 Floating leg On the figure date, the market data specific to the principal flow of the floating leg is as follows: Market data on 2002-06-15 Value Date dt_v 2005-02-22 Time to Value Date tv.fp= (dt_v.fp - dt_f) / B 2.730555556 Interest Rate r.fp 0.04585862 Other figures specific to the principal flow of the floating leg are calculated by the system as follows: • DF From spot D_f.fp= EXP (-r.fp * ((dt_v.fp - dt_f )/ B - t_s)) = 0.882640448 • MV Discount Factor D_V.fp = D_s * D_f.fp = 0.882416508 Other figures calculated by the system are: • Spot Discount Factor D_s.f = EXP (-t_s * r_d) = 0.999746283 On the figure date, the market data specific to Coupon 1 of the floating leg is as follows: Market data – Coupon 1 Fixing Date dt_x.f1 2005-05-22 Value Date dt_v.f1 2002-08-22 Coupon Period p_c.1 = dt_v.f1 - dt_x.f1 92 Time to Value Date tv.f1 = (dt_v.f1 - dt_f) / B 0.188888889 Interest Rate r.f1 3.268827% Fixing Rate r_x.f1 5.0470% Other figures are calculated by the system as follows: • DF From spot D_f.f1 = EXP(-r.f1 * ((dt_v.f1 - dt_f )/ B - t_s)) = 0.994115334 • MV Discount Factor D_V.f1 = D_s * D_f.f1 = 0.0.993863111 646 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap On the figure date, the market data specific to Coupon 2 of the floating leg is as follows: Market data – Coupon 2 Value Date dt_v.f2 2002-11-22 Coupon Period p_c.2 = dt_v.f2 - dt_x.f2 92 Time to Value Date tv.f2 = (dt_v.f2 - dt_f) / B 0.444444444 Interest Rate r.f2 3.419758% Other figures are calculated by the system as follows: • DF From spot D_f.f2 = EXP(-r.f2 * ((dt_v.f2 - dt_f )/ B - t_s)) = 0.985196717 • MV Discount Factor D_V.f2 = D_s * D_f.f2 = 0.984946757 • Fixing Rate r_x.f2 = (D_V.f1 / D_V.f2 - 1) / (p_c.2 / B) + r_s = 4.042332% On the figure date, the market data specific to Coupon 3 of the floating leg is as follows: Market data – Coupon 3 Value Date dt_v.f3 2003-02-22 Coupon Period p_c.3 = dt_v.f3 - dt_x.f3 92 Time to Value Date tv.f3 = (dt_v.f3 - dt_f) / B 0.7 Interest Rate r.f3 3.590392% Other figures are calculated by the system as follows: • DF From spot D_f.f3 = EXP(-r.f3 * ((dt_v.f3 - dt_f )/ B - t_s)) = 0.975472271 • MV Discount Factor D_V.f3 = D_s * D_f.f3 = 0.975224778 • Fixing Rate r_x.f3 = (D_V.f2 / (D_V.f3) - 1) / (p_c.3 / 360) + r_s = 4.400898% On the figure date, the market data specific to Coupon 4 of the floating leg is as follows: Market data – Coupon 4 Value Date dt_v.f4 2003-05-22 Coupon Period p_c.4 = dt_v.f4 - dt_x.f4 89 Time to Value Date tv.f4 = (dt_v.f4 - dt_f) / B 0.947222222 Interest Rate r.f4 3.728194 Other figures are calculated by the system as follows: • DF From spot D_f.f4 = EXP(-r.f4 * ((dt_v.f4 - dt_f )/ B - t_s)) = 0.965601941 • MV Discount Factor D_V.f4 = D_s * D_f.f4 = 0.965356952 • Fixing Rate r_x.f4 =(D_V.f3 / D_V.f4 - 1) / (p_c.4 / B) + r_s = 4.634719% Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 647 11 Swaps 11.1 Interest rate swap On the figure date, the market data specific to Coupon 5 of the floating leg is as follows: Market data – Coupon 5 Value Date dt_v.f5 2003-08-22 Coupon Period p_c.5 = dt_v.f5 - dt_x.f5 92 Time to Value Date tv.f5 = (dt_v.f5 - dt_f) / B 1.202777778 Interest Rate r.f5 3.874303% Other figures are calculated by the system as follows: • DF From spot D_f.f5 = EXP(-r.f5 * ((dt_v.f5 - dt_f )/ B - t_s)) = 0.954778028 • MV Discount Factor D_V.f5 = D_s * D_f.f5 0.954535785 • Fixing Rate r_x.f5 = (D_V.f4 / D_V.f5 - 1) / (p_c.5 / B) + r_s = 4.936051% On the figure date, the market data specific to Coupon 6 of the floating leg is as follows: Market data – Coupon 6 Value Date dt_v.f6 2003-11-22 Coupon Period p_c.6 = dt_v.f6 - dt_x.f6 92 Time to Value Date tv.f6 = (dt_v.f6 - dt_f) / B 1.713888889 Interest Rate r.f6 4.177677% Other figures are calculated by the system as follows: • DF From spot D_f.f6 = EXP(-r.f6 * ((dt_v.f6 - dt_f )/ B - t_s)) = 0.943294395 • MV Discount Factor D_V.f6 = D_s * D_f.f6 = 0.943055066 • Fixing Rate r_x.f6 = (D_V.f5 / D_V.f6 - 1) / (p_c.6 / B) + r_s = 5.570912% On the figure date, the market data specific to Coupon 7 of the floating leg is as follows: Market data – Coupon 7 Value Date dt_v.f7 2004-02-22 Coupon Period p_c.7 = dt_v.f7 - dt_x.f7 92 Time to Value Date tv.f7 = (dt_v.f7 - dt_f) / B 1.713888889 Interest Rate r.f7 4.177677% Other figures are calculated by the system as follows: • DF From spot D_f.f7 = EXP(-r.f7 * ((dt_v.f7 - dt_f )/ B - t_s)) = 0.931226633 • MV Discount Factor D_V.f7 = D_s * D_f.f7 = 0.930990365 • Fixing Rate r_x.f7 = (D_V.f6 / D_V.f7 - 1) / (p_c.7 / B) + r_s = 5.570912% 648 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap On the figure date, the market data specific to Coupon 8 of the floating leg is as follows: Market data – Coupon 8 Value Date dt_v.f8 2004-05-22 Coupon Period p_c.8 = dt_v.f8 - dt_x.f8 90 Time to Value Date tv.f8 = (dt_v.f8 - dt_f) / B 1.963888889 Interest Rate r.f8 4.326066% Other figures are calculated by the system as follows: • DF From spot D_f.f8 = EXP(-r.f8 * ((dt_v.f8 - dt_f )/ B - t_s)) = 0.918881027 • MV Discount Factor D_V.f8 = D_s * D_f.f8 = 0.918647892 • Fixing Rate r_x.f8 = (D_V.f7 / D_V.f8 - 1) / (p_c.8 / B) + r_s = 5.874191% On the figure date, the market data specific to Coupon 9 of the floating leg is as follows: Market data – Coupon 9 Value Date dt_v.f9 2004-08-22 Coupon Period p_c.9 = dt_v.f9 - dt_x.f9 92 Time to Value Date tv.f9 = (dt_v.f9 - dt_f) / B 2.21944444 Interest Rate r.f9 4.42678% Other figures are calculated by the system as follows: • DF From spot D_f.f9 = EXP(-r.f9 * ((dt_v.f9 - dt_f )/ B - t_s)) = 0.906756779 • MV Discount Factor D_V.f9 = D_s * D_f.f9 = 0.90652672 • Fixing Rate r_x.f9 = (D_V.f8 / D_V.f9 - 1) / (p_c.9 / B) + r_s = 5.732132% On the figure date, the market data specific to Coupon 10 of the floating leg is as follows: Market data – Coupon 10 Value Date dt_v.f10 2004-11-22 Coupon Period p_c.10 = dt_v.f10 - dt_x.f10 92 Time to Value Date tv.f10 = (dt_v.f10 - dt_f) / B 2.475 Interest Rate r.f10 4.506321% Other figures are calculated by the system as follows: • DF From spot D_f.f10 = EXP(-r.f10 * ((dt_v.f10 - dt_f )/ B - t_s)) = 0.894799223 • MV Discount Factor D_V.f10 = D_s * D_f.f10 = 0.894572197 • Fixing Rate r_x.f10 = (D_V.f9 / D_V.f10 - 1) / (p_c.10 / B) + r_s = 5.729155% Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 649 11 Swaps 11.1 Interest rate swap On the figure date, the market data specific to Coupon 11 of the floating leg is as follows: Market data – Coupon 11 Value Date dt_v.f11 2005-02-22 Coupon Period p_c.11 = dt_v.f11 - dt_x.f11 92 Time to Value Date tv.f11 = (dt_v.f11 - dt_f) / B 2.730555556 Interest Rate r.f11 4.585862% Other figures are calculated by the system as follows: • DF From spot D_f.f11 = EXP(-r.f11 * ((dt_v.f11 - dt_f )/ B - t_s)) = 0.882640448 • MV Discount Factor D_V.f11 = D_s * D_f.f11 = 0.882416508 • Fixing Rate r_x.f11 = (D_V.f10 / D_V.f11 - 1) / (p_c.11 / B) + r_s = 5.890396% Valuation figures – floating leg The valuation method commonly used for a vanilla IR swap is the Theoretical method. • Principal flow Fixed Amount A_x.fp = -A = -1,000,000 Market Value V.fp = A_x.p * D_V.f1 -993,863.11 = -1,000,000 * 0.993863111 • Coupon 1 Fixed Amount A_x.1= -A * r_x.f1 * p_c.1 / B -12,897.89 = -1,000,000 * 0.050470 *92 / 360 Market Value V.f1 = A_x.1 * D_V.f1 -12,818.74 = -12,897.89 * 0.993863111 • Coupon 2 Estimated Amount A_e.f2= -A * r_x.f2 * p_c.2 / B -10,330.40 = -1,000,000 * 0.04042332 * 92 / 360 Market Value V.f2 = A_e.2 * D_V.f2 -1,258.54 = -1,277.78 * 0.984946757 Spread Amount A_e.2 = -A * r_s * p_c.2 / B -1,277.78 = -1,000,000 * 0.05 * 92 / B • Coupon 3 Estimated Amount A_e.f3 = -A * r_x.f3 * p_c.3 / B -11,246.74 = -1,000,000 * 0.04400898 * 92 / 360 Market Value V.f3 = A_e.3 * D_V.f3 -1,246.12 = -1,277.78 * 0.975224778 Spread Amount A_e.3 = -A * r_s * p_c.3 / B -1,277.78 = -1,000,000 * 0.05 * 92 / 360 650 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap • Coupon 4 Estimated Amount A_e.f4= -A * r_x.f4 * p_c.4 / B -11,458.06 = -1,000,000 * 0.04634719 * 89 / 360 Market Value V.f4= A_e.4 * D_V.f4 -1,193.29 = -1,236.11 * 0.965356952 Spread Amount A_e.4 = -A * r_s * p_c.4 / B -1,236.11 = -1,000,000 * 0.05 * 89 / 360 • Coupon 5 Estimated Amount A_e.f5= -A * r_x.f5 * p_c.5 / B -12,614.35 = -1,000,000 * 0.04936051 * 92 / 360 Market Value V.f5 = A_e.5 * D_V.f5 -1,219.68 = -1,277.78 * 0.954535785 Spread Amount A_e.5 = -A * r_s * p_c.5 / B -1,277.78 = -1,000,000 * 0.05 * 92 / 360 • Coupon 6 Estimated Amount A_e.f6= -A * r_x.f6 * p_c.6 / B -13,451.74 = -1,000,000 * 0.05263725 * 92 / 360 Market Value V.f6 = A_e.6 * D_V.f6 -1,205.01 = -1,277.78 * 0.943055066 Spread Amount A_e.6 = -A * r_s * p_c.6 / B -1,277.78 = -1,000,000 * 0.05 * 92 / 360 • Coupon 7 Estimated Amount A_e.f7= -A * r_x.f7 * p_c.7 / B -14,236.77 = -1,000,000 * 0.05570912 * 92 / 360 Market Value V.f7 = A_e.7 * D_V.f7 -1,189.60 = -1,277.78 * 0.930990365 Spread Amount A_e.7 = -A * r_s * p_c.7 / B -1,277.78 = -1,000,000 * 0.05 * 92 / 360 • Coupon 8 Estimated Amount A_e.f8= -A * r_x.f8 * p_c.8 / B -14,685.48 = -1,000,000 * 0.05874191 * 90 / 360 Market Value V.f8 = A_e.8 * D_V.f8 -1,148.31 = -1,250.00 * 0.918647892 Spread Amount A_e.8 = -A * r_s * p_c.8 / B -1,250.00 = -1,000,000 * 0.05 * 90 / 360 • Coupon 9 Estimated Amount A_e.f9= -A * r_x.f9 * p_c.9 / B -14,648.78 = -1,000,000 * 0.05732132 * 92 / 360 Market Value V.f9= A_e.9 * D_V.f9 -1,158.34 = -1,277.78 * 0.90652672 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 651 11 Swaps 11.1 Interest rate swap Spread Amount A_e.9 = -A * r_s * p_c.9 / B -1,277.78 = -1,000,000 * 0.05 * 92 / 360 • Coupon 10 Estimated Amount A_e.f10 = -A * r_x.f10 * p_c.10 / B -14,641.17 = -1,000,000 * 0.05729155 * 92 / 360 Market Value V.f10 = A_e.10 * D_V.f10 -1,143.06 = -1,277.78 * 0.894572197 Spread Amount A_e.10 = -A * r_s * p_c.10 / B -1,277.78 = -1,000,000 * 0.05 * 92 / 360 • Coupon 11 Estimated Amount A_e.f11= -A * r_x.f11 * p_c.11 / B -15,053.23 = -1,000,000 * 0.05890396 * 92 /360 Market Value V.f11 = A_e.11 * D_V.f11 -1,127.53 = -1,277.78 * 0.882416508 Spread Amount A_e.11 = -A * r_s * p_c.11 / B -1,277.78 = -1,000,000 * 0.05 * 92 / 360 • Total Floating Market Value = V.fp + V.f1 + V.f2 + V.f3 +V.f4 + V.f5 + V.f6 + V.f7 + V.f8 + V.f9 + V.f10 + V.f11 = -1,018,571.34 Result figures – floating leg The setup of the instrument impacts the way result figures are computed. • Principal flow Total Profit Total_Profit.fp = -A * D_V.fp -882,416.51 = -1,000,000 * 0.882416508 MtoM Profit MtoM_Profit.fp = -A * D_f.fp -882,640.45 = -1,000,000 * 0.882640448 Other Profit Other_Profit.fp = Total_Profit.fp - MtoM_Profit.fp 223.94 = -882,416.51 - -882,640.45 • Coupon 1 Total Profit Total Profit.f1 = V.f1 = 12,818.74 Accrued Interest Accrued_Interest.f1 = (dt_f - dt_x.f1) / (dt_v.f1 - dt_x.f1) * A_x.1 -3,364.67 = (2002/06/15 – 2002/05/22) / (2002/08/22 - dt_x.f1) * -12,897.89 MtoM Profit MtoM_Profit.f1 = A_x.1 * D_f.f1 - Accrued_Interest.f1 -9,457.32 = -12,897.89 * 0.994115334 – (-3,364.67) Other Profit = Total_Profit.f1- Accrued_Interest.f1- MtoM_Profit.f1 = 3.25 • Coupon 2 Total Profit Total_Profit.f2 = A_e.f2 * D_V.f2 = -12,818.74 652 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap MtoM Profit = A_e.f2 * D_f.f2 = -10,177.48 Other Profit = Total_Profit.f2- MtoM_Profit.f2 = 2.58 • Coupon 3 Total Profit Total_Profit.f3 = A_e.f3 * D_V.f3 = -10,968.10 MtoM Profit = A_e.f3 * D_f.f3 = -10,970.88 Other Profit = Total_Profit.f23- MtoM_Profit.f3 = 2.78 • Coupon 4 Total Profit Total_Profit.f4= A_e.f4 * D_V.f4 = -11,061.11 MtoM Profit = A_e.f4 * D_f.f4 = -11,063.92 Other Profit = Total_Profit.f4- MtoM_Profit.f4 = 2.81 • Coupon 5 Total Profit Total_Profit.f5= A_e.f5 * D_V.f5 = -12,040.85 MtoM Profit = A_e.f5 * D_f.f5 = -12,043.91 Other Profit = Total_Profit.f5 - MtoM_Profit.f5 = 3.06 • Coupon 6 Total Profit Total_Profit.f6 = A_e.f6 * D_V.f6 = -12,685.73 MtoM Profit = A_e.f6 * D_f.f6 = -12,688.95 Other Profit = Total_Profit.f6 - MtoM_Profit.f6 = 3.22 • Coupon 7 Total Profit Total_Profit.f7 = A_e.f7 * D_V.f7 = -13,254.30 MtoM Profit = A_e.f7 * D_f.f7 = -13,257.66 Other Profit = Total_Profit.f7- MtoM_Profit.f7 = 3.36 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 653 11 Swaps 11.1 Interest rate swap • Coupon 8 Total Profit Total_Profit.f8 = A_e.f8 * D_V.f8 = -13,490.78 MtoM Profit = A_e.f8 * D_f.f8 = -13,494.21 Other Profit = Total_Profit.f8- MtoM_Profit.f8 = 3.42 • Coupon 9 Total Profit Total_Profit.f9 = A_e.f9 * D_V.f9 = -13,279.51 MtoM Profit = A_e.f9 * D_f.f9 = -13,282.88 Other Profit = Total_Profit.f9- MtoM_Profit.f9 = 3.37 • Coupon 10 Total Profit Total_Profit.f10 = A_e.f10 * D_V.f10 = -13,097.59 MtoM Profit = A_e.f10 * D_f.f10 = -13,100.91 Other Profit = Total_Profit.f10 - MtoM_Profit.f10 = 3.32 • Coupon 11 Total Profit Total_Profit.f11 = A_e.f11 * D_V.f11 = -13,283.22 MtoM Profit = A_e.f11 * D_f.f11 = -13,286.59 Other Profit = Total_Profit.f11- MtoM_Profit.f11 = 3.37 • Total Floating Total Profit = SUM(Total_Profits) -1,018,571.34 Accrued Interest = Accrued_Interest.f1 = -3,364.67 MtoM Profit = SUM(MtoM_Profits) = -1,015,465.17 Other Profit = SUM(Other_Profits) = 258.49 654 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Risk figures – floating leg The risk method commonly used for a vanilla IR swap is the Theoretical method. • Principal flow IR Exposure 1bp E_i.fp = (-A) * (-(tv.f1-t_s) * D_s * D_f.f1 - t_s * D_s * D_f.f1) * 0.0001 = 18.77 • Coupon 1 IR Exposure 1bp E_i.f1 = (A_x.1) * (-(tv.f1-t_s) * D_s * D_f.f1 - t_s * D_s * D_f.f1) * 0.0001 = 0.24 • Coupon 2 IR Exposure 1bp E_i.f2 = (A_e.2) * (-(tv.f2-t_s) * D_s * D_f.f2 - t_s * D_s * D_f.f2) * 0.0001 = 0.06 • Coupon 3 IR Exposure 1bp E_i.f3 = (A_e.3) * (-(tv.f3-t_s) * D_s * D_f.f3 - t_s * D_s * D_f.f3) * 0.0001 = 0.09 • Coupon 4 IR Exposure 1bp E_i.f4 = (A_e.4) * (-(tv.f4-t_s) * D_s * D_f.f4 - t_s * D_s * D_f.f4) * 0.0001 = 0.11 • Coupon 5 IR Exposure 1bp E_i.f1 = (A_e.5) * (-(tv.f5-t_s) * D_s * D_f.f5 - t_s * D_s * D_f.f5) * 0.0001 = 0.15 • Coupon 6 IR Exposure 1bp E_i.f6 = (A_e.6) * (-(tv.f6-t_s) * D_s * D_f.f6 - t_s * D_s * D_f.f6) * 0.0001 = 0.18 • Coupon 7 IR Exposure 1bp E_i.f7 = (A_e.7) * (-(tv.f7-t_s) * D_s * D_f.f7 - t_s * D_s * D_f.f7) * 0.0001 = 0.20 • Coupon 8 IR Exposure 1bp E_i.f8 = = (A_e.8) * (-(tv.f8-t_s) * D_s * D_f.f8 - t_s * D_s * D_f.f8) * 0.0001 = 0.23 • Coupon 9 IR Exposure 1bp E_i.f9 = (A_e.9) * (-(tv.f9-t_s) * D_s * D_f.f9 - t_s * D_s * D_f.f9) * 0.0001 = 0.26 • Coupon 10 IR Exposure 1bp E_i.f10 = (A_e.10) * (-(tv.f10-t_s) * D_s * D_f.f10 - t_s * D_s * D_f.f10) * 0.0001 = 0.28 • Coupon 11 IR Exposure 1bp E_i.f11 = (A_e.11) * (-(tv.f11-t_s) * D_s * D_f.f11 - t_s * D_s * D_f.f11) * 0.0001 = 0.31 • Total Floating IR Exposure 1bp = 20.87 Effective Duration = -E_i.ftotal / V.ftotal / 0.0001 = 0.204904667 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 655 11 Swaps 11.1 Interest rate swap 11.1.1.4.5 Total transaction figures (fixed and floating) • Valuation figures Market Value = -22,962.28 • Result figures Total Profit = -22,962.28 Accrued Interest = 9,190.89 MtoM Profit = -32,159.00 Other Profit = 5.83 • Risk figures Ir Exposure 1bp = -239.12 11.1.2 Asset swap An asset swap is created when the Asset Swap action is performed on a bond: see 3.1.1.3.1 Asset swap on page 218. The structure of the asset swap transaction resulting from this action depends on the setup of the Swap Instrument selected in the Asset Swap dialog. A swap used in the creation of an asset swap is set up in the same way as a vanilla swap (see 11.1.1 Single-currency IR swap on page 629), with the following exception. 11.1.2.1 Instrument setup • Legs characteristics For each leg of the Swap Instrument, it is possible to define the sign of the leg versus the transaction, and to define the leg instrument. Schedule structure information must not be provided for the asset leg instrument. Information Description Instrument • When no instrument is specified for the asset leg: the asset swap’s cashflows are taken directly from the bond characteristics. • When an instrument is defined for the asset leg, it must not have its own cashflow structure: the asset instrument is replaced with this generic instrument. In this case, the schedule information is not visible in Transaction Manager. In this case, the schedule information is visible in Transaction Manager. The schedules and cashflows will be copied from the asset instrument (that is, the bond) to the asset leg of the swap. The asset instrument will be stored as the swap transaction's Secondary Instrument. 11.1.3 Cross-currency swap Swaps can be cross-currency, which means that the legs are denominated in different currencies. IR cross-currency swap instruments are based on an instrument type derived from the instrument class SWAP. For more information relating to the setup and structure of specific types of cross-currency swaps, see: • 11.1.3.1.1 Plain vanilla cross-currency on page 658 • 11.1.3.1.2 Notional cross-currency on page 658 656 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap • 11.1.3.1.3 Notional cross-currency with upfront on page 659 • 11.1.3.1.4 Cross-currency with upfront on page 659 • 11.1.3.1.5 Non-par cross-currency on page 660 • 11.1.3.1.6 Zero-coupon cross-currency on page 660. 11.1.3.1 Instrument setup A cross-currency swap is set up in a similar way to a single-currency swap. • Main characteristics for cross-currency swaps – Legged Information Description Sign Sign of the transaction. If the sign is not defined at instrument level, it needs to be specified separately for each transaction. Leg Structure The leg structure for the swap instrument. TRM supports swap structures with multiple legs. Pseudo Settlement Pseudo Repayment The pseudo settlement/repayment options should not be activated if there is an exchange of capital on the corresponding leg. It is possible to set or override these options at transaction level. – Legs (optional) For each leg it is possible to define which is the sign of the leg versus the transaction, and which is the leg instrument. If this information is not provided at instrument setup, it needs to be specified at deal entry. Information Description Instrument The instrument to be used for this leg by default. Sign versus Transaction Choose from: Same, Opposite, or Any. See A.2.307 Swap on page 866. • Maturity definition It is possible to set up maturity information at instrument level. Information Description Calendar parameters Calendars used to calculate the maturity date. Gap Set Gap set used for supplying the available maturity periods. Maturity Date Period If defined, this maturity period is applied to each transaction. See A.2.230 Maturity Date Setup on page 827. • Upfront cashflow definition To create a payable upfront cashflow, use the Swap, Upfront trading feature. See A.2.316 Swap, Upfront on page 869. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 657 11 Swaps 11.1 Interest rate swap • Result treatment setup The result treatment of cross-currency swaps needs to be defined in the instrument definition to define which FX rate is used in the accounting process when there is an exchange of capital on the corresponding leg. See A.2.308 Swap (Book, FX Rate) on page 867 (the default method) and A.2.309 Swap (Deal, FX Rate) on page 867. It is also possible to set up: • Spot day and value date calculations • Manual charges • Cashflow and transaction charge rules • Branch codes. See Appendix A Features on page 713. 11.1.3.1.1 Plain vanilla cross-currency A swap where the two legs are in different currencies, and the value and maturity date principals are settled. On each leg, the value and maturity date settlement amounts are equal (but opposite). For a plain vanilla cross-currency swap, the structure can be demonstrated as follows: Currency 2 Currency 1 • Instrument setup – Swap characteristics Information Description Leg Structure Swap 2-Legs Pseudo Settlement Not selected. Pseudo Repayment 11.1.3.1.2 Notional cross-currency A swap where the two legs are in different currencies, and both the value and maturity date principal amounts are notional (that is, not settled). For a notional cross-currency swap, the structure can be demonstrated as follows: Notional Currency 2 Notional Currency 1 658 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap • Instrument setup – Swap characteristics Information Description Leg Structure Swap 2-Legs Pseudo Settlement Both these options should be selected. Pseudo Repayment 11.1.3.1.3 Notional cross-currency with upfront A swap where the two legs are in different currencies, and the value and maturity date principal amounts are notional (that is, not settled). A separate settled upfront cashflow is created for the value date, for the leg(s) where Deal Price is not equal to 100, calculated as follows: (100 - Deal Price) / 100 * Nominal Amount For a notional cross-currency swap with an upfront cashflow, the structure can be demonstrated as follows: Notional Upfront cashflow Currency 2 Notional Currency 1 • Instrument setup – Swap characteristics Information Description Leg Structure Swap 2-Legs Pseudo Settlement Both these options should be selected. Pseudo Repayment – Upfront cashflow setup See A.2.316 Swap, Upfront on page 869. 11.1.3.1.4 Cross-currency with upfront A swap where the two legs are in different currencies, and the value and maturity date principal amounts are settled. On each leg, the value and maturity date settlement amounts are equal (but opposite). A separate settled upfront cashflow is created for the value date, for the leg(s) where Deal Price is not equal to 100, calculated as follows: (100 - Deal Price) / 100 * Nominal Amount Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 659 11 Swaps 11.1 Interest rate swap For a cross-currency swap with an upfront cashflow, the structure can be demonstrated as follows: Currency 2 Upfront cashflow Currency 1 • Instrument setup – Swap characteristics Information Description Leg Structure Swap 2-Legs Pseudo Settlement Not selected. Pseudo Repayment – Upfront cashflow setup See A.2.316 Swap, Upfront on page 869. 11.1.3.1.5 Non-par cross-currency A swap where the two legs are in different currencies, and the value and maturity date principal amounts are settled. The value date settlement amounts on each leg are calculated as follows: Nominal Amount * Deal Price For a non-par cross-currency swap, the structure can be demonstrated as follows: Currency 2 Not equal to 100 Currency 1 Not equal to 100 Currency 2 Currency 1 • Instrument setup – Swap characteristics Information Description Leg Structure Swap-2-Legs-Non-Par Pseudo Settlement Not selected. Pseudo Repayment 11.1.3.1.6 Zero-coupon cross-currency A swap where the two legs are in different currencies, and the value and maturity date principal amounts are settled. One leg pays no interest. On this leg, the value date settlement is calculated as follows: Nominal Amount * Deal Price 660 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap The other leg’s value and maturity date settlement amounts are calculated from the value date settlement amount of the zero-coupon leg. For a zero-coupon cross-currency swap, the structure can be demonstrated as follows: Currency 1 Currency 2 Currency 1 • Currency 2 Zero leg Instrument setup – Swap characteristics Information Description Leg Structure Swap-2-Legs-Zero Pseudo Settlement Not selected. Pseudo Repayment 11.1.3.2 Deal capture The transaction data for a cross-currency swap is the same way as for a single-currency vanilla swap (see 11.1.1.2 Deal capture on page 633), with the following exceptions. 11.1.3.2.1 Input data • Transaction view Information Description Currency Currency of the first leg. Nominal Amount Notional amount of the swap in the currency of Leg 1. Pseudo Settlement Yes or No to specify whether the exchange of capital is notional. Pseudo Repayment • Leg view Information Description Currency 2nd Currency of the second leg. The FX rate is automatically populated by the system but can be changed manually: the notional amount of the second leg is adjusted accordingly. 11.1.3.2.2 Generated data The generated data for a cross-currency swap is the same way as for a single-currency swap, except that one leg is in a different currency. See 11.1.1.2.2 Generated data on page 634. 11.1.3.3 Processing This section describes the actions that can be done throughout the life of a cross-currency swap. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 661 11 Swaps 11.1 Interest rate swap 11.1.3.3.1 Early expiration Cross-currency swaps can be closed-out earlier than their agreed maturity date. This process is referred to as early expiration. • Execution Early expiration of a cross-currency swap requires the following information: Information Description Opening Date Date when the early expiration is executed. By default, this is today’s date unless a Fixing/Action Date is specified at transaction level. Value Date Date when the early expiration is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Leg Leg to which the early expiration applies. Currency Currency of the defined leg. Amount to Expire Amount to be early expired. This defaults to the amount still available on the defined leg, taking into account previous partial early expirations and roll overs. Net Amount Net amount to be settled between the two parties (Net Amount = Accrued Interest + Sell Profit/Loss). (Leg 1) (Leg 2) Note: For cross-currency IR swaps that have multiple settlements in different currencies, it is possible to specify the Net Amount (P/L being settled) for each of the legs. Options • Net Amount Amortize P/L Switch on Amortize P/L to amortize the P/L from the value date until the original maturity date. If this switch is off, the Sell P/L flow created by the early expiration (arising from Net Amount – Accrued Interest) occurs on the early expiration value date. • No Fee Realization Switch on No Fee Realization so that fees keep amortizing to maturity. For example, this can be used in the case of an asset swap, which mirrors the issue fees, to keep the fees amortizing even when the asset swap is fully unwound. If this switch is off, at early expiration, the fees that were amortizing until the maturity date are closed. The execution generates an early expiration transaction with the following attributes: Transaction sign = opposite of initial transaction Nominal amount = amount to expire Opening date = date when the early expiration is done Value date = date when the early expiration is settled Kind = Early Expiration The remaining attributes are inherited from the initial transaction. The early expiration transaction generates closing cashflows for the initial transaction and P/L cashflows if there is a difference between the early expiration price and the original deal price. • Cancellation You can undo the early expiration by canceling the early expiration transaction. 11.1.3.4 Trade assignment Trade assignments are done as in single-currency swaps. Refer to 11.1.1.3.4 on page 637. 662 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap 11.1.3.5 Position monitoring In this section, numerical examples demonstrate how the different figures are calculated for a cross-currency swap. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. This example shows a cross-currency swap 5,000,000 EUR / 6,300,000 USD, with the following deal data: Setup data Fixed Leg Date Basis Act/360 Floating Leg Date Basis 30E/360 Instrument Yield Type Periodic Valuation Method Theoretical Risk Method Theoretical Valuation Date Figure Date Risk Date Figure Date Risk Yield Type Continuous AI Method Linear Accrual Method Linear Accrual Accrual Date Basis (Fixed Leg) 30E/360 Accrual Date Basis (Floating Leg) Actual/360 Coupon Rate (Fixed Leg) r_c Risk Profile (Floating Leg) 2.71% Plain Vanilla (simple risk) Transaction data Opening Date dt_o 2002-06-07 Maturity Date d_m 2004-06-07 Spot Date ds 2002-06-07 Unless otherwise stated, the figure date used in the calculations is 2002-08-15. On this date, the market data is as follows: Market data on 2002-08-15 Figure date dt_f 2002-08-15 Days to Spot d_fs 4 Discount Rate r_d 3.054125% FX Conversion Rate S 1.240000 Other market data and figures are calculated by the system as follows: • Time to Spot t_s = d_fs / B 0.011111111 = 4 / 360 • MV Spot Discount Factor D_s = EXP (-t_s * r_d) = 0.9996607103 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 663 11 Swaps 11.1 Interest rate swap 11.1.3.5.1 Fixed leg Transaction data specific to the fixed leg is as follows: Transaction data Nominal Amount A 5,000,000.00 Deal Price P 100.00% Transaction data specific to the principal flow of the fixed leg is as follows: Transaction data Value Date dv.p 2004-06-07 Amount A = c_m 5,000,000.00 Payment Date dp.p 2004-06-07 Calculated transaction data specific to the principal flow of the fixed leg is as follows: • Book Value Book_Value = A * P 5,000,000 = 5,000,000 * 1.00 Transaction data specific to the coupon flows of the fixed leg is as follows: Transaction data Coupon 1 Coupon 2 Coupon 3 Coupon 4 Value Date dv.c1 2002-12-07 dv.c2 2003-06-07 dv.c3 2003-12-07 dv.c4 2004-06-07 Payment Date dp.c1 2002-12-09 dp.c2 2003-06-09 dp.c3 2003-12-08 dp.c4 2004-06-07 Calculated transaction data specific to the coupon flows of the fixed leg is as follows: • Coupon 1 Period t_p1 = DAYS360 (ds, dv.c1) / B = 0.50 Amount A.c1 = c_m * t_p1 * r_c 67,750.00 = 5,000,000 * 0.5 * 0.0271 • Coupon 2 Period t_p2 = DAYS360 (dv.c1, dv.c2) / B = 0.50 Amount A.c2 = c_m * t_p2 * r_c 67,750.00 = 5,000,000 * 0.5 * 0.0271 • Coupon 3 Period t_p3 = DAYS360 (dv.c2, dv.c3) / B = 0.50 Amount A.c3 = c_m * t_p3 * r_c 67,750.00 = 5,000,000 * 0.5 * 0.0271 • Coupon 4 Period t_p4 = DAYS360 (dv.c3, dv.c4) / B = 0.50 664 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Amount A.c4 = c_m * t_p4 * r_c 67,750.00 = 5,000,000 * 0.5 * 0.0271 On the figure date, the market data specific to the principal amount of the fixed leg is as follows: Market data on 2002-08-15 Interest Rate r.p 4.250223% Other market data and figures specific to the principal amount of the fixed leg are calculated by the system as follows: • Time to Payment Date tv.p = (dp.p - dt_f) / B 1.838888889 = (2004/06/07 – 2002/08/15) / 360 • MV Discount Factor D_V.p = D_s * D.p = 0.9249422473 • DF From Spot D.p = EXP (-(tv.p - t_s) * r.p) = 0.9252561772 On the figure date, the market data specific to the coupon flows of the fixed leg is as follows: Market data Coupon 1 Coupon 2 Coupon 3 Coupon 4 Interest Rate r.c1 r.c2 r.c3 r.c4 3.333684% 3.664738% 3.950147% 4.250223% Other market data and figures specific to the coupon flows of the fixed leg are calculated by the system as follows: • Coupon 1 Time to Payment Date tv.c1 = (dp.c1 - dt_f) / B 0.32222222 = (2002/12/09 – 2002/08/15) / 360 MV Discount Factor D_V.c1 = D_s * D.c1 = 0.9893463479 DF From Spot D.c1 = EXP (-(tv.c1 - t_s) * r.c1) = 0.9896821368 • Coupon 2 Time to Payment Date tv.c2 = (dp.c2 - dt_f) / B 0.827777778 = (2003/06/09 – 2002/08/15) / 360 MV Discount Factor D_V.c2 = D_s * D.c2 = 0.9701854493 DF From Spot D.c2 = EXP (-(tv.c2 - t_s) * r.c2) = 0.9705147349 • Coupon 3 Time to Payment Date tv.c3 = (dp.c3 - dt_f) / B 1.333333333 = (2003/12/08– 2002/08/15) / 360 MV Discount Factor D_V.c3 = D_s * D.c3 = 0.9487887872 DF From Spot D.c3 = EXP (-(tv.c3 - t_s) * r.c3) = 0.9491108107 • Coupon 4 Time to Payment Date tv.c4 = (dp.c4 - dt_f) / B 1.838888889 = (2004/06/07 – 2002/08/15) / 360 MV Discount Factor D_V.c4 = D_s * D.c4 = 0.9249422473 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 665 11 Swaps 11.1 Interest rate swap DF From Spot D.c4 = EXP (-(tv.c4 - t_s) * r.c4) = 0.9252561772 Valuation figures – fixed leg The valuation method commonly used for a cross-currency IR swap is the Theoretical method. • Principal flow Market Value V.p = c_m * D_V.p 4,624,711.25 = 5,000,000 * 0.9249422473 • Coupon 1 Market Value V.c1 = A.c1 * D_V.c1 67,028.22 = 67,750.00 * 0.9893463479 • Coupon 2 Market Value V.c2 = A.c2 * D_V.c2 65,730.06 = 67,750.00 * 0.9701854493 • Coupon 3 Market Value V.c3 = A.c3 * D_V.c3 64,280.44 = 67,750.00 * 0.9487887872 • Coupon 4 Market Value V.c4 = A.c4 * D_V.c4 62,664.84 = 67,750 * 0.9249422473 • Total Fixed Market Value = 4,884,414.79 Result figures – fixed leg The setup of the instrument impacts the way result figures are computed. • Principal flow Total Profit Total_Profit.p = V.p – A -375,288.76 = 4,624,711.25 – 5,000,000 MtoM Profit MtoM_Profit.p = A * D.p - Book_Value -373,719.11 = 5,000,000 * 0.9252561772 – (-5,000.000) Other Profit Other_Profit.p = Total_Profit.p - MtoM_Profit.p -1,569.65 = -375,288.76 – (-373,719.11) • Coupon 1 Total Profit Total_Profit.c1 = V.c1 = 67,028.22 Accrued Interest = DAYS360 (dt_o, dt_f) / DAYS360 (dt_o, dv.c1) * A.c1 = 25,594.44 MtoM Profit MtoM_Profit.c1 = A.c1 * D.c1 - Accrued_Interest.c1 41,456.52 = 67,750.00 * 0.9896821368 – 25,594.44 Other Profit Other_Profit.c1 = Total_Profit.c1 - Accrued_Interest.c1 - MtoM_Profit.c1 -22.75 = 67,028.22 – 25,594.44 – 41,456.52 • Coupon 2 Total Profit Total_Profit.c2 = V.c2 = 65,730.06 666 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap MtoM Profit MtoM_Profit.c2 = A.c2 * D.c2 65,752.37 = 67,750.00 * 0.9705147349 Other Profit Other_Profit.c2 = Total_Profit.c2 - MtoM_Profit.c2 -22.31 = 65,730.06 – 65,752.37 • Coupon 3 Total Profit Total_Profit.c3 = V.c3 = 64,280.44 MtoM Profit MtoM_Profit.c3 = A.c3 * D.c3 64,302.26 = 67,750 * 0.9491108107 Other Profit Other_Profit.c3 = Total_Profit.c3 - MtoM_Profit.c3 -21.82 = 64,280.44 – 64,302.26 • Coupon 4 Total Profit Total_Profit.c4 = V.c4 = 62,664.84 MtoM Profit MtoM_Profit.c4 = A.c4 * D.c4 62,686.11 = 67,750 * 0.9252561772 Other Profit Other_Profit.c4 = Total_Profit.c4 - MtoM_Profit.c4 -21.27 = 62,664.84 – 62,686.11 • Total Fixed Total Profit = Total_Profit.p + Total_Profit.c1 + Total_Profit.c2 + Total_Profit.c3 + Total_Profit.c4 = -115,585.21 MtoM Profit = MtoM_Profit.p + MtoM_Profit.c1 + MtoM_Profit.c2 + MtoM_Profit.c3 + MtoM_Profit.c4 = -139,521.86 Other Profit = Other_Profit.p + Other_Profit.c1 + Other_Profit.c2 +Other_Profit.c3 + Other_Profit.c4 = -1,657.79 Risk figures – fixed leg The risk method commonly used for a vanilla cross-currency IR swap is the Theoretical method. • Principal flow IR Exposure 1bp E_i.p = (A) * (-(tv.p - t_s) * D.p * D_s - t_s * D.p * D_s) * 0.0001 = -850.43 Effective Duration U_eff.p = -E_i.p / V.p / 0.0001 1.838889 = -(-850.43) / 4,624,711.24 / 0.0001 • Coupon 1 IR Exposure 1bp E_i.c1 = (A.c1) * (-(tv.c1 - t_s) * D.c1 * D_s - t_s * D.c1 * D_s) * 0.0001 = -2.16 Effective Duration U_eff.c1 = -E_i.c1 / V.c1 / 0.0001 0.32222 = -(-2.16) / 67,028.22 / 0.0001 • Coupon 2 IR Exposure 1bp E_i.c2 = (A.c2) * (-(tv.c2 - t_s) * D.c2 * D_s - t_s * D.c2 * D_s) * 0.0001 = -5.44 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 667 11 Swaps 11.1 Interest rate swap Effective Duration U_eff.c2 = -E_i.c2 / V.c2 / 0.0001 0.82778 = -(-5.44) / 65,730.06 / 0.0001 • Coupon 3 IR Exposure 1bp E_i.c3 = (A.c3) * (-(tv.c3 - t_s) * D.c3 * D_s - t_s * D.c3 * D_s) * 0.0001 = -8.57 Effective Duration U_eff.c3 = -E_i.c3 / V.c3 / 0.0001 1.333333333 = -(-8.57) / 64,280.44 / 0.0001 • Coupon 4 IR Exposure 1bp E_i.c4 = (A.c4) * (-(tv.c4-t_s) * D.c4 * D_s - t_s * D.c4 * D_s) * 0.0001 = -11.52 Effective Duration U_eff.c4 = -E_i.c4 / V.c4 / 0.0001 1.838888889 = -(11.52) / 62,664.84 / 0.0001 • Total Fixed IR Exposure 1bp = E_i.p + E_i.c1 + E_i.c2 + E_i.c3 + E_i.c4 = -878.13 Effective Duration = -E_i.fixed / V.fixed / 0.0001 = 1.797815966 11.1.3.5.2 Floating leg Transaction data specific to the floating leg is as follows: Transaction data Nominal Amount A.f -6,300,000.00 Spread r_s 0.00% Deal Price P.f 98.00% Calculated transaction data specific to the principal flow of the floating leg is as follows: • Book Value (Local) Book_Value_Local.f = A.f * P.f -6,174,000.00 = -6,300,000 * 0.98 • Book Value Book_Value = Book_Value_Local.f / S_0 -5,060,655.74 = -6,174,000.00 / 1.22 On the figure date, the market data specific to the floating leg is as follows: Market data on 2002-08-15 Discount Rate r_d.f 1.044962% Spot Discount Factor D_s.f = EXP(-t_s * r_d.f) 0.999883900 On the figure date, the market data specific to the principal flow of the floating leg is as follows: Market data on 2002-08-15 Value Date dt_v.fp 2004-06-07 Time to Value Date tv.fp = (dt_v.fp - dt_f) / B 1.838888889 Interest Rate r.fp 1.850345% 668 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Other figures specific to the principal flow of the floating leg are calculated by the system as follows: • DF From Spot D_f.fp = EXP(-r.fp * ((dt_v.fp - dt_f ) / B - t_s)) = 0.966745315 • MV Discount Factor D_V.fp = D_s.f * D_f.fp = 0.966633076 On the figure date, the market data specific to Coupon 1 of the floating leg is as follows: Market data - Coupon 1 Fixing Date dt_x.f1 2002-06-07 Value Date dt_v.f1 2002-09-09 Coupon Period p_c.1 = dt_v.f1 - dt_x.f1 92 Time to Value Date tv.f1 = (dt_v.f1 - dt_f) / B 0.069444444 Interest Rate r.f1 1.057590% Fixing Rate r_x.f1 2.300000% Other figures specific to Coupon 1 of the floating leg are calculated by the system as follows: • DF From Spot D_f.f1 = EXP(-r.f1 * ((dt_v.f1 - dt_f ) / B - t_s)) = 0.999383263 • MV Discount Factor D_V.f1 = D_s.f * D_f.f1 = 0.999267234 On the figure date, the market data specific to Coupon 2 of the floating leg is as follows: Market data - Coupon 2 Value Date dt_v.f2 2002-12-09 Coupon Period p_c.2 = dt_v.f2 - dt_v.f1 91 Time to Value Date tv.f2 = (dt_v.f2 - dt_f) / B 0.3222222222 Interest Rate r.f2 1.108930% Fixing Rate r_x.f2 1.122367% Other figures specific to Coupon 2 of the floating leg are calculated by the system as follows: • DF From Spot D_f.f2 = EXP(-r.f2 * ((dt_v.f2 - dt_f ) / B - t_s)) = 0.99655594 • MV Discount Factor D_V.f2 = D_s.f * D_f.f2 = 0.99644024 On the figure date, the market data specific to Coupon 3 of the floating leg is as follows: Market data - Coupon 3 Value Date dt_v.f3 2003-03-07 Coupon Period p_c.3 = dt_v.f3 - dt_v.f2 88 Time to Value Date tv.f3 = (dt_v.f3 - dt_f) / B 0.566666667 Interest Rate r.f3 1.158815% Fixing Rate r_x.f3 1.224132% Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 669 11 Swaps 11.1 Interest rate swap Other figures specific to Coupon 3 of the floating leg are calculated by the system as follows: • DF From Spot D_f.f3 = EXP(-r.f3 * ((dt_v.f3 - dt_f ) / B - t_s)) = 0.993582818 • MV Discount Factor D_V.f3 = D_s.f * D_f.f3 = 0.993467462 On the figure date, the market data specific to Coupon 4 of the floating leg is as follows: Market data - Coupon 4 Value Date dt_v.f4 2003-06-09 Coupon Period p_c.4 = dt_v.f4 - dt_v.f3 94 Time to Value Date tv.f4 = (dt_v.f4 - dt_f) / B 0.827777778 Interest Rate r.f4 1.238751% Fixing Rate r_x.f4 1.411424% Other figures specific to Coupon 4 of the floating leg are calculated by the system as follows: • DF From Spot D_f.f4 = EXP(-r.f4 * ((dt_v.f4 - dt_f ) / B - t_s)) = 0.989934533 • MV Discount Factor D_V.f4 = D_s.f * D_f.f4 = 0.989819601 On the figure date, the market data specific to Coupon 5 of the floating leg is as follows: Market data - Coupon 5 Value Date dt_v.f5 2003-09-08 Coupon Period p_c.5 = dt_v.f5 - dt_v.f4 91 Time to Value Date tv.f5 = (dt_v.f5 - dt_f) / B 1.080555556 Interest Rate r.f5 1.357238% Fixing Rate r_x.f5 1.743871% Other figures specific to Coupon 5 of the floating leg are calculated by the system as follows: • DF From Spot D_f.f5 = EXP(-r.f5 * ((dt_v.f5 - dt_f ) / B - t_s)) = 0.985589927 • MV Discount Factor D_V.f5 = D_s.f * D_f.f5 = 0.9854755 On the figure date, the market data specific to Coupon 6 of the floating leg is as follows: Market data - Coupon 6 Value Date dt_v.f6 2003-12-08 Coupon Period p_c.6 = dt_v.f6 - dt_v.f5 91 Time to Value Date tv.f6 = (dt_v.f6 - dt_f) / B 1.333333333 Interest Rate r.f6 1.521607% Fixing Rate r_x.f6 2.223238% Other figures specific to Coupon 6 of the floating leg are calculated by the system as follows: • DF From Spot D_f.f6 = EXP(-r.f6 * ((dt_v.f6 - dt_f ) / B - t_s)) = 0.980082011 • MV Discount Factor D_V.f6 = D_s.f * D_f.f6 = 0.979968224 670 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap On the figure date, the market data specific to Coupon 7 of the floating leg is as follows: Market data - Coupon 7 Value Date dt_v.f7 2004-03-08 Coupon Period p_c.7 = dt_v.f7 - dt_v.f6 91 Time to Value Date tv.f7 = (dt_v.f7 - dt_f) / B 1.586111111 Interest Rate r.f7 1.685976% Fixing Rate r_x.f7 2.553961% Other figures specific to Coupon 7 of the floating leg are calculated by the system as follows: • DF From Spot D_f.f7 = EXP(-r.f7 * ((dt_v.f7 - dt_f ) / B - t_s)) = 0.973795339 • MV Discount Factor D_V.f7 = D_s.f * D_f.f7 = 0.973682281 On the figure date, the market data specific to Coupon 8 of the floating leg is as follows: Market data - Coupon 8 Value Date dt_v.f8 2004-06-07 Coupon Period p_c.8 = dt_v.f8 - dt_v.f7 91 Time to Value Date tv.f8 = (dt_v.f8 - dt_f) / B 1.838888889 Interest Rate r.f8 1.850345% Fixing Rate r_x.f8 2.884959% Other figures specific to Coupon 8 of the floating leg are calculated by the system as follows: • DF From Spot D_f.f8 = EXP(-r.f8 * ((dt_v.f8 - dt_f ) / B - t_s)) = 0.966745315 • MV Discount Factor D_V.f8 = D_s.f * D_f.f8 = 0.966633076 Valuation figures – floating leg • Principal flow Fixed/Estimated Amount A_x/A_e = A.f = -6,300,000.00 Local Market Value V_lf = A_x.p * D_V.fp -6,089,788.38 = -6,300,000 * 0.966633076 Market Value V.fp = V.fl / S -4,911,119.66 = -6,089,788.38 / 1.240000 Spread Amount A_s = V.fp / S -3,960,580.37 = -4,911,119.66 / 1.240000 • Coupon 1 Fixed Amount A_x.f1 = A.f * r_x.f1 * p_c.1 / B -37,835.00 = -6,300,000 * 0.02300 * 94 / 360 Local Market Value V_lf1 = A_x.f1 * D_V.f1 -37,807.28 = -37,835.00 * 0.999267234 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 671 11 Swaps 11.1 Interest rate swap Market Value V.f1 = V.lf1 / S -30,489.74 = -37,807.28 / 1.240000 • Coupon 2 Estimated Amount A_e.f2 = A.f * r_x.f2 * p_c.2 / B -17,873.69 = -6,300,000 * 0.01122367 * 91 / 360 Local Market Value V_fl2 = A_e.f2 * D_V.f2 -17,810.07 = -17,873.69 * 0.99644024 Market Value V.f2 = V.lf2 / S -14,362.96 = -17,810.07 / 1.240000 • Coupon 3 Estimated Amount A_e.f3 = A.f * r_x.f3 * p_c.3 / B -18,851.63 = -6,300,000 * 0.01224132 * 88 / 360 Local Market Value V_lf3 = A_e.f3 * D_V.f3 -18,728.48 = -18,851.63 * 0.993467462 Market Value V.f3 = V.lf3 / S -15,103.62 = -18,728.48 / 1.240000 • Coupon 4 Estimated Amount A_e.f4 = A.f * r_x.f4 * p_c.4 / B -23,217.92 = -6,300,000 * 0.01411424 * 94 / 360 Local Market Value V_lf4 = A_e.f4 * D_V.f4 -22,981.56 = -23,217.92 * 0.989819601 Market Value V.f4 = V.lf4 / S -18,533.51 = -22,981.56 / 1.240000 • Coupon 5 Estimated Amount A_e.f5 = A.f * r_x.f5 * p_c.5 / B -27,771.15 = -6,300,000 * 0.01743871 * 91 / 360 Local Market Value V_lf5 = A_e.f5 * D_V.f5 -27,367.78 = -27,771.15 * 0.9854755 Market Value V.f5 = V.lf5 / S -22,070.79 = -27,367.78 / 1.240000 • Coupon 6 Estimated Amount A_e.f6 = A.f * r_x.f6 * p_c.6 / B -35,405.07 = -6,300,000 * 0.02223238 * 91 / 360 Local Market Value V_lf6 = A_e.f6 * D_V.f6 -34,695.84 = -35,405.07 * 0.979968224 Market Value V.f6 = V.lf6 / S -27,980.52 = -34,695.84 / 1.240000 • Coupon 7 Estimated Amount A_e.f7 = A.f * r_x.f7 * p_c.7 / B -40,671.83 = -6,300,000 * 0.02553961 * 91 / 360 672 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Local Market Value V_lf7 = A_e.f7 * D_V.f7 -39,601.44 = -40,671.83 * 0.973682281 Market Value V.f7 = V.lf7 / S -31,936.64 = -39,601.44 / 1.240000 • Coupon 8 Estimated Amount A_e.f8 = A.f * r_x.f8 * p_c.8 / B -45,942.97 = -6,300,000 * 0.02884959 * 91 / 360 Local Market Value V_lf8 = A_e.f8 * D_V.f8 -44,410.00 = -45,942.97 * 0.966633076 Market Value V.f8 = V.lf8 / S -35,814.51 = -44,410.00 / 1.240000 • Total Floating Market Value = -5,107,411.95 Result figures – floating leg • Principal flow Total Profit (Local) Total_Profit_Local.fp = V.fl - Book_Value_Local.f 84,211.62 = -6,089,788.38 – (-6,174,000.00) Accrued Profit (Local) Accrued_Profit_Local.fp = (dt_f - dt_o) / (dt_v.fp - dt_o) * (A.f - Book_Value_Local.f) -11,893.30 = (2002/08/15 – 2002/06/07) / (2004/06/07 – 2002/06/07) * (-6,300,000 – (-6,174,000)) MtoM Profit (Local) MtoM_Profit_Local.fp = A.f * D_f.fp - Book_Value_Local.f - Accrued_Profit_Local.fp 95,397.81 = -6,300,000 * 0.966745315 - (-6,174,000.00) – (-11,893.30) Other Profit (Local) Other_Profit_Local.fp = Total_Profit_Local.fp - Accrued_Profit_Local.fp - MtoM_Profit_Local.fp 707.11 = 84,211.62 – (-11,893.30) - 95,397.81 Total Profit Total_Profit.fp = V.fp - Book_Value.f 149,536.08 = -4,911,119.66 – (-5,060,655.74) Accrued Profit Accrued_Profit.fp = Accrued_Profit_Local.fp / S_0 -9,748.60 = -11,893.30 / 1.220000 MtoM Profit MtoM_Profit.fp = MtoM_Profit_Local.fp / S 76,933.72 = 95,397.81 / 1.240000 FX Profit FX_Profit.fp = Book_Value_Local.f * (1/S - 1/S_0) 81,623.48 = -6,174,000.00 * (1/1.24 – 1/1.22) Other Profit Other_Profit.fp = Total_Profit.fp - Accrued_Profit.fp - MtoM_Profit.fp - FX_Profit.fp = 727.48 • Coupon 1 Total Profit (Local) Total_Profit_Local.f1 = V.lf1 = -37,807.28 Accrued Interest (Local) Accrued_Interest_Local.f1 = (dt_f - dt_o) / (dt_v.f1 - dt_o) * A_x.1 -27,772.50 = (2002/08/15 – 2002/06/07) / (2002/06/07 - 2002/06/07) * -37,835.00 MtoM Profit (Local) MtoM_Profit_Local.f1 = A_x.1 * D_f.f1 - Accrued_Interest_Local.f1 -10,039.17 = -37,835.00 * 0.999383263 – (-27,772.50) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 673 11 Swaps 11.1 Interest rate swap Other Profit (Local) Other_Profit_Local.f1 = Total_Profit_Local.f1 - Accrued_Interest_Local.f1 - MtoM_Profit_Local.f1 4.39 = -37,807.28 – (-27,772.50) – (-10,039.17) Total Profit Total_Profit.f1 = V.f1 = -30,489.74 Accrued Interest Accrued_Interest.f1 = Accrued_Interest_Local.f1 / S -22,397.18 = -27,772.50 / 1.240000 MtoM Profit MtoM_Profit.f1 = MtoM_Profit_Local.f1 / S -8,096.10 = -10,039.17 / 1.240000 Other Profit Other_Profit.f1 = Total_Profit.f1- Accrued_Interest.f1- MtoM_Profit.f1 = 3.54 • Coupon 2 Total Profit (Local) Total_Profit_Local.f2 = V.lf2 = -17,810.07 MtoM Profit (Local) MtoM_Profit_Local.f2 = A_e.f2 * D_f.f2 -17,812.14 = -17,873.69 * 0.99655594 Other Profit (Local) Other_Profit_Local.f2 = Total_Profit_Local.f2 - MtoM_Profit_Local.f2 2.07 = -17,810.07 – (-17,812.14) Total Profit Total_Profit.f2 = V.f2 = -15,103.62 MtoM Profit MtoM_Profit.f2= MtoM_Profit_Local.f2 / S -15,105.37 = -17,812.14 / 1.240000 Other Profit Other_Profit.f2 = Total_Profit.f2- MtoM_Profit.f2 = 1.67 • Coupon 3 Total Profit (Local) Total_Profit_Local.f3 = V.lf3 = -18,728.48 MtoM Profit (Local) MtoM_Profit_Local.f3 = A_e.f3 * D_f.f3 -18,730.66 = -18,851.63 * 0.993582818 Other Profit (Local) Other_Profit_Local.f3 = Total_Profit_Local.f3 - MtoM_Profit_Local.f3 2.17 = -18,728.48 – (-18,730.66) Total Profit Total_Profit.f3 = V.f3 = -15,103.62 MtoM Profit MtoM_Profit.f3= MtoM_Profit_Local.f3 / S -15,105.37 = -18,730.66 / 1.240000 Other Profit Other_Profit.f3 = Total_Profit.f3- MtoM_Profit.f3 = 1.75 • Coupon 4 Total Profit (Local) Total_Profit_Local.f4 = V.lf4 = -22,981.56 MtoM Profit (Local) MtoM_Profit_Local.f4 = A_e.f4 * D_f.f4 -22,984.23 = -23,217.92 * 0.989934533 674 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Other Profit (Local) Other_Profit_Local.f4 = Total_Profit_Local.f4 - MtoM_Profit_Local.f4 2.67 = -22,981.56 – (-22,984.23) Total Profit Total_Profit.f4 = V.f4 = -18,533.51 MtoM Profit MtoM_Profit.f4= MtoM_Profit_Local.f4 / S -18,535.67 = -22,984.23 / 1.240000 Other Profit Other_Profit.f4 = Total_Profit.f4- MtoM_Profit.f4 = 2.15 • Coupon 5 Total Profit (Local) Total_Profit_Local.f5 = V.lf5 = -27,367.78 MtoM Profit (Local) MtoM_Profit_Local.f5 = A_e.f5 * D_f.f5 -27,370.96 = -27,771.15 * 0.985589927 Other Profit (Local) Other_Profit_Local.f5 = Total_Profit_Local.f5 - MtoM_Profit_Local.f5 3.18 = -27,367.78 – (-27,370.96) Total Profit Total_Profit.f5 = V.f5 = -22,070.79 MtoM Profit MtoM_Profit.f5= MtoM_Profit_Local.f5 / S -22,073.36 = -27,370.96 * 1.240000 Other Profit Other_Profit.f5 = Total_Profit.f5- MtoM_Profit.f5 = 2.56 • Coupon 6 Total Profit (Local) Total_Profit_Local.f6 = V.lf6 = -34,695.84 MtoM Profit (Local) MtoM_Profit_Local.f6 = A_e.f6 * D_f.f6 -34,699.87 = -35,405.07 * 0.980082011 Other Profit (Local) Other_Profit_Local.f6 = Total_Profit_Local.f6 - MtoM_Profit_Local.f6 4.03 = -34,695.84 – (-34,699.87)) Total Profit Total_Profit.f6 = V.f6 = -27,980.52 MtoM Profit MtoM_Profit.f6= MtoM_Profit_Local.f6 / S -27,983.76 = -34,699.87 / 1.240000 Other Profit Other_Profit.f6 = Total_Profit.f6- MtoM_Profit.f6 = 3.25 • Coupon 7 Total Profit (Local) Total_Profit_Local.f7 = V.lf7 = -39,601.44 MtoM Profit (Local) MtoM_Profit_Local.f7 = A_e.f7 * D_f.f7 -39,606.04 = -40,671.83 * 0.973795339 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 675 11 Swaps 11.1 Interest rate swap Other Profit (Local) Other_Profit_Local.f7 = Total_Profit_Local.f7 - MtoM_Profit_Local.f7 4.60 = -39,601.44 – (-39,606.04) Total Profit Total_Profit.f7 = V.f7 = -31,936.64 MtoM Profit MtoM_Profit.f7= MtoM_Profit_Local.f7 / S -31,940.35 = -39,606.04 / 1.240000 Other Profit Other_Profit.f7 = Total_Profit.f7- MtoM_Profit.f7 = 3.71 • Coupon 8 Total Profit (Local) Total_Profit_Local.f8 = V.lf8 = -44,410.00 MtoM Profit (Local) MtoM_Profit_Local.f8 = A_e.f8 * D_f.f8 -44,415.15 = -45,942.97 * 0.966745315 Other Profit (Local) Other_Profit_Local.f8 = Total_Profit_Local.f8 - MtoM_Profit_Local.f8 5.16 = -44,410.00 – (-44,415.15) Total Profit Total_Profit.f8 = V.f8 = -35,814.51 MtoM Profit MtoM_Profit.f8= MtoM_Profit_Local.f8 / S -35,818.67 = -44,415.15 / 1.240000 Other Profit Other_Profit.f8 = Total_Profit.f8- MtoM_Profit.f8 = 4.16 • Total Floating Accrued Interest (Local) = -27,772.50 MtoM Profit (Local) = -120,260.39 Total Profit = -46,756.21 Accrued Interest = -22,397.18 MtoM Profit = -96,984.19 Other Profit = 750.28 Risk figures – floating leg • Principal flow IR Exposure 1bp E_i.fp = A.f * (-(tv.f1 - t_s) * D_s.f * D_f.f1 - t_s * D_s.f * D_f.f1) * 0.0001 / S = 35.26 • Coupon 1 IR Exposure 1bp E_i.f1 = (A_x.1) * (-(tv.f1 -t_s) * D_s.f * D_f.f1 - t_s * D_s.f * D_f.f1) * 0.0001 / S = 0.21 • Total Floating IR Exposure 1bp E_i.floating = 35.47 676 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Effective Duration = -E_i.floating / V.floating / 0.0001 = 0.069444445 11.1.3.5.3 Total transaction figures (fixed and floating) • Valuation figures Market Value = -222,997.16 • Result figures Total Profit = -162,341.42 Accrued Interest = 3,197.27 MtoM Profit = -236,506.04 FX Profit = 81,623.48 Other Profit = -907.52 • Risk figures Ir Exposure 1bp = -842.66 11.1.4 Brazilian IDxUSD Swap Brazilian IDxUSD swap instruments are based on an instrument type derived from the class LOAN. 11.1.4.1 Deal entry The reset dates are set up using method irregular dates. The deal rate is entered in the field Nominal/Spot rate. The FX rate is entered in the field FX Rate. 11.1.4.2 Resetting Resetting is carried out as follows: 1. Fix the second referee event using the fixing interest rate. 2. Fix the first referee event using the fixing FX rate. 3. Fix the floating cashflow using the CETIP index rate To allow optional reset, add the feature ALLOW-DEACTIVATE-FIXING. To deactivate a reset, right-click on the cashflow and click Deactivate. To reactivate it, click Reactivate. 11.1.4.3 Expressions It is possible to make reference to previous values of a reference schedule. The syntax is the same as for ordinary reference to previous values, except the part previous is replaced by referee_previous. For example, referee_previous refers to the previous nominal rate of the referee schedule. The [] operator no longer applies. Instead, a date such as value_date returns the serial number of the date (1900-01-01 = 0). 11.1.5 Overnight index swap An overnight index swap is set up with two legs: one with a fixed rate structure, the other with a floating rate structure. The fixed rate leg is a standard loan and the floating leg is based on a daily compounded overnight index, such as EONIA. Other characteristics of the floating leg may include Fixing Rate and Coupon Frequency depending on the swap. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 677 11 Swaps 11.1 Interest rate swap Overnight index swap instruments are based on an instrument type derived from the instrument class SWAP. The following information is relevant to overnight index swaps. 11.1.5.1 Instrument setup Instrument setup for an overnight index swap is similar to that of a standard interest rate swap (see 11.1 on page 629), except for the following: • Main characteristics – – Legged Information Description Leg Structure Select a 2-leg structure for the overnight index swap: SWAP-2-LEG Legs Define which is the sign of the leg versus the transaction, and which instrument to use for the leg. Usually, this information is defined at instrument level, if this is not case, then you can define it at deal capture. Information Description Instrument The instrument to be used for this leg by default. The relevant instruments for legs are loans. Sign versus Transaction • For the fixed rate leg, select a loan with fixed rate structure similar to single currency IR swap. • For the floating rate leg, select a loan with an overnight compounded floating rate structure. Choose from: Same, Opposite, or Any. See A.2.307 Swap on page 866. • Base valuation parameters Information Description (Valuation) Method Theoretical See A.2.50 Base Valuation Setup on page 734. • IR valuation parameters Information Description AI Method Select Expression to calculate the accrued interest of the compound overnight swap from the historical values of the fixing quote. For details of this calculation, see 11.1.5.4 Position monitoring on page 679. For more generic information about the Expression method, see 2.1.6.1 Accrued interest calculations on page 67. See A.2.49 Base IR Setup on page 733. 678 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap • Risk parameters Information Description Risk Profile Compound (O/N) For more information about risk profiles, see 2.3.4.8 Risk profiles on page 124. See A.2.338 Valuation Setup (Floating) on page 879. 11.1.5.2 Deal capture In addition to the standard deal parameters, the following information is required to enter an overnight index swap. 11.1.5.2.1 Input data The data you need to input at deal entry is similar to a standard interest rate swap, except for the schedule: • Schedule view The following schedule information must be provided for each leg. Information Description Fixing Rate Select the fixing rate you want to use. Fixing Period Select the overnight fixing period, O/N. Expression Compounding expression. See D.4.3.10 Compound on page 928. 11.1.5.2.2 Generated data The generated data are similar to the generated data of a standard interest rate swap. 11.1.5.3 Processing The actions that can be done throughout the life of an overnight index swap are similar to those that can be done for a standard single-currency swap. 11.1.5.4 Position monitoring This section describes the valuation methods used to calculate overnight index swaps. It also provides a numerical example to illustrate these calculations. The standard valuation method for overnight index swaps is Theoretical. 11.1.5.4.1 Calculations The formulas below are for one unit, and results are in transaction currency. Local market value of the compound O/N leg is calculated as the sum of the discounted values of estimated coupons: Equation 11-1 Local market value where – Dip The discount factor between the payment date and the valuation date or spot according to the configuration. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 679 11 Swaps 11.1 Interest rate swap – – – Di1 The estimation discount factor between the valuation date and start date of the cashflow i, or 1, if the valuation date is within the coupon period. Din The estimation discount factor between the valuation date and the end date of cashflow i. E[] The method used to estimate the size of the coupon. The estimation of a coupon before the start of the coupon period is simply: Equation 11-2 Coupon estimation: before the start of the coupon period The estimation of the coupon during the coupon period, historical O/N rates r1, r2.....,rn are used as part of the estimate: Equation 11-3 Coupon estimation: during the coupon period Where the historical compounding factor A h is calculated from the known O/N rates: Equation 11-4 Historical compounding factor Where P i is the length of the ith overnight period, calculated using the date basis of the fixing quote. The set of periods includes only business days, and Friday’s period length is calculated from three days. The estimation method and risk calculations are described in more detail in 2.3.4.8 Risk profiles on page 124. Accrued interest ( I a ) is based on the historical compounding factor: Equation 11-5 Accrued Interest Ia = Ah – 1 For example, let us consider the valuation of a coupon with the following data: From When 2009-05-14 Until When 2009-08-14 Fixing To 2009-08-13 Payment Date 2009-08-14 Date Basis Act / 360 Nominal Amount 1000000 Valuation date 2009-05-20 Historical O/N rate (constant) 3.68% Historical period 3 business days + one weekend Di1 680 (start date discount factor) 1 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.1 Interest rate swap Din (end date discount factor) 0.9920420458606090 Dip (payment date discount factor) 0.9920420458606090 Valuation figures • Historical compounding factor ( A h ) for one weekend, three business days: Equation 11-6 Example: Historical compounding factor • Coupon estimate Equation 11-7 Example: Coupon estimate • Market value Equation 11-8 Example: Market Value Risk values • Payment Date Equation 11-9 Example: Payment Date • Period Start Equation 11-10 Example: Period Start • Period End Equation 11-11 Example: Period End Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 681 11 Swaps 11.2 Total return swap 11.1.6 Other swap structures TRM supports more exotic swap structures. The following sections give a brief description of these structures. 11.1.6.1 Callable/puttable (cancelable) swap A callable swap is an interest rate swap where the fixed rate payer has the right to terminate the contract. The swap is puttable if it is the fixed rate receiver that has the right to terminate the contract. Instrument setup for a callable swap is similar to that of a standard IR swap, except that the call or put events are added to a cashflow structure using a secondary schedule template. The call or put event should specify the following information: • Call/put periods or dates • Call/put price = 0 • Any other characteristics, for example, whether the call/put option gives the right to terminate the contract to the payer (call: Transaction Sign = "+") or to the receiver (put: Transaction Sign = "-") of the fixed leg. Note that the sign means the same no matter to which leg the call events are associated. A cancelable swap is modeled by adding call or put events to one of the legs of an ordinary swap. Executing the call will cancel the whole swap transaction. Note: In an asset swap where the bond leg is callable, the swap automatically inherits the call schedule of the swap. 11.1.6.2 Basis swap Basis swaps are floating-to-floating swaps which can be input by selecting floating cashflow structures for both legs using different market references. Basis swaps are usually cross currency but can also be single currency. For more information about how basis swaps are calculated, see 2.2 Yield curves on page 81. 11.1.6.3 Constant maturity swap Constant maturity swaps are also supported by TRM. In this case, the period used for the floating leg must be longer than the coupon period. 11.1.6.4 Roller coaster swap It is possible to schedule periodical principal increases/amortizations on both legs of a swap. If this option is used, it is possible to set up roller coasters. 11.2 Total return swap A Total Return Swap (TRS) is a type of derivative that enables the holder of an asset (typically a fixed-rate bond) to hedge the asset’s exposure by transferring the credit and market risks to a counterparty without transferring the underlying asset. The total returns from the asset (for example, the interest flows, dividends, MtoM profit, and so on) are transferred to the counterparty, while the owner of the asset receives a fixed spread from the counterparty. TRS transactions can be fully or partially early expired. Partial early maturities are limitless and can occur at any time until the full value of the TRS has been matured. 682 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.2 Total return swap A DRS (Deferred Rate Settlement) is a special kind of TRS, where the coupons of a swapped bond are transferred at maturity of the swap, and the swap is made against the daily compounded EONIA. Note: TRM only supports the swapping of a bond against a fixed or floating rate. 11.2.1 Instrument setup Total Return Swap instruments are based on an instrument type derived from the instrument class TRS. • Main characteristics The following basic information may be captured when defining the instrument and is relevant to any kind of total return swap. – Legged Information Description Transaction Sign Direction of the transaction. If the sign is not defined at instrument level, it needs to be specified separately for each transaction. Leg Structure The leg structure for the swap instrument. TRM supports swap structures with multiple legs. Pseudo Settlement Select these options to make the principal notional (no exchange of capital). Pseudo Repayment – Legs For each leg it is possible to define which is the sign of the leg versus the transaction, and which is the leg instrument. If this information is not provided at instrument setup, it needs to be specified at deal entry. Information Description Instrument The instrument to be used for this leg by default (for example, a fixed-rate bond). For deferred total return swaps, the floating leg of the swap is a cost-of carry cashflow of the bond’s notional value. This structure can be obtained in the instrument by using the schedule for Cost-of-Carry, Compounding, Bullet Repayment. Sign versus Transaction Choose from: Same, Opposite, or Any. See A.2.327 TRS - Total Return Swap on page 875. • Maturity definition It is possible to set up maturity information at instrument level. Information Description Calendar parameters Calendars used to calculate the maturity date. Gap Set Gap set used for supplying the available maturity periods. Maturity Date Period If defined, this maturity period is applied to each transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 683 11 Swaps 11.2 Total return swap See A.2.230 Maturity Date Setup on page 827. • Roll over The Roll Over action is available on the transaction if the Allow Roll Over trading feature is associated with the instrument. See A.2.9 Allow Roll Over on page 716. The parameters required are described in 11.2.3.2 Roll over on page 686. • Deferred parameters With a deferred TRS, all the cashflows of the deal which occur during its life will be paid at maturity. This means that they will be reinvested at the same rate between their value date and payment date. If the return cashflows in the TRS are to be deferred until the maturity date, use the TRS Deferred trading feature. See A.2.328 TRS Deferred on page 875. It is also possible to set up: • Branch codes • Cashflow and transaction charge rules • Manual charges • Spot date calculation. See Appendix A Features on page 713. 11.2.2 Deal capture 11.2.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a TRS. • 684 Transaction view Information Description Nominal Amount Nominal amount of the swap, which also serves as the nominal (reference) amount of Leg 1. Value Date Date when the swap starts, and from which interest starts to accrue. This defaults to the spot date of the first leg. Maturity Date Date when the transaction matures. Fixing Offset Offset, in days, between the maturity date and the fixing of the swap. Expiry Date Fixing date of the swap. This defaults to Maturity Date - Fixing Offset but can be modified. Deal Price Price of the first leg of the deal. © Wall Street Systems IPH AB - Confidential 11 Swaps 11.2 Total return swap In addition, the following optional information can be captured: Information Description Maturity Code If you enter a maturity code at deal entry, the maturity date is calculated automatically; otherwise you can enter the date manually. If the maturity definition parameters are defined at instrument level, these are used by default and cannot be modified. See A.2.230 Maturity Date Setup on page 827. Value Date Code If the Value Date Setup feature is applied at instrument level, you can enter the value date period you want to use to calculate the value date for the transaction, for example, 3M (3 months). This can be used to compute the value date for a forward purchase of a TRS. If you specify a value date period in the instrument setup, this is used as the default in the transaction and cannot be modified. See A.2.339 Value Date Setup on page 879. • Leg view If the legs are not defined on the swap instrument they must be selected here. Note that the different legs of a deferred TRS are always in the same currency. • Schedule view Schedule information must be provided for each leg. For deferred TRS transactions, the floating leg of the swap is a cost-of carry cashflow of the bond’s notional value. This structure can be obtained in the instrument by using the Cost-of-Carry, Compounding, Bullet Repayment system-defined schedule. See B.2.1.1.12 Cost of Carry Compounding, Bullet Repayment on page 892. 11.2.2.2 Generated data • Cashflows The cashflows are generated as follows: – Settlement cashflows are marked as pseudo – All cashflows with a value date later than the maturity date of the TRS are marked as pseudo. For a deferred TRS, the interests are deferred until maturity. Therefore, all the amounts that would normally be paid during the life of the deal are paid at maturity and reinvested during the period. – A cost-of-carry amount is generated for each cashflow to reflect the reinvestment of the interest until the maturity of the deal. 11.2.3 Processing This section describes the actions that can be done throughout the life of a total return swap. 11.2.3.1 Early expiration TRS transactions can be closed-out earlier than their agreed maturity date. This process is referred to as early expiration. • Execution Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 685 11 Swaps 11.2 Total return swap Early expiration of a swap requires the following information: Information Opening Date Description Date when the early expiration is executed. By default, this is today’s date unless a Fixing/Action Date is specified at transaction level. Value Date Date when the early expiration is settled. This must be earlier than the original maturity date and later than the original value date of the initial transaction. Amount to Expire Amount to be early expired. This defaults to the amount still available to be early expired, taking into account previous partial early expirations and roll overs. Net Amount Net amount to be settled between the two parties: (Net Amount = Accrued Interest + Sell Profit/Loss) Options • Amortize P/L Switch on to amortize the P/L from the value date until the original maturity date. If this switch is off, the Sell P/L flow created by the early expiration (arising from Net Amount – Accrued Interest) occurs on the early expiration value date. • No Fee Realization Switch on so that fees keep amortizing to maturity. If this switch is off, at early expiration, the fees that were amortizing until the maturity date are closed. The execution generates an early expiration transaction with the following attributes: Transaction sign = opposite of initial transaction Nominal amount = amount to expire Opening date = date when the early expiration is done Value date = date when the early expiration is settled Kind = Early Expiration The remaining attributes are inherited from the initial transaction. The early expiration transaction generates closing cashflows for the initial transaction. • Cancellation You can undo the early expiration by canceling the early expiration transaction. 11.2.3.2 Roll over You can defer the maturity of a TRS to a later date. This process is referred to as a roll-over. • Setup It is possible to restrict the use of the roll over methods at instrument level (see below for a description of the available methods). It is also possible to specify the default roll over method for the instrument. The Roll Over action is available on the transaction if the Allow Roll Over feature is associated with the instrument. See A.2.9 Allow Roll Over on page 716. • Execution Roll over of TRS deals can be done in four different ways. In all cases, the following information is needed to process the roll over: 686 Information Description Roll Over Date Date when the roll over is executed. © Wall Street Systems IPH AB - Confidential 11 Swaps 11.2 Total return swap Information Description Maturity Date The maturity date for the rollover. The defaulting is defined as follows: • If the parent transaction was defined with a maturity period, the roll over maturity date defaults according to that period, otherwise you have to enter the maturity date. • If the switch No Maturity Defaulting is selected at the instrument level (Roll Over page), then the maturity date of the rollover is never defaulted and you must enter it. Note: If the specified maturity date does not fall on a business day, you can choose to keep the non business day or to change it. Nominal Amount Amount of the roll over. By default, this is the amount left of the initial transaction but you can override this if you want to perform a partial roll over. Rate (Mandatory) New interest rate for the roll-over, that is, the rate at which interest is calculated from the old maturity date until the new maturity date. By default, the rate is defaulted from the initial transaction, however it is possible to disable this defaulting by selecting the switch No Rate Defaulting at the instrument level (Roll Over page). Roll Over Method Roll over method: Settle All, Settle Interest, Delay Interest, or Compound Interest. Spread New spread to be used in the roll over transaction. The outcome of the roll over depends on the method chosen as follows: Method Description Settle All The initial transaction is paid in its entirety at the initial maturity date. The default nominal amount of the roll over transaction equals the sum of the interest and principal cashflows of the initial transaction. Settle Interest The interest of the initial transaction is paid at the initial maturity date, but the principal payment is deferred. The part of the principal which is rolled over is paid back at the end of the roll over transaction. Delay Interest Nothing is paid at the initial maturity date: both the interest and principal payments are deferred. The parts of the principal and interest cashflows which are rolled over are paid back when the first interest payment of the roll over transaction occurs. Compound Interest This method is the same as Delay Interest, but the closed interest of the initial transaction is reinvested in the roll over. New interest accrues on top of the initial transaction’s interest. The execution generates a new transaction with the following attributes: Nominal amount = amount (can be smaller than the initial amount) Rate = roll-over rate Opening date = date when the roll-over is done Value date = maturity date of the initial transaction Maturity date = maturity of the roll-over Kind = Roll-over • Cancellation You can undo the roll over by canceling the roll over transaction. 11.2.3.3 Fixing The Fixing action needs to be executed at the agreed fixing date to fix the interest rates on the floating leg of the TRS transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 687 11 Swaps 11.3 Credit default swap • Execution The following information is needed to process the fixing: Information Description Fixing Date Day the cashflow is fixed. Fixing Quote Rate of the yield curve Nominal Rate Rate which is the rate of the yield curve (and optionally * factor + spread). Amount Amount of the interest flow. The fixing process is performed directly on an individual cashflow in the Cashflow view. • Cancellation You can undo the fixing with the Undo Fixing action. 11.3 Credit default swap A credit default swap (CDS) is a bilateral agreement designed to transfer the credit exposure of a particular entity (or a group of entities) from the buyer to the seller. The entity whose credit risk is transferred in a CDS is referred to as a reference entity. The reference entity is not a party to the contract. The buyer of a CDS pays regular (premium) payments to the seller. In the case where the reference entity defaults, the buyer will receive compensation from the seller, usually in the form of a cash payment, but sometimes, for example, as a par value payment for a bond (issued by the reference entity) against physical delivery. The default is referred to as a credit event and includes events, such as, the failure to pay a coupon or a redemption on a specific instrument issued by the reference entity or the bankruptcy of the reference entity. Following recent changes to the CDS market where previously no specific standard existed, the market has introduced new conventions to standardize CDSs. In standardized (ISDA-driven) CDSs, the buyer pays a fixed quarterly (premium) payment (usually 100 or 500 bp) and these payments, as well as the transaction maturity dates, always fall on the 20th of March, 20th of June, 20th of September, or 20th of December. The quarterly payments are often referred to as fixed coupons or fixed spread. A special convention also applies to the calculation of the coupon amounts, as the calculation period includes the date of the previous coupon (or issue date), and excludes the coupon payment date, except for the last coupon where both dates are included. As the coupon payment dates and amounts are fixed, an accrued interest and an upfront payment are often settled when entering into (or terminating) a CDS transaction. The CDSs described in this section are based on the standard conventions, but it is possible to define and capture CDS transactions using other conventions as well. The standardized CDSs are supported by using the system-defined schedule template Credit Default Swap, ISDA Standard (CD-SWAP-ISDA). The system-defined schedule template CD-SWAP can be used to capture 'non-standard' CDSs, e.g. with non-fixed dates and different calculation conventions for the regular payments. The reference entity of the CDS can be a single entity or a basket of reference entities each with their own weight. Single entity CDSs are often referred to as a single name CDS, while basket entity CDSs are known as credit default index swaps (CDISs) or credit default swap index. The main difference between the two is in the processing of a credit event. In a CDIS, when a credit event occurs, the CDS is impacted only partially based on the weight of the defaulting reference entity. CDSs can be terminated before their maturity through early expiration as e.g. loans or IRS. 11.3.1 Instrument setup Credit default swaps must be based on an instrument type derived from the class CDS. 688 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.3 Credit default swap • Main characteristics The following basic information may be captured when defining the instrument. Information Description AI Method Select ISDA CDS in order to have accrued interest calculated according to the new conventions (including first day). See ISDA CDS on page 72. Structure Select the system-defined Credit Default Swap, ISDA Standard (CD-SWAP-ISDA) primary schedule template: see B.2.1.1.14 Credit Default Swap, ISDA Standard on page 892. The following parameters are relevant for calculating the fixed coupons: • CDS Premium schedule: - Method: ISDA CDS Dates (Q) - Rate Type: ISDA CDS - Adjust Value Date: Yes, Except Last - Convention: Following Note: For non-standardized CDSs, select the system-defined Credit Default Swap (CD-SWAP) primary schedule template: see B.2.1.1.13 Credit Default Swap on page 892. Reference Entity • For single name contracts, select the reference entity defined in the Client Editor. • For CDISs (basket CDSs), select the reference entity with the basket of entities defined in the Client Editor’s Member Clients page. See the TRM User Guide for more information. • Settlement Offset The number of business days after the value date that the upfront and accrued interest are settled. For example, three days for standardized CDSs. Recovery Rate The default recovery rate, used in calculating CDS Deal Spread (see below), and also used as the default recovery price in the case of a credit event. Price Rounding parameters Method and precision used to round the deal price when calculated. Dates definition For standardized CDSs, Gap Set and Maturity Date Period do not apply. The Tenor field in Transaction Manager needs to be used to capture the tenor of the transaction, which is then translated into a standardized maturity date. Information Description Spot Days To comply with standard conventions, set this field to 0. This results in the value date being equal to the opening date. Thus, accrued interest is calculated to the trade date. Note: The settlement will occur later according to the defined Settlement Offset. See A.2.110 Credit Default Swap on page 762. • Credit spread curve setup It is possible to add a credit spread curve at instrument level: see A.2.114 Credit Default Swap Curve Setup on page 764. If no credit spread curve is defined at the instrument level, the system uses the credit spread curve attached to the reference entity: the linking of spread curves to entities can be done either in Client Editor or in IR Quote and Yield Curve Editor: see the TRM User Guide. It is also possible to set up: • Branch codes • Cashflow and transaction charge rules Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 689 11 Swaps 11.3 Credit default swap • Manual charges See Appendix A Features on page 713. 11.3.2 Market information 11.3.2.1 Credit spread curves A credit spread curve must be set up to store the credit spread quotes that are taken from the market feed or via Rate Monitor. This curve is needed for valuating CDSs. See the TRM User Guide for information about setting up credit spread curves. 11.3.2.2 Rate Monitor In Rate Monitor, Credit Default Swap page, the credit spread quotes are expressed as basis points and the recovery rate is expressed as a percentage. The calculated Default Probability (%) and Hazard Rate (bp) are also displayed. See the TRM User Guide for information about using Rate Monitor. CDS valuation is based on Par Spreads, and not on quoted upfronts or conventional spreads. Thus, it is Par Spreads that need to be imported or captured manually. Note: When importing from Reuters, the Par Spread is found in field 393 (PRIMACT_1). While the recovery rate is also available in the feed, it is recommended that the recovery rate is captured manually in Rate Monitor. 11.3.3 Deal capture 11.3.3.1 Input data In addition to the standard deal parameters, the following information is required to enter a standardized credit default swap. • Transaction view Information Description Nominal / Spot Rate Fixed coupon (CDS premium) in basis points. Deal Price Upfront %, i.e. the percentage of the nominal amount that will be settled between the transaction parties. Note: If you are using the Enter Board to capture the CDS, this field is displayed as Fixed Spread. Note: If you are using the Enter Board to capture the CDS, this percentage is displayed in the Upfront % field. Deal Rate This field is effectively another representation of the Deal Price, calculated as: 100 - Deal Price Recovery Rate Recovery rate (defaulted from instrument level) used to calculate the CDS Deal Spread. CDS Deal Spread Calculated from the fixed coupon and upfront according to the formula below. Changes to this field automatically trigger the recalculation of the deal price. Note: If you are using the Enter Board to capture the CDS, this field is displayed as Deal Spread. 690 Nominal Amount Notional amount of the transaction. Value Date Value date of the transaction, i.e. the date up to which accrued interest is calculated. For standardized CDSs, this corresponds to the opening date. © Wall Street Systems IPH AB - Confidential 11 Swaps 11.3 Credit default swap Information Description Settlement Date Settlement date of the transaction, i.e. the date when upfront payment and accrued interest are settled. The settlement date corresponds to the value date plus the number of business days specified in the Settlement Offset field at the instrument level (three for the standard convention). Tenor Term of the transaction (e.g. 1Y, 3Y), which calculates the maturity date according to the standard convention For example, the maturity date of a 5Y deal is calculated as the first ISDA date (20th of March, June, September or December) which will be hit five years or more after the trade date plus one day (calendar unadjusted). Maturity Date Maturity date of the CDS. Issuer Reference entity or reference basket entity. Currency Currency of the transaction. In addition, you may define the following information related to the possible credit event: Information Description Settlement Type Method of settlement if a credit event occurs: Cash Settlement or Physical Delivery. Reference Instrument Reference instrument of the transaction. • If Settlement Method = Physical Delivery, this is the default deliverable instrument (for information only). • If Settlement Method = Cash Settlement, the market price of this instrument is used by default as the recovery price (which in turn is used to calculate the settlement amount). When executing the credit event, it is possible to change the instrument to another instrument issued by the reference entity. Note: Normally, the basket of deliverable instruments/obligations is defined in broad terms, and some deliverables are instruments that are not or cannot be defined as instruments in the system. In such cases, the details can, for example, be described in a separate document and linked to the transaction using the Document Link column. • Reference Price Price at which the underlying bond is exchanged or against which the cash settlement is calculated when a credit event occurs. The default value is 100. Settle AI Defines whether the accrued interest of the deliverable bond is to be settled when there is a physical delivery. Schedule view If the cashflow structure of the deal is not defined at the instrument level, you need to specify it at the deal level by applying the system-defined schedule template Credit Default Swap, ISDA Standard (CD-SWAP-ISDA): see B.2.1.1.14 Credit Default Swap, ISDA Standard on page 892. Note: In the case of non-standardized CDSs, you can use the system-defined schedule template Credit Default Swap: see B.2.1.1.13 Credit Default Swap on page 892. 11.3.3.2 Generated data • Cashflows – Principal and Accrued Interest – CDS coupons – Pseudo Redemption (reflecting the notional amount) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 691 11 Swaps 11.3 Credit default swap • Cashflow key-figures Figure Description Figure Default Probability Cumulative probability that there will have been a credit event before the coupon payment. Figure Premium Amount Expected default probability adjusted amount of the coupon payment. Figure Protection Amount Expected protection amount at the coupon payment date: Figure Amount (Nominal Amount * (1 – Recovery Rate) * Probability of default during the coupon period) Expected payment: Premium Amount + Protection Amount Figure Market Value Discounted value of the expected payment. Figure Accrued Interest Accrued interest (premium). 11.3.4 Processing This section describes the actions that can be done throughout the life of a CDS. 11.3.4.1 Early expiration A CDS can be either fully or partially early expired by executing the Early Expiration action and supplying the amount you want to expire and the clean price for calculating the (clean) settlement amount. • Execution Information Description Opening Date Date when the early expiration is executed. By default, this is today’s date but can be modified to any date falling between the opening date and maturity date of the transaction. Value Date Value date of the transaction, i.e. the date up to which accrued interest is calculated. Settlement Date Settlement date of the transaction. The settlement date corresponds to the value date plus the number of business days specified in the Settlement Offset field at the instrument level. Currency Currency of the transaction. Read-only. Amount to Expire Amount you want to be early expired. This defaults to the amount still available (Amount Left) to be early expired, taking into account previous partial early expirations. Amount Left Remaining amount of the initial transaction. Read-only. Clean Price Price used to calculate the Clean Amount. Deal Spread CDS Deal Spread as calculated for new transactions. Clean Amount Amount to be settled (excluding accrued interest) calculated as Amount to Expire * Clean Price / 100 Accrued Interest • The accrued interest to be settled. Cancellation You can undo the early expiration by canceling the new transaction. 692 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.3 Credit default swap 11.3.4.2 Credit event With cash settlement, the seller will pay the difference between the recovery price and the reference price (default 100) on the outstanding notional. The recovery price can be the market price of the reference instrument, or some other price set by an independent third-party. Alternatively, there could be physical delivery of some underlying instrument or loan. In the case of physical delivery, the credit event only terminates the CDS; the physical delivery itself needs to be captured in a separate transaction. • Execution Information Description Opening Date Date when the credit event is executed. By default, this is today’s date but can be modified to any date falling between the opening date and maturity date of the transaction. Value Date Value date of the transaction, i.e. the date up to which accrued interest is calculated. Settlement Date Settlement date of the transaction, i.e. the date when the settlement occurs. Amount Left Amount left of the initial transaction available for the credit event. Read only. Amount Amount of the credit event. Settlement Type Select Cash Settlement or Physical Delivery. Reference Entity • For a single name CDSs, this field displays the reference entity. • For a CDISs, you need to select the defaulting reference entity. The Amount field, i.e. the notional affected by the credit event is calculated based on the weight of the defaulting entity: Amount = Amount Left * Weight Reference Instrument The list contains all the bonds of the reference entity. The instrument used to default the recovery price. Scenario Scenario from which the recovery price is obtained. Reference Price Reference price (usually 100) used to calculate the settlement amount. Recovery Price Price used to calculate the settlement amount. Settlement Amount • Amount * (Reference Price - Recovery Price) • Accrued Interest For cash settlement, the amount to be settled is calculated as For physical delivery, the credit event is processed without any settlement, and the physical delivery is handled independently through the capturing of a separate transaction. Accrued Interest to be settled. The execution generates a new transaction: • – Closing cashflows against the initial transaction – Cashflows reflecting the cash settlement (Settlement Amount and Accrued Interest). Cancellation You can undo the credit event by canceling the new transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 693 11 Swaps 11.3 Credit default swap Important: In the case of a CDIS, after executing the credit event, you must set the defaulting entity to Inactive in Client Editor's Member Clients page of the corresponding basket entity. 11.3.5 Position monitoring 11.3.5.1 Setup The result key figures of the cashflows of a credit default swap are calculated based on the instrument’s valuation method settings: Theoretical or Quoted. • Theoretical - a default probability curve is constructed from par credit default swap rates. The market value of the swap is then estimated based on the probability. • Quoted - the difference between the nominal rate of the transaction and the current market rate for the corresponding swap is multiplied by the risky point value that is derived from the market swap rate and recovery rate. Note: IR exposure is calculated using the Theoretical method even in Quoted mode. See A.2.50 Base Valuation Setup on page 734. 11.3.5.2 Calculations In this section, numerical examples demonstrate how the different figures are calculated for a credit default swap. If you need more theoretical information about the method used in these calculations, see Chapter 2 Market standards and calculations on page 33. This example shows a credit default swap, with the following deal data: Setup data Maturity Date d_m 2008-03-09 Date Basis B Actual/360 Interpolation Date Basis B_i 365 Transaction data Opening Date 2006-03-07 Value Date dt_v 2006-03-09 Nominal Amount A 10,000,000.00 Deal Price r_b 18.0000 Maturity Date d_m 2008-03-09 Date Basis B 360 Other transaction data specific to the coupon flows is as follows: Transaction data Coupon 1 Value Date dt_v.c1 694 Coupon 2 2007-03-09 dt_v.c2 2008-03-09 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.3 Credit default swap Calculated transaction data is as follows: • Coupon 1 Coupon Period p.c1 = (dt_v.c1 – dt_v) / B 1.013888889 = (2007/03/09 – 2006/03/09) / 360 Coupon Amount A.c1 = A * P.c1 * r_b / 10,000 18,250 = 10,000,000.00 * 1.013888889 * 18.0000 / 10,000 • Coupon 2 Coupon Period p.c2 = (dt_v.c2 – dt_v.c1) / B 1.016666667 = (2008/03/09 – 2007/03/09) / 360 Coupon Amount A.c2 = A * p.c2 * r_b / 10,000 18,300.00 = 10,000,000.00 * 1.016666667 * 18 / 10,000 Unless otherwise stated, the figure date used in the calculations is 2006-03-09. On this date, the market data is as follows: Market data on 2006-03-09 Figure Date d_f 2006-03-09 Spot Date d_s.f 2006-03-13 Market Spread S_p 100.00000 Recovery Rate R_c 40.00% MV Discount Factor Spot D_s 0.9996625908 Market data specific to the coupon flows is as follows: Market data Coupon 1 Coupon 2 MV Discount Factor D_V.c1 0.9734527645 D_V.c2 0.9446679058 Default Probablility Pr.c1 0.016529 P.c2 0.032828 Other market data is calculated by the system as follows: • Coupon 1 Risk Time t_r.c1 = (dt_v.c1 - d_f) / 365 1.00000 = (2007/03/09 – 2006/03/09) / 365 • Coupon 2 Risk Time t_r.c2 = (dt_v.c2 - d_f) / 365 2.002740 = (2008/03/09 – 2006/03/09) / 365 Risk Time from Spot t_r = (dt_v.c2 – d_s.f) / 365 1.991780822 = (2008/03/09 – 2006/03/13) / 365 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 695 11 Swaps 11.3 Credit default swap 11.3.5.2.1 Key-figures This example uses the Quoted method to calculate market value, and the Theoretical method to calculate present value and risks. • Hazard Rate lambda = S_p / 10,000 / (1 - R_c) 0.0167 = 100.00 / 10,000 / (1 – 0.40) • Continuous Rate rate = -LN(D_V.c2 / D_s) / ((dt_v.c2 – d_s.f) / 365) 0.028408934 = LN(0.9446679058 / 0.9996625908) / ((2008/03/09 – 2006/03/13) / 365 • Risk Rate r_r = (rate + lambda) 0.045076 = 0.028408934 + 0.0167 • Risky Point Value rpv = ((1 - EXP(-(r_r) * t_r)) / r_r) * A * 0.0001 1904.99 = ((1 – EXP(-(0.045076) * 1.991780822)) / 0.045076 * 10,000,000 * 0.0001 • Market Value = (S_p - r_b) * rpv * D_s 156,156.14 (100.00 – 18.0000) * 1904.99 * 0.9996625908 • Coupon 1 Premium Amount A_p.c1 = -A.c1 * (1 – 0.5 * Pr.c1) -18,099.17 = -18,250 * (1 – 0.5 * 0.016529) Protection Amount A_d.c1 = A * (1 – R_p) * Pr.c1 99,173.55 = 10,000,000 * (1 * 0.40) * 0.016529 Amount A_f.c1 = A_d.c1 + A_p.c1 81,074.38 = 99,173.55 + (-18,099.17) Market Value V.c1 = A_f.c1 * D_V.c1 78,922.08 = 81,074.38 * 0.9734527645 IR Exposure 1bp E_pb.c1 = -A_f.c1 * D_V.c1 * t_r.c1 * 0.0001 -7.89 = 81,074.38 * 0.9734527645 * 1.0000 * 0.0001 Effective Duration U_eff.c1 = -E_pb.c1 / V.c1 / 0.0001 1.00 = -(-7.89) / 78,922.08 / 0.0001 • Coupon 2 Premium Amount A_p.c2 = -A.c2 * (1 – 0.5 * (p.c2 + P.c1)) -8,846.26 = -18,300 * (1 – 0.5 * (1.016666667 + 0.016529)) Protection Amount A_d.c2 = A * (1 - R_p) * (p.c2 - P.c1) 6,000,826.45 = 10,000,000 (1 – 0.40) * (0.032828 – 0.016529) Amount A_f.c2 = A_d.c2 + A_p.c2 5,991,980.19 = 6,000,826.45 + (-8,846.26) Market Value V.c2 = A_f.c2 * D_V.c2 5,660,431.37 = 5,991,980.19 * 0.9446679058 IR Exposure 1bp E_pb.c2 = -A_f.c2 * D_V.c2 * t_r.c2 * 0.0001 -15.13 = 79,948.73 * 0.9446679058 * 2.002740 * 0.0001 Effective Duration U_eff.c2 = -E_pb.c2 / V.c2 / 0.0001 2.00 = -(-15.13) / 75,525.00 / 0.0001 696 © Wall Street Systems IPH AB - Confidential 11 Swaps 11.3 Credit default swap • Total transaction Market Value V.t = V.c1 + V.c2 154,447.08 = 78,922.08 + 75,525.00 IR Exposure 1bp E_pb.t = E_pb.c1 + E_pb.c2 -23.02 = -7.89 + (-15.13) Effective Duration U_eff.t = -E_pb.t / V.t / 0.0001 1.49 = -(-23.02) / 154,447.08 / 0.0001 Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 697 11 Swaps 11.3 Credit default swap 698 © Wall Street Systems IPH AB - Confidential Chapter 12 Commodities 12.1 Gold 12.1.1 Gold deposit A gold (XAU) deposit is a short-term deposit, with one interest payment at maturity which is settled in another currency (normally US Dollars). Gold deposits are set up in a similar way to generic loans and processed in TRM as dual-currency transactions. 12.1.1.1 Instrument setup Gold deposits are based on an instrument type derived from the class LOAN. Instrument setup for gold deposits is similar to that of a standard loan (see 3.10 Loan on page 326), except for the following: • Gold main characteristics Information Description Currency XAU Structure Select the cashflow structure template you want for the instrument. One system template is provided for gold deposits. This is a fixed bullet structure: see B.2.1.1.45 XAU, Unknown FX Rate, Fixed on page 899. • Weight difference instrument It is possible to manage any difference in the weight of gold that is delivered and issue the appropriate compensation for the difference between counterparties. Weight differences are captured at transaction level. You need to define the instrument used to capture the difference. See A.2.25 Allow Weight Difference on page 722. • Sight account transfer instrument It is possible to manage transfers between the account where the gold is physically held and the custodian sight account. Transfers between accounts are captured at transaction level. You need to define the instrument used for the transfer. See A.2.20 Allow Sight Account Transfer on page 721. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 699 12 Commodities 12.1 Gold 12.1.1.2 Deal capture 12.1.1.2.1 Input data Deals on gold instruments are captured in a similar way to those on a standard loan (see 3.10 Loan on page 326). To complete the capture of a gold deposit transaction, you need to specify the settlement currency and the settlement FX rate either at transaction level or at schedule level. Hint: At the transaction level, the settlement currency is displayed in the Currency 2 column. 12.1.1.3 Processing This section describes the actions that can be done throughout the life of a gold deposit transaction. 12.1.1.3.1 Roll over You can defer the maturity of a gold deposit to a later date. This process is referred to as a roll-over. See A.2.10 Allow Roll Over (Dual Currency) on page 717. • Setup It is possible to restrict the use of the roll-over methods at instrument level. It is also possible to specify the default roll over method for the instrument. • Execution Roll-over of gold transactions can be done in several ways. In all cases, the information needed to process the roll over is as follows: Information Roll Over Date Description Date when the action is executed. By default, this is today’s date unless a Fixing/Action Date was specified at transaction level. Roll Over Method Method used for the roll over. Nominal Amount Amount of the roll over. This defaults to the amount left of the initial transaction but you can override this if you want to perform a partial roll over. Additional Amount Amount to be added to the initial principal amount if you want to increase capital at roll over. This field becomes available when one of the Allow Increase roll over methods has been selected. New Nominal Amount Original nominal amount plus the additional amount. Gap Gap used to compute the maturity date. Maturity Date The maturity date for the rollover. The defaulting is defined as follows: This field becomes available when one of the Allow Increase roll over methods has been selected. • If the parent transaction was defined with a maturity period, the roll over maturity date defaults according to that period, otherwise you have to enter the maturity date. • If the switch No Maturity Defaulting is selected at the instrument level (Roll Over page), then the maturity date of the rollover is never defaulted and you must enter it. Note: If the specified maturity date does not fall on a business day, you can choose to keep the non business day or to change it. 700 © Wall Street Systems IPH AB - Confidential 12 Commodities 12.1 Gold Information Description Deal Rate (Mandatory) New interest rate for the roll-over, that is, the rate at which interest is calculated from the old maturity date until the new maturity date. By default, the rate is defaulted from the initial transaction, however it is possible to disable this defaulting by selecting the switch No Rate Defaulting at the instrument level (Roll Over page). • Spread Spread to be added to the interest rate. FX Rate FX rate used to convert the new interest amount into the settlement currency. Cancellation You can undo the roll over by canceling the roll over transaction. 12.1.1.3.2 Weight differences It is possible to manage any difference in the weight of gold that is delivered and issue the appropriate compensation for the difference between counterparties at maturity. Weight differences in a gold transaction are captured using a processing action on the redemption flow. • Setup In the instrument definition, you need to attach the FX instrument used to capture weight differences for gold deposit transactions. See A.2.25 Allow Weight Difference on page 722. • Execution At cashflow level, the action is executed on the maturity cashflow. The following information is needed to process the Weight Difference action: Information Description Opening Date Date when the action is executed. By default, this is today’s date unless a Fixing/Action Date was specified at transaction level. Value Date Value date of the weight difference cashflow. This defaults to the spot date of the instrument. Direction Direction of the cashflow. Choose from: • Over Delivery - when the weight of the gold that is delivered is over the expected weight • Under Delivery - when the weight of the gold that is delivered is under the expected weight. Currency Currency of the cashflow. Amount Amount of the weight difference in XAU. FX Rate Rate used to calculate the settlement amount. Settlement Currency Currency in which the weight difference is settled. Settlement Amount Settlement amount calculated using the Amount and FX Rate values. Add to Package Switch on to add the new transaction to the same package as the underlying gold deposit (if it is part of a package). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 701 12 Commodities 12.2 Setting up commodities as currencies 12.1.1.3.3 Sight account transfers It is possible to manage transfers between the account where the gold is physically held and the custodian sight account. • Setup In the instrument definition, you need to attach the cash transfer instrument that you want to used to make the transfer. See A.2.20 Allow Sight Account Transfer on page 721. • Execution At cashflow level, the action is executed on the cashflow for which the transfer is made. The following information is needed to process the Sight Account Transfer action: Information Description Opening Date Date when the action is executed. By default, this is today’s date unless a Fixing/Action Date was specified at transaction level. Value Date Value date of the transfer. This is taken from the cashflow. Currency Currency of the transfer. Amount Amount of the transfer. Direction Direction of the transfer. Choose from: Add to Package • From Custody • To Custody. Switch on to add the new transaction to the same package as the underlying gold deposit (if it is part of a package). 12.1.2 Gold IR swap TBC 12.2 Setting up commodities as currencies Commodity futures, swaps and forwards are not currently defined as separate instrument classes, but can now be set up using the existing currency- and instrument-based functionality. They have financial net settlement, with no physical delivery of the commodity. You can set up the commodities as currencies in Currency Editor. This also applies to all geographic or grade-based variations such as electricity in a specific area, or a specific crude oil grade. As in any currency, the setup identifies the currency in which the commodity is priced in the market, as well as point factor, etc. The setup must include a default valuation curve even though this curve may not be actually used in this context. All Commodity Prices are best managed as FX rates of commodity currencies against their respective pricing currencies (i.e. Quote Base Currency given in the journal of the commodity currency). Regardless of the actual quoting structure of the commodity in the marketplace, TRM can only handle FX quotes as a combination of a spot FX rate and a set of tenor-based forward points, as in normal currencies. Consequently, in situations where a forward price curve is required for valuation of commodity swaps and forwards, forward prices must be first converted into a combination of a single spot rate and a series of forward points, for the period between spot and the date for which the forward price is given as defined in Gap Set given in the Journal of the commodity currency, before it is taken into the system. 702 © Wall Street Systems IPH AB - Confidential 12 Commodities 12.3 Commodity futures 12.3 Commodity futures 12.3.1 Setting up instruments Commodity futures can be modeled using FX-FUTURE type instruments and commodity currencies. Commodity futures are settled financially and behave similarly to FX futures, so existing FX futures functionality in commodity futures instruments and transactions can be used. 12.4 Commodity swaps and forwards 12.4.1 Schedule structure Commodity swaps and forwards are set up as loan-type instruments, with a specific schedule structure. The system templates include a COMMODITY-SWAP schedule template which holds commodity position and settlement schedules. 12.4.1.1 Commodity Position schedule This principal-type schedule is used to model the commodity amounts purchased or sold at fixed price in a commodity swap or forward transaction. • In a forward transaction, the method Bullet is used, so a single commodity position cashflow is generated at the Maturity Date of the transaction. • In a swap transaction, method, frequency and calculation method are used to split the transaction nominal amount in traded commodity to any number of periodic amounts reflecting the conditions of the swap transaction. Cashflows generated by this schedule are pseudo-redemption cashflows with no valuation. Their only purpose is to model the commodity deliveries for which financial settlements can be calculated. In monitoring, they will produce values in the Nominal Amount key figure, to facilitate analysis of open positions in terms of the purchased or sold commodity. 12.4.1.2 Commodity Settlement schedule This interest-type schedule is used to model the financial settlements from commodity position cashflows. The schedule is a referenced one and automatically creates a settlement cashflow for each date on which there is a commodity position cashflow. The currency of this schedule is always the commodity itself (the currency of the transaction). The currency in which the commodity is priced and in which the financial settlement from the commodity delivery is settled is given in the Settlement Currency field. The schedule creates a floating cashflow where the settlement conditions are modeled in an expression. By default, the following expression is used in the schedule: abs(reference_amount)*(fx-cap) where the fixed commodity price at which the commodity has been purchased or sold is given in field Cap and currency pair referencing commodity market price is given in field Fixing Rate (e.g. XCU/USD) but this can be modified. This schedule also underlies the market valuation of the transaction which is based on the figure amount received by evaluating the expression (see 12.3.1 Setting up instruments on page 703). Schedule is modeled as an interest-type schedule, because commodity swaps are typically settled against periodic monthly average commodity prices. Sometimes it is possible to use a simple expression like the default, because periodic average prices are quoted in the market. Otherwise these averages must be calculated internally using expressions like: abs(reference_amount)*(average(@,@,@,@,[fx])-cap) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 703 12 Commodities 12.4 Commodity swaps and forwards This expression can only be evaluated in an interest-type cashflow identifying a cashflow period (From When – Until When). Cashflows generated by this schedule use cashflow type (2, 12, Periodic Netting) which clearly separates commodity settlement cashflows from true interest cashflows. Also, when realized results are being analyzed, all results from Periodic Netting cashflows are shown as realized mtom profit instead of realized interest. In monitoring, cashflows from this schedule generate values for all relevant valuation, result and risk figures. 12.4.2 Setting up instruments Commodity swaps and forwards are set up as loan-type instruments attached to a Schedule Template derived from the system template. When setting up the instrument, consider the following: • GENERIC-IR-METHOD. Valuation is handled by this approach. • DUAL-CURRENCY. Since valuation is based on Settlement Currency amounts of commodity settlement cashflows, dual currency valuation is used. This is automatically handled by normal GENERIC-IR-METHOD but in order for fixings to work properly, feature Dual Currency (DUAL-CURRENCY) must be attached. • BASE-IR-SETUP. Since valuation is based on figure amounts received by evaluating expression used in settlement cashflows, Estimate Method in IR Valuation setup must be set to Estimate Expression. • FLOATING-SETUP. Risk Profile in Floating Valuation setup must be explicitly set to None. • FX-ESTIMATE. If forward prices (forward FX rates of commodity currencies) are to be used in valuation when evaluating the expressions of cashflows, feature FX-ESTIMATE must be set. If this feature is not used, figure amounts of commodity settlement cashflows used in valuation are calculated using spot rate of commodity currency only: all future settlements amounts are estimated using current spot price. If the feature is used, TRM uses forward prices of respective Value Dates instead. Sometimes, as in the case of electricity swaps, standard periods (e.g. year 2008 or Q3 2008) with irregular delivery amounts (for electricity, monthly hours) are traded in large volumes. In a normal commodity swap transaction, handling these irregular amounts would require the user to calculate them outside the system and manually insert them separately into every transaction (either in Schedule Date / Schedule Data or directly in the cashflow Fixing Quote). This can be very time-consuming and error-prone. These swaps can also be set up as separate contract-specific instruments as follows: • Set up a bond instrument without a fixed issuer. If this is done, the issuer is defaulted during transaction entry as Owner or Counterparty of the transaction, using the same logic as in loan-type transactions • In the expression of a floating schedule it is possible to refer to transaction-level fields in addition to other cashflow fields by prefixing the field id with "0." (e.g. 0.nominal_rate would evaluate to a value in the Nominal/Spot Rate field of the transaction). In the context of standardized commodity swaps, this makes it possible to create instrument cashflows as part of the instrument setup, with irregular amounts (by updating fixing_quotes manually in instrument cashflows) using an expression like the following: reference_amount*(fx-0.nominal_rate) and identifying a fixed commodity price at which the commodity has been purchased or sold dynamically for every transaction traded in the instrument by giving it in the transaction field Nominal/Spot Rate. Note that if irregular amounts are given in instrument cashflows, the Rate Type of Commodity Position schedule must be set to Price %, and irregular amounts must be calculated outside the system and given manually as a percentage of the total contract amount in the Fixing Quote 704 © Wall Street Systems IPH AB - Confidential 12 Commodities 12.4 Commodity swaps and forwards field of the commodity position cashflows. This enables TRM to calculate the respective cashflow amounts correctly from the transaction Nominal Amount when a transaction is entered. 12.4.3 Deal capture Commodity swap and forward transactions are captured similarly to any other schedule based transactions in the system. 12.4.3.1 Input data You need to consider the following transaction attributes when capturing a commodity swap or forward transaction: • Transaction view Information Description Currency Traded commodity. Nominal Amount Total commodity amount of the deal. If the swap transaction has several periodic deliveries, this amount is split between them according to the method, frequency and calculation method of the commodity position schedule. Value Date Start date of the first commodity delivery period. In order for price averaging to work correctly, Value Date must be set to one day before the first day of the period. For example, if calendar month August 2008 is the first delivery period, Value Date must be set to July 31st, 2008. Maturity Date End date of the last commodity delivery period. Maturity Code If you enter a maturity code, the date is calculated automatically; otherwise you can enter the date manually. If the maturity definition parameters are defined at instrument level, they are used by default and cannot be modified. Deal Rate / Deal Price These fields must not be used. If values are given in any of these fields for a commodity swap or forward transaction, the system will incorrectly create a settlement cashflow for the transaction. The fixed commodity price of the deal is given in the Cap field of the Commodity Settlement schedule instead. • Schedule view Schedule fields Method, Frequency and Calculation Method of the Commodity Position schedule are used to define how the Nominal amount of the transaction is split between different delivery periods. In a commodity forward transaction, Method is set to Bullet as there is only one delivery period underlying the transaction. You can enter the following schedule attributes in the Commodity Settlement schedule: Information Description Settlement Currency Currency in which the commodity is priced and the financial settlement is made. Cap Fixed commodity price of the transactions. At fixing, this price is compared against the market price of the commodity to calculate the financial settlement amount. Fixing Rate The currency pair from which the market price of the commodity is taken. This is set to Commodity Currency / Settlement Currency. Payment Offset (Days / Business Days) Number of days between end date of the delivery period and payment date of the financial settlement. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 705 12 Commodities 12.4 Commodity swaps and forwards 706 © Wall Street Systems IPH AB - Confidential Chapter 13 Funds In TRM, the term fund is used to cover all types of fund including investment funds, managed funds, mutual funds and hedge funds. Funds enable investors to invest collectively in a wide range of investments and to share the related fund management fees (such as shareholder transaction costs, investment advisory fees, and marketing and distribution expenses). 13.1 Fund shares In TRM, you can issue and buy back fund shares. Different fund share instruments can be set up so that you can issue capitalization or distribution shares in different currencies. 13.1.1 Instrument setup Fund share instruments must be based on an instrument type derived from the class FUND-SHARE. • Main characteristics: Fund share instrument setup is the same as for equities. See 4.1 Equity on page 345 for more information. However, the following setup is specific to fund shares: Information Description Relative Spread Switch on/off If the switch is off, the bid and ask spread% are interpreted as absolute numbers i.e.: When you publish a NAV in Rate Monitor, the bid price of the NAV per unit will be calculated as: Bid Spread% * NAV *Scaling Factor. For example, if the NAV is 100 and the scaling factor = 1, and you set: • Switch off • Bid Spread%: 95 Then the bid NAV is: 0,95*100*1 = 95. If the switch is on, the bid and ask spread% are interpreted as relative numbers i.e.: When you publish a NAV in Rate Monitor, the bid price of the NAV per unit will be calculated as: (1+ Spread%) * NAV* Scaling Factor CellCode character. For example, if the NAV is 100 and the scaling factor = 1, and you set: • Switch on • Bid Spread%: -5 Then the bid NAV is: (1-0,05)*100*1 = 95. Bid Spread% Number (0-100). Note: When you publish a NAV in Rate Monitor, the bid price of the NAV per unit is calculated using the Bid Spread% (see the field Relative Spread for more explanation about the calculation). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 707 13 Funds 13.2 Fund fees Information Description Ask Spread% Number (0-100). Note: When you publish a NAV in Rate Monitor, the ask price of the NAV per unit is calculated using the Ask Spread% (see the field Relative Spread for more explanation about the calculation). See A.2.165 Fund on page 791. 13.1.2 Deal capture 13.1.2.1 Input data In addition to the standard deal parameters, the following information is required to enter a transaction with a fund share instrument: Information Description Deal Price Price of one unit. Units Number of units bought or sold. The Fund Trading Unit feature is used to define the minimum bid size of shares or fund shares. See A.2.321 Trading Unit (Equity) on page 871. Value Date Official date when money is transferred. This defaults to the spot date as defined for the instrument. The following optional information can also be captured: Information Description Value Date Code If the Value Date Setup feature is applied at instrument level, you can enter the value date period you want to use to calculate the value date for the transaction, for example, 3M (3 months). This can be used to compute the value date for a forward purchase of equity. Note: If you specify a value date period in the instrument setup, this is used as the default in the transaction and cannot be modified: see A.2.339 Value Date Setup on page 879. 13.1.2.2 Generated data Fund share cashflows are the same as for equities. See 4.1.2.2 Generated data on page 347 for more information. 13.2 Fund fees Fund fee calculation instruments are assigned to the fund for which you want to calculate and realize the fee accrual. Fund fee calculation instruments are assigned to a fund in the Fund Fee page of Portfolio Editor: see the TRM User Guide for more information. 13.2.1 Instrument setup Fund fee instruments must be based on an instrument type derived from the class FUND-FEE. • 708 Fund fee accrual main characteristics: © Wall Street Systems IPH AB - Confidential 13 Funds 13.2 Fund fees The following information may be captured when defining the instrument: Information Description Date Basis Date basis used to calculate accrued interest for the instrument. Fee Rate Rate. Note: If you specify a fee rate, you do not need to specify any ladder values (see Ladder Rule and Ladder). Fee IR Reference Underlying yield curve used for fee calculation. Note: The yield curves are set up in IR Quote and Yield Curve Editor. If you specify a yield curve (and/or Period, Positive Spread, or Negative Spread), you do not need to specify any ladder values (see Ladder Rule and Ladder). Scenario • Rates scenario to be used for calculating interest for this instrument. Fund fee realization: The following information may also be captured: Information Description Frequency Frequency of fee realization. Frequency Unit Unit of time to use for fee realization: Business Days, Days, Months, Weeks, or Years. Convention Convention to use for interest realization: • None – no adjustment is made to the date. • Backward - fee realization is moved to the first business day before the value • Following – fee realization is moved to the first business day after the value date. date. • Last of Month – fee realization is moved to the last business day of the month. Note: You must select Frequency Unit = Business Days. • Last of Month Calendar – fee realization is moved to the last calendar day of the month. Note: You must select Frequency Unit = Business Days. • Last of week - fee realization is moved to the last business day of the week. • Modified Following – fee realization is moved to the first business date after the value date except where this would cause the payment date to fall into the month following the value date, in which case the payment date is the first business date before the value date. • Method Not Modified. Method of realizing interest: • At Withdrawal - not applicable • Periodically - interest is realized at regular intervals (see Frequency field). • At Expiration - not applicable. See A.2.166 Fund Fee Accrual and Realization on page 792. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 709 13 Funds 13.2 Fund fees 13.2.2 Deal capture In Fund Fee Manager you can enter fee transactions manually (e.g. one-off custody, broker or operation fees). Note: Accrued fund fee transactions are generated by the activity Fund Data Calculation/Reporting. Fund fee realization is done by the activity Fund Fee Realizing. See 13.2.3 Processing on page 710 for more information. 13.2.2.1 Generated data • Transaction Transaction Type = Fund fee Counterparty = Fund company that manages the fund • Cashflows – Cashflow per fund's market value balance (as set in the Charging Basis defined in the Fund Fee page of Portfolio Editor) – If the fund fee is unrealized: daily accrued fund fee interest cashflows are generated – If the fund fee is realized: realized fund fee interest cashflows are generated. 13.2.3 Processing This section describes the processing that you can perform, either manually in the relevant application, or automatically, as an activity, using Activity Manager. 13.2.3.1 Accrued fund fee calculation Accrued fund fee calculation transactions are generated: • By the activity Fund Data Calculation/Reporting when the NAV report status is set to Published. You can schedule to run this activity as often as required (for example, nightly). See the TRM User Guide for more information about the activity Fund Data Calculation/Reporting and how to set up activities in general. • In NAV Monitor when you manually set the NAV report to Published. See the TRM User Guide for more information. 13.2.3.2 Accrued fund fee realization You can realize accrued fund fees manually, by right-clicking on the transaction in the Transaction view of the Fund Fee Manager and selecting the Realize Fund Fee action. • 710 Execution © Wall Street Systems IPH AB - Confidential 13 Funds 13.2 Fund fees The following information is needed to realize the fund fee: Information Description Date Date of the action i.e. the realization date. Opening Date Transaction date. Payment Date By default, the Payment Date is the realization date. However, you can change the default date. Amount Amount of the realized fund fee cashflow. By default, this is the total amount of accrued fund fees, but it can be changed to a lesser amount if you do not want to realize the total. Update Realization Date Switch on to allow the next interest realization date to be automatically updated. Note: You can realize the accrued fund fee using the activity Fund Fee Realizing. See the TRM User Guide for information. • Cancellation You can cancel the fund fee manually by right-clicking on the transaction in the Transaction view of the Fund Fee Manager and selecting the Undo Realize Fund Fee action. The following information is needed to process the cancellation: Information Description Date Date of the action i.e. the undo realization date. By default the date is today's date. Note: You can cancel interest realization using the activity Fund Fee Realizing. See the TRM User Guide for information. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 711 13 Funds 13.2 Fund fees 712 © Wall Street Systems IPH AB - Confidential Appendix A Features A.1 Categories of features Context Description Primary Each instrument must have one primary feature attached to it. Primary features enable trade capture in Transaction Manager (or Enter Board). When a primary feature is added to an instrument, underlying pages are displayed in Instrument Editor to allow you to complete the instrument definition. Primary features cannot be deleted. Trading Trading features affect deal entry at transaction or cashflow level. They can be specific to one or more instrument classes or be applicable to all instruments Valuation Approach This type of feature defines the valuation approach to be used for an instrument. If a valuation setup has been defined for the instrument (see below), these settings are applied to the valuation approach. Valuation Setup This type of feature is always optional. If valuation setup is configured for an instrument, the configuration is taken into account by the valuation approach feature (see above). If a valuation setup has not been applied for the instrument, the valuation approach defined for the instrument follows its default behavior. Action This type of feature enables some actions to be carried out on an instrument. Function Function features enable the use of specific functions in an expression. See Appendix D Expressions on page 917. Accounting This type of feature defines the instrument as requiring specific accounting treatment. Performance Performance features are used in performance measurement, specifically by the Performance Monitor application. A.2 List of features A.2.1 ABS - Asset Backed Security Id: Usage: ABS Defines an Asset/Mortgage Backed Security. This instrument behaves in the same way as an Amortizing Bond, except that any future flows are not generated until they are known. With: ABS Context: Primary Setup: As for BOND, Repayment Estimates Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 713 A Features A.2 List of features Information Description Estimation Date Date from when the estimation is valid. Outstanding Percentage of the initial nominal amount which is outstanding (the current repayment included). WAL Date This date is used when the expected maturity date is different to the coupon date, i.e. when the method WAL Date is selected during the generation. Value Date Date on which the repayment may occur. Percentage Percentage of the principal estimated to be repaid. Active From First and/or last date that the estimation is valid. Active To Setup: Repayments Information Description Date Date from when the estimation is valid. Value Date Date on which the repayment may occur. Payment Date Date on which the repayment will be paid. Percentage Percentage of the principal estimated to be repaid. WAL (Years) Used to calculate the expected maturity in the next estimate regeneration. A.2.2 ABS Valuation Id: ABS-METHOD Usage: Determines the instrument is valuated as an Asset-Backed Security. With: ABS Context: Valuation Approach Setup: None A.2.3 Accrual Yield Setup Id: Usage: ACCRUAL-YIELD-SETUP Used to set up Accrual Yield data. This feature allows the setup of Accrual Yield data per instrument. The instrument definition overrides any Accrual Yield setup defined in Result Editor. 714 With: ABS, BOND Context: Valuation Approach Setup: Accrual Yield © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Interest Type The interest type used for yield accrual: Periodic Rate, Compounded Rate, Discount Rate, and so on. Date Basis Date basis applied for yield accrual. Accrued Interest Method applied for interest accrual: for example, Linear or Actual/Actual Accrual. A.2.4 Allow Ad-Hoc Instructions Id: ALLOW-ADHOC-INSTRUCTIONS Usage: Allows ad-hoc settlement instructions to be added to a cashflow in Transaction Manager. With: CASH, COMMERCIAL-LOAN, EQUITY, FX Context: Action Setup: None Details: This feature allows you to attach counterparty settlement instructions ad hoc at transaction level, even if no standard settlement instructions or even bank accounts have been defined for the counterparty in Client Editor. When capturing the counterparty's ad hoc instructions, you can choose banks that have already been defined in the system, and then enter the bank account numbers required for settlement. A.2.5 Allow Ad-Hoc Clients/Instructions Id: ALLOW-ADHOC-CLIENT-INSTRUCTION Usage: Allows ad-hoc payment counterparties and settlement instructions to be added to a cashflow in Transaction Manager. With: CASH, COMMERCIAL-LOAN, EQUITY, FX Context: Action Setup: None Details: This feature allows you to attach a payment counterparty as well as its banks and account numbers ad hoc at transaction level, even if the payment counterparty or the banks have not been previously defined in the system. The payment counterparty and its instructions can be saved and reused later when entering similar ad hoc instructions. A.2.6 Allow Forcing Type to Spot Id: ALLOW-SPOT-FORCING Usage: Allows you to change the transaction type Forward into Spot for secondary traded securities. If this feature is present in the instrument setup, and the related transaction is a forward transaction (Transaction Type = Forward), then the Set Transaction Type to Spot action is enabled at transaction level. With: DISCOUNT, BOND, CONVERTIBLE-BOND, INDEX-LINKED-BOND, EQUITY, ABS, CREDIT-STEP-UP Context: Action Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 715 A Features A.2 List of features A.2.7 Allow FX Currency Pair Shift Id: ALLOW-FX-PAIR-SHIFT Usage: Allows an FX Pair shift action to be done on an existing FX deal. With: FX, FX-SWAP Context: Action Setup: None Details: With this feature, it is possible to split a position from one underlying currency pair into two new positions, each of which contains one of the currencies with a third currency (usually, the portfolio currency). The data that displays in the FX Pair Shift dialog defaults from the initial deal, but can be modified. It is also possible to split a position without an existing FX deal. In both cases, the information required to generate the resulting FX pair shift transactions is the same: see the TRM User Guide for more information. A.2.8 Allow Manual Classification Id: ALLOW-MANUAL-CLASSIFICATION Usage: Enables manual classification of transactions in Transaction Manager. With: ALL Context: Action Setup: None A.2.9 Allow Roll Over Id: ALLOW-ROLL-OVER Usage: Enables roll-over for long-term loans. With: LOAN, TRS, COMMERCIAL-LOAN Context: Action Setup: Roll Over Information Description Excluded Methods Roll over methods to exclude from the selection list of the Default Method field and the Roll Over dialog in Transaction Manager. Default Method Roll over method to use as default for this loan. This can be modified in Transaction Manager to any other method that has not been excluded in the Excluded Methods field. Switches 716 • Select No Maturity Defaulting to disable the defaulting of the maturity date when performing the roll over action regardless of whether the parent maturity was defined with a gap or not. • Select No Rate Defaulting to disable the defaulting of the rate from the initial transaction. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.10 Allow Roll Over (Dual Currency) Id: ALLOW-ROLL-OVER-DUAL Usage: Enables roll-over for gold deposit transactions. With: LOAN, COMMERCIAL-LOAN Context: Action Setup: Roll Over Information Description Excluded Methods Roll over methods to exclude from the selection list of the Default Method field and the Roll Over dialog in Transaction Manager. Default Method Roll over method to use as default for this instrument. This can be modified in Transaction Manager to any other method that has not been excluded in the Excluded Methods field. Switches • Select No Maturity Defaulting to disable the defaulting of the maturity date when performing the roll over action regardless of whether the parent maturity was defined with a gap or not. • Select No Rate Defaulting to disable the defaulting of the rate from the initial transaction. A.2.11 Allow Roll Over (FX) Id: ALLOW-FX-ROLL-OVER Usage: Enables the rollover of FX forwards and FX swaps with the closing of maturing cashflows without settlement. With: FX, FX-SWAP Context: Action Setup: None Details: Defers the maturity of FX Forwards and swap transactions to a later date. Information Description Roll Over Date Date when the roll over is done Value Date Value date of the roll over transaction. This corresponds to the maturity date of the initial transaction. Maturity Code Gap added to the value date to calculate the maturity date. This defaults to the maturity code of the initial transaction. Maturity Date New maturity date of the FX deal. This must be later than the maturity date of the initial transaction. Amount Left Remaining amount of the initial transaction. (Read-only) Amount Amount to roll over defaults to the amount left. You can enter any amount between 0 and the remaining amount of the initial transaction. The amount is expressed in the same currency (base or quote) as the input amount of the initial transaction. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 717 A Features A.2 List of features Information Description Currency Shows the currency of the roll over. The amount is expressed in either the base or quote currency depending on the initial transaction. (Read-only.) Settle Differential By default, this switch is off: the Spot Rate for the roll over is equal to the Original Deal Rate. Switch on if the Spot Rate for the roll-over is different from the Original Deal Rate. If this switch is on: the Spot Rate (see below) defaults to the spot rate of the market but can be modified. The roll over generates a netting cashflow to handle the settlement of the difference. Original Deal Rate Spot Rate This defaults to the deal rate of the initial transaction. (Read-only.) Exchange spot rate of the roll over. This defaults to the Original Deal Rate. If Settle Differential is activated (see above), this field becomes available. The Spot Rate defaults to the spot rate of the market but can be modified. Note: Roll Over Date, Value Date, Maturity Code, Maturity Date, and Settle Differential are adjusted automatically. Base CCY Interest % Interest rate of the base currency for the period from the original settlement date to the new settlement date. Quote CCY Interest % Interest rate of the quote currency for the period from the original settlement date to the new settlement date. Forward Points Forward points of the roll over transaction. This defaults to the number of forward points from the roll over date to the maturity date. Note: Roll Over Date, Value Date, Maturity Code, and Maturity Date are adjusted automatically. Deal Rate Deal rate for the roll over. • If the Spot Rate for the roll-over is equal to the Original Deal Rate: Deal Rate = Original Deal Rate + Forward Points • If the Spot Rate for the roll-over is different from the Original Deal Rate: Deal Rate = Spot Rate + Forward Points Quote Amount The corresponding amount of the roll over transaction. (Read-only.) Quote Currency Shows the currency of the deal. The currency can be quote or base depending on default Currency.(Read-only.) A.2.12 Allow Roll Over (FX - Margin Result) 718 Id: ALLOW-FX-ROLL-OVER-MARGIN Usage: Enables the rollover with margins of FX forwards and FX swaps with the closing of maturing cashflows without settlement. With: FX, FX-FORWARD, FX-SWAP Context: Action Setup: None Details: Roll Over Margin © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.13 Allow Roll Over (repo) Id: ALLOW-REPO-ROLL-OVER Usage: Enables roll over of repo transactions. With: REPO Context: Action Setup: Roll Over Information Description Excluded Methods Roll over methods to exclude from the selection list of the Default Method field and the Roll Over dialog in Transaction Manager. Default Methods Roll over method to use as default for rollovers in this instrument. This can be modified in Transaction Manager to any other method that has not been excluded in the Excluded Methods field. Re-Price Re-price collateral of the repo transaction using the current market price at the time of rollover. A.2.14 Allow Roll Over (Short Loan) Id: ALLOW-ROLL-OVER-ONE Usage: Enables roll-over for short-term deposit/loans and discount papers. With: SHORT-LOAN Context: Action Setup: Roll Over Information Description Excluded Methods Roll over methods to exclude from the selection list of the Default Method field and the Roll Over dialog in Transaction Manager. Default Method Roll over method to use as default for this loan. This can be modified in Transaction Manager to any other method that has not been excluded in the Excluded Methods field. Switches • Select No Maturity Defaulting to disable the defaulting of the maturity date when performing the roll over action regardless of whether the parent maturity was defined with a gap or not. • Select No Rate Defaulting to disable the defaulting of the rate from the initial transaction. A.2.15 Allow Roll Over (Short Loan - Margin Result) Id: ALLOW-ROLL-OVER-ONE-MARGIN Usage: Allows changing the margin rate when rolling over a short loan transaction. With: SHORT-LOAN Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 719 A Features A.2 List of features Context: Action Setup: Roll Over Information Description Excluded Methods Roll over methods to exclude from the selection list of the Default Method field and the Roll Over dialog in Transaction Manager. Default Method Roll over method to use as default for this loan. This can be modified in Transaction Manager to any other method that has not been excluded in the Excluded Methods field. Switches • Select No Maturity Defaulting to disable the defaulting of the maturity date when performing the roll over action regardless of whether the parent maturity was defined with a gap or not. • Select No Rate Defaulting to disable the defaulting of the rate from the initial transaction. A.2.16 Allow Roll Over (FX - Swap Style) Id: ALLOW-FX-ROLL-OVER-SWAP-STYLE Usage: Enables the rollover of FX forwards and FX swaps with normal netted settlement of maturing and new cashflows on the rollover value date. This feature ensures the correct split of FX and IR profit. With: FX, FX-SWAP Context: Action Setup: None A.2.17 Allow Roll Over (FX - Swap Style - Margin Result) Id: ALLOW-FX-ROLL-OVER-SWAP-MARGIN Usage: Enables the rollover of FX forwards and FX swaps with normal netted settlement of maturing and new cashflows on the rollover value date. This feature ensures the correct split of FX and IR profit, as well as the separate calculation of margin results. With: FX, FX-SWAP Context: Action Setup: None A.2.18 Allow Roll Over (Guarantee) 720 Id: ALLOW-ROLL-OVER-SWAP Usage: Enables the rollover of one-leg swap instruments acting as guarantees. With: SWAP Context: Action Setup: None © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.19 Allow Security Loan Id: ALLOW-SECURITY-LOAN Usage: Specifies if the instrument can loaned. With: CREDIT STEP-UP, INDEX-LINKED-BOND, CONVERTIBLE-BOND, EQUITY, ABS, BOND Context: Trading Setup: None A.2.20 Allow Sight Account Transfer Id: ALLOW-SIGHT-ACCOUNT-TRANSFER Usage: Enables the management of transfers between the account where the gold is physically held and the custodian sight account. Using this feature, you can attach the cash payment instrument that is used to make the gold transfers. This feature is used instead of the Allow Weight Difference feature: see A.2.25 Allow Weight Difference on page 722. With: LOAN, SWAP Context: Action Setup: Sight Account Transfer Information Description Instrument Cash transfer instrument used to transfer gold between accounts. A.2.21 Allow Signature Date Id: ALLOW-SIGNATURE-DATE Usage: Enables the setting up of a signature date on the instrument and the creation of the related accounting entries. With: ABS, BOND, CREDIT-STEP-UP, LOAN, SWAP, TRS Context: Action Setup: None A.2.22 Allow Spread Curves Id: ALLOW-SPREAD-CURVES Usage: Enables the addition of a spread curve to the transaction. With: ABS, BOND, CDS, COMMERCIAL-LOAN, CONVERTIBLE-BOND, CREDIT-STEP-UP, DISCOUNT, LOAN, INDEX-LINKED-BOND, SHORT-LOAN, SWAP, SWAPTION, TRS Context: Trading Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 721 A Features A.2 List of features A.2.23 Allow Swap Id: ALLOW-SWAP Usage: Allows swapping action on bonds to create an asset swap. With: BOND, CONVERTIBLE-BOND, CREDIT-STEP-UP, INDEX-LINKED-BOND Context: Action Setup: None A.2.24 Allow Transaction Transfer Id: BOND-TRANSACTION-TRANSFER Usage: Allows transfer of transactions between portfolios. If this feature is present in the instrument setup, then the Transaction Transfer action is enabled at the transaction level. The purpose of the action is to transfer the transaction from one portfolio to another at a given price. This is effectively a sale in one portfolio and a purchase in another portfolio. The functionality currently has a limited scope. It is intended only for outstanding transactions that were not partially sold and that were not merged into an average balance position. It is also supported only for basic instrument configurations and does not include dirty priced bonds. With: BOND Context: Action Setup: None A.2.25 Allow Weight Difference Id: ALLOW-WEIGHT-DIFFERENCE Usage: Enables the management of any difference in the weight of gold that is delivered. Using this feature, you can specify the FX instrument that is used to issue the appropriate compensation transaction for the weight difference. This feature is used instead of the Allow Sight Account Transfer feature: see A.2.20 Allow Sight Account Transfer on page 721. 722 With: LOAN, SWAP Context: Action Setup: Weight Difference Information Description Instrument FX instrument used to capture weight differences for gold transactions. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.26 Allow Valuation Curves Id: ALLOW-VALUATION-CURVES Usage: Enables the overwriting of curves defined at the instrument level. This feature should be used with the feature Base Valuation Setup (A.2.50 Base Valuation Setup on page 734). When used together, the user can define valuation and estimation curves in the Valuation Curve view in Transaction Manager. See TRM User Guide for more information about valuation and estimation curves. Note: Top instrument and leg instruments must be set up with feature Allow Valuation Curves and no curves must be defined in the Yield Curve page of the leg instruments. With: SWAP Context: Trading Setup: None A.2.27 Alternative Repayment Estimates Id: ALTERNATIVE-ESTIMATES Usage: Enables the overriding of the repayment estimation (Repayment Estimates page) of ABS and MBS deals. Adds two pages to the instrument: Alternative Repayment Estimate Setup and Alternative Repayment Estimates to define alternative repayment estimates to overwrite the primary repayment estimates in the selected valuation modes. With: ABS Context: Valuation Setup Setup: Alternative Repayment Estimate Setup Information Description Valuation Modes Default, Benchmark, or Theoretical. Setup: Alternative Repayment Estimates, same as Repayment Estimates page, see A.2.1 ABS Asset Backed Security on page 713. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 723 A Features A.2 List of features A.2.28 Australian Bond Future Option Id: BOND-FUTURE-AU-OPTION Usage: Enables the setup of Australian Bond Future Options. With: BOND-OPTION Context: Primary Setup: Bond Option, see A.2.77 Bond Option on page 745. Setup: Trading Unit Information Description Contract Size Minimum amount which can be traded. Minimum Bid Size Smallest allowed bid size. This is typically 1.0 (meaning 1 contract). Rounding Method Up, Down or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum contract size, the amount is rounded up, down, or to the nearest corresponding amount. A.2.29 Australian CIB Id: BOND-AU Usage: Defines an Australian index-linked bond. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index (Not used for Australian index-linked bonds) Value must be entered as 100.00 for calculation purposes only. A.2.30 Australian FRN 724 Id: FRN-AU Usage: Defines the instrument as an Australian FRN. With: BOND Context: Primary Setup: As for BOND. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.31 Australian FRN Method Id: FRN-AU-METHOD Usage: Defines the valuation method used for Australian FRN instruments. With: FRN-AU Context: Valuation Approach Setup: None A.2.32 Australian IAB Id: BOND-AU-ANNUITY Usage: Determines that in the settlement price calculation, the adjusted annuity is rounded to six decimal places. Adds the Issue Index page to the instrument where you define the name of the index and the value of the index at issue. These values appear respectively in the Fixing Rate and Divider fields of the Schedule page of the instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. A.2.33 Australian IAB Valuation Id: BOND-AU-IL-ANNUITY-METHOD Usage: Determines that the instrument is valuated as a direct quote. For a valuation using a yield curve, use the feature Australian Index-Linked Annuity Par Curve Valuation (A.2.36 Australian IAB Par Curve Valuation on page 726). With: INDEX-LINKED-BOND Context: Valuation Approach Setup: None A.2.34 Australian IAB (Round to 3) Id: BOND-AU-ANNUITY-ROUND-3 Usage: Same as feature Australian Index-Linked Annuity, except that in the settlement price calculation, the adjusted annuity is rounded to three decimal places. See A.2.32 Australian IAB on page 725. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 725 A Features A.2 List of features With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. A.2.35 Australian IAB Valuation (Round to 3) Id: IAB-METHOD-ROUND-3 Usage: Same as Australian Index-Linked Annuity, except that adjusted annuity payments are rounded to three decimal places. For a valuation using a yield curve, use the feature Australian Index-Linked Annuity Par Curve Valuation (A.2.37 Australian IAB Par Curve Valuation (Round to 3) on page 727). With: INDEX-LINKED-BOND Context: Valuation Approach Setup: None A.2.36 Australian IAB Par Curve Valuation Id: BOND-AU-IL-ANNUITY-PAR-METHOD Usage: Determines that the instrument is valuated by fetching the yield from the curve defined in the Yield Curves page of the instrument. For a direct quote valuation, use the feature Australian Index Linked Annuity Valuation (A.2.32 Australian IAB on page 725). 726 With: INDEX-LINKED-BOND Context: Valuation Approach Setup: Yield Curves Information Description Usage The yield used for valuation is interpolated from the par curve at the maturity of the bond. Select Par Yield Curve Select the yield curve you have set up for this valuation. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.37 Australian IAB Par Curve Valuation (Round to 3) Id: IAB-PAR-METHOD-ROUND-3 Usage: Same as feature Australian Index-Linked Annuity Par Curve Valuation, except that adjusted annuity payments are rounded to three decimal places. See A.2.36 Australian IAB Par Curve Valuation on page 726. For a direct quote valuation, use the feature Australian Index-Linked Annuity Valuation (A.2.34 Australian IAB (Round to 3) on page 725). With: INDEX-LINKED-BOND Context: Valuation Approach Setup: Yield Curves Information Description Usage The yield used for valuation is interpolated from the par curve at the maturity of the bond. Select Par Yield Curve Select the yield curve you have set up for this valuation. A.2.38 Australian Index-Linked Bond Valuation Id: BOND-AU-TIB-METHOD Usage: Determines that the instrument is valuated as an Australian Treasury index-linked bond. With: BOND-AU Context: Valuation Approach Setup: None A.2.39 Australian MBS Id: MBS-AU Usage: Defines the instrument as an Australian MBS. With: ABS Context: Primary Setup: Same as for Bonds and the following specific setup in the Bond page: Information Description N-Periods’ Rounding Nearest number to which the number of coupon periods ’n’ (as calculated in Equation 3-9 on page 303) between the next coupon date and the Weighted Average Life date is rounded. For example, 0 for none, 1 for an integer, or 0.1 for a rounding to the first decimal. N-Periods’ Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified N-Periods’ Rounding number. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 727 A Features A.2 List of features Information Description Days Divisor The divisor used in the pricing (valuation) formula: • 365 • 365.25. A.2.40 Australian MBS Valuation Id: MBS-AU-METHOD Usage: Defines the valuation method used for Australian MBS instruments. With: MBS-AU Context: Valuation Approach Setup: None. A.2.41 Average FX Rate Forward Id: FX-AVERAGE-RATE-FORWARD Usage: Defines an average FX rate forward instrument. With: FX Context: Primary Setup: Same as for a non-deliverable forward FX instrument (see A.2.248 Non Deliverable Forward FX Instrument on page 837) and Observation page. Information Description Observation Method Choices are: Irregular and Business Days. Weighting Method • If you select Business Days, observation dates are defined for all business days (regarding the fixing currency at transaction level) between the spot date and the value date - the fixing offset (specified in the Netting page). • If you select Irregular, you can define the observation dates and weights at deal entry in the views Observation Date and Observation Schedule in Transaction Manager. Choices are: Irregular Weights and Equally Weighted (default). Note: Only editable when the observation method is Irregular. Average Rounding Method Average Rounding Rounding method and precision to be used for the average. A.2.42 Average FX Rate Valuation 728 Id: FX-AVERAGE-RATE-METHOD Usage: Allows the valuation of average FX rate forward instruments. With: FX-AVERAGE-RATE-FORWARD © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Context: Valuation Approach Setup: None A.2.43 Average FX Rate Option Id: FX-AVERAGE-RATE-OPTION Usage: Defines an average FX rate option instrument. With: FX-OPTION Context: Primary Setup: Same as for a standard FX option instrument (see A.2.182 FX Option on page 800) and Observation page. Information Description Observation Method Choices are: Irregular and Business Days. Weighting Method • If you select Business Days, observation dates are defined for all business days (regarding the fixing currency at transaction level) between the spot date and the value date - the fixing offset (specified in the Netting page). • If you select Irregular, you can define the observation dates and weights at deal entry in the views Observation Date and Observation Schedule in Transaction Manager. Choices are: Irregular Weights and Equally Weighted (default). Note: Only editable when the observation method is Irregular. Average Rounding Method Average Rounding Rounding method and precision to be used for the average. A.2.44 Average FX Rate Option Valuation Id: FX-AVERAGE-RATE-OPTION-METHOD Usage: Allows the valuation of average FX rate option instruments. With: FX-OPTION Context: Valuation Approach Setup: None A.2.45 Bank Account Balance Id: BANK-ACCOUNT-BALANCE Usage: Defines the instrument used to calculate bank-account balances. With: BANK-ACCOUNT Context: Primary Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 729 A Features A.2 List of features A.2.46 Bank Account Interest Id: BANK-ACCOUNT-INTEREST Usage: Defines the interest-calculation instrument. With: BANK-ACCOUNT Context: Trading Setup: Interest Accrual Information Description Date Basis Date basis used to calculate accrued interest for this instrument. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Interest Rate Curve Underlying yield curve (set up in IR Quote and Yield Curve Editor) used for interest calculation. Note: If you specify a yield curve (and/or Period, Positive Spread, or Negative Spread), you do not need to specify any Ladder values (see Ladder Rule and Ladder). Period Positive Spread Period of the underlying yield curve to be used for interest calculation (for example, O/N). Spread to be added to the interest rate if the account balance is positive. Note: This field is static (i.e. not time-dependent). Spread values are applied when the account balance is created for the first time, and subsequent changes to the spreads do not impact existing account balances. In the case where spreads may change over time, ladders should be used instead. Negative Spread Spread to be added to the interest rate if the account balance is negative. Note: This field is static (i.e. not time-dependent). Spread values are applied when the account balance is created for the first time, and subsequent changes to the spreads do not impact existing account balances. In the case where spreads may change over time, ladders should be used instead. Scenario Rate scenario to be used for calculating interest for this instrument. Ladder Rule Ladder rule (defined in Ladder Rule Editor) or interest rate ladder set (defined in Ladder Set Editor) that you want applied to this instrument. Ladder You can apply a ladder rule or a ladder, but not both. Note: If you specify one of the Ladder values, you do not need to specify any Interest Rate Curve values. 730 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Switches Activate the switches that apply to the instrument. • Compound Daily AI - switch on to calculate daily compounded interest accrual, that is, to calculate interest on the sum of the outstanding balance and total interest accrued to date. • Fixing Must Match - switch on to create accrued interest cashflows even if there is no fixed rate. Such cashflows will have the attribute Not Fixed. • Interest on Value Date - switch on to calculate accrued interest based on today’s closing balance rather than today’s opening balance (whether interest is calculated on opening or closing balance depends on market conventions; for example, in South Africa, it is calculated on the closing balance). • Round Daily AI - switch on to round daily interest accrual according to the Amount Precision defined for the currency. If the switch is off, then daily interest accrual is calculated as an exact number, and rounding will only occur on the total accumulated accrued interest (for example, when the interest is realized). • Split Interest by Sign - switch on to have positive and negative accrued interest calculated separately. If this switch is not turned on, the accrued interest will be netted. Setup: Interest Realization Information Description Frequency Frequency of interest realization (if Method = Periodically). Frequency Unit Unit of time to use for interest realization: Business Days, Days, Months, Weeks, or Years. Convention Convention to use for interest realization: • None – no adjustment is made to the date. • Backward - interest realization is moved to the first business day before the value date. • Following – interest realization is moved to the first business day after the value date. • Frn Convention – the payment is forwarded to the next business day. However, if the month changes, the realization goes back to the previous business day. • Last of Month – interest realization is moved to the last business day of the month. You must select Frequency Unit = Business Days. • Last of Month Calendar – interest realization is moved to the last calendar day of the month. You must select Frequency Unit = Business Days. • Last of Week - interest realization is moved to the last business day of the week, even if you want to move the realization to the last calendar day. You must select Frequency Unit = Business Days. • Medio/Ultimo – if the interest date falls between the 1st and the 15th of the month (15th included), the realization takes place on the 15th of the month (medio). If the interest date falls between the 15th and the end of the month, the realization takes place at the end of the month (ultimo). If it falls on a non-business day, the realization is moved back to the previous business day. • Modified Following – interest realization is moved to the first business date after the value date except where this would cause the payment date to fall into the month following the value date, in which case the payment date is the first business date before the value date. • Not Modified. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 731 A Features A.2 List of features Information Description Method Method of realizing interest: Amount Rounding • At Withdrawal - not applicable. • Periodically - interest is realized at regular intervals (see Frequency field). • At Expiration - not applicable. Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Settlement Method Interest payment method: Capitalize to compound interest or Settle to receive or pay interest. Payment Offset Number of days after interest calculation that you want to realize the interest. A.2.47 Bank Account Valuation Id: BANK-ACCOUNT-METHOD Usage: Determines the instrument is valuated as a bank-account. With: BANK-ACCOUNT Context: Valuation Approach Setup: None A.2.48 Base IR Exposure Setup Id: BASE-IR-EXPOSURE-SETUP Usage: Used to configure IR Exposure calculations: see 2.3.4.1.2 IR Exposure 1 on page 119 for more information. Note that the parameters in this feature are also used if a RISK-YIELD feature is present (see A.2.291 Risk Yield on page 859). However, in this case, Interest Type and Date Basis are used only for the period between the valuation date and spot date. Between spot date and risk date, Interest Type and Date Basis defined in Risk Yield setup are used. With: ALL Context: Valuation Setup Setup: IR Exposure Information Description Exposure Offset Offset for the revaluation. If this field is left blank, the offset is taken from the Risk Rate field in Portfolio Editor. Sensitivity Scaling 732 Multiplicative factor for IR exposure and duration figures. Effective convexity is multiplied twice by this factor. This is always a positive number (generally between 0 and 1). © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Date Basis Date basis used to compute the dates in the calculations. Note: For Money Market future and Fed Fund future instruments using Par method calculation, select Actual/365. Yield Type Price type for the quotation used to determine which FX rate is used in risk calculations. Note: For Money Market future and Fed Fund future instruments using Par method calculation, select Continuous Yield. Switches Activate the switches that apply to this instrument. • Valuation Modes To Spot determines whether or not discounting is done on instruments valued on Par from the spot date to valuation date. Valuation mode: Default, Benchmark, or Theoretical. A.2.49 Base IR Setup Id: BASE-IR-SETUP Usage: This feature is used to configure the valuation of quoted IR instruments with coupons. With: ABS, BOND, CDS, COMMERCIAL-LOAN, CONVERTIBLE-BOND, CREDIT-STEP-UP, DISCOUNT, LOAN, INDEX-LINKED-BOND, SHORT-LOAN, SWAP, TRS Context: Valuation Setup Setup: IR Valuation Information Description AI Method Method used to calculate accrued interest: for example, Linear, Actual/Actual, Coupon %, French, Thai, and so on. The AI method defined here is used in the calculation of the market value, when the quoted method is used (see A.2.50 Base Valuation Setup on page 734). In this case, the calculation is as follows: Price% * Nominal Amount + Accrued Interest Note: If the AI method is not specified in the instrument’s result definition, the system defaults to the value defined here for result calculation. For information about setting up results: see the TRM User Guide. Estimate Method Method used to determine how floating cashflows are estimated in valuation. With Estimate Expression, for example, the amount of the coupon is estimated from the associated expression. This method is used with structured, mostly fixed-rate deals that may have the occasional non-fixed coupon. Note: For standard floating rate instruments: the FLOATING-SETUP feature should be used: see A.2.338 Valuation Setup (Floating) on page 879. Switches Activate the switches that apply to this instrument. • Valuation Modes Dirty Price - determines whether price used for valuation includes accrued interest (dirty price) or not. If it is on, the market value for accrued interest is not calculated, even if the user has configured an AI Method. Valuation mode: Default, Benchmark, or Theoretical. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 733 A Features A.2 List of features A.2.50 Base Valuation Setup Id: BASE-VALUATION-SETUP Usage: Use this feature to customize the default settings of any valuation approach. With: ALL Context: Valuation Setup Setup: Base Valuation Information Description Active From/To Set active from and to dates if you want the valuation setup to be used only for a given period. Method Method used to calculate the result key figures of the cashflows: Quoted or Theoretical. If you select Quoted and no market price is found for the instrument, then the deal price is used to calculate the market value of the transaction. Switches Activate the switches that apply to this instrument. • FX Method To Spot determines whether or not discounting is done on instruments valued on Par from the spot date to valuation date. Method used to convert a domestic cashflow into a foreign currency when theoretical valuation is selected: Spot Rate, Today’s Rate (Forward Points), or Today’s Rate (IR Differential). For more information about FX method calculations, see 2.1.6.3 FX rate calculation on page 79. Valuation Modes Valuation mode: Default, Benchmark, or Theoretical. A.2.51 Bond Id: BOND Usage: Defines the instrument as a bond. With: BOND, CONVERTIBLE-BOND, CREDIT-STEP-UP Context: Primary Setup: Bond Information Description Issuer Issuer of the instrument. Issuers are those clients that have been given the role Issuer (in Client Editor’s Roles page). 734 Currency Currency of the instrument. Transaction Sign Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow: • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy/Lend or Sell/Borrow if you want this to be the default direction of the transaction, that is, the direction cannot be modified at deal entry. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description AI Method Method used to calculate settlement accrued interest, i.e. the interest accrued from the start date of the current coupon until the value date of the transaction. Settlement Switches Amount Rounding • If the bond is traded with clean price, then the settlement accrued interest is settled between the buyer and seller. • If the bond is traded with dirty price, the accrued interest is calculated purely for accounting purposes. Activate the switches that apply to the instrument’s settlement flows. • Dirty Price - switch on to use the dirty price for the instrument, that is, to include accrued interest in the instrument’s price. • Round per Unit - switch on to round the settlement principal and accrued interest amounts per trading unit. Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Default Price Denom. For fractional prices, defines the default denominator. If a default price denominator is specified, the Deal Price can be entered as a fraction at deal entry. For example, if you enter 32 in this field, a Deal Price entered as 100-5 is displayed as 100 5/32. See the TRM User Guide. Coupon Rate Setup: Interest rate of a fixed-rate bond. Schedule (See B.1 Schedule parameters on page 883) Cashflow Details: As the cashflows are an intrinsic characteristic of a bond issue, they must be defined at instrument level. Generation of the cashflows is automatically done in the instrument setup and takes into account all the information specified in the schedule. Some fields can be manually modified at cashflow level if necessary. The cashflows are saved in the database along with the instrument, and are used directly to generate the cashflows of the deal when the bond is sold or purchased. Actions can be performed on the instrument’s cashflows at instrument level, for example, Fix Price, to fix floating coupons. Setup: Trading Unit Information Description Trading Units If the denomination of a bond instrument is specified at instrument setup, the deal is input in units and the Nominal Amount is computed by the system. Only available if Minimum Bid Size is blank. Minimum Bid Size Minimum face amount that can be traded for the instrument (i.e. the face amount must be a multiple of the minimum bid size). When a minimum bid size is set for the instrument, then it cannot be traded in units, and the Units field is not populated at transaction level. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 735 A Features A.2 List of features Information Description Rounding Method Up, Down or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum contract size, the amount is rounded up, down, or to the nearest corresponding amount. For a bond that has trading units, the amount rounding specified at schedule and cashflow level is used for calculations of amounts out of one unit, and the rounding specified at bond level is used to round the final cashflow amounts. Therefore in order to achieve the expected result it is necessary to use a rounding precision of four digits at schedule/cashflow level and a precision of two digits at bond level. Note: For denominated instruments or instruments with trading units, the cashflow amount is first calculated for one unit, and then multiplied by the number of units. Two levels of amount rounding take place and are controlled when setting up the instrument: - A first rounding is done when calculating the cashflow amount for one unit. This is controlled at the interest schedule level by using the field 'Amount Rounding'. - Setup: A second amount rounding is done when multiplying the cashflow amount per unit by the number of units to get the final cashflow amount. This is controlled by the 'Amount Rounding' in the Bond feature. This is usually set to 0.01. Dates Information Description Issue Date Date when the instrument is issued, i.e., the date when securities bought on the Primary Market are delivered to the buyers. By default, a deal made spot days before issue (or earlier) is considered as a primary market deal. That is, both spot and value dates default to the issue date and the Primary Market value is set to Yes. On the other hand, a deal made later is considered as a secondary market deal, so the value and spot dates default according to spot days. Note: It is possible to manually shift the value date provided the new date is not set before the issue date. Maturity Date Date when the instrument matures. This is used as the default in the transaction and cannot be modified. Spot Days Number of business days between opening and value dates. Defaults to currency when left blank. Calendar Counts the number of business days. Defaults to currency when left blank. Holiday Calendar Calendar used to determine whether the value date found using calendar is business or not. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. 736 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.52 Bond - Brazilian LFT Id: BOND-BR-LFT Usage: Defines a Brazilian LFT (Letra Financeira do Tesouro) instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND A.2.53 Bond - Brazilian LFT Valuation Id: BOND-BR-LFT-METHOD Usage: Determines that the instrument is valuated as a Brazilian LFT (Letra Financeira do Tesouro) bond. With: BOND-BR-LFT Context: Valuation Approach Setup: None A.2.54 Bond - Brazilian FX-Linked NBC Id: BOND-BR-NBC-FX Usage: Defines a Brazilian FX-Linked NBC-E/NTN-D instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the PTAX-index (FX rate). See 7.2.1 Simple Index on page 426. Issue Index Index ratio used to adjust the coupon and redemption flows of the bond. A.2.55 Bond - Brazilian FX-Linked NBC Valuation Id: BOND-BR-NBC-FX-METHOD Usage: Determines that the instrument is valuated as a Brazilian FX-Linked NBC bond. With: BOND-BR-NBC-FX Context: Valuation Approach Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 737 A Features A.2 List of features A.2.56 Bond - Brazilian Inflation-Linked NTN Id: BOND-BR-NTN Usage: Defines a Brazilian inflation-linked NTN (Nota do Tesouro Nacional) instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the IGPM-index (NTN-C) or the ICPA-index (NTN-B). See 7.2.1 Simple Index on page 426. Issue Index Index ratio used to adjust the coupon and redemption flows of the bond. A.2.57 Bond - Brazilian Inflation-Linked NTN Valuation Id: BOND-BR-NTN-METHOD Usage: Determines that the instrument is valuated as a Brazilian Inflation-Linked NTN bond. With: BOND-BR-NTN Context: Valuation Approach Setup: None A.2.58 Bond - Canadian RRB Id: BOND-CA-RRB Usage: Defines a Canadian Real Return bond instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. A.2.59 Bond - Canadian Index-Linked Bond Valuation 738 Id: BOND-CA-RRB-METHOD Usage: Determines that the instrument is valuated as Canadian Real Return bond. With: BOND-CA-RRB © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Context: Valuation Approach Setup: None A.2.60 Bond Denominations Setup Id: DENOMINATED-BOND-SETUP Usage: Allows the setup of denominations for a Denominated Bond (see feature A.2.120 Denominated Bond on page 767). With: BOND, CREDIT-STEP-UP Context: Trading Setup: Denominations Information Description Trading Unit Minimum amount which can be traded. A.2.61 Bond Forward Id: BOND-FORWARD Usage: Defines the instrument as a Bond Forward. With: BOND-FORWARD Context: Primary Setup: Bond Forward Information Description Issuer Client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty Client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Underlying Underlying bond instrument. Currency Currency in which the instrument is traded. Setup: Netting Information Description Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max Offset Maximum number of days’ offset allowed. Fixing Subscenario Subscenario from which the rate is retrieved. Calendar Calendar to use when calculating the fixing date. Payment Offset Number of business days between value date and payment date. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 739 A Features A.2 List of features Information Description Method Frequency Business Days as method and 1 as frequency. Choose when you want the netting to occur. For example, for daily netting, select A.2.62 Bond Forward (Swedish) Id: BOND-FORWARD-SWEDISH Usage: Defines the instrument as a Swedish bond forward. With: BOND-FORWARD Context: Primary Setup: Bond Forward Information Description Issuer Client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty Client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Underlying Underlying bond instrument. Currency Currency in which the instrument is traded. Setup: Netting Information Description Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max Offset Maximum number of days’ offset allowed. Fixing Subscenario Subscenario from which the rate is retrieved. Calendar Calendar to use when calculating the fixing date. Switches Activate the switches that apply to the instrument. • Settlement Currency Settlement Currency - switch on if the P/L cashflow is paid in a different currency. Currency in which the P/L cashflow is paid (if the switch Settlement Currency is switched on). Leave this field blank if you want to specify the settlement currency when you enter the deal. Payment Offset Number of business days between the value date and the payment date (should be 3 for a Swedish Bond forward). Discount Rate Rate used to discount settlements between the value date and the netting date (used to default the discount rate when performing netting). Leave this field blank if you want to specify the discount rate when performing netting. Method 740 (Read-only.) Defaults to Last of Month. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description First Time Fee Rate Fixed percentage of the nominal amount, which will be discounted back from the underlying value date to the payment date with the discount rate. This fee amount is settled on the first netting flow. Leave this field blank if you want to specify the first time fee rate when performing netting. A.2.63 Bond Forward Dates Id BOND-FORWARD-DATE Usage Used to specify the dates of Bond forward instruments. With BOND-FORWARD Context Trading Setup Bond Forward Dates Information Description Last Trading Day Last day the instrument can be traded. Settlement Date Last day on which the cash settlement can take place. A.2.64 Bond Forward Valuation Id: BOND-FORWARD-METHOD Usage: Determines that the instrument is valuated as a bond forward. With: BOND-FORWARD Context: Valuation Approach Setup: None A.2.65 Bond - French OAT€i Id: BOND-FR-OAT€I Usage: Defines the instrument as a French OAT€i instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 741 A Features A.2 List of features A.2.66 Bond - French Index-Linked Bond Valuation Id: BOND-FR-OAT€I-METHOD Usage: Determines that the instrument is valuated as a French OAT€i instrument. With: INDEX-LINKED-BOND Context: Valuation Approach Setup: None A.2.67 Bond Future Id: BOND-FUTURE Usage: Defines the instrument as a single Bond Future. For a CTD Future: see A.2.116 CTD Future on page 765. With: BOND-FUTURE Context: Primary Setup: Bond Future Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Underlying Underlying bond instrument. Currency Currency in which the instrument is traded. Default Price Denom. For fractional prices, defines the default denominator. If a default price denominator is specified, the Deal Price can be entered as a fraction at deal entry. For example, if you enter 32 in this field, a Deal Price entered as 100-5 is displayed as 100 5/32. See the TRM User Guide. Setup: Trading Unit Information Description Contract Size Minimum amount which can be traded. Minimum Bid Size Smallest allowed bid size. This is typically 1.0 (meaning 1 contract). Tick Size Minimum price movement (tick size and value). Tick Value Rounding Method Rounding method used in the calculations: Up, Down, or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum bid size, the amount is rounded up, down, or to the nearest corresponding amount. Setup: 742 Netting, see A.2.319 Ticks Netting on page 870. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.68 Bond Future - Australian Id: BOND-FUTURE-AU Usage: Defines an Australian bond future instrument. With: BOND-FUTURE Context: Primary Setup: Bond Future Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Currency Currency in which the instrument is traded - Australian Dollar (AUD). Setup: Trading Unit Information Description Contract Size Minimum amount which can be traded. Minimum Bid Size Smallest allowed bid size. This is typically 1.0 (meaning 1 contract). Price Precision Number of decimal places for the contract price. Rounding Method Up, Down or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum contract size, the amount is rounded up, down, or to the nearest corresponding amount. A.2.69 Bond Future Valuation Id: BOND-FUTURE-METHOD Usage: Determines that the instrument is valuated as a bond future. With: BOND-FUTURE Context: Valuation Approach Setup: None A.2.70 Bond Future Option Valuation Id: BOND-FUTURE-OPTION-METHOD Usage: Determines that the instrument is valuated as a bond future option. With: BOND-OPTION Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 743 A Features A.2 List of features Context: Valuation Approach Setup: None A.2.71 Bond - Greek Index-Linked Bond Id: BOND-GR-IX Usage: Defines a Greek index-linked bond instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. A.2.72 Bond - Greek Index-linked Bond Valuation Id: BOND-GR-IX-METHOD Usage: Determines that the instrument is valuated as a Greek index-linked bond. With: INDEX-LINKED-BOND Context: Valuation Approach Setup: None A.2.73 Bond - Israeli Index-Linked Bond 744 Id: BOND-IL-IX Usage: Defines a Israeli Index-Linked bond instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.74 Bond - Israeli Index-Linked Bond Valuation Id: BOND-IL-IX-METHOD Usage: Determines that the instrument is valuated as a Israeli Index-Linked bond. With: BOND-IL-IX Context: Valuation Approach Setup: None A.2.75 Bond - Italian BTP€i Id: BOND-IT-BTP€I Usage: Defines an Italian BTP€i instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. A.2.76 Bond - Italian Index-Linked Bond Valuation Id: BOND-IT-BTP€I-METHOD Usage: Determines that the instrument is valuated as an Italian index-linked instrument. With: INDEX-LINKED-BOND Context: Valuation Approach Setup: None A.2.77 Bond Option Id: BOND-OPTION Usage: Defines the instrument as a bond option. With: BOND-OPTION Context: Primary Setup: Bond Option Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 745 A Features A.2 List of features Information Description Issuer Issuer (writer) of the option. Issuers are those clients that have been given the role Issuer (in Client Editor’s Roles page). Underlying Underlying bond instrument. This is the bond that will be delivered in the case of physical delivery. Strike Strike price of the option. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Currency Currency of the bond option. Type Type of option: Call or Put. Price Type Price %. Exercise Type Defines when the option can be exercised. Delivery Type Defines whether there is a physical delivery or a cash settlement. Flags Future Style Premium: Premium is not paid upfront but netted daily. A.2.78 Bond Option Valuation Id: BOND-OPTION-METHOD Usage: Determines that the instrument is valuated as a bond option. With: BOND-OPTION Context: Valuation Approach Setup: None A.2.79 Bond Pricing 746 Id: BOND-PRICING Usage: Use this feature to price bonds. With: BOND Context: Action Setup: None Details: When the Pricing action is performed on a bond transaction that has this feature, you are given two pricing options: - Swap Spread - calculates the spread to be add to the floating leg of an asset swap generated from a given bond so that the market value of the asset swap is zero. - Yield/Price - calculates yields using a given price and vice versa. Yield to maturity is calculated according to the trading convention (set up using TRADING-YIELD feature) and any other convention (set up using YIELD feature). Yield to next call date is calculated for callable bonds. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.80 Branch Codes Id: BRANCH-CODE Usage: Enables grouping of instruments in monitors and reports by branch code. Note: The dates entered in the Active From and Active To fields are used only by Performance Monitor. With: ALL Context: Trading Setup: Branch Codes Information Description Active From The date from when this branch code is active. The Active From date can be today’s date or an earlier date, but not a future date. Leave this field blank unless you expect that the branch code assigned to the instrument will change. In this case, the new branch code cannot be entered in the system in advance, but only when it comes into effect. Branch codes that were active prior to the current branch code are available for historical purposes only (to display historical data in Performance Monitor). Active To The date until when this branch code is active. Branch Type Name of the branch code (corresponding to a number between 0 and 19), for example, Sector. Branch One of the values within the branch code type, for example, Utilities. A.2.81 Bootstrap Instrument Id: BOOTSTRAP-INSTRUMENT Usage: Enables a bond or discount paper instrument to be used in the definition of a yield curve. With: BOND, DISCOUNT Context: Trading Setup: None A.2.82 Call Account Id: CALL-ACCOUNT Usage: Allows the setup of a call account instrument. With: CALL-ACCOUNT Context: Primary Setup: Account Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 747 A Features A.2 List of features Information Description Currency Currency of the call account. Leave this field blank if you want to specify the currency when you enter the transaction. Minimum Balance Maximum Balance Notice Period Positive Notice Period Negative Minimum notice period for calling the money (Notice Period Positive for incoming money, Notice Period Negative for outgoing money). Use Last Instructions - select to use the settlement instructions from the last movement instead of using the default settlement instructions. Switches Setup: Balance cannot fall below or go over this amount. If one field is empty, then any value can be entered in the other field. Interest Accrual Information Description Date Basis Date basis used to calculate accrued interest for this instrument. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Interest Rate Curve Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Underlying yield curve used for interest calculation. Note: It is not possible to change interest or update accrued interest for call money/accounts if the instrument has an interest rate curve attached. Instead, changes to the interest rates must be done in Rate Monitor. Period Period of underlying yield curve to be used for interest calculation. Positive Spread Spread to be added to the interest rate if the account balance is positive. Note: This field is static (i.e. not time-dependent). Spread values are applied when the account balance is created for the first time, and subsequent changes to the spreads do not impact existing account balances. In the case where spreads may change over time, ladders should be used instead. Negative Spread Spread to be added to the interest rate if the account balance is negative. Note: This field is static (i.e. not time-dependent). Spread values are applied when the account balance is created for the first time, and subsequent changes to the spreads do not impact existing account balances. In the case where spreads may change over time, ladders should be used instead. Scenario Rates scenario to be used for calculating interest for this instrument. Ladder Rule Ladder rule that you want applied to this call instrument. Ladder rules are defined in Ladder Rule Editor. Ladder Interest rate ladder that you want applied to this call instrument. Note that you can apply a ladder rule or a ladder, but not both. Ladder sets are defined in Ladder Set Editor. 748 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Switches Activate the switches that apply to the instrument. • Compound Daily AI - switch on to calculate daily compounded interest accrual, that is, to calculate interest on the sum of the outstanding balance and total interest accrued to date. • Fixing Must Match - switch on to create accrued interest cashflows even if there is no fixed rate. Such cashflows will have the attribute Not Fixed. • Interest on Value Date - switch on to calculate accrued interest based on today’s closing balance rather than today’s opening balance (whether interest is calculated on opening or closing balance depends on market conventions; for example, in South Africa, it is calculated on the closing balance). • Round Daily AI - switch on to round daily interest accrual according to the Amount Precision defined for the currency. If the switch is off, then daily interest accrual is calculated as an exact number, and rounding will only occur on the total accumulated accrued interest (for example, when the interest is realized). • Setup: Split Interest by Sign - switch on to have positive and negative accrued interest calculated separately. If this switch is not turned on, the accrued interest will be netted. Interest Realization Information Description Frequency Frequency of interest realization if Method = Periodically. Frequency Unit Unit of time to use for interest realization: Business Days, Days, Months, Weeks, or Years. Convention Convention to use for interest realization: None, Backward, Following, Modified Backward, or Modified Following. Method Method of realizing interest. Choose from: • • At Expiration - interest is realized when the account is closed At Withdrawal - interest is realized when there is an absolute reduction in the balance • Amount Rounding Periodically - interest is realized at regular intervals (see Frequency field). Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Settlement Method Interest payment method. Choose from: Payment Offset • Capitalize - to compound interest • Settlement - to receive or pay interest. Number of days after interest calculation that you want to realize the interest. A.2.83 Call Account Valuation Id: CALL-ACCOUNT-METHOD Usage: Determines that the instrument is valuated as a call account. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 749 A Features A.2 List of features With: CALL-ACCOUNT, CALL-MONEY Context: Valuation Approach Setup: None A.2.84 Call Money Id: CALL-MONEY Usage: Allows the setup of a call money instrument. With: CALL-MONEY Context: Primary Setup: Roll Over, and Account, Interest Accrual, and Interest Realization as described for Call Account: see A.2.82 Call Account on page 747. Information Description Frequency Frequency of roll over. Frequency Unit Unit of time to use for roll over: Business Days, Days, Months, Weeks, or Years. Convention Convention to use for roll over: None, Backward, Following, Modified Backward, or Modified Following. A.2.85 Call Money Valuation Id: CALL-MONEY-METHOD Usage: Allows the valuation of call money transactions. With: CALL-MONEY Context: Valuation Approach Setup: None A.2.86 Cancel Provisional Settlements 750 Id: DELETE-PROVISIONAL-SETTLEMENTS Usage: Allows the cancellation of provisional settlements and removes the Paid flag from cashflows at cashflow level in Transaction Manager. With: COMMERCIAL-LOAN, LOAN, SHORT-LOAN, SWAP Context: Action Setup: None © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.87 Cap/Floor/Collar Id: CAP-FLOOR-COLLAR Usage: Defines the instrument as a Cap/Floor/Collar. With: CAP-FLOOR-COLLAR Context: Primary Setup: Cap/Floor/Collar Information Description Currency Currency of the instrument. Leave this field blank if you want to specify the currency when you enter the transaction in Transaction Manager. Transaction Sign Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow: • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy/Lend or Sell/Borrow if you want this to be the default direction of the transaction, that is, the direction cannot be modified at deal entry. AI Method Method used to calculate settlement accrued interest. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Structure Schedule Template to be applied on the instrument. If you specify the schedule in the instrument setup, this is used as the default in the transaction and cannot be modified. Leave this field blank if you want to apply a schedule to the instrument when you enter the deal. Transaction Type Cap, Floor, Collar, or Cap & Floor. A.2.88 Cap/Floor/Collar Valuation Id: CAP-FLOOR-COLLAR-METHOD Usage: Determines that the instrument is valuated as a cap/floor. With: CAP-FLOOR-COLLAR Context: Valuation Approach Setup: None A.2.89 Cashflow Charges Id: CASHFLOW-CHARGES Usage: Allows you to attach a rule to automatically apply charges to individual cashflows, for example, a coupon cashflow. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 751 A Features A.2 List of features With: ALL Context: Trading Setup: Cashflow Charges Information Description Cashflow Charges Cashflow charge rule to apply to the instrument. Cashflow charge rules are set up Cashflow Charge Editor. A.2.90 Cash Collateral Account Id: CASH-COLLATERAL-ACCOUNT Usage: Allows the setup of a cash collateral account instrument. With: CASH-COLLATERAL-ACCOUNT Context: Primary Setup: Account Information Description Currency Currency of the cash collateral account. Leave this field blank if you want to specify the currency when you enter the transaction. Minimum Balance Maximum Balance Notice Period Positive Notice Period Negative Setup: Balance cannot fall below or go over this amount. If one field is empty, then any value can be entered in the other field. Minimum notice period for movement of cash (Notice Period Positive for incoming money, Notice Period Negative for outgoing money). Interest Accrual Information Description Date Basis Date basis used to calculate accrued interest for this instrument. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Interest Rate Curve Underlying yield curve used for interest calculation. Note: It is not possible to change interest or update accrued interest for cash collateral accounts if the instrument has an interest rate curve attached. Instead, changes to the interest rates must be done in Rate Monitor. Period 752 Period of underlying yield curve to be used for interest calculation. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Positive Spread Spread to be added to the interest rate if the account balance is positive. Note: This field is static (i.e. not time-dependent). Spread values are applied when the account balance is created for the first time, and subsequent changes to the spreads do not impact existing account balances. In the case where spreads may change over time, ladders should be used instead. Negative Spread Spread to be added to the interest rate if the account balance is negative. Note: This field is static (i.e. not time-dependent). Spread values are applied when the account balance is created for the first time, and subsequent changes to the spreads do not impact existing account balances. In the case where spreads may change over time, ladders should be used instead. Scenario Rates scenario to be used for calculating interest for this instrument. Ladder Rule Ladder rule that you want applied to this instrument. Ladder rules are defined in Ladder Rule Editor. Ladder Interest rate ladder that you want applied to this instrument. Note that you can apply a ladder rule or a ladder, but not both. Ladder sets are defined in Ladder Set Editor. Switches Activate the switches that apply to the instrument. • Compound Daily AI - switch on to calculate daily compounded interest accrual, that is, to calculate interest on the sum of the outstanding balance and total interest accrued to date. • Fixing Must Match - switch on to create accrued interest cashflows even if there is no fixed rate. Such cashflows will have the attribute Not Fixed. • Interest on Value Date - switch on to calculate accrued interest based on today’s closing balance rather than today’s opening balance (whether interest is calculated on opening or closing balance depends on market conventions; for example, in South Africa, it is calculated on the closing balance). • Round Daily AI - switch on to round daily interest accrual according to the Amount Precision defined for the currency. If the switch is off, then daily interest accrual is calculated as an exact number, and rounding will only occur on the total accumulated accrued interest (for example, when the interest is realized). • Split Interest by Sign - switch on to have positive and negative accrued interest calculated separately. If this switch is not turned on, the accrued interest will be netted. Setup: Interest Realization Information Description Frequency Frequency of interest realization if Method = Periodically. Frequency Unit Unit of time to use for interest realization: Business Days, Days, Months, Weeks, or Years. Convention Convention to use for interest realization: None, Backward, Following, Modified Backward, or Modified Following. Method Method of realizing interest. Choose from: • At Withdrawal - interest is realized when there is an absolute reduction in the balance • Periodically - interest is realized at regular intervals (see Frequency field). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 753 A Features A.2 List of features Information Description Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Settlement Method Interest payment method. Choose from: Payment Offset • Capitalize - to compound interest • Settlement - to receive or pay interest. Number of days after interest calculation that you want to realize the interest. A.2.91 Cash Payment Id: PAYMENT Usage: Defines a cash payment instrument. With: CASH Context: Primary Setup: Movement Information Transaction Sign Description Sign of the payment. If the sign is not defined at instrument level, it needs to be specified separately for each payment transaction. Currency Currency of the payment. Leave this field blank if you want to specify the currency when you enter the payment. Amount Rounding Precision used to round cashflow amounts. Rounding Method Method used to round cashflow amounts. Cashflow Main Type Main type assigned to a cashflow. For example, for a generic payment instrument: select Payment. The type defines the purpose or origin of the cashflow. Cashflow Type Cashflow type of the cashflow. The cashflow types available for selection depend on the cashflow type selected in the Cashflow Main Type field. 754 Attributes Attributes of the cashflow: Nominal Amount, Not Bookable, Not Payable, or Pseudo. Attributes 2nd Further attributes of the cashflow. Our Client The portfolio-owner from whose account the payment is made and to whom the cashflow belongs. This is usually the user organization. Our Full Chain When this switch is set to on, the settlement instructions chain defaulting stops at the Our Bank/Account level. This means that the instructions defined in the instrument are considered to be complete, and the system will not try to automatically complete the chain from the Client Editor setup. Our Bank The bank of the user organization (or another portfolio-owner on whose behalf the payment is made) used for the payment. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Our Account The bank account of the user organization (or of the portfolio-owner on whose behalf the payment is made) used for the payment. Counterparty The counterparty of the payment. Counterparty Full Chain When this switch is set to on, the settlement instructions chain defaulting stops at the Counterparty Bank/Account level. This means that the instructions defined in the instrument are considered to be complete, and the system will not try to automatically complete the chain from the Client Editor setup. Counterparty Bank The bank of the counterparty. Counterparty Account The bank account of the counterparty. A.2.92 Choose Coupon Id: CHOOSE-COUPON Usage: Allows choice of coupon for rainbow structures. With: BOND, CREDIT-STEP-UP, LOAN, SWAP Context: Action Setup: None A.2.93 Collateral Id: COLLATERAL Usage: Allows a security to be used as collateral (for example, with a Repo deal). With: BOND, DISCOUNT, CASH-COLLATERAL-ACCOUNT Context: Trading Setup: None A.2.94 Collateral Delivery Id: COLLATERAL-DELIVERY Usage: TBC With: COLLATERAL-TRANSFER Context: Trading Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 755 A Features A.2 List of features A.2.95 Collateral Setup Id: COLLATERAL-SETUP Usage: Allows a collateral agreement to be assigned to the repo instrument. With: REPO, MARGIN-MOVEMENT, SUBSTITUTION Context: Trading Setup: Collateral Agreement Information Description Collateral Agreement ID of the collateral agreement defined in Collateral Agreement Editor. The collateral agreement outlines the details of the master repurchase agreement. A.2.96 Collateral Transfer Id: COLLATERAL-TRANSFER Usage: Defines the instrument as a Collateral Transfer. With: COLLATERAL-TRANSFER Context: Primary Setup: None A.2.97 Collateral Valuation Id: COLLATERAL-METHOD Usage: Determines that the instrument is valuated as a Collateral Transfer. With: COLLATERAL-TRANSFER Context: Valuation Approach Setup: None A.2.98 Competitive Premiums 756 Id: COMPETITIVE-PREMIUM Usage: Allows you to enter details of any competing quotes you receive from your counterparties in the Competitive Quote view of Transaction Manager. With: CAP-FLOOR-COLLAR, FRA-OPTION, FX-OPTION, SWAPTION Context: Trading Setup: None Details: When a competitive quote is modified, it is stored in the Premium Price field at transaction level. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.99 Competitive Prices Id: COMPETITIVE-PRICE Usage: Allows you to enter details of any competing quotes you receive from your counterparties in the Competitive Quote view of Transaction Manager. With: BOND, CREDIT-STEP-UP, EQUITY Context: Trading Setup: None Details: When a competitive quote is modified, it is stored in the Deal Price field at transaction level. A.2.100 Competitive Rates Id: COMPETITIVE-RATE Usage: Allows you to enter details of any competing quotes you receive from your counterparties in the Competitive Quote view of Transaction Manager. With: BOND, CREDIT-STEP-UP, DISCOUNT, FRA, FX, SHORT-LOAN Context: Trading Setup: None Details: When a competitive quote is modified, it is stored in the Deal Rate field at transaction level. A.2.101 Competitive Rates (FX Swap) Id: FX-SWAP-COMPETITIVE-RATE Usage: Allows you to enter details of any competing quotes for FX swaps that you receive from your counterparties in the Competitive Quote view of Transaction Manager. With: FX Context: Trading Setup: None Details: When a competitive quote is modified, it is stored in the transaction as follows: - Near Quote updates the transaction field Nominal/Spot Rate. - Quote updates the transaction field Deal Rate. A.2.102 Complex Payment (cash) Id: COMPLEX-PAYMENT Usage: Defines the instrument as a complex cash payment. With: CASH Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 757 A Features A.2 List of features Context: Primary Setup: Movement Information Description Transaction Sign Sign of the initial payment transaction. If the sign is not defined at instrument level, it needs to be specified separately for each payment transaction at deal entry. The parameters of the initial payment are defined in the Movement Leg page (ID = 0). Setup: Movement Leg Information Description ID Number representing the order in which the payment is made. The ID of the initial transaction = 0. The ID is displayed in the Origin column in Transaction Manager’s Cashflow view. Payment Sign Currency Select from: Any, Negative, or Positive. The payment sign for the cashflow leg is relative to the transaction sign of the initial payment transaction. Currency of the payment. Leave this field blank if you want to specify the currency when you enter the payment. Amount Rounding Precision used to round cashflow amounts. Cashflow Main Type Main type assigned to a cashflow. For example, for a generic payment instrument: select Payment. The type defines the purpose or origin of the cashflow. Cashflow Type Cashflow type of the cashflow. The cashflow types available for selection depend on the cashflow type selected in the Cashflow Main Type field. 758 Attributes Attributes of the cashflow: Nominal Amount, Not Bookable, Not Payable, or Pseudo. Attributes 2nd Further attributes of the cashflow. Our Client The portfolio-owner from whose account the payment is made and to whom the cashflow belongs. This is usually the user organization. Our Bank The bank of the user organization (or another portfolio-owner on whose behalf the payment is made) used for the payment. Our Account The bank account of the user organization (or of the portfolio-owner on whose behalf the payment is made) used for the payment. Counterparty The counterparty of the payment. Counterparty Bank The bank of the counterparty. Counterparty Account The bank account of the counterparty. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.103 Convertible Bond Id: CONVERTIBLE-BOND Usage: Defines the instrument as a Convertible Bond. With: CONVERTIBLE-BOND Context: Trading Setup: As for BOND, Convertible Bond Information Description Active From The first/last date when these conversion terms are valid. Active To Type Defines whether the user can enter conversion price or conversion ratio. Par Value If the convertible bond is traded using units, enter the par value of one unit. Conversion Price The price of one unit of the underlying when the convertible is converted to the underlying. If Type = Conversion Price, you can enter the conversion ratio. Otherwise, it is calculated using the conversion price and par value: Conversion Price = Par Value/Conversion Ratio Conversion Ratio The ratio of units (units of convertible to units of underlying) when the convertible is converted to the underlying. If Type = Conversion Ratio, you can enter the conversion price. Otherwise it is calculated using the conversion ratio and par value: Conversion Ratio = Par Value/Conversion Price Underlying The instrument into which the convertible can be converted. Comment Any comment you want to add about the instrument. A.2.104 Convertible Bond Valuation Id: CONVERTIBLE-BOND-METHOD Usage: Determines that the instrument is valuated as a Convertible Bond. With: CONVERTIBLE-BOND Context: Valuation Approach Setup: None A.2.105 Convertible Bond Setup Id: CONVERTIBLE-BOND-SETUP Usage: Allows you to configure the valuation of a Convertible Bond. With: CONVERTIBLE-BOND Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 759 A Features A.2 List of features Context: Valuation Setup Setup: Convertible Bond Valuation Information Description Quality The quality used for present value calculations. Analytic Quality The quality used to define how many event/flow level figures are calculated. Risk Quality The quality used for risk calculations (except convexity). Convexity Quality The quality used for convexity calculations. Valuation Modes Valuation modes: Default, Benchmark, or Theoretical. This setup is valuation mode dependent. A.2.106 Cost of Carry Balance Id: COST-OF-CARRY-BALANCE Usage: Defines the instrument used to calculate cost-of-carry balances. With: COST-OF-CARRY Context: Primary Setup: None A.2.107 Cost of Carry Interest Id: COST-OF-CARRY-INTEREST Usage: Defines the interest-calculation parameters for a cost-of-carry instrument. If this feature is not included in the instrument definition, accrued interest will not be calculated on the balance. With: COST-OF-CARRY Context: Trading Setup: Interest Accrual Information Description Date Basis Date basis used to calculate accrued interest for this instrument. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Interest Rate Curve Underlying yield curve used for interest calculation. Note: If you specify a yield curve, you do not need to specify any Ladder values (see Ladder Rule and Ladder). 760 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Period Period of the underlying yield curve to be used for interest calculation (for example, O/N). Scenario Rate scenario to be used for calculating interest for this instrument. Ladder Rule Ladder rule (defined in Ladder Rule Editor) or interest rate ladder set (defined in Ladder Set Editor) that you want applied to this instrument. Ladder You can apply a ladder rule or a ladder, but not both. Note: If you specify one of the Ladder values, you do not need to specify any Interest Rate Curve values. Switches Activate the switches that apply to the instrument. • Compound Daily AI - switch on to calculate daily compounded interest accrual, that is, to calculate interest on the sum of the outstanding balance and total interest accrued to date. • Fixing Must Match - switch on to create accrued interest cashflows even if there is no fixed rate. Such cashflows will have the attribute Not Fixed. • Interest on Value Date - switch on to calculate accrued interest based on today’s closing balance rather than today’s opening balance (whether interest is calculated on opening or closing balance depends on market conventions; for example, in South Africa, it is calculated on the closing balance). • Round Daily AI - switch on to round daily interest accrual according to the Amount Precision defined for the currency. If the switch is off, then daily interest accrual is calculated as an exact number, and rounding will only occur on the total accumulated accrued interest. • Split Interest by Sign - switch on to have positive and negative accrued interest calculated separately. If this switch is not turned on, the accrued interest will be netted. Setup: Interest Realization as described for Bank Account Interest: see A.2.46 Bank Account Interest on page 730. Note that the settlement method Settle does not apply to cost-of-carry. A.2.108 Cost of Carry Valuation Id: COST-OF-CARRY-METHOD Usage: Determines the instrument is valuated as a cost-of-carry balance. With: COST-OF-CARRY Context: Valuation Approach Setup: None A.2.109 Credit Client Setup Id: CREDIT-CLIENT-SETUP Usage: Bond risk can be guaranteed by entities other than the issuer entity. This feature allows you to define the primary and secondary guarantors of an issue and the proportions of the issue they are guaranteeing. It is possible to use limits to expand the credit exposure against these guarantors (see the TRM User Guide for more information about limit management in TRM). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 761 A Features A.2 List of features With: BOND Context: Trading Setup: Guarantors Information Description Level Level of the guarantor: primary or secondary. Client Client ID of the guarantor. Cover Percent Percentage of the issue the guarantor is covering by the guarantee. A.2.110 Credit Default Swap Id: CDS Usage: Defines the instrument as a Credit Default Swap. With: CDS Context: Primary Setup: CDS Information Description Currency Currency of the instrument. Leave this field blank if you want to specify the currency when you enter the deal. Transaction Sign Sign of the transaction. Choose from: Any, Buy/Lend, or Sell/Borrow. If the sign is not defined at instrument level, it can be specified at deal entry. AI Method Method used to calculate accrued interest (premium), if it starts to accrue before the value date of the transaction or when a credit event occurs. Settlement Switches Activate the switches that apply to the instrument’s settlement flows. • Dirty Price - switch on if you want to use the dirty price for the instrument, that is, to include accrued interest in the instrument’s price. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Structure Select the schedule template to be used to create premium payments for the transaction, for example, the system-defined Credit Default Swap, ISDA Standard (CD-SWAP-ISDA) primary schedule. The schedule is used to generate the fixed premium payments (that is, the cost of protection): see B.2.1.1.14 Credit Default Swap, ISDA Standard on page 892. Reference Entity 762 Reference entity of the instrument. Reference entities are defined in Client Editor’s Member Clients page. Settlement Offset The number of business days after the trade date that the upfront and accrued interest are settled. Recovery Rate Default recovery rate used in the deal price calculation in Transaction Manager. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Price Rounding parameters Method and precision used to round the deal price when calculated. Setup: Dates Information Description Gap Set Gap set used for supplying the maturity periods for an instrument; these in turn are used to define exact dates. This is a mandatory field. Maturity Date Period Maturity period used to calculate the maturity date for an instrument at deal entry, for example, 6M or 1Y. If you specify the maturity date period in the instrument setup, this is used as the default in the transaction and cannot be modified. Spot Days Number of business days between opening and value dates. Defaults to currency spot days when left blank. Calendar Counts the number of business days. Defaults to currency calendar when left blank. Holiday Calendar Calendar used to determine whether the value date found using calendar is business or not. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. A.2.111 Credit Default Swap Valuation Id: CDS-METHOD Usage: Determines that the instrument is valuated as a Credit Default Swap. With: CDS Context: Valuation Approach Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 763 A Features A.2 List of features A.2.112 CreditManager position template Id: Usage: CREDITMANAGER-EXPORT Used to set up CMI data. See the TRM User Guide for more information. With: All Context: Trading Setup: CMI Information Description Template CM template used to map export data. CM Debt Issuer Type Type of debt issuer. The possible values are Libor or Government (Govt). CM Seniority Level Seniority class of the instrument. CM Spread Curve Spread curve used for future valuations of exposures. A.2.113 Credit Rating Id: CREDIT-RATING Usage: Used to define instrument ratings. With: All traded instruments. Context: Trading Setup: Credit Ratings Information Description Rating ID Rating ID of the rating agency (for example, Moody’s or Standard & Poors). Rating Code Rating Code gives the actual rating of the agency (A+, BB, and so on). Active From Period for which the credit rating information is active. Active To You can leave the Active To field blank: the rating is then assumed to be valid either indefinitely (if there are no other ratings) or until the next Active From date (if you specify another rating). A.2.114 Credit Default Swap Curve Setup Id: CREDIT-SPREAD-CURVE-SETUP Usage: Used to add a credit spread curve to an instrument. Note: It is also possible to link a default credit spread curve to a reference entity (client). This means that it is not necessary to define a credit spread curve at instrument level for valuing credit default swaps. If no credit spread curve is defined at instrument level, the valuation defaults to the credit spread curve defined for the reference entity (that is, the client stored as the issuer of the transaction). With: 764 CDS © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Context: Valuation Setup Setup: Yield Curves Information Description Active From The first and/or last date that the credit spread curve is valid for the instrument. Active To Usage Credit Spread Credit spread curves are used in the valuation of Credit Default Swaps. Yield Curve ID of the credit spread curve. Only credit spread curves (defined in Credit Spread Curve Editor) are available for selection. If you leave this field blank, TRM defaults to the yield curve defined for the currency. A.2.115 Credit-Step-Up Id: CREDIT-STEP-UP Usage: Defines the instrument as a credit step-up bond. With: CREDIT-STEP-UP Context: Primary Setup: As for BOND, Credit Step-Up Information Description Type Select from Downgrade or Upgrade: • Downgrade when the credit rating deteriorates • Upgrade when the credit rating improves. Date Date the step up/down action comes into effect. Rate Offset Offset that applies to fixed rate flows. Spread Offset Offset that applies to floating rate flows. Effective After Date after which the coupons are affected by a change in credit rating. A.2.116 CTD Future Id: CTD-FUTURE Usage: Defines the instrument as a CTD Future. With: BOND-FUTURE Context: Primary Setup: CTD Future Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 765 A Features A.2 List of features Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Currency Currency of the instrument. Leave this field blank if you want to specify the currency when you enter the deal. First Delivery Date Start and end dates for the delivery period. Last Delivery Date Date Basis Date basis used to calculate the implied repo rate used to determine the cheapest to deliver. You can see the implied repo rate in the following TRM applications: • Transaction Manager: In Transaction Figure view, you can see the implied repo rate (column Implied Repo Rate) for one bond i.e. the 'cheapest' (CTD) bond at the time of valuation (column Delivery Instrument). • Rate Monitor: You can display the implied repo rate for each bond in a CTD future's basket of deliverable bonds, by selecting Period as one of the axes, usually the vertical one, and figure Implied Repo Rate. See TRM User Guide for more information. Default Price Denom. For fractional prices, defines the default denominator. If a default price denominator is specified, the Deal Price can be entered as a fraction at deal entry. For example, if you enter 32 in this field, a Deal Price entered as 100-5 is displayed as 100 5/32. See the TRM User Guide. Setup: Basket Information Description Instrument Bond instrument to include in the basket. Conversion Factor Conversion factor of the instrument. This is used to determine the exact price of the underlying bond. Setup: Trading Unit Information Description Contract Size Nominal value of one future contract. Minimum Bid Size Smallest allowed bid size. This is typically 1.0 (meaning 1 contract). Tick Size Minimum price movement (tick size and value). Tick Value Rounding Method Up, Down or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum contract size, the amount is rounded up, down, or to the nearest corresponding amount. 766 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.117 Currency Conversion Id: CURRENCY-CONVERSION Usage: Allows conversion of a coupon into a different currency. With: BOND, CREDIT-STEP-UP, LOAN, SWAP Context: Action Setup: None A.2.118 Debt Flows Valuation (payment amount extraction) Id: DEBT-FLOWS-METHOD Usage: Valuation approach used to valuate debt flows. With: COMMERCIAL-LOAN, EQUITY Context: Valuation Approach Setup: None A.2.119 Delivery Id: DELIVERY Usage: Defines the instrument as deliverable (handled by a Custodian) and enables the generation of a delivery cashflow. With: ABS, BOND, COMMERCIAL-LOAN, CONVERTIBLE-BOND, CREDIT-STEP-UP, EQUITY, INDEX-LINKED-BOND Context: Trading Setup: None Details: When this feature is present in an instrument’s setup, it is possible to transfer deliverable transactions from one custodian or custody account to another using the Custody Account Transfer action in Transaction Manager’s Transaction view. The action creates a Transfer type of transaction which has two delivery flows to represent the movement of the security from one account to another. See the TRM User Guide for more information. A.2.120 Denominated Bond Id: DENOMINATED-BOND Usage: Allows the setup of a Denominated Bond. With: BOND, CREDIT-STEP-UP Context: Primary Setup: As for BOND Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 767 A Features A.2 List of features A.2.121 Discount Paper Id: DISCOUNT Usage: Allows the setup of a Discount Paper. With: DISCOUNT Context: Primary Setup: Discount Paper Information Description Currency Currency of the discount paper (that is, if it is a listed discount paper). Leave this field blank if you want to specify the currency when you enter the deal or if you are defining an OTC discount paper. Date Basis Date basis of the instrument. Leave this field blank if you want to specify the date basis when you enter the deal. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Amount Rounding Method Price Rounding Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Nearest number to which the price is rounded. For example, if Price Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Price Rounding Method Up, Down or Nearest. The price is rounded up, down, or to the nearest figure as calculated using the specified Price Rounding number. Rate Rounding Nearest number to which the rate is rounded. For example, if Rate Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rate Rounding Method Up, Down or Nearest. The rate is rounded up, down, or to the nearest figure as calculated using the specified Rate Rounding number. Interest Type Discount Rate. The yield type of the discount paper. This is a mandatory field. Transaction Sign Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy/Lend or Sell/Borrow if you want this to be the default direction of the transaction, that is, the direction cannot be modified at deal entry. Principal Cashflow Type Type of principal cashflows, if you want to override the defaults supplied by the instrument type. Issuer Issuer of the instrument. Setup: 768 Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow: • Trading Unit © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Trading Units If the denomination of a bond instrument is specified at instrument setup, the deal is input in units and the Nominal Amount is computed by the system. Only available if Minimum Bid Size is blank. Minimum Bid Size Minimum face amount that can be traded for the instrument (i.e. the face amount must be a multiple of the minimum bid size). When a minimum bid size is set for the instrument, then it cannot be traded in units, and the Units field is not populated at transaction level. Rounding Method Up, Down or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum contract size, the amount is rounded up, down, or to the nearest corresponding amount. For a bond that has trading units, the amount rounding specified at schedule and cashflow level is used for calculations of amounts out of one unit, and the rounding specified at bond level is used to round the final cashflow amounts. Therefore in order to achieve the expected result it is necessary to use a rounding precision of four digits at schedule/cashflow level and a precision of two digits at bond level. Note: For denominated instruments or instruments with trading units, the cashflow amount is first calculated for one unit, and then multiplied by the number of units. Two levels of amount rounding take place and are controlled when setting up the instrument: - A first rounding is done when calculating the cashflow amount for one unit. This is controlled at the interest schedule level by using the field 'Amount Rounding'. - Setup: A second amount rounding is done when multiplying the cashflow amount per unit by the number of units to get the final cashflow amount. This is controlled by the 'Amount Rounding' in the Bond feature. This is usually set to 0.01. Dates Information Description Issue Date Date when the instrument is issued, i.e., the date when securities bought on the Primary Market are delivered to the buyers. By default, a deal made spot days before issue (or earlier) is considered as a primary market deal. That is, both spot and value dates default to the issue date and the Primary Market value is set to Yes. On the other hand, a deal made later is considered as a secondary market deal, so the value and spot dates default according to spot days. Note: It is possible to manually shift the value date provided the new date is not set before the issue date. Maturity Date Date when the instrument matures. This is used as the default in the transaction and cannot be modified. Spot Days Number of business days between opening and value dates. Defaults to the one defined at currency level when left blank. Calendar Counts the number of business days. Defaults to the one defined at currency level when left blank. Holiday Calendar Calendar used to determine whether the value date found using calendar is business or not. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 769 A Features A.2 List of features Information Description Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. A.2.122 Discount Paper OTC Id: DISCOUNT-OTC Usage: Embeds the maturity dates setup instead of the fixed dates. With: DISCOUNT Context: Primary Setup: As for Discount Papers, and Dates Information Description Spot Days Number of business days between opening and value dates. Defaults to currency when left blank. Calendar Counts the number of business days. Defaults to currency when left blank. Holiday Calendar Calendar used to determine whether the value date found using calendar is business or not. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. Gap Set Gap set used for supplying the maturity periods for an instrument; these in turn are used to define exact dates. This is a mandatory field. Maturity Date Period Maturity period used to calculate the maturity date for an instrument at deal entry, for example, 6M or 1Y. If you specify the maturity date period in the instrument setup, this is used as the default in the transaction and cannot be modified. A.2.123 Discount Valuation 770 Id: DISCOUNT-METHOD Usage: This feature is similar to feature Fixed IR Valuation, except that when the Quoted method is used, this feature calculates the IR exposure based on the yield calculated using the market quote of the discount paper. The yield is calculated according to the setup in the IR Exposure page (A.2.48 Base IR Exposure Setup on page 732). With: DISCOUNT Context: Valuation Approach Setup: None © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.124 Dividend Estimate Id: DIVIDEND-ESTIMATE Usage: If specified, this is taken into account by option valuation to estimate the dividend the underlying equity may pay before expiry. This feature is used when you need to have an estimate of the yearly dividend expressed as a compound rate. This estimate is then converted into continuously compounded yield and used in the Black-Scholes valuation model. With: EQUITY, INDEX Context: Valuation Setup Setup: Dividend Estimate Information Description Active From First and/or last date that the dividend estimate is valid. Active To Annual Dividend Annual dividend yield. Enter this value as a decimal figure, not a percentage (for example, for 10%, enter 0.1). Price Type r@compound A.2.125 Dual Currency Id: Usage: DUAL-CURRENCY Enables the handling of dual-currency structures. This feature allows you to define the characteristics of the principal cashflow. With: BOND, COMMERCIAL-LOAN, CREDIT-STEP-UP, EQUITY, LOAN Context: Action Setup: Dual Currency Information Description Settlement Currency Currency in which the principal cashflow is settled. Settlement FX Rate Rate used to calculate the settlement amount of the principal cashflow. Need Fixing Specify whether the FX rate needs to be fixed: • Select No when the FX rate is known • Select Yes, Unmarked when the FX rate is unknown. Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max. Offset Maximum number of days’ offset allowed. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 771 A Features A.2 List of features A.2.126 Dual Currency Forecast Id: DUAL-CURRENCY-FORECAST Usage: Defines the instrument as a dual-currency forecast exposure instrument. With: FORECAST Context: Primary Setup: Forecast Information Description Currency Currency of the cashflow forecast. Amount Rounding Precision used to round cashflow amounts. Rounding Method Method used to round cashflow amounts. Price Type Price type for the quotation used to determine which FX rate is used in risk calculations. A.2.127 Equity Id: EQUITY Usage: Defines the instrument as an equity. With: EQUITY Context: Primary Setup: Equity Information Issuer Description Issuer of the equity. In TRM, issuers are set up as clients with the role Issuer (in Client Editor’s Roles page). Price Type Amount (1/100)/Unit and Amount (1/100)/Underlying Unit: Allow trading and quoting equities in pence. Cash Dividend and Return of Capital corporate action definitions follow the Price Type of the instrument, so, for example, for equities traded in pence, the dividend and return of capital amounts are also entered in pence. Note: Cash amounts/prices in other corporate actions are to be entered in the main currency unit, e.g. pounds. Minimum Price Denom. Not in use. Default Price Denom. Not in use. Currency Currency in which the equity is traded. Transaction Sign 772 Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow: • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy/Lend or Sell/Borrow if you want this to be the direction of the transactions, that is, the direction cannot be modified at deal entry. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down, or Nearest. The amount is rounded up, down or to the nearest figure as calculated using the specified Amount Rounding number. A.2.128 Equity Cash Dividend Id: EQUITY-CASH-DIVIDEND Usage: Used to calculate the dividend given to shareholders. This information is used by the activity of type "Dividend" that must be run in the beginning of the ex-dividend date in order to create the dividend transactions. With: EQUITY Context: Trading Setup: Cash Dividend Information Description Description Comment or information you want to enter about the dividend, for example “Regular dividend 2005”. Date Date on which the dividend was declared or the information was entered in the instrument setup. Ex-Dividend Date First date when the instrument is traded without a dividend. Record Date Date when the issuer of a security determines the holders who are entitled to receive this dividend. Payment Date Date on which the dividend is settled. Dividend Per Unit Amount of the dividend per one unit of the security. Currency Currency in which the dividend is settled. A.2.129 Equity Conversion Id: EQUITY-CONVERSION Usage: Enables you to update the instrument definition with conversion information. This information is used by the activity of type "Conversion". With: EQUITY Context: Trading Setup: Equity Conversion Information Description Description Comment or information you want to enter about the conversion. Date Date on which the conversion was declared or the information was entered in the instrument setup. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 773 A Features A.2 List of features Information Description New Equity ID of the equity that is received as a result of the conversion. This can be the same as or different from the original equity. Conversion Date Date on which the new equity position is received. Record Date Date on which the company considers holders of the security as being entitled to the corresponding corporate action. Conversion Payment Date Date on which the settlement amount is paid if receipt of the new equity incurs a cost. Units to Sell Number of units to be sold with this equity conversion. Units to Receive Number of units to receive with this equity conversion. Rounding Precision New Units Rounding precision for the new units in the case of fractional units. Rounding Method New Units Up, Down, or Nearest. Method used for rounding precision in the case of fractional units. Price to Pay Per Unit Price of one unit if receipt of new equity incurs a cost. Currency Currency of the new equity. Odd Lot Compensation Price Compensation price per leftover share. Compensation Price Currency Currency in which a resulting odd lot compensation amount is paid. A.2.130 Equity Detachment 774 Id: EQUITY-DETACHMENT Usage: Enables you to update the instrument definition with detachment information. This information is used by the activity of type "Detachment". With: EQUITY Context: Trading Setup: Equity Detachment Information Description Description Comment or information you want to enter about the detachment. Date Date on which the detachment was declared or the information was entered in the instrument setup. New Equity ID of the equity that is received. This can be the same as or different from the original equity. Detachment Date Date on which the new equity position is received. Record Date Date on which the company considers holders of the security as being entitled to the corresponding corporate action. Settlement Date Date on which the settlement amount is paid if receipt of the new equity incurs a cost. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Units to Sell Number of units to be sold with this equity detachment. The ratio of Units to Sell and Units to Receive determines how many units are received according to the existing equity position. Units to Receive Number of units to receive with this equity detachment. The ratio of Units to Sell and Units to Receive determines how many units are received according to the existing equity position. Rounding Precision Rounding precision for the new units in the case of fractional units. Rounding Method Up, Down, or Nearest. Method used for rounding precision in the case of fractional units. Value of the Right Theoretical value of the subscription right that is transferred from the equity. This is a mandatory field (with Value of the Equity) used to determine how much of the book value is transferred from the original equity to the new one. The book value amount to be transferred is calculated as follows: Book value amount * (Units to receive * Value of right) / (Units to sell * Value of equity) Value of the Equity Market value of the subscription right that is transferred from the equity. This is a mandatory field (with Value of the Right) used to determine how much of the book value is transferred from the original equity to the new one. The book value amount to be transferred is calculated as follows: Book value amount * (Units to receive * Value of right) / (Units to sell * Value of equity) Price to Pay Per Unit Price of one unit if receipt of new equity incurs a cost. Currency Currency of the new equity. Odd Lot Compensation Price Compensation price per leftover share. Compensation Price Currency Currency in which a resulting odd lot compensation amount is paid. A.2.131 Equity Future Id: EQUITY-FUTURE Usage: Defines the instrument as an Equity Future. With: EQUITY-FUTURE Context: Primary Setup: Equity Future Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Underlying The underlying equity instrument or equity index. Currency The currency in which the instrument is traded. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 775 A Features A.2 List of features Setup: Netting, see A.2.319 Ticks Netting on page 870. A.2.132 Equity Info Id: EQUITY-INFO Usage: Allows the definition of the weight of an equity in an index composition. With: EQUITY Context: Trading Setup: Equity Info Information Description Active From Start of the active period within which the equity information is valid. Active To End of the active period within which the equity information is valid. Outstanding Size Number of shares held by the investors (including insiders and public). Float Size Total number of shares publicly owned and available for trading. The float is calculated by subtracting restricted shares from outstanding shares. Votes per Unit Number of votes entitled per one share. Total Votes Total number of votes (votes per unit multiplied by the number of shares). Par Value Par value of the security. A.2.133 Equity Option Id: EQUITY-OPTION Usage: Defines the instrument as an equity option. With: EQUITY-OPTION Context: Primary Setup: Equity Option Information Description Issuer Issuer (writer) of the option. Underlying ID of the underlying equity instrument. This can be an instrument that belongs to the instrument class EQUITY. Strike Amount Rounding Strike price of the option. If the option is exercised this price is used to buy or sell the underlying securities. Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. 776 Rounding Method Up, Down, or Nearest. The amount is rounded up, down or to the nearest figure as calculated using the specified Amount Rounding number. Currency Currency in which the equity option is traded. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Type Option type: Call or Put. • Select Call if the holder of the option has a right to buy the underlying security at the strike price. • Select Put if the holder of the option has a right to sell the underlying security at the strike price. Price Type Price type of the equity option: Amount/Unit Exercise Type American European Delivery Type Type of delivery for the option: Cash Settlement or Physical Delivery. • Select Cash Settlement if the underlying security is not delivered when the option is exercised, but the difference between market price of the underlying and the strike price is settled (multiplied by the relevant number of units). • Select Physical Delivery if the underlying securities are delivered when the option is exercised. Contract Multiplier Number of underlying shares or stocks in one option contract. Option Needed Number of options needed (Option Needed) to receive the specified number of equities (Underlying Received). The ratio between the number of options and the number or equities is known as the equity conversion factor. You only need to use these fields if there is not a one-to-one correspondence between the number of options and the number of underlying equities. Underlying Received Switches Activate the switches that apply to the instrument. • Future Style Premium: switch on so that the premium is not paid upfront but netted daily. A.2.134 Equity Option Pricing Id: EQUITY-OPTION-PRICING Usage: Use this feature to price Equity Option instruments. With: EQUITY-OPTION Context: Action Setup: None Details: When the Pricing action is performed on an equity option transaction that has this feature, you can find the premium price, as well as the theoretical price and the Greeks, by manually changing the volatility while keeping the other parameters constant. A.2.135 Equity Option Setup Id: EQUITY-OPTION-SETUP Usage: Use this feature to customize the default settings of Equity Option valuation. With: EQUITY-OPTION Context: Valuation Setup Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 777 A Features A.2 List of features Setup: Option Valuation Details: Note that in order to value a listed option using the price, the Base Valuation Setup must be used with Method = Quoted, otherwise it is the Theoretical method which is used. - When Method = Quoted, and if a price quote is given for the option instrument, the market value of the option is derived form it. Risk figures are based on implied volatility, which is calculated from the quoted price. - When Method = Quoted, and if no price quote exists, but a volatility quote is given for the option instrument, both market value and risks are calculated using this quote. - When Method = Theoretical, the (historical) volatility of the underlying equity is used for both market value and risk calculations. Information Description Pricer The pricer you want to use: Default, Analytic, Finite Difference, or Monte Carlo. Quality The quality used for valuation and/or risk calculations. Risk Quality Intrinsic Method Select from: Valuation Modes • Zero Volatility: the valuation is done by setting the volatility equal to zero. This is the default method. • Spot: the valuation is done by setting the volatility to zero, the asset rate to zero, and the cash rate to zero. • Forward: the valuation is done by setting the volatility to zero, the cash rate to zero, the asset rate equal to the asset rate minus the cash rate. Default, Benchmark, or Theoretical. This setup is valuation mode dependent. A.2.136 Equity Option Valuation Id: EQUITY-OPTION-METHOD Usage: Determines that the instrument is valuated as an Equity Option. With: EQUITY-OPTION Context: Valuation Approach Setup: None Details: If there is no setup for the approach (EQUITY-OPTION-SETUP), the default parameters are: Pricer = Analytic Quality and Risk Quality = 1 Note that in order to value a listed option using the price, the Base Valuation Setup must be used with Method = Quoted, otherwise it is the Theoretical method which is used. A.2.137 Equity Return of Capital 778 Id: EQUITY-CAPITAL-RETURN Usage: Enables you to update the instrument definition with return of capital information. This information is used by the activity of type "Return of Capital". With: EQUITY © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Context: Trading Setup: Return of Capital Information Description Description Comment or information you want to enter about the return of capital. Date Date on which the return of capital was declared or the information was entered in the instrument setup. Position Date Date of the equity position. This date determines how much capital is paid. Record Date Date on which the company considers holders of the security as being entitled to the corresponding corporate action. Payment Date Value date on which the capital is settled. Amount per Unit Amount of capital to be returned for each unit held. Note: Amount per Unit may be expressed as a negative value in the event of an increase in capital. Currency Currency of the return of capital. A.2.138 Equity Split Id: EQUITY-SPLIT Usage: Used to increase or decrease the number of outstanding shares by splitting the equity position. This information is also used by the Split activity in order to create Odd Lot adjustment transactions. With: EQUITY Context: Trading Setup: Equity Split Information Description Description Comment or information you want to enter about the split or reverse split. Date Date on which the split was declared or the information was entered in the instrument setup. Split Date Date on which the position is split. Record Date Date on which the company considers holders of the security as being entitled to the corresponding corporate action. From Units The split ratio: the number of shares into which the existing unit must be split. To Units For example, to split 1 unit into 5 units: From Units = 1, and To Units = 5. To enter a reverse split, inverse the ratio. Rounding Precision Rounding precision for the new units in case fractional units result from the split. Rounding Method Rounding method for the new units: up, down, or nearest. Odd Lot Compensation Price Compensation price per leftover share. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 779 A Features A.2 List of features Information Description Odd Lot Compensation Currency Currency in which a resulting odd lot compensation amount is paid. Odd Lot Compensation Value Date Value date of a resulting Odd Lot compensation transaction. A.2.139 Estimation Curve Setup Id: ESTIMATION-CURVE-SETUP Usage: Used to add an estimation yield curve to the instrument. With: ABS, BOND, CDS, COMMERCIAL-LOAN, CREDIT-STEP-UP, LOAN, SWAP, SWAPTION, TRS Context: Valuation Setup Setup: Yield Curves Information Description Active From First and/or last date that the yield curve is valid for the instrument. Active To Usage Estimation The yield curve is used to estimate the coupons for a floater. In this case, the valuation curve is only used for discounting the cashflows. If no estimation curve is applied to the instrument, the valuation curve is also used for the estimation of the coupon. Yield Curve ID of the yield curve. If you leave this field blank, TRM defaults to the yield curve defined for the currency. Valuation Modes Default, Benchmark, or Theoretical. A.2.140 Exotic Structure (Option) Id: EXOTIC-STRUCTURE Usage: Defines an exotic FX option instrument. With: FX-OPTION Context: Trading Setup: Exotic Option Information Description Option Schedule Option Schedule Template to be applied on the FX Option. If you specify the option schedule in the instrument setup, this is used as the default in the transaction and cannot be modified. Leave this field blank if you want to apply an option schedule to the FX Option when you enter the deal. 780 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.141 Expiry Date Setup Id: EXPIRY-DATE-SETUP Usage: Used to specify expiry dates of OTC options. With: FRA-OPTION, FX-OPTION, SWAPTION Context: Trading Setup: Expiry Date Setup Information Description Calendar Calendars used to calculate the expiry date of an OTC option. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the expiry date calculation takes both calendars into account. Gap Set Gap set used for supplying the expiry periods for an OTC option; these in turn are used to define exact dates. This is a mandatory field. Expiry Date Period Expiry period used to calculate the expiry date for an OTC option at deal entry, for example, 6M or 1Y. If you specify the expiry date period in the instrument setup, this is used as the default in the transaction and cannot be modified. A.2.142 External Valuation Id: EXTERNAL-METHOD Usage: Use this approach to override TRM figures with externally computed figures. With: ALL Context: Valuation Approach Setup: None A.2.143 Fed Fund Future Chain Id: MM-FUTURE-FF-30 Usage: Used to define a fed fund future on the average daily Fed Funds overnight rate for a calendar month, expiring on the last business day of that month. With: MM-FUTURE-CHAIN Context: Trading Setup: Contracts Information Description Calendar Holiday Calendar The calendars used to determine the business days when calculating the trading, delivery, and underlying dates. Root Symbol The root exchange symbol of the chain, for example, enter 'I' for LIFFE Euribor future chain. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 781 A Features A.2 List of features Information Description Monthly Contracts The number of monthly contracts available for trading. Trading Offset The number of business days of the last trading day of the month. Formatter The display formatting for the contracts: • Default: MMM YY displays as SEP 10. • Symbol: Root Symbol + Month Code + Single Digit Year using the same example as above, displays as EDU0 (ED is the root symbol, U is the month code for September, and 0 is the last digit of the year 2010.) Month Codes: Jan = F, Feb = G, Mar = H, Apr = J, May = K, Jun = M, Jul = N, Aug = Q, Sep = U, Oct = V, Nov = X, Dec = Z Note: The default formatter is always used in Rate Monitor. In other applications, the formatting depends on the selected formatter. Setup: Trading Units, see A.2.231 MM Future on page 827. A.2.144 Fed Fund Future Dates Id: FF-FUTURE-DATE Usage: Used to specify the dates of Fed fund futures. With: MM-FUTURE Context: Trading Setup: Future Dates Information Description Last Trading Day Last day when the futures contract can be traded. This corresponds to the final day during which trading may take place in a futures contract, after which it must be settled. Delivery Period Start Last day on which delivery (cash settlement) of the underlying instrument can take place. Delivery Period End Last date of the delivery period (last trade date plus contract period length). A.2.145 Fed Fund Future Par Valuation 782 Id: FF-FUTURE-PAR-METHOD Usage: Enables Par method calculation for valuation of Fed Fund futures. With: MM-FUTURE Context: Valuation Approach Setup: IR Exposure, see A.2.48 Base IR Exposure Setup on page 732 for specific Date Basis and Yield Type settings. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.146 Fed Fund Future Valuation Id: Usage: FF-FUTURE-METHOD Determines the instrument is valuated as a Fed fund future. The behavior of this feature replicates that of the MM Future valuation approach except for some differences in IR exposure calculations (see 9.3.1.3.3 Position monitoring on page 496 for more information). With: MM-FUTURE Context: Valuation Approach Setup: None A.2.147 Filtered Valuation Id: FILTER-METHOD Usage: Enables the filtering out (i.e. Silence, set to 0) of certain key-figures coming from any normal valuation feature. To determine which key-figures are filtered out (per cashflow), you need to use the following cashflow attributes: - No Position: To filter out position-related key-figures (e.g. Nominal Amount, Units) - No Valuation: To filter out valuation-related key-figures (e.g. Market Value, Results) - No Risk: To filter out risk-related key-figures (e.g. IR Exposure, FX Exposure). With: ALL Context: Valuation Approach Setup: None A.2.148 Fixed Bond Valuation Id: FIXED-BOND-METHOD Usage: Valuation approach for Fixed Rate Bonds. This approach is the same as FIXED-IR-QUOTED-METHOD but adds the concept of Risk Yield in IR exposure calculations (formerly Yield to Maturity). With: BOND, CONVERTIBLE-BOND, CREDIT-STEP-UP Context: Valuation Approach Setup: None A.2.149 Fixed IR Quote Valuation Id: FIXED-IR-QUOTED-METHOD Usage: This feature is a combination of IR and QUOTED, which means that this valuation approach recognizes the IR result settings and defaults to quoted valuation if not otherwise stated in the Base Valuation Setup. With: IR quoted instruments. Context: Valuation Approach Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 783 A Features A.2 List of features Setup: None Details: This is an "internal" method, that is, it is not directly available in the setup but some methods are 'internally' defaulting to it for certain cashflows. A.2.150 Fixed IR Valuation Id: FIXED-IR-METHOD Usage: Defines the valuation approach for Fixed Rate or FX/Index-Linked IR transactions. This feature estimates future cashflow amounts based on the expression. With: COMMERCIAL-LOAN, DISCOUNT, FRA, LOAN, CASH Context: Valuation Approach Setup: None Details: This valuation approach also recognizes the Result IR setup, and can therefore calculate the accrued interest/profit. This is the case for all the %IR% methods. A.2.151 Fixed Quoted Valuation Id: FIXED-QUOTED-METHOD Usage: This approach defaults to quoted valuation (which is the case for all the %QUOTED% methods) if the Base Valuation Setup is not done. Otherwise it works in the same way as the Fixed Method. With: Quoted instruments Context: Valuation Approach Setup: None Details: This is an 'internal' approach, that is, it is not directly available in the setup but some valuation approaches are 'internally' defaulting to it for certain cashflows. A.2.152 Force Trade Date Performance Id: PERFORMANCE-TRADE-DATE Usage: Used to identify instruments to which trade date performance measurement should always be applied (that is, never value date). This feature is used by Performance Monitor. With: Cash Context: Performance Setup: None A.2.153 Forecast 784 Id: FORECAST Usage: Determines a cashflow forecast instrument. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features With: FORECAST Context: Primary Setup: Forecast Information Description Currency Currency of the cashflow forecast. Amount Rounding Precision used to round cashflow amounts. Rounding Method Method used to round cashflow amounts. Price Type Price type for the quotation used to determine which FX rate is used in risk calculations. A.2.154 Forecast Valuation Id: FORECAST-METHOD Usage: Valuation approach used for operational cashflow forecasts. With: FORECAST Context: Valuation Approach Setup: None A.2.155 Forward Price Setup Id: FORWARD-PRICE-SETUP Usage: Allows forward curves to be attached to an index or instrument which are then used by the expression to estimate the future value or price. See also A.2.207 Index Estimate on page 817 and A.2.218 Instrument Quote Estimate on page 822. With: INDEX, BOND, EQUITY Context: Valuation Setup Setup: Forward Price Setup Information Description Active From First and/or last date that the forward curve is valid for the instrument. Active To Forward Curve ID of the yield curve. A.2.156 FRA Dates Id: FRA-DATE Usage: Used to specify value and maturity dates of listed FRA. With: FRA Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 785 A Features A.2 List of features Context: Trading Setup: FRA Dates Information Description Last Fixing Day Day the reference rate is fixed. Settlement arrangements are also made on this date. Settlement Date First day of the future period agreed by both parties and the date on which the transfer of funds with regards to profit/loss is made. (Also known as the Value Date) Maturity Date Last day of the contract period. A.2.157 Forward Rate Agreement (Deposit) Id: FRA-DEPOSIT Usage: Defines a forward rate agreement on a deposit. With: FRA Context: Primary Setup: Forward Rate Agreement Information Description Currency Currency of the FRA (that is, if it is a listed forward rate agreement). Leave this field blank if you want to specify the currency when you enter the deal (if you are defining an OTC forward rate agreement). Date Basis Date basis of the instrument. Leave this field blank if you want to specify the date basis when you enter the deal. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Interest Type Interest rate type of the forward rate agreement. Principal Cashflow Type Type of principal cashflows, if you want to override the defaults supplied by the instrument type. Interest Cashflow Type Type of interest cashflows, if you want to override the defaults supplied by the instrument type. Setup: Netting Information Description Fixing Offset Minimum number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Leave this field blank if you want to specify the fixing offset when you enter the deal. 786 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Fixing Subscenario Prices scenario from which the floating rate is retrieved (for example, EUR/USD Spot 9:00 London, or EUR/USD Spot 9:00 Tokyo). Leave this field blank if you want to specify it when you enter the deal. Calendar Calendar to use when calculating the fixing date. Switches Activate the switches that apply to the instrument. • Settlement Currency Settlement Currency - switch on if the P/L cashflow is paid in a different currency. Currency in which the P/L cashflow is paid (if the switch Settlement Currency is switched on). Leave this field blank if you want to specify the settlement currency when you enter the deal. Payment Offset Number of business days after which effective payment of the P/L is made Fixing Rate ID of the yield curve used to calculate the closing price of the forward contract. The forward contract is fixed with the price and TRM calculates the profit/loss using this closing price and the deal rate. Leave this field blank if you want to specify it when you enter the deal. Fixing Period Length of time for which fixing is to be executed (for example, 3M, 6M, 1Y, and so on). Leave this field blank if you want to specify the fixing period when you enter the deal. A.2.158 Forward Rate Agreement (Discount) Id: FRA-DISCOUNT Usage: Defines a forward rate agreement on a discount paper. With: FRA Context: Primary Setup: Forward Rate Agreement Information Currency Description Currency of the FRA (that is, if it is a listed forward rate agreement). Leave this field blank if you want to specify the currency when you enter the deal (if you are defining an OTC forward rate agreement). Date Basis Date basis of the instrument. Leave this field blank if you want to specify the date basis when you enter the deal. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Interest Type Interest rate type of the forward rate agreement. Principal Cashflow Type Type of principal cashflows, if you want to override the defaults supplied by the instrument type. Interest Cashflow Type Type of interest cashflows, if you want to override the defaults supplied by the instrument type. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 787 A Features A.2 List of features Setup: Netting Information Description Fixing Offset Minimum number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Leave this field blank if you want to specify the fixing offset when you enter the deal. Fixing Subscenario Prices scenario from which the floating rate is retrieved (for example, EUR/USD Spot 9:00 London, or EUR/USD Spot 9:00 Tokyo). Leave this field blank if you want to specify it when you enter the deal. Calendar Calendar to use when calculating the fixing date. Switches Activate the switches that apply to the instrument. • Settlement Currency Settlement Currency - switch on if the P/L cashflow is paid in a different currency. Currency in which the P/L cashflow is paid (if the switch Settlement Currency is switched on). Leave this field blank if you want to specify the settlement currency when you enter the deal. Payment Offset Number of business days after which effective payment of the P/L is made Fixing Rate ID of the yield curve used to calculate the closing price of the forward contract. The forward contract is fixed with the price and TRM calculates the profit/loss using this closing price and the deal rate. Leave this field blank if you want to specify it when you enter the deal. Fixing Period Length of time for which fixing is to be executed (for example, 3M, 6M, 1Y, and so on). Leave this field blank if you want to specify the fixing period when you enter the deal. A.2.159 Forward Rate Agreement (Swedish) Id: FRA-SWEDISH Usage: Defines a Swedish forward rate agreement. With: FRA Context: Primary Setup: Forward Rate Agreement Information Description Currency Currency of the FRA (that is, if it is a listed forward rate agreement). Leave this field blank if you want to specify the currency when you enter the deal (if you are defining an OTC forward rate agreement). Date Basis Date basis of the instrument. Leave this field blank if you want to specify the date basis when you enter the deal. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. 788 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Interest Type Interest rate type of the forward rate agreement. Principal Cashflow Type Type of principal cashflows, if you want to override the defaults supplied by the instrument type. Interest Cashflow Type Type of interest cashflows, if you want to override the defaults supplied by the instrument type. Setup: Netting Information Description Fixing Offset Number of days’ offset is allowed, that is, the difference in days between the fixing date and the due date (default is 0). Fixing Max Offset Maximum number of days’ offset allowed. Fixing Subscenario Subscenario from which the rate is retrieved. Calendar Calendar to use when calculating the fixing date. Switches Switch on Settlement Currency if the P/L cashflow is paid in a different currency. Settlement Currency Currency in which the P/L cashflow is paid (if the switch Settlement Currency is switched on). Leave this field blank if you want to specify the settlement currency when you enter the deal. Payment Offset Number of business days between value date and payment date, should be 3 for Swedish FRA. Discount Rate Rate used to discount settlements between value date and netting date (used to default discount rate when performing netting). Leave this field blank if you want to specify the discount rate when performing netting. Method Defaults to Last of Month. (Read-only) First Time Fee Rate Fixed percentage of the nominal amount, which will be discounted back from the underlying value date to the payment date with the discount rate. This Fee amount is settled on the first netting flow). Leave this field blank if you want to specify the first time fee rate when performing netting. A.2.160 FRA Valuation Id: FRA-METHOD Usage: Determines that the instrument is valuated as an FRA. With: FRA Context: Valuation Approach Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 789 A Features A.2 List of features A.2.161 FRA Option Id: FRA-OPTION Usage: Defines an FRA option instrument. With: FRA-OPTION Context: Primary Setup: FRA Option Information Description Issuer Issuer (writer) of the option. Underlying TBC Strike TBC Type Call or Put. Exercise Type American or European. Delivery Type Cash Settlement or Physical Delivery. A.2.162 FRA Option Valuation Id: FRA-OPTION-METHOD Usage: Determines that the instrument is valuated as an FRA option. With: FRA-OPTION Context: Valuation Approach Setup: None A.2.163 FRA Periods 790 Id: FRA-PERIODS Usage: Used to calculate maturity and value dates of OTC FRA contracts. With: FRA-DEPOSIT, FRA-DISCOUNT Context: Trading Setup: Periods Information Description Gap Set Gap set used for supplying the FRA periods; these in turn are used to define exact dates. Gap Specific gap within the gap set used to calculate the FRA period. Calendar Calendar and Holiday Calendar used to calculate the FRA period. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the date calculation takes both calendars into account. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.164 FRN Valuation Id: FRN-METHOD Usage: Determines that discount margin is used in the valuation. This feature should be used with the feature Z-DM/Spread Setup (A.2.343 Z-DM/Spread Setup on page 882). With: BOND Context: Valuation Approach Setup: None A.2.165 Fund Id: FUND-SHARE Usage: Defines a fund share instrument. With: FUND-SHARE Context: Primary Setup: Fund Information Description Issuer Issuer of the fund (the fund management company). In TRM, issuers are set up as clients with the role Issuer (in the Roles page in Client Editor). Payment Agent Third party through whom all the payments relative to this instrument are channelled. Minimum Price Denom. Not in use. Default Price Denom. Not in use. Currency Currency in which the fund is traded. Sign to be applied to the transaction: Any (default), Buy, or Sell: Transaction Sign • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy or Sell if you want this to be the direction of the transactions, and if you don't want this direction to be modified at deal entry. Amount Rounding Amount (nearest number to which the amount is rounded). Rounding Method Rounding method to be applied: Down, Nearest, Up. Note: The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number). Setup: Fund Spread Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 791 A Features A.2 List of features Information Description Relative Spread Switch on/off If the switch is off, the bid and ask spread% are interpreted as absolute numbers i.e. When you publish a NAV in Rate Monitor, the bid price of the NAV per unit will be calculated as: Bid Spread% * NAV *Scaling Factor. For example, if the NAV is 100 and the scaling factor = 1, and you set: • Switch off • Bid Spread%: 95 Then the bid NAV is: 0,95*100*1 = 95. If the switch is on, the bid and ask spread% are interpreted as relative numbers i.e. When you publish a NAV in Rate Monitor, the bid price of the NAV per unit will be calculated as: (1+ Spread%) * NAV* Scaling Factor CellCode character For example, if the NAV is 100 and the scaling factor = 1, and you set: • Switch on • Bid Spread%: -5 Then the bid NAV is: (1-0,05)*100*1 = 95. Bid Spread% Number (0-100). Note: When you publish a NAV in Rate Monitor, the bid price of the NAV per unit is calculated using the Bid Spread% (see the field Relative Spread for more explanation about the calculation). Ask Spread% Number (0-100). Note: When you publish a NAV in Rate Monitor, the ask price of the NAV per unit is calculated using the Ask Spread% (see the field Relative Spread for more explanation about the calculation). A.2.166 Fund Fee Accrual and Realization Id: FUND-FEE Usage: Defines a fund fee instrument. With: FUND-FEE Context: Primary Setup: Fund Fee Accrual Information Description Date Basis Date basis used to calculate accrued interest for this instrument. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Fee Rate Rate. Note: If you specify a fee rate, you do not need to specify any ladder values (see Ladder Rule and Ladder). 792 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Fee IR Reference Underlying yield curve used for fee calculation. The yield curves are set up in IR Quote and Yield Curve Editor. If you specify a yield curve (and/or Period, Positive Spread, or Negative Spread), you do not need to specify any ladder values (see Ladder Rule and Ladder). Period Period of the underlying yield curve to be used for interest calculation (for example, O/N). Positive Spread Spread to be added to the underlying yield curve for interest calculation (lending). Note: This field is static (i.e. not time-dependent). Spread values are applied when the account balance is created for the first time, and subsequent changes to the spreads do not impact existing account balances. In the case where spreads may change over time, ladders should be used instead. Negative Spread Spread to be added to the underlying yield curve for interest calculation (borrowing). Note: This field is static (i.e. not time-dependent). Spread values are applied when the account balance is created for the first time, and subsequent changes to the spreads do not impact existing account balances. In the case where spreads may change over time, ladders should be used instead. Scenario Rates scenario to be used for calculating interest for this instrument. Ladder Rule Ladder rule (defined in Ladder Rule Editor) or interest rate ladder set (defined in Ladder Set Editor) that you want applied to this instrument. Ladder You can apply a ladder rule or a ladder, but not both. Note: If you specify one of the Ladder values, you do not need to specify any Interest Rate Curve values. Switches Activate the switches that apply to the instrument. • Compound Daily AI - switch on to calculate daily compounded interest accrual, that is, to calculate interest on the sum of the outstanding balance and total interest accrued to date. • Fixing Must Match - switch on to create accrued interest cashflows even if there is no fixed rate. Such cashflows will have the attribute Not Fixed. • Interest on Value Date - switch on to calculate accrued interest based on today’s closing balance rather than today’s opening balance (whether interest is calculated on opening or closing balance depends on market conventions; for example, in South Africa, it is calculated on the closing balance). • Round Daily AI - switch on to round daily interest accrual according to the Amount Precision defined for the currency. If the switch is off, then daily interest accrual is calculated as an exact number, and rounding will only occur on the total accumulated accrued interest (for example, when the interest is realized). • Split Interest by Sign - switch on to have positive and negative accrued interest calculated separately. If this switch is not turned on, the accrued interest will be netted. Setup: Fund Fee Realization Information Description Frequency Frequency of fee realization. Frequency Unit Unit of time to use for fee realization: Business Days, Days, Months, Weeks, or Years. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 793 A Features A.2 List of features Information Description Convention Convention to use for interest realization: • None – no adjustment is made to the date. • Backward - fee realization is moved to the first business day before the value date. • Following – fee realization is moved to the first business day after the value date. • Last of Month – fee realization is moved to the last business day of the month. Note: You must select Frequency Unit = Business Days. • Last of Month Calendar – fee realization is moved to the last calendar day of the month. Note: You must select Frequency Unit = Business Days. • Last of week - fee realization is moved to the last business day of the week. • Modified Following – fee realization is moved to the first business date after the value date except where this would cause the payment date to fall into the month following the value date, in which case the payment date is the first business date before the value date. • Method Amount Rounding Not Modified. Method of realizing interest: • At Withdrawal - not applicable. • Periodically - interest is realized at regular intervals (see Frequency field). • At Expiration - not applicable. Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Settlement Method Interest payment method: Capitalize to compound interest or Settle to receive or pay interest. Payment Offset Number of days after interest calculation that you want to realize the interest. A.2.167 Fund Fee Valuation 794 Id: FUND-FEE-METHOD Usage: Determines the instrument is valuated as a fund fee. With: FUND-FEE Context: Valuation Approach Setup: None © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.168 Future Dates Id: FUTURE-DATE Usage: Used to define dates of future instruments. With: BOND-FUTURE, EQUITY-FUTURE, FX-FUTURE, INDEX-FUTURE Context: Trading Setup: Future Dates Information Description Last Trading Day Last day when the futures contract can be traded. This corresponds to the final day during which trading may take place in a futures contract, after which it must be settled. Settlement Date Last day on which delivery (cash settlement) of the underlying instrument can take place. A.2.169 Future Valuation Id: FUTURE-METHOD Usage: Valuation approach used for future contracts. With: EQUITY-FUTURE, INDEX-FUTURE Context: Valuation Approach Setup: None A.2.170 FX Id: FX Usage: Defines an FX instrument (spot or forward). With: FX Context: Primary Setup: Dates Information Description Gap Set Gap set used for supplying the value date periods; these in turn are used to define exact dates. Value Date Period Value date period used to calculate the value date for the instrument at deal entry. If this is specified at the instrument level, it is used as default in the transaction and cannot be modified. Spot Days Number of business days between opening and value dates. Defaults to currency spot days when left blank. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 795 A Features A.2 List of features Information Description Calendar Calendar and Holiday Calendar used to calculate the value date. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the value date calculation takes both calendars into account. Note: When you define the Calendar or Holiday Calendar in one date setup, the Calendar fields in all date setup pages applied to the instrument default to the same values. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. A.2.171 FX Cross Method Id: FX-CROSS-METHOD Usage: Used when you deal a currency pair where neither of the currencies in the deal are the same as the portfolio base currency. This feature calculates the Base Spot FX Rate and Base FX Rate at cashflow level. This will, in turn have an impact on result calculations. With: FX, FX-SWAP Context: Trading Setup: FX Cross Method Information Description FX Cross Method Method used to calculate the rates when you deal a currency pair where neither of the currencies in the deal are the same as the portfolio base currency. • Default (no value): the basis currency depends on which amount is entered first. If FX Base Amount is entered first, then Currency 1 will be treated as the basis currency. • Prefer Base Currency: the FX rates between the portfolio currency and the basis currency are fetched from the market, and the FX rates between the portfolio currency and the other currency in the deal are calculated. The basis currency is determined based on the quotation of the currency: - If the quotation is one unit of Currency 1 per Currency 2, then Currency 1 is the basis currency. For example, whether you deal EUR/USD or USD/EUR, EUR will be the basis currency. The definition of the basis currency is configured in Currency Editor’s Cross Rates page using the Indirect switch: see the TRM User Guide. • Prefer Sell Currency: the FX rates between the portfolio currency and the sold currency are fetched from the market, and the FX rates between the portfolio currency and the purchased currency are calculated. The Sell currency is treated as the basis currency. 796 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.172 FX Estimate (Forward) Id: FX-ESTIMATE Usage: This feature is used to change the way the Estimate Expression estimation method evaluates the expression, as follows: Instead of using the spot rate for estimation, the fx function will use the spot rate + forward points of the currency pair when estimating the future value of the currency pair quote. With: LOAN Context: Function Setup: None A.2.173 FX Estimate (IR Difference) Id: FX-ESTIMATE-IR-DIFFERENCE Usage: This feature is used to change the way the Estimate Expression estimation method evaluates the expression, as follows: Instead of using the spot rate for estimation, the fx function will use the spot rate + the IR differential between the two currencies (using the default curves) when estimating the future value of the currency pair quote. With: BOND, LOAN Context: Function Setup: None A.2.174 FX Fixing Id: FX-FIXING Usage: Allows fixing of the FX rate of a dual currency structure. With: BOND, CREDIT-STEP-UP, LOAN, SWAP Context: Action Setup: None A.2.175 FX Forward Id: FX-FORWARD Usage: Used to default/calculate forward figures (forward points) when dealing FX Forwards. With: FX, FX-SWAP Context: Trading Setup: FX Forward Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 797 A Features A.2 List of features Information Description Switches Activate the switches that apply to the instrument. • Absolute IR Difference The way in which FX forward points are calculated from base and quote currency interest rates depends on this switch. It determines the relationship between the base currency interest rate, the quote currency interest rate, the spot FX rate and the forward points. If On: Forward Points = Spot Rate * (Quote Currency Discount Factor - Base Currency Discount Factor) If Off: Forward Points = Spot Rate*(Quote Currency Discount Factor/Base Currency Discount Factor-1) • Special Spot Value Decides the selection of the base currency. This selects the currency on which the interest rate is calculated when the profit method FX Interest is used. For FX swaps, the interest result is always calculated based on the difference between spot and forward amounts. • Truncate Rate When this switch is used, the deal rate (calculated from FX Spot Rate and Base/Quote Interest %) is truncated according to the rounding precision defined for the currency pair. This is mainly needed for capturing gold forwards. • Use One IR Only Sets one interest rate to always be zero. By default, the currency for which the amount has been captured by the user has an interest rate, and the other currency’s rate is zero. The Forward Points are calculated accordingly. A.2.176 FX Future Id: FX-FUTURE Usage: Defines an FX Future contract. With: FX-FUTURE Context: Primary Setup: FX Future Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Base Currency The currency pair: Base Currency/Settlement Currency. Settlement Currency A.2.177 FX Future Netting 798 Id: FX-FUTURE-NETTING Usage: Allows netting of FX future contracts. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features With: FX-FUTURE Context: Trading Setup: Netting Information Description Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max Offset Maximum number of days’ offset allowed. Fixing Subscenario Subscenario from which the exchange rate is retrieved. Calendar Calendar to use when calculating the fixing date. Switches Activate the switches that apply to the instrument. • Settlement Currency - switch on if the P/L cashflow is paid in a different currency. Payment Offset Number of business days between value date and payment date. Method Select Business Days for daily netting. Frequency For daily netting, enter 1 when Method = Business Days. Details: As for other futures, there are initial and maintenance margins and daily cash settlements. If the market quote for the future has changed from the previous day, the daily change in market value is settled every day (netted) until the contract is closed or expires. Information Description Fixing Price Fixing market quote. This is defaulted by the system and can be changed by the user. P/L Profit or loss (settlement amount) from the FX future. This is calculated automatically by TRM and can be changed by the user. A.2.178 FX Future Valuation Id: FX-FUTURE-METHOD Usage: Determines the valuation approach used for FX future contract instruments. With: FX-FUTURE Context: Valuation Approach Setup: None A.2.179 FX - Lagged FX Function Id: FX-LAG Usage: Enables the use of the FX lag function in the expression. With: BOND, LOAN Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 799 A Features A.2 List of features Context: Function Setup: None A.2.180 FX Margin Result Id: FX-MARGIN Usage: Enables the calculation of margin results for FX spot and FX forward transactions. When this feature is used, special Margin cashflows are created in the transaction. These cashflows are then used by the system to calculate Margin Results, for example, visible in Treasury Monitor and in reports. See 6.1 FX spot and FX forward on page 383 for information about the calculation of margin results. With: FX Context: Trading Setup: None A.2.181 FX Valuation Id: FX-METHOD Usage: Determines the valuation approach used for FX instruments. With: CASH, FX, FX-SWAP Context: Valuation Approach Setup: None A.2.182 FX Option Id: FX-OPTION Usage: Defines an FX option instrument. With: FX-OPTION Context: Primary Setup: FX Option Information Description Exercise Instrument Underlying FX instrument. Type Option type: Call or Put. Exercise Type American, European, or Templatized (should be used for Bermudan option). Delivery Type Type of delivery for the option: Cash Settlement or Physical Delivery. Setup: 800 Dates © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Gap Set Gap set used for supplying the expiry periods for the option; these in turn are used to define exact dates. This is a mandatory field. Expiry Date Period Expiry period used to calculate the expiry date for the option at deal entry, for example, 6M or 1Y. If you specify the expiry date period in the instrument setup, this is used as the default in the transaction and cannot be modified. Premium Offset Number of days offset between the applied date defined in the Applied On field and the premium date. Applied On Date on which the settlement of the premium takes place (Premium Date). This is the spot date by default. Calendar Calendars used to calculate the expiry date and premium date of an option instrument. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the expiry date and premium date calculation takes both calendars into account. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. A.2.183 FX Option Compound Id: FX-OPTION-COMPOUND Usage: Defines the instrument as an FX compound option. With: FX-OPTION Context: Primary Setup: FX Compound Option, and Dates (same as FX Option) Information Description Exercise Instrument Underlying Option. Type Call on Call, Call on Put, Put on Call, or Put on Put. Exercise Type European or American or Templatized. Option Schedule Option Schedule template to be used for the compound exercise definition. The selected Option Schedule template should create a Compound Exercise transaction event. A.2.184 FX Option Digital Id: FX-OPTION-DIGITAL Usage: Defines an FX digital option instrument. With: FX-OPTION Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 801 A Features A.2 List of features Context: Primary Setup: FX Option and Dates (same as FX Option) Information Description Type Call or Put. Exercise Type European (for a Digital option) or American (for a One Touch option) or Templatized. A.2.185 FX Option Listed Id: FX-OPTION-LISTED Usage: Defines an exchange traded FX option. With: FX-OPTION-LISTED Context: Primary Setup: FX Option Listed Information Description Issuer Issuer (writer) of the option. Exercise Instrument ID of the underlying FX instrument. This can be an instrument that belongs to the instrument class FX. Strike Strike price of the option. If the option is exercised this price is used to buy or sell the underlying currencies. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. 802 Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Currency Currency of the listed FX option. Type Option type: Call or Put. • Select Call if the holder of the option has a right to buy the underlying currency at the strike price. • Select Put if the holder of the option has a right to sell the underlying currency at the strike price. Price Type Price type of the listed instrument: Amount, Price %, or Price Points. Underlying Currency Currency of the underlying FX instrument. Settlement Currency Currency of the settlement flow. Exercise Type American or European. Delivery Type Type of delivery for the option: Cash Settlement or Physical Delivery. • Select Cash Settlement if the underlying currency is not delivered when the option is exercised, but the difference between exchange spot rate of the underlying/settlement currencies and the strike price is settled (multiplied by the relevant amount). • Select Physical Delivery if the underlying currency is delivered when the option is exercised. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Flags Future Style Premium: Premium is not paid upfront but netted daily. Setup: Dates Information Description Expiry Date Last date the option can be exercised before it expires. Delivery Offset Number of days offset allowed before delivery must take place. Leave this field blank if you want to specify the delivery offset when you enter the deal. Spot Days Number of business days between opening and value dates. Defaults to currency spot days when left blank. Note: It is recommended not to specify the spot days in the instrument setup as these are taken by default from the spot days of the two currencies at deal entry. Calendar Calendars used to calculate the expiry date of the option. Holiday Calendar Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. A.2.186 FX Option Premium Id: FX-OPTION-PREMIUM Usage: Used to specify premium characteristics for FX OTC Options. With: FX-OPTION Context: Trading Setup: FX Premium Information Type Description Determines how the premium amount is calculated. If defined, this premium type is applied to each transaction. Leave this field blank if you want to specify the premium type when you enter the deal. Currency Currency of the premium. If defined, the premium currency is applied to each transaction. Leave this field blank if you want to specify the premium currency when you enter the deal. A.2.187 FX Option Pricing Id: FX-OPTION-PRICING Usage: Use this feature to price FX options. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 803 A Features A.2 List of features With: FX-OPTION, FX-OPTION-LISTED Context: Action Setup: None Details: This feature enables the system to provide the theoretical premium (option value) before the actual premium is captured. In addition, the Volatility, Greeks, Intrinsic Value, and Time Value are also shown. It is possible to modify the volatility and thereby, update the other values. Intrinsic Value is stored as part of the option flow. This means that it is possible to differentiate which part of the paid premium is Intrinsic Value (IV), and which part is Time Value (TV). MtoM profit can be split into MtoM Profit (IV) and MtoM Profit (TV), and each profit component can be booked separately. A.2.188 FX Option Setup Id: FX-OPTION-SETUP Usage: Use this feature to customize the default settings of FX option valuation (A.2.189 FX Option Valuation on page 805). With: FX-OPTION, FX-OPTION-LISTED Context: Valuation Setup Setup: Option Valuation Information Description Pricer Defines the valuation method to be used: • Default: Uses the method most relevant to the specific option. Typically, Analytic where available, Finite difference for others (i.e. Bermudan and compound). • Analytic: Uses the exact or approximation formula: - Black-Scholes (vanilla and European digital options): - Ikeda-Kunitomo (barrier options): In the case of an analytic single barrier, this is the equivalent to Merton-Reiner-Rubinstein. - Bjerksund-Stensland (American options) See 10.8.6.2.2 Option valuation models on page 611 for more information about these methods. • Finite Difference: used to solve the Black-Scholes partial differential equation numerically, applying barrier and terminal conditions relevant to the option. Finite difference method can be used for all option types, including Bermudan and Compound. • Monte Carlo (simulation) used to generate time paths for the underlying FX rate, according to the lognormal distribution, and calculate the expected value from the simulated outcomes. Monte Carlo simulation may be used for all option types except American. Note: European barrier options can use either analytic or Finite Difference methods. On the other hand, American barrier options must use the Finite Difference method. Quality Controls some of the parameters that affect the accuracy of Finite Difference and Monte Carlo methods. A higher value means increased accuracy though may result in a higher use of memory and CPU. Choose a number between 1 and 10. 804 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Risk Quality Controls some of the parameters that affect the accuracy of Finite Difference and Monte Carlo methods. A higher value means increased accuracy though may result in a higher use of memory and CPU. Choose a number between 1 and 10. Note: If set to zero, risk figures are not calculated at all. Intrinsic Method Controls how the intrinsic value is calculated. Select from: • Valuation Modes Zero Volatility: The intrinsic value is the value of the option (according to the chosen valuation method), assuming that the volatility of the underlying rate is zero. This is the default method. • Spot: The intrinsic value is the difference between spot rate and strike price. • Forward: The intrinsic value is the difference between the forward rate and strike price. Default, Benchmark, or Theoretical. This setup is valuation mode dependent. Switches Activate the switches that apply to the instrument. • Use Volatility Smile - switch on so that the valuation is done by taking into account the out of the money option, that is, those with a delta different from 50%. A.2.189 FX Option Valuation Id: FX-OPTION-METHOD Usage: Determines that the instrument is valuated as an FX option. With: FX-OPTION, FX-OPTION-LISTED Context: Valuation Approach Setup: None Details: If there is no setup for the approach (FX Option Setup), the following default parameters are applied: - Pricer: Default, uses the method most relevant to the specific option. Typically, Analytic where available, Finite difference for others (i.e. Bermudan and compound). - Quality and Risk Quality: Set to 1 (lowest quality) - Intrinsic Method: Zero Volatility See 10.8.6.2.2 Option valuation models on page 611. A.2.190 FX Pricer (Forward) Id: FX-PRICER-FORWARD Usage: Defines the characterization of a standalone Forward instrument to be used in the FX Pricing tool. With: FX Context: Trading Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 805 A Features A.2 List of features A.2.191 FX Pricer (Option) Id: FX-PRICER-OPTION Usage: Defines the characterization of the option (plain vanilla or digital and vanilla/digital compound or barrier) to be used in FX Pricing tool. With: FX-OPTION Context: Trading Setup: FX Pricer Information Description Property OPTION-TYPE Value Select the relevant value according to the option instrument you are defining: • Vanilla • Vanilla Compound • Vanilla Barrier • Digital • Digital Compound • Digital Barrier A.2.192 FX Setup Id: FX-SETUP Usage: Used to freeze some basic characteristics of an FX instrument, such as currency pair. With: FX, FX-SWAP Context: Primary Setup: FX Setup Information Description Base Currency Base and quote currencies for the instrument. Quote Currency Leave these fields blank if you want to specify the currencies when you enter the deal. Transaction Sign Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow: Issuer • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy/Lend or Sell/Borrow if you want this to be the direction of the transactions, that is, the direction cannot be modified at deal entry. Issuer of the instrument. Issuers are those clients that have been given the role Issuer (in Client Editor’s Roles page). 806 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.193 FX Swap Id: FX-SWAP Usage: Defines an FX swap instrument. With: FX-SWAP Context: Primary Setup: Dates Information Description Gap Set Gap set used for supplying the value date periods; these in turn are used to define exact dates. Value Date Period Value date period used to calculate the value date for the instrument at deal entry. If this is specified at the instrument level, it is used as default in the transaction and cannot be modified. Maturity Date Period Maturity period used to calculate the maturity date for an instrument at deal entry, for example, 6M or 1Y. If you specify the maturity date period in the instrument setup, this is used as the default in the transaction and cannot be modified. Spot Days Number of business days between opening and value dates. Defaults to currency spot days when left blank. Calendar Calendar and Holiday Calendar used to calculate the value date. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the value date calculation takes both calendars into account. Note: When you define the Calendar or Holiday Calendar in one date setup, the Calendar fields in all date setup pages applied to the instrument default to the same values. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. A.2.194 FX Swap Cost-of-Funding Id: FX-SWAP-COST-OF-FUNDING Usage: Defines a cost of funding FX Swap. With: FX-SWAP Context: Trading Setup: Cost of Fund Details This feature allows the defaulting of fixing curve/spread curve. Information Description Active from/to Set active from and to dates if you want the defaulting to be used only for a given period. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 807 A Features A.2 List of features Information Description Currency Currency you want to specify. C-o-F Curve The default curve from which the interest rate will be defaulted. Note: Only IR quotes (i.e. curve with fixing/interest calculation usage) defined with the Bootstrap Yield Curve feature are available. C-o-F Spread Curve The default spread curve from which the spread will be defaulted. Scenario The default scenario from which the values will be retrieved. Method Defaulting method: Ask, Bid, Bid/Ask (Spread Against), Bid/Ask (Spread in Favor), or Mid. • If you select Bid/Ask (Spread Against): if you are buying the base currency of the quoted currency pair, the Ask price is used; if you are selling the base currency of the quoted currency pair, the Bid price is used. • If you select Bid/Ask (Spread in Favor): if you are buying the base currency of the quoted currency pair, the Bid price is used; if you are selling the base currency of the quoted currency pair, the Ask price is used. A.2.195 FX Swap Margin Result Id: FX-SWAP-MARGIN Usage: Enables the calculation of margin results for FX swap transactions. When this feature is used, the transaction margins result in (Not Payable and Not Bookable) Margin cashflows being created in the transaction. See 6.4 FX swap on page 416 for information about the calculation of margin results. With: FX-SWAP Context: Trading Setup: None A.2.196 FX Swap Quote Default 808 Id: FX-SWAP-QUOTE-DEFAULT Usage: Allows defaulting of the FX Spot Rate, Forward Points, and Base Currency Interest Rate at swap deal entry. With: FX-SWAP Context: Action Setup: Quote Default Information Description Scenario Scenario you want to use to price the transactions. Mode Pricing mode: • Select Automatic if you want to retrieve the quotes automatically in Transaction Manager. • Select Manual if you want to retrieve the quotes manually in Transaction Manager. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Method Defaulting method: Ask, Bid, Bid/Ask (Spread Against), Bid/Ask (Spread in Favor), or Mid. Values to Default • If you select Bid/Ask (Spread Against): if you are buying the base currency of the quoted currency pair, the Ask price is used; if you are selling the base currency of the quoted currency pair, the Bid price is used. • If you select Bid/Ask (Spread in Favor): if you are buying the base currency of the quoted currency pair, the Bid price is used; if you are selling the base currency of the quoted currency pair, the Ask price is used. Choose from: • Forward Points The FX spot rate and the forward points are taken from the market. The base currency interest rate is taken from the market from the yield curve defined for the currency (in Currency Editor’s Journals page) on the spot date and the maturity date, and the quote currency interest rate is calculated from the FX forward points and the base currency interest rate. If the FX forward points are changed manually, the Quote Currency Interest Rate and Deal Rate columns are updated. • Interest Rates The FX spot rate, base currency interest rate, and the quote currency interest rate are taken from the market. Forward points are calculated from the FX spot rate of the deal and the discount factors in the base and quote currencies of the transaction. The forward points are updated if one of the following columns is changed: Nominal/Spot Rate, Base Currency Interest Rate, and Quote Currency Interest Rate. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 809 A Features A.2 List of features A.2.197 FX Swap Split Id: FX-SWAP-SPLIT Usage: Enables the definition of the near / far leg to be used to split the two legs of an FX swap into two separate FX transactions. With: FX-SWAP Context: Trading Setup: FX Swap Split Information Description Near Leg Instrument Far Leg Instrument Select the near / far instrument to be used when you execute an FX swap order to/from the trading platform. A.2.198 FX Time Option Id: FX-TIME-OPTION Usage: Used to define the periods for which the start and end of the exercise window are derived and to specify time option owner. With: FX-TIME-OPTION Context: Primary Setup: FX Time Option Information Description Base Currency Base and quote currencies for the instrument. Quote Currency Leave these fields blank if you want to specify the currencies when you enter the deal. Transaction Sign Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow: Owner • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy/Lend or Sell/Borrow if you want this to be the direction of the transactions, that is, the direction cannot be modified at deal entry. Owner of the contract. Select Counterparty or Portfolio Owner. Leave this field blank if you want to specify the owner when you enter the deal. Note: This is used with Optimal maturity method when you are using the valuation approach FX Time Option Valuation. Setup: 810 Dates Information Description Gap Set Gap set used for supplying the available exercise periods. Value Date Period Period from which start of exercise window is derived. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Maturity Date Period Period from which end of exercise window is derived. Calendar Calendars used to calculate the exercise date. Holiday Calendar Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. A.2.199 FX Time Option Valuation Id: FX-TIME-OPTION-METHOD Usage: Used to specify the time option valuation method. With: FX-TIME-OPTION Context: Valuation Approach Setup: Time Option Valuation Information Description Maturity Method Maturity method for FX Time Option instrument: • Earliest: Processes open transactions with maturity at the start of the window. • Latest: Processes open transactions with maturity at the end of the window. • Optimal: Processes open transactions with maturity at either start (earliest) or end (latest) of the window, so that the value for the owner is maximized. Valuation Modes Modes to be used for valuation: Benchmark, Default or Theoretical A.2.200 FX Trading Platform Id: TRADING-PLATFORM Usage: Enables the FX spot, FX forward, FX swap, and NDF instruments to be used in the order processing to and from the trading platform. With: FX Context: Trading Setup: None A.2.201 Generic IR Valuation Id: GENERIC-IR-METHOD Usage: Valuation approach for floating rate transactions. This approach uses different risk profiles for estimating future interest payments based on the FLOATING-SETUP: see A.2.338 Valuation Setup (Floating) on page 879. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 811 A Features A.2 List of features With: BOND, CAP-FLOOR-COLLAR, COMMERCIAL-LOAN, CREDIT-STEP-UP, LOAN Context: Valuation Approach Setup: None Details: The difference between Fixed Method and the Generic IR Method is as follows: in the Fixed Method, any non-fixed cashflows are estimated using the expression (any expression, not just an interest rate one), and then valuated as a fixed cashflow; whereas the Generic IR Method assumes an IR floating risk-wise, that is, two risk flows. This means that the Generic IR Method can valuate correctly both Fixed and Floating-Rate IR products. A.2.202 Generic Loan Id: GENERIC-LOAN Usage: Used to set up a long-term loan. With: LOAN Context: Primary Setup: Generic Loan Information Currency Description Currency of the loan. Leave this field blank if you want to specify the currency when you enter the deal. Transaction Sign Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow. • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy/Lend or Sell/Borrow if you want this to be the default direction of the transaction, that is, the direction cannot be modified at deal entry. AI Method Method used to calculate accrued interest, if interest starts to accrue before the value date of the transaction. Settlement Switches Activate the switches that apply to the instrument’s settlement flows. • Amount Rounding Dirty Price - switch on to use the dirty price for the instrument, that is, to include accrued interest in the instrument’s price. Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down or to the nearest figure as calculated using the specified Amount Rounding number. Structure Schedule Template to be applied on the loan. If you specify the schedule in the instrument setup, this is used as the default in the transaction and cannot be modified. Leave this field blank if you want to apply a schedule to the loan when you enter the deal. 812 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.203 Index Id: INDEX Usage: Defines a simple index instrument. With: INDEX Context: Primary Setup: Quoted and Market Info pages, see A.2.274 Quoted on page 849. A.2.204 Index Averaging Id: INDEX-AVERAGING Usage: Allows the definition of a performance averaging index. With: INDEX Context: Primary Setup: As for INDEX COMPOSITION (see A.2.205 Index Composite on page 814) Index Numerator Dates Information Description Date Input Date when the calculation is done. Observation Date Date when the price is observed. Calendar Calendar used to compute the dates. Setup: Index Denominator Dates Information Description Date Input Date when the calculation is done. Observation Date Date when the price is observed. Calendar Calendar used to compute the dates. Setup: Index Schedule Information Description Start Date Date from when the dates should be generated. End Date Date until when the dates should be generated. Method Method used to determine how the dates should be generated (for example, Months). Frequency Frequency that should be applied to the method to determine how dates should be generated (for example, if Frequency = 2 and Method = Months, then one date will be generated every two months). Convention Convention used to adjust the observation date when it falls on a non-business day. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 813 A Features A.2 List of features Information Description Roll From Start Select Yes if you want generation to begin from the start date. Schedule Type Schedule type according to the type of performance index. A.2.205 Index Composite Id: INDEX-COMPOSITE Usage: Allows the definition of a composite index instrument. With: INDEX Context: Primary Setup: Structure Information Description Currency Reference currency for the index, used as the basis of index calculations. Composition Type Defines the component types used in this index: DEBT-SECURITY (bond, quoted Discount Paper), EQUITY, and COMPOSITE (other composite index). Weight Cap The max % of the market value a single component can attain. Input Method Defines how weightings are input (see also Composition page below). Available methods are: Units/Nominal: the absolute units for the component • Market value: the market value of the component in index currency • Weight %: the % of the total market value of the component • Outstanding: number of times the outstanding units/nominal (typically 1). Available for Bond and Equity • Free Float: same as above but with the units available for trading. Available only for Equity. Rounding Precision Rounding precision to be applied in calculations. Rounding Method Rounding method to be applied in calculations. Setup: Base Information Description From Date of the revision To Read-only. Date up to which this revision is valid. Index Value 814 • • For the initial base, the default is 100. • For revision bases, this is defaulted to the last known frozen base (from the previous day). It can be changed (if incorrect in the database for example) but should normally not be changed: it will be used as the base for index calculations for every date until the next revision. Market Value The total market value of the index in the index currency. It is automatically set with Calculate (see Actions). It can also be forced and then calculate will adjust composition to match it. Last Market Value Read-only. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Attributes • Error: calculation of the base is impossible (incorrect base/component attributes and/or inputs/market value) • Keep Market Value: affects Calculate button behavior (see below); always on when method is %. • Modified: composition has been modified for this base and calculation must be done before saving Setup: Composition Information Description Base Date Reference of the base (corresponds to Base "From"). Component Id of the component; available components are indexes. Currency Read-only. Currency of the component, retrieved from component characteristics. Calendar Read-only. Calendar of the component, retrieved from component characteristics. FX Rate Cross-rate between Component currency and index currency, defaulted from fixing scenario. Can be changed by the user. It is the base rate used in calculation relative to this base for this component. Component Value Price of the component. This is defaulted from the fixing scenario and can be changed by the user. It is the base price used in calculations relative to this base for this component. Input Base weight for this component. The significance of this weight depends on the input method defined in the index structure (see above). Units/Nominal Read-only. This is the absolute weight in units which is calculated for the component depending on the input method. Amount Read-only. Amount of the component for the base in index currency. The sum of the amount of all components for a base gives the base market value of the index. Attributes Keep Input forces the Calculate action to keep the input for this component. Setup: Rebase Information Description Date Date of the market value shift Old Value Market value of the index before the external event was taken into account New Value Market value of the index including the impact of the external event. Setup: Re-Balance Information Description Date Input Date of the CA to be balanced. Component Id of the component. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 815 A Features A.2 List of features Information Description Old Units/Nominal Number of units before rebalancing New Units/Nominal Number of units after rebalancing Source Where the rebalancing comes from • Manual: inserted by the user A.2.206 Index Derived Id: INDEX-DERIVED Usage: Allows the definition of a derived index instrument. With: INDEX, QUOTED Context: Primary Setup: As for INDEX COMPOSITION (see A.2.205 Index Composite on page 814) Index Structure Information Description Currency Reference currency for the index, used as the basis of index calculations. Composition Type Index is the only available type. Weight Cap The max % of the market value a single component can attain. Input Method Defines how weightings are input (see also Composition page below). Available methods are: Units/Nominal; the absolute units for the component • Weight %; the % of the total market value of the component Rounding Precision Rounding precision to be applied in calculations. Rounding Method Rounding method to be applied in calculations. Setup: Schedule Information Description Start Date Date from when rebalancing starts. End Date Date when rebalancing stops (if you do not know if it will stop, just use a distant future date). Method Specifies how the rebalancing dates are calculated. Frequency A function of the Method selected. For example, if Method is Months, entering 3 here gives a frequency of 3 months. Convention Business convention to be followed. Roll from Start Yes or No. Date Type Select Re-balance. Setup: 816 • Re-Balance Date © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Date Input Date when rebalancing is executed. Setup: Re-Balance Information Description Date Input Date of rebalancing. Component Id of the component. Old Units/Nominal Number of units before rebalancing. New Units/Nominal Number of units after rebalancing. Source Where the rebalancing comes from • Manual: inserted by the user • Rebalance: inserted by the rebalancing action A.2.207 Index Estimate Id: IX-ESTIMATE Usage: This feature is used to change the way the Estimate Expression estimation method (see A.2.150 Fixed IR Valuation on page 784) evaluates the expression, as follows: Instead of using the spot rate for estimation, the ix function will prolong the current index value using the forward curve attached to the index (see A.2.155 Forward Price Setup on page 785) when estimating the future value of the index. With: BOND, LOAN Context: Function Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 817 A Features A.2 List of features A.2.208 Index Future Id: INDEX-FUTURE Usage: Defines the instrument as an index future. With: INDEX-FUTURE Context: Primary Setup: Index Future Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Underlying Underlying index instrument. Currency Currency in which the instrument is traded. Setup: Netting, see A.2.319 Ticks Netting on page 870. A.2.209 Index - Lagged Index Function Id: INDEX-LAG Usage: Enables the use of the index lag function in the expression. With: BOND, CREDIT-STEP-UP, LOAN Context: Function Setup: None A.2.210 Index-Linked Bond Id: INDEX-LINKED-BOND Usage: This feature is used with any kind of Index-Linked Bond. With: INDEX-LINKED-BOND, BOND-BR-LFT Context: Primary Setup: As for BOND A.2.211 Index Option 818 Id: INDEX-OPTION Usage: Defines an index option instrument. With: INDEX-OPTION © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Context: Primary Setup: Index Option Information Description Issuer Issuer (writer) of the option. Underlying ID of the underlying index instrument. This can be an instrument that belongs to the instrument class INDEX. Strike Strike index value of the option. If the option is exercised, the strike is used to calculate the cash settlement. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down, or Nearest. The amount is rounded up, down or to the nearest figure as calculated using the specified Amount Rounding number. Currency Currency in which the index option is traded. Type Option type: Call or Put. • Select Call if the holder of the option receives cash if the index value at expiry is higher than strike. • Select Put if the holder of the option receives cash if the index value at expiry is lower than strike. Price Type Price type of the index option: Amount/Unit. Exercise Type Defines when the option can be exercised: European or American. Delivery Type Type of delivery for the option: Cash Settlement or Physical Delivery. Index options must always have Cash Settlement. Flags Activate the switches that apply to the instrument. • Future Style Premium - switch on to define the instrument as having a premium of this type. A.2.212 Index Option Setup Id: INDEX-OPTION-SETUP Usage: Use this feature to customize the default settings of index option valuation. With: INDEX-OPTION Context: Valuation Setup Setup: Option Valuation Information Description Pricer The pricer to use. Choose from: Default, Analytic, Finite Difference, or Monte Carlo. Quality The quality used for valuation and/or risk calculations. Risk Quality Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 819 A Features A.2 List of features Information Description Intrinsic Method Select from: Valuation Modes • Zero Volatility: the valuation is done by setting the volatility equal to zero. This is the default method. • Spot: the valuation is done by setting the volatility to zero, the asset rate to zero, and the cash rate to zero. • Forward: the valuation is done by setting the volatility to zero, the cash rate to zero, the asset rate equal to the asset rate minus the cash rate. Default, Benchmark, or Theoretical. This setup is valuation mode dependent. A.2.213 Index Option Valuation Id: INDEX-OPTION-METHOD Usage: Determines the valuation approach used for options on an index. With: INDEX-OPTION Context: Valuation Approach Setup: None Details: If there is no setup for the valuation approach (INDEX-OPTION-SETUP), the default parameters are: Pricer = Analytic Quality and Risk Quality = 1 Note that in order to value a listed option using the price, the Base Valuation Setup must be used with Method = Quoted, otherwise the Theoretical method is used. A.2.214 Index Rebase (Index-Linked Bond) 820 Id: INDEX-REBASE Usage: Enables time-dependent index valuation of Israeli index-linked bonds. With: INDEX Context: Trading Setup: Rebase Information Description Date Date when rebasing is done. Type Choices are: Value or Factor • Value - When you select this option, the New / Old Value fields are available for editing, the Factor field is no longer available. • Factor - When you select this option, only the Factor field is available for editing, the New / Old Value fields are no longer available. Old Value Index value before the rebase. Defaults to the same value as specified in the Factor field when type Factor is selected. New Value Index Value after the rebase. Defaults to 1 when type Factor is selected. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Factor Rebase factor. When type Value is selected, this field displays Old Value / New Value, rounded to 9 decimals (i.e. trailing zeros are not displayed). Details: - Example 1: When Type = Value, the Rebase page displays as follows: Date: January 2010 Type: Value Old Value: 120 New Value: 100 Factor: 1.2 (= round(120/100),9) - Example 2: When Type = Factor, the Rebase page displays as follows: Date: January 2010 Type: Factor Old Value: 1.2 New Value: 1.0 Factor: 1.2 A.2.215 Index Totaling Id: INDEX-TOTALING Usage: Allows the definition of a performance totaling index. With: INDEX Context: Primary Setup: As for INDEX COMPOSITION (see A.2.205 Index Composite on page 814) Index Totaling Dates Information Description Date Input Date when the calculation is done. Observation Date Date when the price is observed. Calendar Calendar used to compute the dates. Setup: Totaling Information Description Floor The floor to use in the totaling formulae. Cap The cap to use in the totaling formulae. Setup: Schedule Information Description Start Date Date from when generation starts. End Date Date when generation stops (if you do not know if generation will stop, just use a distant future date). Method Defines how the generation dates are calculated. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 821 A Features A.2 List of features Information Description Frequency A function of the Method selected. For example, if Method is Months, entering 3 here gives a frequency of 3 months. Convention Business convention to be used. Roll from Start Yes or No. Date Type Use average numerator and denominator for date types. Setup: Totaling Date Information Description Date Input Date of the calculation. Observation Date The date when the price will be retrieved for the components following the given calendar. Calendar For each Date Input there must be as many records as there are distinct calendars in the components. The Observation Dates for each calendar can be different. A.2.216 Index - UK Index Function Id: INDEX-UK Usage: Enables the use of the UK Index function in the expression to calculate the interest of UK index-linked bonds. With: BOND, CREDIT-STEP-UP, LOAN Context: Function Setup: None A.2.217 Index Valuation Id: INDEX-METHOD Usage: Defines the valuation approach used for indexes. This feature is only relevant to certain index options where the valuation is done via the underlying. 822 With: INDEX Context: Valuation Approach Setup: None © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.218 Instrument Quote Estimate Id: IQ-ESTIMATE Usage: This feature is used to change the way the Estimate Expression estimation method (see A.2.150 Fixed IR Valuation on page 784) evaluates the expression, as follows: Instead of using the spot rate for estimation, the iq function will prolong the current instrument price using the forward curve attached to the instrument (see A.2.155 Forward Price Setup on page 785) when estimating the future value of the instrument. With: Quoted instruments Context: Function Setup: None A.2.219 Internal Deal Mirroring Id: IDM Usage: Enables the instrument to be used in internal deal mirroring. With: SHORT-LOAN, LOAN, FX, FX-SWAP, FX-OPTION, FX-OPTION-LISTED, FX-FUTURE, COMMERCIAL-LOAN Context: Trading Setup: None A.2.220 IR Derivative Valuation Id: Usage: IR-DERIVATIVE-METHOD Determines that the instrument is valuated using the Hull White valuation approach. The parameters that control the numerical valuation method are specified using the IR-DERIVATIVE-SETUP feature (see A.2.221 IR Derivative Valuation Setup on page 823). With: SWAP, BOND Context: Valuation Approach Setup: None A.2.221 IR Derivative Valuation Setup Id: IR-DERIVATIVE-SETUP Usage: Use this feature to specify the parameters for Hull White valuation of IR derivatives. This valuation approach is activated by the IR-DERIVATIVE-METHOD feature (see A.2.220 IR Derivative Valuation on page 823). With: SWAP, BOND Context: Valuation Setup Setup: IR Derivative Valuation Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 823 A Features A.2 List of features Information Description Calibration Calibration method as defined in Calibration Single Editor. See the TRM User Guide for more information about calibration models. Quality Parameter required in order to control the accuracy of the valuation. Choose from: 1 to 9. A higher value means more precision but a slower calculation time. Analytic Quality Parameter required in order to control how many event/flow level figures are calculated. Risk Quality • A value greater than 5 means that present value is distributed among events. • A value less than 5 means that only total present value is shown. Quality used for risk calculations (except convexity). Choose from: 0 to 9. A higher value means more precision in risk calculations. 0 means IR risk is not calculated. Convexity Quality Quality used for convexity calculations. Choose from: 0 to 9. A higher value means more precision in convexity calculations. 0 means convexity is not calculated. A.2.222 IR Pricer (Swap) Id: IR-PRICER-SWAP Usage: Use this feature to define the characterization of the swap to be used in the IR Pricing tool. With: IR SWAP, LOAN Context: Trading Setup: IR Pricer Information Description Property Value Select the property and value: Setup: • CALLABLE: Yes or No • LEG-1-TYPE: Fixed or Floating • LEG-2-TYPE: Fixed or Floating • SWAP-TYPE: Single Currency or Cross Currency. Base Valuation, see A.2.50 Base Valuation Setup on page 734. A.2.223 IR Pricer (Swaption) Id: IR-PRICER-SWAPTION Usage: Use this feature to define the characterization of a swaption instrument to be used in the IR Pricing tool. Instruments with this feature are available in the IR Pricing tool. Note: This feature can only be used on swaption instruments that meet the following conditions: The underlying swap must be IRP eligible (i.e. defined with IR Pricer (swap) feature), must not callable, and the exercise type of the swaption must be either European or American. 824 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features With: SWAPTION Context: Trading Setup: IR Pricer Information Description Property Value Select the property and value: • AMORTIZATION-TYPE (Underlying Amortization Type): Bullet or Amortizing • EXERCISE-TYPE: European or American • LEG-1-TYPE: Fixed or Floating • LEG-2-TYPE: Fixed or Floating • SWAP-TYPE: Single Currency or Cross Currency. Note: Except for the AMORTIZATION-TYPE property, all other properties are set automatically by the system from underlying swap characterization and swaption instrument definition. A.2.224 Issue Id: ISSUE Usage: Defines the IR instrument (Bond) as an instrument issued by a portfolio owner in the system. With: BOND, LOAN Context: Trading Setup: None Details: This feature has the effect of setting the transaction type to Own Issue, if the instrument is traded in a portfolio where the owner is the same as the issuer of the instrument, and if the portfolio switch Own Issuing is set. The transaction type can be used, for example, in charges rules (for example, fees), and also (FIFO) selling with the processing of such transactions taking place in reverse order (that is, buys (buybacks) are matched against earlier sells (issues)). A.2.225 Japanese JGBi Id: BOND-JP-IX Usage: Defines a Japanese Index-Linked bond instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 825 A Features A.2 List of features A.2.226 Japanese Index-Linked Bond Valuation Id: BOND-JP-IX-METHOD Usage: Determines that the instrument is valuated as a Japanese Index-Linked bond. With: BOND-JP-IX Context: Valuation Approach Setup: None A.2.227 Loan Structure Id: LOAN-STRUCTURE Usage: Used to specify the loan structure (schedule template) at instrument level. With: LOAN Context: Trading Setup: Loan Structure Information Description Structure Schedule Template to be applied on the loan. If you specify the schedule in the instrument setup, this is used as the default in the transaction and cannot be modified. Leave this field blank if you want to apply a schedule to the loan when you enter the deal. A.2.228 Manual Charges 826 Id: MANUAL-CHARGES Usage: Enables charges, such as fees and taxes, to be added manually to a transaction at cashflow level. With: ALL Context: Trading Setup: Manual Charges Information Description Currency Currency of the charge. Date Basis Date basis for the currency specified in the Currency field. The date basis is the number of days (in months and years) used for calculations denominated in this currency. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.229 Margin Movement Id: MARGIN-MOVEMENT Usage: Allows the setup of a Margin movement (margin call) instrument. With: MARGIN-MOVEMENT Context: Primary Setup: None A.2.230 Maturity Date Setup Id: MATURITY-DATE-SETUP Usage: Used to default/compute maturity date of OTC debt instruments or FX swaps. With: CAP-FLOOR-COLLAR, CDS, COMMERCIAL-LOAN, DISCOUNT, FRA, FX-SWAP, LOAN, SHORT-LOAN, SWAP, TRS Context: Trading Setup: Maturity Date Setup Information Description Calendar Calendars used to calculate the maturity date of an instrument. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the maturity date calculation takes both calendars into account. Gap Set Gap set used for supplying the maturity periods for an instrument; these in turn are used to define exact dates. This is a mandatory field. Maturity Date Period Maturity period used to calculate the maturity date for an instrument at deal entry, for example, 6M or 1Y. If you specify the maturity date period in the instrument setup, this is used as the default in the transaction and cannot be modified. A.2.231 MM Future Id: MM-FUTURE Usage: Defines a money market future instrument. With: MM-FUTURE Context: Primary Setup: MM Future Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 827 A Features A.2 List of features Information Description Currency The currency in which the instrument is traded. Setup: Trading Unit Information Description Contract Size Standard size of the futures contract (for example, 1,000,000). Minimum Bid Size Smallest allowed bid size. This is typically 1.0 (meaning 1 contract). Tick Size Minimum price movement (tick size and value). Tick Value Rounding Method Rounding method used in the calculations: Up, Down, or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum bid size, the amount is rounded up, down, or to the nearest corresponding amount. Allow Trading in Half of Tick Size Setup: Allows trading this instrument at a price with a precision of half the tick size (used for eurodollar Future contracts and options for nearest expiring month). Netting Information Description Fixing parameters Leave these fields blank if you want to define the fixing parameters at deal entry. Calendar Calendar used to calculate the dates. Switches Switch on Settlement Currency if settlement is made in a different currency. Settlement Currency If the Settlement Currency switch is on, the currency in which settlement is made. Payment Offset Number of business days between value date and payment date. This must be the same as the value for Spot Days on the page Spot Date Setup. Method Frequency Choose when you want netting to occur. For example, for daily netting, select Business Days as method and 1 as frequency. A.2.232 MM Future - Australian Bank Bill Future 828 Id: MM-FUTURE-AU-BB Usage: Defines an Australian bank bill future instrument. With: MM-FUTURE Context: Primary Setup: MM Future Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Currency Currency in which the instrument is traded - Australian Dollar (AUD). Setup: Trading Unit Information Description Contract Size Minimum amount which can be traded. Minimum Bid Size Smallest allowed bid size. This is typically 1.0 (meaning 1 contract). Price Precision Number of decimal places for the contract price. Rounding Method Up, Down or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum contract size, the amount is rounded up, down, or to the nearest corresponding amount. Setup: Netting, see A.2.319 Ticks Netting on page 870. A.2.233 MM Future - Australian 90-Day Bank Bill Future Chain Id: MM-FUTURE-AUD-90 Usage: Defines an Australian 90 day bank bill future instrument. With: MM-FUTURE-CHAIN Context: Trading Setup: Contracts Information Description Calendar Holiday Calendar The calendars used to determine the business days when calculating the trading, delivery, and underlying dates. Root Symbol The root exchange symbol of the chain, for example, enter 'I' for LIFFE Euribor future chain. Quarterly Contracts The number of quarterly contracts available for trading with an expiry in March, June, September and December. Monthly Contracts The number of monthly contracts (nearest months, excluding the quarterly months) available for trading. Trading Offset The number of business days of the last trading day before the third Wednesday of the month. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 829 A Features A.2 List of features Information Description Formatter The display formatting for the contracts: • Default: MMM YY displays as SEP 10. • Symbol: Root Symbol + Month Code + Single Digit Year using the same example as above, displays as EDU0 (ED is the root symbol, U is the month code for September, and 0 is the last digit of the year 2010.) Month Codes: Jan = F, Feb = G, Mar = H, Apr = J, May = K, Jun = M, Jul = N, Aug = Q, Sep = U, Oct = V, Nov = X, Dec = Z Note: The default formatter is always used in Rate Monitor. In other applications, the formatting depends on the selected formatter. Setup: Trading Unit, see A.2.232 MM Future - Australian Bank Bill Future on page 828 A.2.234 MM Future - Money Market Future Chain Id: MM-FUTURE-CHAIN Usage: Defines a money market future chain instrument. Note: With: MM-FUTURE-CHAIN Context: Primary Setup: Future Chain Information Description Issuer The client reflected as the Issuer of the transactions, e.g. the exchange or the clearing house. Counterparty The client reflected as the Counterparty of the transactions, e.g. the clearing house or the broker. Currency The currency in which the instrument is traded. Setup: Netting Information Description Fixing Subscenario Subscenario from which the price is retrieved. Calendar Calendar used to calculate the dates. Settlement Offset Number of business days between fixing date and settlement date of the fixing amount (variation margin). Also, profit/loss realized from the closing of a position will have their value date assigned based on this offset. An offset of 0 will realize profits/losses on the date the position is closed (Opening Date of the closing transaction), and an offset of 1 will realize profits losses on the next business day (i.e. in line with the settlement of the fixings). Method Frequency 830 Choose when you want netting to occur. For example, for daily netting, select Business Days as method and 1 as frequency. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.235 MM Future - Money Market 1M Future Chain Id: MM-FUTURE-1M Usage: Used to define a money market future with monthly contracts expiring on or just before the third Wednesday of the month. With: MM-FUTURE-CHAIN Context: Trading Setup: Contracts Information Description Calendar Holiday Calendar The calendars used to determine the business days when calculating the trading, delivery, and underlying dates. Root Symbol The root exchange symbol of the chain, for example, enter 'I' for LIFFE Euribor future chain. Monthly Contracts The number of monthly contracts available for trading. Trading Offset The number of business days of the last trading day before the third Wednesday of the month. Formatter The display formatting for the contracts: • Default: MMM YY displays as SEP 10. • Symbol: Root Symbol + Month Code + Single Digit Year using the same example as above, displays as EDU0 (ED is the root symbol, U is the month code for September, and 0 is the last digit of the year 2010.) Month Codes: Jan = F, Feb = G, Mar = H, Apr = J, May = K, Jun = M, Jul = N, Aug = Q, Sep = U, Oct = V, Nov = X, Dec = Z Note: The default formatter is always used in Rate Monitor. In other applications, the formatting depends on the selected formatter. Setup: Trading Units, see A.2.231 MM Future on page 827. A.2.236 MM Future - Money Market 3M Future Chain Id: MM-FUTURE-3M Usage: Used to define a three month money market future with quarterly contracts expiring in Mar, Jun, Sep, Dec and monthly (serial) contracts, all expiring on or just before the third Wednesday of the month. With: MM-FUTURE-CHAIN Context: Trading Setup: Contracts Information Description Calendar Holiday Calendar The calendars used to determine the business days when calculating the trading, delivery, and underlying dates. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 831 A Features A.2 List of features Information Description Root Symbol The root exchange symbol of the chain, for example, enter 'I' for LIFFE Euribor future chain. Quarterly Contracts The number of quarterly contracts available for trading with an expiry in March, June, September and December. Monthly Contracts The number of monthly contracts (nearest months, excluding the quarterly months) available for trading. Trading Offset The number of business days of the last trading day before the third Wednesday of the month. Formatter The display formatting for the contracts: • Default: MMM YY displays as SEP 10. • Symbol: Root Symbol + Month Code + Single Digit Year using the same example as above, displays as EDU0 (ED is the root symbol, U is the month code for September, and 0 is the last digit of the year 2010.) Month Codes: Jan = F, Feb = G, Mar = H, Apr = J, May = K, Jun = M, Jul = N, Aug = Q, Sep = U, Oct = V, Nov = X, Dec = Z Note: The default formatter is always used in Rate Monitor. In other applications, the formatting depends on the selected formatter. Setup: Trading Units, see A.2.231 MM Future on page 827. A.2.237 MM Future Method - Australian Id: MM-FUTURE-AU-BB-METHOD Usage: Defines the valuation method used for Australian money market futures. With: MM-FUTURE-AU-BB Context: Valuation approach Setup: None A.2.238 MM Future Dates Id: MM-FUTURE-DATE Usage: Used to specify the dates of MM Futures. With: MM-FUTURE Context: Trading Setup: Future Dates Information Description Last Trading Day Last day when the futures contract can be traded. This corresponds to the final day during which trading may take place in a futures contract, after which it must be settled. 832 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Settlement Date Last day on which delivery (cash settlement) of the underlying instrument can take place. Maturity Date Last date of the delivery period (last trade date plus contract period length). A.2.239 MM Future Option Id: MM-FUTURE-OPTION Usage: Enables the setup of MM future options. With: MM-FUTURE-OPTION Context: Primary Setup: MM Future Option Information Description Issuer Issuer (writer) of the future option. Underlying Underlying future contract. Strike Strike price of the option. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Currency Currency of the option. Type Type of option: Call or Put. Exercise Type Defines when the option can be exercised: American or European. Delivery Type Physical delivery or cash settlement. Flags • Future Style Premium Defines type of settlement as Future Style: premium is not paid upfront but netted daily. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 833 A Features A.2 List of features A.2.240 MM Future Option - Australian Bank Bill Future Option Id: MM-FUTURE-AU-BB-OPTION Usage: Defines and option on an Australian bank bill future instrument. With: MM-FUTURE-OPTION Context: Primary Setup: MM Future Option, see A.2.239 MM Future Option on page 833. Setup: Trading Unit Information Description Contract Size Minimum amount which can be traded. Minimum Bid Size Smallest allowed bid size. This is typically 1.0 (meaning 1 contract). Price Precision Number of decimal places for the contract price. Rounding Method Up, Down or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum contract size, the amount is rounded up, down, or to the nearest corresponding amount. A.2.241 MM Future Option Valuation Id: MM-FUTURE-OPTION-METHOD Usage: Determines the valuation approach used for money market future options. With: MM-FUTURE-OPTION Context: Valuation Approach Setup: None A.2.242 Money Market Future Par Valuation Id: MM-FUTURE-PAR-METHOD Usage: Enables Par method calculation for valuation of MM futures. With: MM-FUTURE Context: Valuation Approach Setup: IR Exposure, see A.2.48 Base IR Exposure Setup on page 732 for specific Date Basis and Yield Type settings. A.2.243 Money Market Future Valuation 834 Id: MM-FUTURE-METHOD Usage: Determines the valuation approach used for money market futures. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features With: MM-FUTURE Context: Valuation Approach Setup: None A.2.244 Mode Specific Method Id: TRAMPOLINE-METHOD Usage: Enables the valuation approach to be Valuation Mode specific to allow simultaneous use of more than one valuation approach for an instrument. For example, with this feature it would be possible to specify NUMERIX-METHOD for ordinary valuation (with mode Default), and PER-LEG-METHOD for Hedge Accounting purposes (with mode Benchmark), when a different valuation approach is required for hedge effectiveness calculations. With: All classes with more than one valuation approach (excluding EXTERNAL-METHOD). Context: Valuation Approach Setup: Mode Valuation Information Description Active From Period for which the valuation approach is valid for the valuation mode. Active To Valuation Approach Valuation approach to be applied according to the selected mode. Valuation Mode Valuation mode in which the specified valuation approach is used. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 835 A Features A.2 List of features A.2.245 Mode/Transaction Specific Method Id: TRANSACTION-METHOD Usage: Allows you to specify the valuation approach at transaction level (in Transaction Manager’s Valuation Approach view). This feature enables the valuation approach to be transaction and valuation mode specific for a specific time frame: it allows you to change the valuation approach for transactions without needing to alter the instrument definition (as this might not be possible since other transactions would also be impacted). When valuing such a transaction, the system uses the approach that is active on the valuation date (in the requested mode) and does the valuation accordingly. If no approach is found at transaction level, the system applies the active approach specified at instrument level (in the Mode Valuation page). See the TRM User Guide for more information. With: All classes with more than one valuation approach. Context: Valuation Approach Setup: Mode Valuation Note: When this valuation approach is used, the setup you define in the Mode Valuation page is only used if no valuation approach has been specified at transaction level for the requested valuation mode and date. Information Description Active From Period for which the valuation approach is valid for the valuation mode(s). Active To Valuation Approach Valuation approach to be applied according to the selected mode(s). Valuation Mode Valuation mode(s) in which the specified valuation approach is used. A.2.246 MtoM Instrument Setup Id: MTOM-SETUP Usage: Used to specify an MtoM instrument if different from the instrument itself. With: ABS, BOND, BOND-FUTURE, BOND-OPTION, CONVERTIBLE-BOND, CREDIT-STEP-UP, DISCOUNT, EQUITY, EQUITY-FUTURE, EQUITY-OPTION, FRA, FRA-OPTION, FX-OPTION-LISTED, INDEX-FUTURE, INDEX-LINKED-BOND, INDEX-OPTION, MM-FUTURE, MM-FUTURE-OPTION Context: Valuation Setup Setup: MtoM Instrument Information Description Active From Period for which the M-to-M instrument is valid. Active To MtoM Instrument ID of the MtoM instrument. The direct market quotation of this instrument is used to value the instrument being defined. Valuation Modes 836 Valuation mode: Default, Benchmark, or Theoretical. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.247 Netted Instrument Id: NETTING Usage: Allows netting of futures and options (except FX instruments: see A.2.248 Non Deliverable Forward FX Instrument on page 837 and FX futures: see A.2.177 FX Future Netting on page 798). With: BOND-OPTION, EQUITY-OPTION, FX-OPTION-LISTED, INDEX-OPTION Context: Trading Setup: Netting Information Description Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max Offset Maximum number of days’ offset allowed. Fixing Subscenario Subscenario from which the rate is retrieved. Calendar Calendar to use when calculating the fixing date. Switches Activate the switches that apply to the instrument. • Settlement Currency Settlement Currency - switch on if the P/L cashflow is paid in a different currency. Currency in which the P/L cashflow is paid (if the switch Settlement Currency is turned on). Leave this field blank if you want to specify the settlement currency when you enter the deal. Payment Offset Number of business days between value date and payment date. Method Select Business Days for daily netting. Frequency For daily netting, enter 1 when Method = Business Days. A.2.248 Non Deliverable Forward FX Instrument Id: FX-NETTED Usage: Allows the netting of Non-deliverable forwards. With: FX, FX-FORWARD-NDF Context: Primary Setup: Netting Information Description Payment Offset Number of business days between value date and payment date. Calendar Calendar to use when calculating the fixing date. Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Subscenario Subscenario from which the FX spot rate is retrieved (for example, EUR/USD Spot 9:00 London, or EUR/USD Spot 9:00 Tokyo). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 837 A Features A.2 List of features Information Description Switches Activate the switches that apply to the instrument. • Settlement Currency Settlement Currency - switch on if the P/L cashflow is paid in a different currency. Currency in which the P/L cashflow is paid (if the switch Settlement Currency is on). Leave this field blank if you want to specify the settlement currency when you enter the deal. Netting Method Details: Specifies the currency of the netting cashflow: Base Currency or Quote Currency. • If you select Base Currency, the net amount is expressed in the base currency of the transaction. • If you select Quote Currency, the net amount is expressed in the quote currency of the transaction. Non-deliverable forwards (NDFs) are FX forward deals that can have a net settlement. Instead of exchanging principal amounts, the counterparties agree on the value date and the contractual spot rate. The difference between the actual spot rate and the contractual rate, multiplied by the nominal amount of the deal, is paid. Information Description Fixing Price FX spot rate between the base currency and the quote currency at the fixing date. P/L Represents the net settlement from the FX transaction. The calculation of the P/L is based on the difference between the agreed deal rate and the fixing price. Setup: Dates Information Description Gap Set Gap set used for supplying the value date periods; these in turn are used to define exact dates. Value Date Period Value date period used to calculate the value date for the instrument at deal entry. If this is specified at the instrument level, it is used as default in the transaction and cannot be modified. Spot Days Number of business days between opening and value dates. Defaults to currency spot days when left blank. Calendar Calendar and Holiday Calendar used to calculate the value date. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the value date calculation takes both calendars into account. Note: When you define the Calendar or Holiday Calendar in one date setup, the Calendar fields in all date setup pages applied to the instrument default to the same values. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. 838 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.249 NumeriX Asset Swap Setup Id: NUMERIX-ASSET-SWAP-SETUP Usage: Configures the NumeriX valuation package parameters for asset swaps. See A.2.250 NumeriX Setup on page 839 for more information. With: BOND Context: Valuation Setup Setup: NumeriX Swap Information Description Active From First and/or last date that the NumeriX valuation model is active. Active To Valuation Method Numerical or analytical method used to valuate transactions with a given valuation model. Calibration Calibration model to apply to this instrument. Quality Parameter required in order to control the accuracy of the valuation. Analytics Quality This parameter controls how many event/flow level figures are calculated. If Analytics Quality is not defined, the default value 10 (= all details) is used. Valuation Modes Parameter required to control the valuation parameters set up: Default, Benchmark, or Theoretical. Calculate Exposure Switch on to inform the system that IR Exposures should be calculated. A.2.250 NumeriX Setup Id: NUMERIX-SETUP Usage: Configures the NumeriX valuation package parameters. It is also possible to specify these parameters at transaction level: see the TRM User Guide for more information. With: ABS, BOND, CREDIT-STEP-UP, LOAN, SWAP, TRS Context: Valuation Setup Setup: NumeriX Information Description Active From First and/or last date that the NumeriX valuation model is active. Active To Calibration Calibration model to apply to this instrument. Model Valuation model to apply to this instrument. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 839 A Features A.2 List of features Information Description Valuation Method Choose the numerical or analytical method to valuate transactions according to the calibration model • For Hull and White (1 factor), the available methods are Forward Monte Carlo, Forward/Backward Monte Carlo, Backward Lattice, Backward PDE, and Backward Tree. • For Hull and White (2 factors and 3 factors), the available methods are Forward Monte Carlo, Backward Lattice, and Backward PDE. • For Black-Karasinsky, Spot Skew, and Black-Derman-Toy, the available methods are Backward PDE and Backward Tree. • For Brace Gatarek Musiela (BGM), the available methods are Forward Monte Carlo, Backward Monte Carlo, Backward Analytic, and Backward American Monte Carlo. • For Deterministic, the available methods are Backward Analytic and Forward Analytic. • For Cross Currency Deterministic, the available methods are Backward Analytic, Forward Analytic, and Backward Tree. • For Cross Currency (2 currencies 3 factors), the available methods are Backward Lattice, Backward PDE, Backward Monte Carlo, and Forward Monte Carlo. • For Cross Currency (3 currencies 5 factors), the available methods are Backward PDE, Backward Monte Carlo, and Forward Monte Carlo. Quality Parameter required in order to control the accuracy of the valuation Analytics Quality This parameter controls how many event/flow level figures are calculated. The used quality levels are as follows: • 2 (or more) = calculate present values • 4 (or more) = calculate fixing rates • 6 (or more) = calculate cap/floor/base components • 8 (or more) = calculate local probabilities • 10 (or more) = calculate global probabilities If Analytics Quality is not defined, the default value 10 (= all details) is used. Valuation Mode Parameter required to control the valuation parameters set up: Default, Benchmark, or Theoretical. Calculate Exposure Switch on to inform the system that IR Exposures should be calculated. A.2.251 NumeriX Single-Swap Valuation Id: NUMERIX-SINGLE-SWAP-METHOD Usage: This feature facilitates the calculation of key-figures for structures externalized to the NumeriX Library. This valuation approach takes both the result setup and the valuation setup from the swap instrument itself. The redemption flows of the swap are not valuated if they are pseudo. 840 With: SWAP Context: Valuation Approach Setup: None © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.252 NumeriX Swap Valuation Id: NUMERIX-SWAP-METHOD Usage: This feature facilitates the calculation of key-figures for structures externalized to the NumeriX Library. This valuation approach uses the result setup defined for the swap instrument, but values the whole swap according to the valuation approach of the instrument setup of Leg 1. The redemption flows of the swap are not valuated if they are pseudo. Note that in addition to the normal NumeriX valuation of the Leg 1 (bond) instrument, the bond may have a setup defined by the NUMERIX-ASSET-SWAP-SETUP valuation approach. In this case, the valuation is taken from this setup rather than from the instrument’s normal setup. With: SWAP Context: Valuation Approach Setup: None A.2.253 NumeriX Valuation Id: NUMERIX-METHOD Usage: Enables the use of the NumeriX package for valuation. This feature facilitates the calculation of key-figures for structures externalized to the NumeriX Library (for example, for structured products such as PRDC, Rainbow, transaction-convertibles, multi-callables, and so on). With: ABS, BOND, CREDIT-STEP-UP, LOAN, SWAP, TRS Context: Valuation Approach Setup: None A.2.254 Option Dates Id: OPTION-DATE Usage: Used to specify the dates (issue, expiry, settlement offset) of listed options. With: BOND-OPTION, EQUITY-OPTION, FRA-OPTION, FX-OPTION-LISTED, INDEX-OPTION, MM-FUTURE-OPTION Context: Trading Setup: Option Dates Information Description Calendar Calendars used to calculate the expiry date of the option. Holiday Calendar Expiry Date Last date the option can be exercised before it expires. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 841 A Features A.2 List of features Information Description Delivery Offset Number of days offset allowed before delivery must take place. Leave this field blank if you want to specify the delivery offset when you enter the deal. A.2.255 Option Premium Id: OPTION-PREMIUM Usage: Used to specify premium characteristics for FRA options and swaptions. With: FRA-OPTION, SWAPTION Context: Trading Setup: Premium Information Description Type Determines how the premium amount is calculated. If defined, the premium type is applied to each transaction. Leave this field blank if you want to specify the premium type when you enter the deal. Currency Currency of the premium. If defined, the premium currency is applied to each transaction. Leave this field blank if you want to specify the premium currency when you enter the deal. A.2.256 Option Template Setup Id: OPTION-TEMPLATE-SETUP Usage: Used to limit the choice of option schedules available to assign to an instrument. With: FX-OPTION Context: Trading Setup: Option Groups Information Group Description Group of option schedule templates. If you assign an option schedule group in the instrument setup, you can only apply schedules from within this group at transaction entry. Option Schedule Groups are defined in Option Schedule Template Group Editor. A.2.257 Payment Agent Id: Usage: PAYMENT-AGENT Used to define a third party to be used as payment client of the cashflows. It is also possible to define whether the third party is the payment client of all cashflows, or only payback cashflows (e.g. coupons and redemptions). Note: If Payment Agent is not used, payment client is either the counterparty or the issuer. 842 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features With: ALL (relevant only) Context: Trading Setup: Payment Agent Information Description Payment Agent Select the third party you want to be used as payment client. Switches Select Except Settlement Flows for the third party to be used as payment client for payback cashflows only (e.g. coupons and redemptions). If you want the third party to be used as payment client for all cashflows, do not select this switch. A.2.258 Performance, Cash In/Out Id: PERFORMANCE-CASH-IN-OUT Usage: Used to identify payment instruments that should be treated as cash injections or outflows. This feature is used by Performance Monitor. With: CASH Context: Performance Setup: None A.2.259 Performance, FX Hedge Id: Usage: PERFORMANCE-FX-HEDGE Used to identify FX instruments that are to be treated as hedges. This feature is used by Performance Monitor. With: FX Context: Performance Setup: None A.2.260 Performance, Index Id: PERFORMANCE-INDEX Usage: Used to identify an Index instrument as a benchmark index. If this feature is applied to the instrument, the index is available for selection in Performance Monitor’s Benchmark selection list. With: INDEX Context: Performance Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 843 A Features A.2 List of features A.2.261 Per-Leg Cashflow Valuation Id: PER-LEG-METHOD Usage: Defines the valuation approach which can be used for IR swaps: this method valuates the legs independently. This feature facilitates the calculation of swap key-figures where each leg is using its own valuation conventions and approach. With: SWAP, TRS Context: Valuation Approach Setup: None A.2.262 Premium Id: PREMIUM Usage: Used to specify premium characteristics for Caps, Floors, and Collars. With: CAP-FLOOR-COLLAR Context: Trading Setup: Premium Information Description Type Determines how the premium amount is calculated. If defined, the premium type is applied to each transaction. Leave this field blank if you want to specify the premium type when you enter the deal. Currency Currency of the premium. If defined, the premium currency is applied to each transaction. Leave this field blank if you want to specify the premium currency when you enter the deal. A.2.263 Premium Date Setup 844 Id: PREMIUM-DATE-SETUP Usage: Used to calculate the premium date of an option instrument. With: CAP-FLOOR-COLLAR, FRA-OPTION, FX-OPTION, SWAPTION Context: Trading Setup: Premium Date Setup Information Description Calendar Calendars used to calculate the premium date of an option instrument. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the premium date calculation takes both calendars into account. Date Type Type of date on which the settlement of the premium takes place (Premium Date). This is the spot date by default. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Offset Number of days offset between the type of date defined in the Date Type field and the premium date. A.2.264 Price Exposure Setup Id: PRICE-EXPOSURE-SETUP Usage: TBC With: EQUITY, EQUITY-FUTURE, EQUITY-OPTION, INDEX-OPTION Context: Valuation Setup Setup: Price Exposure Information Description Exposure Offset TBC Index ID of the index instrument. Valuation Modes Valuation mode: Default, Benchmark, or Theoretical. A.2.265 Price Valuation Id: PRICE-METHOD Usage: Valuation approach to be used with non-IR quoted instruments (especially Equities). With: EQUITY Context: Valuation Approach Setup: None Details: This feature adds the concepts of Price Exposure to the Fixed Quoted Method. A.2.266 Quote Default Id: QUOTE-DEFAULT Usage: Allows the defaulting of the deal price (or the deal rate) for quoted instruments at deal entry. With: All quoted instruments. Context: Action Setup: Quote Default Information Description Scenario Scenario to use to price the transactions. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 845 A Features A.2 List of features Information Description Mode Pricing mode: Method • Select Automatic if you want to retrieve the quotes automatically in Transaction Manager. • Select Manual if you want to retrieve the quotes manually in Transaction Manager. Defaulting method: Ask, Bid, Bid/Ask (Spread Against), Bid/Ask (Spread in Favor), or Mid. • If you select Bid/Ask (Spread Against): when the transaction sign is positive, the Ask price is used; when the transaction sign is negative, the Bid price is used. • If you select Bid/Ask (Spread in Favor): when the transaction sign is positive, the Bid price is used; when the transaction sign is negative, the Ask price is used. A.2.267 Quote Default (Australian FRN) Id: FRN-AU-QUOTE-DEFAULT Usage: Allows the defaulting of the trading margin at deal entry. With: FRN-AU Context: Trading Setup: Same as Quote Default (A.2.266 Quote Default on page 845) and Yield Curve Default page: Information Description Currency The currency that you want to specify. Select AUD. Yield Curve The yield curve to be used instead of the default one defined at currency level (Currency Editor). A.2.268 Quote Default (Australian MBS) 846 Id: MBS-AU-QUOTE-DEFAULT Usage: Allows the defaulting of the trading margin at deal entry. With: MBS-AU Context: Trading Setup: Same as Quote Default (A.2.266 Quote Default on page 845) and Yield Curve Default page: Information Description Currency The currency that you want to specify. Select AUD. Yield Curve The yield curve to be used instead of the default one defined at currency level (Currency Editor). © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.269 Quote Default (Chain) Id: CHAIN-QUOTE-DEFAULT Usage: Allows the definition of market quotes for Money Market Future Chain instruments. With: MM-FUTURE-CHAIN Context: Trading Setup: Quote Default, see A.2.266 Quote Default on page 845. A.2.270 Quote Default (Collateral) Id: COLLATERAL-QUOTE-DEFAULT Usage: Allows the defaulting of the collateral market price for collateral instrument in a Repo deal. With: COLLATERAL-TRANSFER, MARGIN-MOVEMENT, REPO, SUBSTITUTION Context: Action Setup: Quote Default Information Description Scenario Scenario to use to price the transactions. Mode Pricing mode: Method • Select Automatic if you want to retrieve the quotes automatically in Transaction Manager. • Select Manual if you want to retrieve the quotes manually in Transaction Manager. Defaulting method: Ask, Bid, Buy/Sell, or Mid. If you select Buy/Sell: when the transaction sign is positive the Ask price is used, and when the transaction sign is negative, the Bid price is used. A.2.271 Quote Default (Discount Paper OTC) Id: DISCOUNT-OTC-QUOTE-DEFAULT Usage: Allows the defaulting of the nominal rate from the default currency curve in a discount paper OTC transaction at transaction entry. With: DISCOUNT-OTC Context: Trading Setup: Same as Quote Default, see A.2.266 Quote Default on page 845 and Yield Curve Default page. Information Description Currency The currency that you want to specify. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 847 A Features A.2 List of features Information Description Yield Curve The yield curve to be used instead of the default curve defined at currency level (Currency Editor). A.2.272 Quote Default (FX) Id: FX-QUOTE-DEFAULT Usage: Allows the defaulting of the FX Spot Rate, Forward Points, Base Currency Interest Rate and Quote Currency Interest Rate for foreign exchange instruments at deal entry. With: FX Context: Action Setup: Quote Default Information Description Scenario Scenario to use to price the transactions. Mode Pricing mode: Method Values to Default • Select Automatic if you want to retrieve the quotes automatically in Transaction Manager. • Select Manual if you want to retrieve the quotes manually in Transaction Manager. Defaulting method: Ask, Bid, Bid/Ask (Spread Against), Bid/Ask (Spread in Favor), or Mid. • If you select Bid/Ask (Spread Against): if you are buying the base currency of the quoted currency pair, the Ask price is used; if you are selling the base currency of the quoted currency pair, the Bid price is used. • If you select Bid/Ask (Spread in Favor): if you are buying the base currency of the quoted currency pair, the Bid price is used; if you are selling the base currency of the quoted currency pair, the Ask price is used. Choose from: • Forward Points The FX spot rate and the forward points are taken from the market. The base currency interest rate is taken from the market from the yield curve defined for the currency (in Currency Editor’s Journals page) on the spot date and the maturity date, and the quote currency interest rate is calculated from the FX forward points and the base currency interest rate. If the FX forward points are changed manually, the Quote Currency Interest Rate and Deal Rate columns are updated. • Interest Rates The FX spot rate, base currency interest rate, and the quote currency interest rate are taken from the market. Forward points are calculated from the FX spot rate of the deal and the discount factors in the base and quote currencies of the transaction. The forward points are updated if one of the following columns is changed: Nominal/Spot Rate, Base Currency Interest Rate, and Quote Currency Interest Rate. 848 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.273 Quote Default (Short Loan) Id: SHORT-LOAN-QUOTE-DEFAULT Usage: Allows the defaulting of the nominal rate from the default currency curve in a short loan transaction at transaction entry. With: SHORT-LOAN Context: Trading Setup: Same as Quote Default (A.2.266 Quote Default on page 845) and Yield Curve Default page. Information Description Currency The currency that you want to specify. Yield Curve The yield curve to be used instead of the default curve defined at currency level (Currency Editor). A.2.274 Quoted Id: QUOTED Usage: Allows the definition of market quotes for a quoted instrument. The figures displayed in Rate Monitor’s Instrument page correspond to the value of the instrument’s quotation defined by this feature. With: All quoted instruments. Context: Trading Setup: Quoted Information Description Active From Period within which the quotation information is valid. Active To Leave these fields blank if you want the quotation information to apply indefinitely. Price Type Price type of the quoted instrument, for example, Price, Yield, Index, and so on. Quote Handling Quote handling: for example, Generic, CTD, Equity, FRN, Bond, Index-Linked Bond, or Discount Paper. Currency Currency in which the quotation is made. Setup: Market Info Information Description Period Period to which the quotation applies; for example, 3M for a three-month quotation, and so on. For equities and IR instruments, select SPOT. Source Market information source that is supplying the quotation: for example, Reuters or Bloomberg. The actual market sources available to you depend on which ones you use, and your configuration of TRM. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 849 A Features A.2 List of features Information Description Producer The provider of the quotations: for example, Reuters, Bloomberg, and so on. Item Code identifying the market quotation. For the actual codes, refer to the documentation supplied by the market information provider. MI Group Name of the group to which you want this quotation to belong. You use quotation groups if you want to freeze quotations in batches rather than all at once. For more information, see the TRM User Guide. If the group name does not already exist in the selection list, simply type the name into the field. When you save the quotation definition, the group name will be added to the selection list. Date Tag Field in the market quotation that you want to use to supply a date (for example, trade date or maturity date) in the quotations. In particular, this field is used to retrieve the quotations for OTC bonds. Bid Tag Ask Tag Fields in the market quotation that you want to use to supply the bid and ask quotations. Usually, you can leave these two fields blank: they are only necessary if you want to use fields from the market quotation other than the default bid and ask fields. Underlying Period Underlying maturity of the instrument. Strike Strike price or strike yield of the instrument. • For FX Volatilities, the Strike axis is defined by the delta. The delta points are defined by the corresponding mapping: S01 for 0.05, S02 for 0.10, S03 for 0.15, S04 for 0.25, S05 for 0.3, S06 for 0.4, S07 for 0.5. In this field, you set the identifier S0.x according to the delta. For ATM, for example, Strike is set as S07. • For Cap/Floor Volatilities, see the TRM User Guide. Note: In Market Info Source Editor, you specify the identifier when defining the RIC, and not the value of the strike. Scenario Name of the scenario and subscenario that is updated by the retrieved quotations. Subscenario Rate Type Price type for the quotation. Divider (Turkish market only) Number by which the incoming quotation has been divided: for example, if Divider = 1000, a quotation of 1000 TRL is interpreted by TRM as actually being 1,000,000 TRL. Enabled Allows the quotation to be retrieved. Turn off this switch if you want to disable the quotation without deleting its definition. Delayed Prices from your market feed to be stored as of yesterday. Ignore Zero These two switches work together, and must both be on for equities and equity derivatives: Zero is Null • Ignore Zero forces TRM to ignore all zeros in the quotation. • Zero is Null changes zeros to nulls (non-defined quotations) which are then ignored because of the Ignore Zero switch. You need to ignore zeros in equity quotations, because sometimes a quotation contains a zero as a delimiter saying "this is the end of the transmission": if this delimiter is read as an actual quotation value of zero, it distorts the valuation. The only time these switches should not be on is for FX forward quotations, where the points can be 0. 850 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Variable Strike If the switch is off, the strike is constant. If the switch is on, the strike changes, as in the case of a Cap/Floor volatility. A.2.275 Quoted Chain Id: QUOTED-CHAIN Usage: Allows the definition of market quotes for Money Market Future Chain instruments. With: MM-FUTURE-CHAIN Context: Trading Setup: Quoted Information Description Active From Period within which the quotation information is valid. Active To Leave these fields blank if you want the quotation information to apply indefinitely. Price Type Price type of the quoted instrument, for example, Ticks. Quote Handling MM Future Chain. Currency Currency in which the quotation is made. Setup: Market Info Information Description Period Period to which the quotation applies; for example, 3M for a three-month quotation, and so on. For equities and IR instruments, select SPOT. Source Market information source that is supplying the quotation: for example, Reuters or Bloomberg. The actual market sources available to you depend on which ones you use, and your configuration of TRM. Producer Item The provider of the quotations: for example, Reuters, Bloomberg, and so on. Code identifying the market quotation. For the actual codes, refer to the documentation supplied by the market information provider. MI Group Name of the group to which you want this quotation to belong. You use quotation groups if you want to freeze quotations in batches rather than all at once. For more information, see the TRM User Guide. If the group name does not already exist in the selection list, simply type the name into the field. When you save the quotation definition, the group name will be added to the selection list. Date Tag Field in the market quotation that you want to use to supply a date (for example, trade date or maturity date) in the quotations. In particular, this field is used to retrieve the quotations for OTC bonds. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 851 A Features A.2 List of features Information Description Bid Tag Fields in the market quotation that you want to use to supply the bid and ask quotations. Ask Tag Usually, you can leave these two fields blank: they are only necessary if you want to use fields from the market quotation other than the default bid and ask fields. Underlying Period Underlying maturity of the instrument. Strike Strike price or strike yield of the instrument. • For FX Volatilities, the Strike axis is defined by the delta. The delta points are defined by the corresponding mapping: S01 for 0.05, S02 for 0.10, S03 for 0.15, S04 for 0.25, S05 for 0.3, S06 for 0.4, S07 for 0.5. In this field, you set the identifier S0.x according to the delta. For ATM, for example, Strike is set as S07. • For Cap/Floor Volatilities, see the TRM User Guide. In Market Info Source Editor, you specify the identifier when defining the RIC, and not the value of the strike. Scenario Name of the scenario and subscenario that is updated by the retrieved quotations. Subscenario Rate Type Price type for the quotation. Divider (Turkish market only) Number by which the incoming quotation has been divided: for example, if Divider = 1000, a quotation of 1000 TRL is interpreted by TRM as actually being 1,000,000 TRL. Enabled Allows the quotation to be retrieved. Turn off this switch if you want to disable the quotation without deleting its definition. Delayed Prices from your market feed to be stored as of yesterday. Ignore Zero These two switches work together, and must both be on for equities and equity derivatives: Zero is Null • Ignore Zero forces TRM to ignore all zeros in the quotation. You need to ignore zeros in equity quotations, because sometimes a quotation contains a zero as a delimiter saying "this is the end of the transmission": if this delimiter is read as an actual quotation value of zero, it distorts the valuation. • Zero is Null changes zeros to nulls (non-defined quotations) which are then ignored because of the Ignore Zero switch. Note: The only time these switches should not be on is for FX forward quotations, where the points can be 0. Variable Strike If the switch is off, the strike is constant. If the switch is on, the strike changes, as in the case of a Cap/Floor volatility. A.2.276 Range Accrual 852 Id: RANGE-ACCRUAL Usage: Enables the use of the range-accrual function in the expression in order to calculate the interest of range-accrual bonds or loans. With: BOND, CREDIT-STEP-UP, LOAN © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Context: Function Setup: None A.2.277 Repo Cash Delivery Id: REPO-CASH-DELIVERY Usage: Makes actual repo cashflows 'Not Payable' and creates a separate Cash Delivery flow for each collateral instrument. This enables setting of cash settlement instructions correctly when they are dependent on collateral instruments as well as splitting cash settlement amount by collateral instrument to allow delivery versus payment settlements from multi-collateral repos. You must always use this feature in repo- or substitution instruments when Delivery versus Payment (DvP) settlements are required. With: REPO Context: Trading Setup: None A.2.278 Repo Cash Delivery (Floating) Id: REPO-FLOATING-CASH-DELIVERY Usage: Sets repo cashflows on the value date of the repo to Not Payable and creates a separate Cash Delivery flow for each collateral instrument when the transaction is created. The same processing for maturity date takes place when the Fixing action is executed for the floating repo. This enables the correct setting of cash settlement instructions when they are dependent on collateral instruments as well as splitting the cash settlement amount by collateral instrument to allow delivery versus payment settlements from multi-collateral floating repos. With: REPO-FLOATING Context: Trading Setup: None A.2.279 Repo Cash Delivery (Substitution) Id: SUBSTITUTION-CASH-DELIVERY Usage: Creates separates Cash Delivery flows for each collateral instrument (both old and new) on the value date of the substitution when the transaction is created. This enables delivery versus payment settlements in substitutions as well as setting of cash settlement instructions correctly when they are dependent on collateral instruments. With: SUBSTITUTION Context: Trading Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 853 A Features A.2 List of features A.2.280 Repo Rounding Id: REPO-ROUNDING Usage: Used to define the pricing precision of the collateral instrument. The values specified here override the rounding parameters defined for the collateral instrument with the Trading-Yield features: see A.2.323 Trading Yield on page 872. Repo rounding parameters can also be specified at deal entry in the Repo view. With: BOND, DISCOUNT Context: Trading Setup: Repo Rounding Information Description Price Rounding Nearest number to which the collateral price is rounded. Price Rounding Method Up, Down or Nearest. The collateral price is rounded up, down, or to the nearest figure as calculated using the specified Price Rounding number. Maturity Price Rounding Nearest number to which the maturity collateral price is rounded. Maturity Price Rounding Method Up, Down or Nearest. The maturity collateral price is rounded up, down, or to the nearest figure as calculated using the specified Maturity Price Rounding number. A.2.281 Repo Valuation Id: REPO-METHOD Usage: Determines that the instrument is valuated as a repo. With: REPO Context: Valuation Approach Setup: None A.2.282 Repo Valuation (Floating) Id: REPO-FLOATING-METHOD Usage: Determines that the instrument is valuated as a floating repo. With: REPO-FLOATING Context: Valuation Approach Setup: None A.2.283 Repurchase Agreement 854 Id: REPO Usage: Defines the instrument as a Repo. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features With: REPO Context: Primary Setup: Repo Information Description Currency Currency of the repo deal. Leave this field blank if you want to specify the currency of the repo transaction when you enter the deal. Transaction Sign Interest Type Date Basis Sign to be applied to the transaction: Reverse Repo (Buy/Lend) or Repo (Sell/Borrow). • Select either Repo or Reverse Repo if you want this to be the default direction of the transaction, that is, the direction cannot be modified at deal entry. • Leave this field blank if you want to specify the direction of the repo deal at deal entry. Type of interest rate used to calculate the repo interest amount, for example, Periodic Rate. Date basis used to calculate the interest of the repo. If this is not defined at instrument level, date basis of the currency is used unless another date basis is given by the user at deal entry. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Amount Rounding Method chosen. Amount Rounding Method Up, Down or Nearest. Principal Cashflow Type Type of repayment cashflow (for example, Principal or Expiration). Interest Cashflow Type Type of interest cashflows. Switches Activate the switches that apply to the repo. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. • Reinvest Coupon – switch on for a buy/sell back where the coupon is received by the buyer of the bond and only paid back at the end of the repo. This information is displayed in the Reinvest Coupon field in Transaction Manager’s Transaction view. • Use Collateral Price Rounding: Switch on to define that Collateral Price and Maturity Collateral Price are rounded using the rounding parameters of the underlying collateral instrument. If this switch is not on, collateral prices are always calculated exactly. If the feature Repo Rounding is used, the rounding parameters are taken from the rounding setup of the collateral instrument (see A.2.280 Repo Rounding on page 854). Otherwise, the rounding parameters are taken from Trading Yield setup of the collateral instrument (see A.2.323 Trading Yield on page 872). • Use Dirty Price – switch on if Collateral Price/Maturity Collateral Price should be expressed as the dirty price. This information is displayed at the transaction level as Dirty Collateral Price. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 855 A Features A.2 List of features A.2.284 Repurchase Agreement (Floating) Id: REPO-FLOATING Usage: Defines the instrument as a floating-rate repo. With: REPO-FLOATING Context: Primary Setup: As for Repo, Repo Floating Information Description Interest Method Interest calculation method that controls which expression is used in the floating interest cashflow of the transaction. The following methods are available: • Average: The expression 'average' is used to support the calculation of the interest rate as an average of daily observations during the interest period. • Average (Business Days): The expression 'average_q' is used to support the calculation of the interest rate as an average of daily observations during the interest period using quotations on business days only. • Compound: The expression 'compound' is used to support the calculation of the interest rate as a compound rate using daily observations during the interest period. In Arrears: The expression 'ir+spread' is used to support the calculation of the interest rate using a single observation at the end of the interest period. Fixing Rate IR Quote reference used when fixing the cashflow. Fixing Period Tenor from which the quotation is retrieved when fixing the interest rate of the transaction, for example, O/N or 1M. Fixing Subscenario Rate subscenario from which the interest rate is retrieved. Fixing Offset Number of business days before the interest date. Fixing of interest occurs on this date. If the fixing offset is set to anything other than 0 when average/compound interest methods are used, the quotation of the fixing date is used for all dates between the fixing date and the interest date. Fixing Calendar Calendar used for fixing. A.2.285 Result Id: RESULT Usage: This feature is necessary in order to apply result treatments to the instrument. It must be present in the instrument setup unless rule-based classification of transactions is used (in which case, the RESULT-CLASSIFICATION feature must be present instead: see A.2.286 Result with Classification on page 857). 856 With: ALL Context: Trading Setup: None © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.286 Result with Classification Id: RESULT-CLASSIFICATION Usage: Enables classification of transactions according to classification rules and result treatments. With: ALL Context: Trading Setup: Classification Information Description Classification Group Classification group that applies to the instrument. Classification Specific classification within the classification group that applies to the instrument. Result Result treatment that applies to the instrument. Domain Domain in which this classification applies. A.2.287 RiskManager position template Id: RISKMANAGER-EXPORT Usage: Used to set up RMI data. See the TRM User Guide for more information. With: All Context: Trading Setup: RMI Information Description Template RM template used to map export data. • For one-to one mapping, select the appropriate RM template. • For the risk-equivalent cashflow approach, select RiskValueCashflow. Group By Instrument Switch on to export a position aggregated at instrument level. RM Discount Curve RM yield curve used as the discount curve. RM Spread Discount Curve RM yield curve used for the spread. RM Reference Curve RM yield curve used as the reference curve. No Pending Cashflows Switch on if you do not want the Risk Manager Export activity to generate a balance output if there is a payable cashflow on the day of exporting. Native Equity Proxy Equity instrument when you want to use internal market data. If you enter a value in this field, you must also specify the RM TRM Equity Beta. RM Equity Name Name of the RM equity when you want to map a TRM equity to its counterpart in RiskManager (same equity, different names). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 857 A Features A.2 List of features Information Description RM TRM Equity Beta Value to set a factor between the TRM equity and RM proxy. If you have specified a Native Equity Proxy to indicate that you want to use internal market data, you must also enter a value in this field. RM Equity Beta Beta factor between the equity and the stock index. RM Fixing Period RM fixing period used to set floating rates. RM Specific Mapping Yield curve used to discount future coupons (in instrument-specific RMI mapping). RM Index Name of an inflation index (used in instrument-specific RMI mapping). RM Index Lag Name of a reference index to read lag time in months (used in instrument-specific RMI mapping). A.2.288 Risk Setup (BOND) Id: BOND-RISK-SETUP Usage: Used to add risk valuation to a fixed rate bond. With: BOND Context: Valuation Setup Setup: Risk Setup Information Description Method Choices are: • Zero-Coupon (Default): IR exposure is calculated by shifting all curves used in the valuation (discounting, valuation and estimation). • Yield to Maturity: IR exposure is calculated by shifting the risk yield. • Z-Spread: IR exposure is calculated by only shifting the valuation and discounting curves; the estimation curve remains unchanged. Valuation Modes Predefined valuation modes are Benchmark, Default, Theoretical. A.2.289 Risk Setup (FRN) Id: FRN-RISK-SETUP Usage: Used to add risk valuation to an FRN instrument. With: BOND Context: Valuation Setup Setup: None Information Description Method Choices are: Valuation Modes 858 • Zero-Coupon (Default) • Zero Discount Margin (Z-DM) Predefined valuation modes are Benchmark, Default, Theoretical. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.290 Risk Venture Capital Id: RISK-VENTURE-CAPITAL Usage: Enables the investment in Equities under a lending facility. With: EQUITY Context: Action Setup: None A.2.291 Risk Yield Id: RISK-YIELD Usage: For Bonds when using the FIXED-BOND valuation approach, adding this feature forces the valuation to use the quoted price to calculate yield with the desired interest type/date basis and use that for all position cashflows. Interest rate risk calculations are based on interest type/date basis defined here for the period between spot date and risk date, while definitions of IR Exposure setup are used between valuation date and spot date. With: ABS, BOND, CONVERTIBLE-BOND, CREDIT-STEP-UP, INDEX-LINKED-BOND Context: Trading Setup: Risk Yield Information Description Interest Type Interest rate type of the instrument. Date Basis Date basis used in the calculations. A.2.292 Schedule Data Id: SCHEDULE-DATA Usage: Enables the modification of schedule data in the Irregular Value view of Transaction Manager. This feature can be used to provide validity ranges when a given field needs to take several values into account depending on the date without needing to touch any cashflows or add additional schedules. With: CDS, COMMERCIAL-LOAN, LOAN Context: Trading Setup: None A.2.293 Schedule Template Setup Id: SCHEDULE-TEMPLATE-SETUP Usage: Used to limit the choice of schedules available to assign to an instrument. With: CAP-FLOOR-COLLAR, CDS, COMMERCIAL-LOAN, LOAN, SWAPTION Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 859 A Features A.2 List of features Context: Trading Setup: Schedule Groups Information Description Group Group of schedule templates. If you assign a schedule group in the instrument setup, you can only apply schedules from within this group at transaction entry. Schedule Groups are defined in Schedule Template Group Editor. A.2.294 Schuldschein Id: SCHULDSCHEIN Usage: Allows the setting up of a Schuldschein bond. With: BOND, CREDIT-STEP-UP Context: Primary Setup: As for BOND A.2.295 Security Identifiers Id: SECURITY-CODE Usage: Allows you to assign security identifiers to the instrument. Note: You can query transactions by their security identifier or security identifier type in Transaction Manager’s Query view. With: ABS, BOND, COMMERCIAL-LOAN, CONVERTIBLE-BOND, CREDIT-STEP-UP, EQUITY, EQUITY-FUTURE, EQUITY-OPTION, INDEX-FUTURE, INDEX-LINKED-BOND, INDEX-OPTION Context: Trading Setup: Security Identifiers Information Description Type The security identifier type is defined in the Security Identifier Type Editor. Refer to TRM User Guide. Identifier Enter the unique security identification code. Attributes When multiple identifiers are used, it is possible to use the Default switch to flag the identifier that you want to appear by default in other TRM applications: Transaction Manager, Settlement Processing and Treasury Monitor. Note: You can use the option Security Identifier Type (in Transaction Manager) to display either the default type or a specific type, regardless of the default type set at the instrument level. 860 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.296 Security Info Id: SECURITY-INFO Usage: Allows the definition of issue size and par value for the security. Issue size may then be used in index composition or limits. With: BOND, DISCOUNT Context: Trading Setup: Security Info Information Description Active From Start of the active period. Active To End of the active period. Outstanding Size Outstanding nominal. Par Value (Information only) Par value of the security. A.2.297 Security Loan Id: SECURITY-LOAN Usage: Allows the setup of a security loan. With: SECURITY-LOAN Context: Primary Setup: None A.2.298 Settlement Setup Id: SETTLEMENT-SETUP Usage: Allows the definition of the level of automatic aggregation during settlement generation for cashflows related to the instrument. With: All Context: Trading Setup: Settlement Setup Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 861 A Features A.2 List of features Information Description Generation Method The generation methods are: • Transaction Number: (This is the default behavior.) Cashflows belonging to the same transaction are automatically aggregated together in settlement generation (provided their terms match). • Transaction Number, Leg: Same as 'Transaction Number', but aggregation is done within the leg group of a transaction, i.e. cashflows in different leg groups are not aggregated (applies to IRSs, i.e. IRS interest payments would be settled separately). • Cashflow Type: Cashflows belonging to the same transaction are aggregated together as long as they share the same cashflow type. • Continuation Number: Cashflows from transactions sharing the same continuation number are aggregated together. • Continuation Number, Leg: Same as 'Continuation Number', but aggregation is done within leg groups, i.e. cashflows in different leg groups are not aggregated together. • Position: Cashflow aggregation is done across all transactions that use the same instrument within the same portfolio (allowing for example bond coupons to be aggregated across multiple transactions). • None: No settlements are generated for this instrument. A.2.299 Short Term Loan Id: SHORT-LOAN Usage: Allows the setup of a deposit or short-term loan. With: SHORT-LOAN Context: Primary Setup: Short Loan Information Description Currency Currency of the deposit or short-term loan. Leave this field blank if you want to specify the currency when you enter the deal. Date Basis Date basis of the instrument. Leave this field blank if you want to specify the date basis when you enter the deal. Amount Rounding Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rounding Method Up, Down or Nearest. The amount is rounded up, down or to the nearest figure as calculated using the specified Amount Rounding number. Interest Type Interest rate type of the instrument. This is a mandatory field. Transaction Sign 862 Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow: • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy/Lend or Sell/Borrow if you want this to be the default direction of the transaction, that is, the direction cannot be modified at deal entry. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Principal Cashflow Type Type of principal cashflows, if you want to override the defaults supplied by the instrument type. Interest Cashflow Type Type of interest cashflows, if you want to override the defaults supplied by the instrument type. A.2.300 Short Term Loan Margin Result Id: SHORT-LOAN-MARGIN Usage: Enables the calculation of margin results for short-term loan transactions. When this feature is used, the transaction margin results in (Not Payable and Not Bookable) Margin cashflow being created in the transaction. See 3.8 Short term loan on page 305 for information about the calculation of margin results. With: SHORT-LOAN Context: Trading Setup: None A.2.301 Short Term Loan Valuation Id: DEPO-METHOD Usage: Determines that the instrument is valuated as a short term loan. With: SHORT-LOAN Context: Valuation Approach Setup: None A.2.302 Single Swap Valuation Id: SINGLE-SWAP-METHOD Usage: Defines a valuation approach which can be used for IR swaps. This method uses the GENERIC-IR-METHOD (see A.2.201 Generic IR Valuation on page 811) for both legs and does not valuate the pseudo principal amounts. Both the result setup and the valuation setup are taken from the swap instrument itself. With: SWAP, TRS Context: Valuation Approach Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 863 A Features A.2 List of features A.2.303 Special Issue Id: SPECIAL-ISSUE Usage: Specifies sell transactions as being issues by the portfolio owner (if instrument issuer = portfolio owner), and results in a book value of par, and linear accrual of transaction fees (accrued linearly from value date to maturity date). With: BOND, LOAN Context: Trading Setup: None Details: When used in addition to the ISSUE feature, the discount/premium will be amortized linearly over the life of the issue, and partial buybacks will not realize any discount/premium. In other words, discount/premium will be amortized until the original maturity, or until the final buyback that brings the outstanding amount to 0. A.2.304 Spot Date Setup Id: SPOT-DATE-SETUP Usage: Allows you to define the spot days of an instrument. With: ALL Context: Trading Setup: Spot Date Setup Information Spot Days Description Number of business days from the trade date to the settlement date. The number of days varies according to market conventions for the country and instrument. The number of days you select in this field will have an impact on the profit/loss value date; the spot date of a transaction will be used as the value date of the profit/loss flow. Calendar Calendar and Holiday Calendar used to calculate the spot date. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the spot date calculation takes both calendars into account. Note: When you define the Calendar or Holiday Calendar in one date setup, the Calendar fields in all date setup pages applied to the instrument default to the same values. Spot Time Cut-off time for operations. Spot Time Zone For global operations, a cut-off time has to be defined: deals before that time have the number of spot days calculated from that day; deals after that time have the spot days calculated from the following day. Define a time (Spot Time) within a selected time zone (Spot Time Zone). The market convention is 5 p.m. New York time. 864 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.305 Spread Curve Setup Id: SPREAD-CURVE-SETUP Usage: Used to add a spread curve to an instrument. With: ABS, BOND, CDS, COMMERCIAL-LOAN, CONVERTIBLE-BOND, CREDIT-STEP-UP, DISCOUNT, LOAN, INDEX-LINKED-BOND, SHORT-LOAN, SWAP, SWAPTION, TRS Context: Valuation Setup Setup: Yield Curves Information Description Active From First and/or last date that the yield curve is valid for the instrument. Active To Usage Spread The spread curve is added to the valuation curve and the discount curve before calculating the discount factor(s) applied to the cashflows. The spread rate is added to each point of the curve after interpolation has been carried out in the calculation of zero-rates for instruments defined with a spread rate. Yield Curve ID of the yield curve. Only yield curves that have been defined as spread curves (in IR Quote and Yield Curve Editor) are available for selection. If you leave this field blank, TRM defaults to the yield curve defined for the currency. A.2.306 Substitution Id: SUBSTITUTION Usage: Allows the setup of a Substitution instrument. With: SUBSTITUTION Context: Primary Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 865 A Features A.2 List of features A.2.307 Swap Id: SWAP Usage: Allows the setup of a swap instrument. With: SWAP Context: Primary Setup: Legged Information Description Transaction Sign Sign to be applied to the transaction: Any (default), Buy/Lend, or Sell/Borrow: Leg Structure Switches Setup: • Select Any or leave this field blank if you want to specify the direction of the transaction when you enter the deal. • Select either Buy/Lend or Sell/Borrow if you want this to be the default direction of the transaction, that is, the direction cannot be modified at deal entry. Leg structure of the swap instrument. TRM supports swap structures with multiple legs. Choose from: • Swap, One Leg (up to Swap, Five Legs) • Swap, Two Legs, Non-Par • Swap, Two Legs, Zero Coupon. Activate the switches that apply to the instrument. • No Common Maturity • Pseudo Repayment • Pseudo Settlement. Legs Information Description Leg The leg of the transaction to which the information in the following fields applies. Instrument The instrument to be used for this leg. Note: If a bond is used as the swap leg instrument, theoretical valuation is used by default. Sign vs Transaction 866 Choose from: Same, Opposite, or Any. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.308 Swap (Book, FX Rate) Id: SWAP-BOOK-FX Usage: Used to drive the result treatment of IR swaps and the setting of the FX rate in the accounting process for cross-currency swaps. This is the default method. For a single-currency IR swap, even though there is no actual exchange of capital, a trading feature that is responsible for driving the result treatment must still be present in the instrument definition. For a cross-currency swap, if this feature is used, and if the swap is settled on both value date and maturity date, the swap is treated in the same way as a deposit and loan, that is, bookkeeping sets the FX rate on the value date, and FX Profit is calculated at the maturity date as the difference between the value and maturity dates’ FX rates. See also A.2.309 Swap (Deal, FX Rate) on page 867. With: SWAP Context: Trading Setup: None A.2.309 Swap (Deal, FX Rate) Id: SWAP-DEAL-FX Usage: Used to drive the result treatment and the setting of the FX rate in the accounting process for cross-currency swaps. With this method, a cross-currency swap is treated like an FX spot/forward, that is, on the value date and maturity date, the difference between the swap's deal FX rate and the book FX rate of each respective day is realized as FX Profit. This is also the case when realization occurs on one leg only (as determined by the pseudo settlement or repayment parameters defined either in the instrument setup or at deal entry). See also A.2.308 Swap (Book, FX Rate) on page 867. With: SWAP Context: Trading Setup: None A.2.310 Swap Valuation Id: SWAP-METHOD Usage: Defines the standard valuation approach which can be used for all swap instruments. This feature works in the same way as SINGLE-SWAP-METHOD except that the result setup is taken from the swap instrument and the valuation setup is taken from the leg instruments. With: SWAP, TRS Context: Valuation Approach Setup: None Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 867 A Features A.2 List of features A.2.311 Swaption Valuation Id: SWAP-OPTION-METHOD Usage: Defines the valuation approach which can be used for swaptions. With: SWAPTION Context: Valuation Approach Setup: None A.2.312 Swaption Pricing Id: SWAP-OPTION-PRICING Usage: Use this feature to price swaptions. With: SWAPTION Context: Action Setup: None A.2.313 Swap Per Leg Valuation Id: SWAP-PER-LEG-METHOD Usage: Defines a valuation approach which can be used for IR swaps. This approach uses the result setup defined for the swap instrument, but values each leg according to its own valuation approach and setup. With: SWAP Context: Valuation Approach Setup: None A.2.314 Swap Pricing 868 Id: SWAP-PRICING Usage: Use this feature to price swap transactions at transaction level. With: SWAP Context: Action Setup: None Details: When the Pricing action is performed on a swap transaction that has this feature, you are given three pricing options: Goal Seeker, Annuity, or Spread. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.315 Swaption Id: SWAPTION Usage: Defines a swaption instrument. With: SWAPTION Context: Primary Setup: Swaption Information Description Underlying Underlying swap instrument of the swaption. Type Type of option: Call or Put Exercise Type Defines when the option can be exercised: European or American. Delivery Type Cash-Settlement or Physical Delivery. Structure Schedule template to be used for the swaption. If a structure is not defined at instrument level, a schedule needs to be specified for each transaction. A.2.316 Swap, Upfront Id: SWAP-UPFRONT Usage: This feature is used to handle the creation of an upfront cashflow in a swap instrument when the leg price is not equal to 100 (the notional and nominal amounts are calculated based on a price of 100). With: SWAP Context: Trading Setup: None Details: The upfront cashflow is booked according to the result treatment applied to the instrument. Generally the upfront cashflow is included in the transaction’s book value (if one of the invested capital options is specified in the Book Value setup in Result Editor). The upfront can be amortized (as Accrued Profit) according to the Accrual Method setup: see the TRM User Guide for more information about result treatments and how they are defined. A.2.317 Swedish Index-Linked Treasury Bond Id: BOND-SE-RO Usage: Defines a Swedish index-linked treasury bond. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 869 A Features A.2 List of features Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. A.2.318 Swedish Index-Linked Bond Valuation Id: BOND-SE-RO-METHOD Usage: Determines that the instrument is valuated as a Swedish index-linked bond. With: BOND-SE-RO Context: Valuation Approach Setup: None A.2.319 Ticks Netting Id: TICKS-NETTING Usage: This feature allows the user to specify the values used to calculate the change in market value (pseudo cashflows) until the contract is closed or it expires. With: EQUITY-OPTION, INDEX-OPTION, BOND-OPTION, MM-FUTURE-OPTION, FX-OPTION-LISTED Context: Trading Setup: Netting Information Description Fixing Offset Number of days’ offset allowed, that is, the difference in days between the fixing date and the due date (default = 0). Fixing Max Offset Maximum number of days’ offset allowed. Fixing Subscenario Subscenario from which the rate is retrieved. Calendar Calendar used to calculate the dates. Switches Activate the switches that apply to the instrument. • 870 Settlement Currency - switch on if settlement is made in a different currency. Settlement Currency If the Settlement Currency switch is on, the Currency in which settlement is made. Payment Offset Number of business days between value date and payment date. Method Select Business Days for daily netting. Frequency Enter 1 when Method = Business Days. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.320 Trading Unit (Derivative) Id: DERIVATIVE-TRADING-UNIT Usage: Allows you to specify the contract size, tick value, and so on. With: BOND-OPTION, EQUITY-FUTURE, FRA-OPTION, FX-OPTION-LISTED, FX-FUTURE, MM-FUTURE-OPTION, SWAPTION Context: Trading Setup: Trading Unit Information Description Contract Size Unit of trading of the contract. Minimum Bid Size Smallest allowed bid size. Tick Size Minimum price movement (tick size and value). Tick Value Rounding Method Rounding method used in the calculations: Up, Down, or Nearest. If the nominal amount entered does not correspond to a multiple of the minimum bid size, the amount is rounded up, down, or to the nearest corresponding amount. Note: For denominated instruments or instruments with trading units, the cashflow amount is first calculated for one unit, and then multiplied by the number of units. Two levels of amount rounding take place and are controlled when setting up the instrument: - A first rounding is done when calculating the cashflow amount for one unit. This is controlled at the interest schedule level by using the field 'Amount Rounding'. - Allow Trading in Half of Tick Size A second amount rounding is done when multiplying the cashflow amount per unit by the number of units to get the final cashflow amount. This is controlled by the 'Amount Rounding' in the Bond feature. This is usually set to 0.01. Allows trading this instrument at a price with a precision of half the tick size (used for eurodollar Future contracts and options for nearest expiring month). A.2.321 Trading Unit (Equity) Id: EQUITY-TRADING-UNIT Usage: Used to define the minimum bid size of shares or fund shares. With: EQUITY, EQUITY-OPTION Context: Trading Setup: Trading Unit Information Description Minimum Bid Size Smallest allowed bid size. Price Precision Number of decimal places for the equity price. Rounding Method Rounding method used in the calculations of amounts: Up, Down, or Nearest. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 871 A Features A.2 List of features A.2.322 Trading Unit (Index) Id: INDEX-TRADING-UNIT Usage: Used to specify point and tick values for Index Options. With: INDEX-FUTURE, INDEX-OPTION Context: Trading Setup: Trading Unit Information Description Point Value Unit of trading of the contract: value of 1 point of the index. When the index option is exercised, the cash settlement amount is the difference between the strike and current index value multiplied by the point value. Minimum Bid Size Smallest allowed bid size (for example, 1.00000). Tick Size Minimum price movement (tick size and value), for example, 0.5 / €5. Tick Value Tick Size * Point Value = Tick Value Rounding Method Rounding method used in the calculations: Up, Down, or Nearest. Allow Trading in Half of Tick Size Allows trading this instrument at a price with a precision of half the tick size (used for eurodollar Future contracts and options for nearest expiring month). A.2.323 Trading Yield Id: TRADING-YIELD Usage: Allows the specification of the Price/Yield Method and the rounding treatment to be applied. If the instrument is used as collateral for a repo, the rounding treatment specified here can be overridden with the Repo-Rounding feature: see A.2.280 Repo Rounding on page 854. See also A.2.342 Yield on page 881. 872 With: ABS, BOND, COMMERCIAL-LOAN, CONVERTIBLE-BOND, CREDIT-STEP-UP, LOAN, INDEX-LINKED-BOND Context: Trading Setup: Trading Yield Information Description Yield Convention Yield Convention. Choose from: • ISMA • US Street • US Treasury • Brazilian • Government (country specific or Eurozone for governments in the Eurozone) • Index-UK. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Price Rounding Nearest number to which the price is rounded. For example, if Price Rounding = 0.05, a price of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Price Rounding Method Up, Down or Nearest. The price is rounded up, down or to the nearest figure as calculated using the specified Price Rounding number. Rate Rounding Nearest number to which the rate is rounded. For example, if Rate Rounding = 0.05, a rate of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rate Rounding Method Up, Down or Nearest. The rate is rounded up, down or to the nearest figure as calculated using the specified Rate Rounding number. A.2.324 Transaction Charges Id: TRANSACTION-CHARGES Usage: Allows you to attach a rule to automatically apply charges to transactions, for example, a broker fee. With: ALL Context: Trading Setup: Transaction Charges Information Description Transaction Charges Transaction charge rule you want to apply to the instrument. Transaction charge rules are set up in Transaction Charge Editor. See TRM User Guide for more information. A.2.325 Transaction Conversion Id: TRANSACTION-CONVERSION Usage: Allows conversion of a transaction to another type of transaction. With: BOND, CREDIT-STEP-UP, LOAN, SWAP Context: Action Setup: None Details: Information Description Opening Date Opening date of the selected event. Value Date Value date of the selected event. Amount Left Read-only. Amount left of the transaction on corresponding date. Conversion Price 100 by default, used to adjust the nominal amount after conversion. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 873 A Features A.2 List of features Information Description Capitalized Accrued Interest If selected, the Accrued Interest flow is flagged as Not payable and the Nominal amount after the conversion is increased with the accrued interest amount. Conversion Adjustment Price Editable when Capitalized Accrued Interest is selected. If a price is specified in this field, then same behavior as above, except that the nominal amount will be adjusted with this price instead of accrued interest value A.2.326 Transfer (cash) Id: TRANSFER Usage: Defines a cash transfer instrument. With: CASH Context: Primary Setup: Movement Information Description Transaction Sign Sign of the transfer. If the sign is not defined at instrument level, it needs to be specified separately for each transfer transaction. Currency Currency of the transfer. Leave this field blank if you want to specify the currency when you enter the transfer. Amount Rounding Precision used to round cashflow amounts. Rounding Method Method used to round cashflow amounts. Cashflow Main Type Main type assigned to a cashflow. For example, for a generic payment instrument: select Payment. The type defines the purpose or origin of the cashflow. Cashflow Type Cashflow type of the cashflow. The cashflow types available for selection depend on the cashflow type selected in the Cashflow Main Type field. 874 Attributes Attributes of the cashflow: Nominal Amount, Not Bookable, Not Payable, or Pseudo. Attributes 2nd Further attributes of the cashflow. Our Client The portfolio-owner from whose account the transfer is made and to whom the cashflow belongs. This is usually the user organization. Our Full Chain When this switch is set to on, the settlement instructions chain defaulting stops at the Our Bank/Account level. This means that the instructions defined in the instrument are considered to be complete, and the system will not try to automatically complete the chain from the Client Editor setup. Our Bank The bank of the user organization (or another portfolio-owner on whose behalf the transfer is made) used for the transfer. Our Account The bank account of the user organization (or of the portfolio-owner on whose behalf the transfer is made) used for the transfer. © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Counterparty The counterparty of the transfer. Counterparty Full Chain When this switch is set to on, the settlement instructions chain defaulting stops at the Counterparty Bank/Account level. This means that the instructions defined in the instrument are considered to be complete, and the system will not try to automatically complete the chain from the Client Editor setup. Counterparty Bank The bank of the transfer. A.2.327 TRS - Total Return Swap Id: TRS Usage: Defines a Total Return Swap instrument. This feature is also used to define a DRS. With: TRS Context: Primary Setup: Legged Information Description Transaction Sign Direction of the transaction. If the sign is not defined at instrument level, it needs to be specified separately for each transaction. Leg Structure Leg structure for the swap instrument. TRM supports swap structures with multiple legs. Switches Activate the switches that apply to the instrument. • Setup: Pseudo Settlement and Pseudo Repayment - switch on these options to make the principal notional (no exchange of capital). Legs Information Description Leg Leg of the swap. Instrument Instrument to be used for this leg by default (for example, a fixed-rate bond). Sign versus Transaction Sign of the leg in relation to the sign (direction) of the transaction. Choose from: Same, Opposite, or Any. A.2.328 TRS Deferred Id: TRS-DEFERRED Usage: Defines a deferred TRS, where the return cashflows in the TRS are to be deferred until the maturity date. With: TRS Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 875 A Features A.2 List of features Context: Trading Setup: None A.2.329 UK ILG (3M) Id: BOND-UK-IG3M Usage: Defines a UK 3 month index-linked gilt. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. A.2.330 UK ILG (8M) Id: BOND-UK-IG8M Usage: Defines a UK 8 month index-linked gilt. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. A.2.331 UK Index-Linked Bond (3M) Valuation 876 Id: BOND-UK-IG3M-METHOD Usage: Determines that the instrument is valuated as UK 3 month index-linked gilt. With: BOND-UK-IG3M Context: Valuation Approach Setup: None © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.332 UK Index-Linked Bond (8M) Valuation Id: BOND-UK-IG8M-METHOD Usage: Determines that the instrument is valuated as UK 8 month index-linked gilt. With: BOND-UK-IG8M Context: Valuation Approach Setup: None A.2.333 US Index-Linked Bond Valuation Id: BOND-US-TIPS-METHOD Usage: Determines that the instrument is valuated as US Tips bond. With: BOND-US-TIPS Context: Valuation Approach Setup: None A.2.334 US TIPS Id: BOND-US-TIPS Usage: Defines a US Tips instrument. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. A.2.335 US TIPS (with Rounding) Id: BOND-US-TIPS-ROUND Usage: Defines a US Tips instrument with rounding. With: INDEX-LINKED-BOND Context: Trading Setup: As for BOND, Issue Index Information Description Index Instrument ID of the underlying index. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 877 A Features A.2 List of features Information Description Issue Index Value of the underlying index at issue. This value is used to adjust the coupon and redemption flows of the bond. A.2.336 VaR Mapping Type Id: VAR-MAPPING-TYPE Usage: Used to enable multiple VaR mappings per currency for interest rate instruments. The default mapping consists of one mapping per currency. VaR mappings are defined in VaR Mapping Editor, see TRM User Guide for more information. Note: For swaps, VaR mapping follows the swap instrument setup and not the leg instrument setup. With: BOND, SWAP Context: Valuation Setup Setup: VaR Mapping Type Information Description Type Select the VaR mapping type. The standard configuration has two mapping types, GOVT and SWAP. It is possible to add or modify mapping types during the implementation of the system, see TRM System Admin Guide. A.2.337 Valuation Curve Setup Id: VALUATION-CURVE-SETUP Usage: Used to add a valuation or discount yield curve to the instrument. With: ALL Context: Valuation Setup Setup: Yield Curves Information Description Active From First and/or last date that the yield curve is valid for the instrument. Active To Usage • Discount The yield curve is used to discount cashflows between figure date and figure spot date. • Valuation The yield curve is used to discount cashflows from cashflow payment date until figure spot date. The yield curve calculates the instrument’s current market value and present value (which is needed for measuring your current risk). Yield Curve ID of the yield curve. Only yield curves that have been defined as discount or valuation curves (in IR Quote and Yield Curve Editor) are available for selection. If you leave this field blank, TRM defaults to the yield curve defined for the currency. 878 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features A.2.338 Valuation Setup (Floating) Id: FLOATING-SETUP Usage: Allows you to select the risk profile you want to use for IR risk calculations for Floaters. With: ABS, BOND, CAP-FLOOR-COLLAR, COMMERCIAL-LOAN, CREDIT-STEP-UP, LOAN Context: Valuation Setup Setup: Floating Valuation Information Description Risk Profile Risk profile you want to use for IR risk calculations for Floaters. Choose from: None, Plain Vanilla, Generic, Constant Maturity, Compound (O/N), Generic Compound (O/N), Compound (Simple), Average (Simple), or Fed Fund (for federal fund instruments). For more information about risk profiles, see 2.3.4.8 Risk profiles on page 124. Valuation Modes • If Risk Profile = None, GENERIC-IR-METHOD (see A.2.201 Generic IR Valuation on page 811) defaults to Estimate Expression (see also A.2.49 Base IR Setup on page 733). • If Risk Profile = Plain Vanilla and you are setting up a FRN instrument, set up the discount margin parameters: see A.2.343 Z-DM/Spread Setup on page 882. Valuation Mode: Default, Benchmark, or Theoretical. This setup is valuation mode dependent. A.2.339 Value Date Setup Id: VALUE-DATE-SETUP Usage: Allows you to define how the value date is calculated. With: ALL OTC instruments. Context: Trading Setup: Value Date Setup Information Description Calendar Calendar and Holiday Calendar used to calculate the value date. Holiday Calendar If you enter both a Calendar and a Holiday Calendar, the value date calculation takes both calendars into account. Note: When you define the Calendar or Holiday Calendar in one date setup, the Calendar fields in all date setup pages applied to the instrument default to the same values. Gap Set Gap set used for supplying the value date periods; these in turn are used to define exact dates. Value Date Period Value date period used to calculate the value date for the instrument at deal entry. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 879 A Features A.2 List of features A.2.340 Volatility Surface Setup Id: VOLATILITY-SETUP Usage: Allows you to attach a volatility structure to an instrument. TRM supports usage of the volatility surface by taking into account: the time to expiry, delta correction, and the underlying maturity, and linking them to real-time price sources (such as Reuters). You can price Caps, Floors, and Collars by using a volatility structure with ATM volatility or skew (flat or forward), Swaptions with ATM straddle volatility or three dimensional structure, and Bond Options by using a three dimensional structure. With: BOND-OPTION, CAP-FLOOR-COLLAR, FRA-OPTION, LOAN, SWAPTION Context: Valuation Setup Setup: Volatility References Information Description Active From First and/or last date that the volatility reference is valid for the instrument. Active To Usage Adjustment Volatility or Volatility. Volatility Reference ID of the volatility reference you want to use. Valuation Mode Valuation Mode: Default, Benchmark, or Theoretical. A.2.341 XAU Loan Id: XAU-LOAN Usage: Defines a gold deposit instrument. With: XAU-LOAN Context: Primary Setup: XAU Loan Information Currency Description Currency of the instrument. Leave this field blank if you want to specify the currency when you enter the deal. Transaction Sign Sign of the transaction. Choose from: Any, Buy/Lend, or Sell/Borrow. If the sign is not defined at instrument level, it can be specified at deal entry. AI Method Settlement Switches Method used to calculate accrued interest (premium), if it starts to accrue before the value date of the transaction or when a credit event occurs. Activate the switches that apply to the instrument’s settlement flows. • Amount Rounding Dirty Price - switch on if you want to use the dirty price for the instrument, that is, to include accrued interest in the instrument’s price. Nearest number to which the amount is rounded. For example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. 880 © Wall Street Systems IPH AB - Confidential A Features A.2 List of features Information Description Rounding Method Up, Down or Nearest. The amount is rounded up, down, or to the nearest figure as calculated using the specified Amount Rounding number. Structure Schedule template to be used to create payments for the transaction, for example, the system-defined XAU Unknown FX Rate, Fixed (XAU-UNKNOWN-FX-FIXED) primary schedule. See B.2.1.1.45 XAU, Unknown FX Rate, Fixed on page 899. Setup: Interest Amount Information Description No XAU Amount Rounding When switched on interest amount is not calculated from intermediate rounded USD amount. A.2.342 Yield Id: YIELD Usage: Allows you to define multiple, different yield types that can be used, for example, in Rate Monitor for comparison purposes. This feature works in a similar way to the Trading-Yield feature (see A.2.323 Trading Yield on page 872) except that it allows multiple values, and does not have price rounding. With: ABS, BOND, CONVERTIBLE-BOND, CREDIT-STEP-UP, INDEX-LINKED-BOND Context: Trading Setup: Yield Information Yield Convention Rate Rounding Description Yield Convention. Choose from: • ISMA • US Street • US Treasury • Brazilian • Government (country specific or Eurozone for governments in the Eurozone) • Index-UK. Nearest number to which the rate is rounded. For example, if Rate Rounding = 0.05, a rate of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Rate Rounding Method Up, Down or Nearest. The rate is rounded up, down or to the nearest figure as calculated using the specified Rate Rounding number. Default Switch on to indicate that the selected Yield Convention is the default convention. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 881 A Features A.2 List of features A.2.343 Z-DM/Spread Setup Id: DISCOUNT-MARGIN-SETUP Usage: This feature allows you to take the discount margin into account when calculating the discount factors used in the estimation of the future coupon and redemption cashflows of an FRN. After the calculation of the discount margin, the payment discount factor of each flow is adjusted. The derived risk structure is achieved by setting the risk parameters: see A.2.338 Valuation Setup (Floating) on page 879. See also 2.1.5 Discount Margin on page 66 for more information about the calculation. 882 With: BOND Context: Valuation Setup Setup: Discount Margin Information Description Date Basis Date basis used to compute the dates in the discount margin calculation. Yield Type Type of rate used in the discount margin calculation. Yield Curve Reference rate used in the discount margin calculation. © Wall Street Systems IPH AB - Confidential Appendix B Schedules In TRM, a schedule drives the generation of a set of cashflows of the same type (for example, interest flows). Schedules are directly used to generate the cashflows for instruments belonging to the following instrument classes: Asset Backed Securities, Bonds, Caps, Floors, and Collars, Loans, and Commercial Loans. • Schedules are also indirectly used for structured products which comprise the above-mentioned instrument classes, namely: Swaps, Total Return Swaps, and Swaptions. • B.1 Schedule parameters This section describes the information that can be specified at schedule level to determine how a set of cashflows are generated. Not all parameters are relevant to all types of cashflows. Information Description Id Unique identifier of the schedule, it is automatically assigned by the system. Description Descriptive name for the schedule, provided by the user. Reference Schedule Id of the reference schedule if this schedule is linked to another one. Group Logical group the schedule belongs to: if the schedule is deleted, all members of its group are deleted too. Cashflow Group Determines if the cashflows are part of the same (sequential) or separate (parallel) interest calculations. Category Category of the cashflow: Balance / Payback / Settlement. Option/Trigger Type Category of the event: • Call: Call option • In: Trigger/Knock In • Out: Trigger/Knock Out • Put: Put option Main Type Main type of the cashflows to be generated: Dividend, Event, Principal, Interest, P/L, Fee/Tax, and so on. Type Cashflow type belonging to the main type, for example, Accrued Interest, Coupon, and so on, depending on the Main Type specified above. Additional cashflow types can be added using Cashflow Type Editor. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 883 B Schedules B.1 Schedule parameters Information Description Kind Kind to be set on the generated cashflows; each cashflow can have one or more of the following kinds attached: • Annuity Component • Capitalized • Cash Settled • Conditional • Deferred • Discount Interest • Fixed Annuity • Inactive • Interest • In-Triggerable • Optional • Out-Triggerable • Risk Asset • Up-Front Interest. Sign For optional events: who has the right to do the action: Asset / Liability. Start Date Schedule start date: cashflow generation starts from here. End Date Schedule end date: cashflow generation ends here. Method Used to define the method of frequency for the generated cashflows (or events) (to be used with Frequency): • Bullet: Only one flow at the end of the schedule period • Business Days: One flow every Frequency business day • Days: One flow every Frequency day • IMM Dates (M): One flow every 3rd Wednesday of every Frequency month • ISDA Dates (Q): 15 March, 15 June, 15 Sept. and 15 Dec. • ISDA CDS Dates (Q): 20 March, 20June, 20 Sept. and 20 Dec. • Last of Month: One flow the last day of every Frequency month • Months: One flow every Frequency month • Months (sticky): The same as Last of Month if the end date falls at month end, otherwise like Months. • Times/Year: Frequency determines how many times per year • Weeks: One flow every Frequency week • Years: One flow every Frequency year • Irregular: This method is used when no other method can be applied as there is no logical frequency for the generation of the schedule’s cashflow/event dates. It activates the New Irregular Date processing action in Transaction Manager’s Schedule level. This enables the user to enter specific dates for the corresponding schedule in the Irregular Dates level. Note that it is not necessary to specify a Frequency with this method. See the TRM User Guide for more information. Frequency Number of time units (to be used with Method). Calculation Method Method used to compute the amounts of the repayment flows: None / Annuity / Fixed Annuity / Linear / Percentage See 2.1.6 Calculation methods on page 67. 884 © Wall Street Systems IPH AB - Confidential B Schedules B.1 Schedule parameters Information Description Exclude Interest Periods For Annuity and Fixed Annuity calculation methods, coupons to be excluded from the calculation: None / First / First and Last / Last Roll From Start Yes or No: When set to Yes, dates are calculated from Start Date rather than End Date. FRN Yes or No: Defines how payment dates are modified when the value date is a bank holiday: dates are calculated from Start Date and the time step is added after calendar adjustments. Long Stub Yes or No: To change the first coupon period to a long first coupon. By default, it is a short first coupon when the period is broken. Selecting Yes in the field Roll from Start causes a long last coupon. Min. Stub Length Minimum stub length in calendar days. If a short stub is less than the minimum length, a time step is added to create a long stub. Fixed Roll Date Specific date to be used in the schedule each year, without reference to the year: for example, 15 March annually. First Date First date generated from a schedule. Required value if it does not follow the standard rolling dates. Penultimate Date Last-but-one date for a schedule used for adjusting irregular periods, for example, in an Annuity situation. Currency Currency of the instrument. Interest Type Rate type is used to interpret the value in the Rate field. Rate Value of the rate (for example: for 5% interest, select 5 in this field, and Interest Rate in the Rate Type field). Rate Offset Rate offset added to the previous rate step while rolling from the reference date. Date Basis Date basis used to calculate the interest cashflows. Accrual Date Basis Date basis used to calculate accrued amounts: for example, accrual date basis for Amortization. Convention Convention to follow to adjust the payment date: • Backward - previous business day • Business Days - next business day (same as Following) • Following - next business day • Modified Backward - previous business day except if not in the same month (next in this case) • Modified Following - next business day except if not in the same month (previous in this case) • None - no adjustment. Note: By default, the last interest payment date is adjusted to the last repayment date of the transaction (market convention). This behavior can be changed at transaction level by setting the attribute No Common Interest / Repayment Maturity in the Attribute field. Calendar Calendar used for adjustment purposes. Holiday Calendar Additional calendar to supplement the calendar you specify in the Calendar field. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 885 B Schedules B.1 Schedule parameters Information Description Payment Offset Calendar Days / Business Days / Months Number of business days, calendar days, or months after which a convention is to be applied. Payment Client Client used to settle all cashflows generated from this schedule. Adjust Value Date Determines whether a value date falling on a non-business day will be adjusted according to the selected convention (Backward, Following, Modified Following, and so on). Adjusting the value date will affect the calculation of the interest amount. Payment In Advance • Select Yes if you want the value date to be adjusted. • Select Yes, Except First/Last if you want the value date to be adjusted except for the first and/or last interest periods. • Select Yes, Except First or Yes, Except Last, if you want the value date to be adjusted except for the start date of the first or the end date of the last interest period. For example, if you selected Yes, Except Last then the end date of the last interest period will not be adjusted. Yes or No: When set to Yes, payment is made at the beginning of the period rather than at the end. Min Payment Stub Length Minimum payment stub length in calendar days. Payment Adjust Method Method used to adjust payments: for example, Capitalizing, Up Front, or Value Dates. Payment Adjust End Date Used by the Payment Adjust Method as the date on which payment adjustment ceases. Need Fixing Fixing Date Method Fixing(/Notification) Offset Calendar Days / Business Days / Months If a short stub is less than the minimum length, a time step is added to create a long stub. Specifies if fixing will be required for the cashflows: • No: No fixing needed • Yes: Standard floating cashflow • Yes, unmarked: Dual-currency FX rate fixing needed • Yes, by periods: Special cashflow where periods must be re-created from dates (used mainly in triggers). Impacts the calculation of fixing dates: • In Arrears: Fixing occurs at the end of the interest/event period, i.e.; fixing from/to dates are calculated from the period end date • In Advance: Fixing occurs at the beginning of the interest/event period, i.e.; fixing from/to dates are calculated from the start date • Entire Period: Fixing occurs during the interest/event period, i.e.; fixing from is calculated from start date and fixing to from end date • Based on Previous: Fixing occurs at/around the previous similar event, i.e.; fixing from/to calculated as of the date of the previous event (or schedule start date for the first event). Minimum number of days’ offset allowed for fixing or notification (default is 0). The fixing/notification offset is a positive number, which corresponds to the number of days (or business days or months) before the calculated value date (e.g. coupon calculation date) or event-from date (e.g. call date). With the field Fixing(/Notification) Max Offset, it enables you to define the notification period. This period is defined from the fixing/notification-from date (calculated from the event-from date using the max fixing/notification offset) to the fixing/notification-to date (calculated from the event-to date using the fixing/notification offset). Note: You can combine months with calendar days and/or business days. 886 © Wall Street Systems IPH AB - Confidential B Schedules B.1 Schedule parameters Information Description Fixing(/Notification) Max Offset Calendar Days / Business Days / Months Maximum number of days’ offset allowed for fixing or notification (default is Fixing/Notification Offset above). The fixing/notification max offset is a positive number, which corresponds to the number of days (or business days or months) before the calculated event-to date. Note: You can combine months with calendar days and/or business days. Fixing Convention Convention to be followed if the fixing date is a business holiday: • Backward - previous business day • Business Days - next business day (same as Following) • Following - next business day • Modified Backward - previous business day except if not in the same month (next in this case) • Modified Following - next business day except if not in the same month (previous in this case) • None - no adjustment. Fixing Calendar Calendar used for fixing. Fixing Holiday Calendar Additional calendar to supplement the calendar you specify in the Fixing Calendar field. Expression Expression used to compute the cashflow payoff. Used in floating cashflow and several events (for example, triggers). Fixing Rate ID of the market variable to be used for fixing. Fixing Period Length of time for which fixing is to be executed (for example, 3M, 6M, 1Y, and so on). Fixing Subscenario Rates scenario from which the floating rate is retrieved. Spread Expression parameter. Floor Expression parameter. Cap Expression parameter. Factor Expression parameter. Divider Expression parameter. Offset Calendar Days / Business Days / Months Mainly used in the context of events (e.g. call): The offset is a positive number, which corresponds to the number of days (or business days or months) before the coupon date. With the field Max Offset, it enables you to define an exercise (event) period. This period is defined from the event-from date and the event-to date, which are both calculated from the coupon date. Note: You can combine months with calendar days and/or business days. Max Offset Calendar Days / Business Days / Months The max offset is a positive number, which corresponds to the number of days (or business days or months) before the coupon date. Settlement Currency Settlement currency for dual-currency structures. Settlement FX Rate FX rate between currency and settlement currency for dual-currency structures. Note: You can combine months with calendar days and/or business days. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 887 B Schedules B.1 Schedule parameters Information Description Amount Rounding Nearest number to which the cashflow amount is rounded: for example, if Amount Rounding = 0.05, an amount of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Note: For denominated instruments or instruments with trading units, the cashflow amount is first calculated for one unit, and then multiplied by the number of units. This field controls that level of rounding. The actual cashflow rounding is done after multiplying by the number of units in the transaction. For Bonds, this is controlled by the ‘Amount Rounding’ defined in the Bond feature. Amount Rounding Method Up, Down or Nearest. The amount is rounded up, down or to the nearest figure as calculated using the specified Amount Rounding number. Calculation Rounding Nearest number to which the calculation is rounded: for example, if Calculation Rounding = 0.05, a calculation of 1.23 would be rounded to 1.20 or 1.25, depending on the Rounding Method chosen. Calculation Rounding Method Up, Down or Nearest. The calculation is rounded up, down or to the nearest figure as calculated using the specified Calculation Rounding number. Base Rounding Nearest number to which the base amount is rounded. Base Rounding Method Up, Down or Nearest. The base amount is rounded up, down or to the nearest figure as calculated using the specified Base Rounding number. Gap Set Defines the set of selectable gaps (see Gap). Gap Gap into which the cashflows’ value date falls. Trading Unit When a set amount rounding is applied to a Trading Unit, the final amount is obtained by multiplying by the number of units. Not Payable Yes or No: Used for Subsidy and Subsidy Adjustment schedules. If Yes, Subsidy Call and Subsidy calculation are enabled. Post Settlement Yes or No: Set to Yes for schedules using a value obtained during the settlement calculations (for example, deal rate or aggregated rate). Pseudo Yes (Yes, Payback, Yes, Settlement) or No: To indicate whether cashflows from this schedule are pseudo or genuine cashflows. This attribute only has an impact on the settlement flow when used with a Principal Increase type of schedule. For any other type of schedule, this attribute has no impact. Attributes 888 Attributes that affect the cashflow generation and amount calculations: • Flip Flop - enables the nominal amount to change sign (for example, for a Flip-Flop IR Swap) • Mark First Stub • Mark Last Stub • Mark Stubs Automatically • Prepayment Base Rate. © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates Information Description Cashflow Attributes 1st Specific attributes of the generated cashflow: Cashflow Attributes 2nd • Booked • No Figures • Nominal Amount • Not Bookable • Not Payable • Paid • Pseudo • Special. Specific attributes of the generated cashflow: • ABS • All-in • Amortized • External Key-Figures • Fixed Amount • Guaranteed • Late • No Partial Realization • No Valuation • Re-offer • Split Interest. B.2 Templates Templates are used to default the cashflow structure of a deal or instrument. In addition to the cashflow structure and some default schedule parameters, templates also contain information about the availability of the parameters, if the parameters are mandatory, and if any rules default from these parameters. TRM is delivered with a set of system-defined templates. However, it is possible for users to define their own templates, but with some constraints: • User-defined templates must be derived from a system template. • The default setup for system-defined templates cannot be changed when the user templates are created. There are two types of templates, primary and secondary: • Primary templates can be attached only to the transaction (or leg in case of a swap) or instrument. Assigning a primary template defines the main cashflow structure of the deal. (Only one primary template can be attached per transaction.) It is possible to supplement the primary template using secondary templates. • Secondary templates can only be attached to a component of a primary template. The criteria used by the system to identify if it is possible to attach a secondary template to a given schedule depends on the type of cashflows that are to be generated. Secondary templates can be used for different purposes, such as, to accompany certain primary templates as a way of adding further parameters. B.2.1 System-defined templates This section describes the pre-packaged templates (primary and secondary) which can be used to create user-defined templates. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 889 B Schedules B.2 Templates B.2.1.1 Primary templates Primary templates are listed hereafter in alphabetical order. B.2.1.1.1 ABS-MBS, Fixed Rate ID: ABS-FIXED Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template for fixed-rate Asset-Backed Securities. B.2.1.1.2 ABS-MBS, Floating Rate ID: ABS-FLOATING Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template for floating-rate Asset-Backed Securities. B.2.1.1.3 Australian Capital Indexed Bond ID: BOND-AU-CIB Type: Primary Composition: 1 interest, 1 principal, 1 ex dates Linked To: Transaction Description: Use this template or any user-defined template derived from it to define Australian Capital Indexed bonds. B.2.1.1.4 Australian Indexed Annuity Bond ID: BOND-AU-IAB Type: Primary Composition: 1 fixed interest, 1 amortization, 1 interest adjustment, 1 fixing dates, 3 ex dates Linked To: Instrument Description: Use this template or any user-defined template derived from it to define Australian Indexed Annuity bonds. B.2.1.1.5 Brazilian FX-Linked Bond (NBC) 890 ID: BOND-BR-NBC Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template to define a Brazilian FX-Linked Bond (NBC-E/NTN-D). © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates B.2.1.1.6 Brazilian IDxUSD Swap ID: IDxUSD Type: Primary Composition: 1 interest, 2 reference, 1 principal Linked To: Transaction Description: Use this template for Brazilian IDxUSD Swaps. B.2.1.1.7 Brazilian LFT Bond ID: BOND-BR-LFT Type: Primary Composition: 1 principal Linked To: Transaction Description: Use this template to define a Brazilian LFT Bond. B.2.1.1.8 Canadian Real Return Bond ID: BOND-CA-RRB Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template to define a Canadian Real Return Bond. B.2.1.1.9 Cap ID: CAP Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template for Caps. The principal schedule represents the Nominal Amount and generates pseudo cashflows as no principal is paid in the case of a cap. Interest schedule is used to generate the caplets. The expression fields contains the formula, the cap value should be put in the Cap field. B.2.1.1.10 Cap and Floor ID: CAP-FLOOR Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 891 B Schedules B.2 Templates Description: Use this template to create a Cap/Floor. The principal schedule represents the Nominal Amount and generates pseudo cashflows as no principal is paid in the case of a cap/floor. Interest schedule is used to generate the caplets. The expression fields contain the formula, the cap and floor values should be put in the Cap and Floor fields. B.2.1.1.11 Collar ID: COLLAR Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template to create Collars. The principal schedule represents the Nominal Amount and generates pseudo cashflows as no principal is paid in the case of a cap/floor. Interest schedule is used to generate the caplets. The expression fields contain the formula, the collar boundaries should be put in the Cap and Floor fields. B.2.1.1.12 Cost of Carry Compounding, Bullet Repayment ID: COC-COMPOUNDING-BULLET Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template for the floating leg of Deferred Rate Settings agreements. B.2.1.1.13 Credit Default Swap ID: CD-SWAP Type: Primary Composition: 1 premium, 1 notional position Linked To: Transaction Description: Use this template to define a Credit Default Swap. B.2.1.1.14 Credit Default Swap, ISDA Standard 892 ID: CD-SWAP-ISDA Type: Primary Composition: 1 premium, 1 notional position Linked To: Transaction Description: Use this template to define a Credit Default Swap with interest dates created on ISDA dates, i.e. quarterly basis on the 20th of March, June, September, and December. © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates B.2.1.1.15 Dual Currency, Known FX Rate ID: DUAL-CURRENCY-KNOWN-FX Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template for dual currency instruments when both interest rate and FX rate are known when the deal is entered. For both interest and principal schedules you can choose a different settlement currency and select the settlement FX rate. B.2.1.1.16 Dual Currency, Known FX Rate, Floating ID: DUAL-CURRENCY-KNOWN-FX-FLOATING Type: Primary Composition: 1 interest, 1, principal Linked To: Transaction Description: Same as above, but for floaters. B.2.1.1.17 Dual Currency, Unknown FX Rate ID: DUAL-CURRENCY-UNKNOWN-FX Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template for dual currency instruments when the settlement FX rate is not known beforehand. For both interest and principal schedules you can choose a different settlement currency. Note that this template covers fixed interest rates only. For floating rates, you also have to use the fixing dates secondary template (see B.2.1.2 Secondary templates on page 900). B.2.1.1.18 Exercise ID: EXERCISE Type: Primary Composition: 1 exercise Linked To: Transaction Description: Use this template for Bermuda Swaptions. Define the exercise periods using dates method and frequency. This template must be used in conjunction with a Knocks secondary template to deal swaptions with barriers (see B.2.1.2 Secondary templates on page 900). Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 893 B Schedules B.2 Templates B.2.1.1.19 Fixed Expression, Bullet Repayment ID: FIXED-EXPRESSION-BULLET Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: TBC B.2.1.1.20 Fixed, Annuity Repayment ID: FIXED-ANNUITY Type: Primary Composition: 1 exercise, 1 principal Linked To: Transaction Description: Use this template for fixed annuity structures. The system computes the amortization amounts in order to have even interest and principal repayment amounts throughout the life of the deal. B.2.1.1.21 Fixed, Bullet Repayment ID: FIXED-BULLET Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Simple fixed rate structure. This template is used for both bullet repayment and amortizing structures. B.2.1.1.22 Floating, Bullet Repayment ID: FLOATING-BULLET Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Same as above, but for floating rate. The expression handles the formula used to fix the rate. A classical expression is "ir + spread%" (see Appendix D Expressions on page 917 for details). B.2.1.1.23 Floor 894 ID: FLOOR Type: Primary Composition: 1 interest, 1 principal © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates Linked To: Transaction Description: Use this template for Floors. The principal schedule represents the Notional Amount as no principal is paid in the case of a floor. Interest schedule is used to generate the floorlets. The expression fields contain the formula; the cap value should be put in the Cap field. B.2.1.1.24 French Index-Linked Bond (OAT) ID: BOND-FR-OATI Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template to define a French Index-Linked Bond (OAT). B.2.1.1.25 Greek Index-Linked Bond ID: BOND-GR-IX Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template to define a Greek Index-Linked Bond. B.2.1.1.26 Guarantee, Fixed underlying ID: GUARANTEE-ON-FIXED Type: Primary Composition: 2 interest, 2 principal Linked To: Transaction Description: TBC B.2.1.1.27 Guarantee, Floating underlying ID: GUARANTEE-ON-FLOATING Type: Primary Composition: 2 interest, 2 principal Linked To: Transaction Description: TBC B.2.1.1.28 Israeli Index-Linked Bond ID: BOND-IL-IX Type: Primary Composition: 1 interest, 1 principal, 1 ex-dates Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 895 B Schedules B.2 Templates Linked To: Transaction Description: Use this template to define an Israeli Index-Linked Bond. B.2.1.1.29 Israeli Index-Linked Bond Galil ID: BOND-IL-IX-GALIL Type: Primary Composition: 1 interest, 1 principal, 1 ex-dates Linked To: Transaction Description: Use this template to define an Israeli GALIL Index-Linked Bond. B.2.1.1.30 Italian Index-Linked Bond (BTP) ID: BOND-IT-BTPI Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template to define an Italian Index-Linked Bond (BTP). B.2.1.1.31 Japanese Index-Linked Bond ID: BOND-JP-IX Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template to define an Japanese Index-Linked Bond. B.2.1.1.32 LPI-Linked Annuity Repayment ID: LPI-ANNUITY Type: Primary Composition: 1 interest, 1 principal, 1 interest premium Linked To: Transaction Description: Limited Price Inflation index linked structure, with annuity repayment and no adjustment of the nominal amount. B.2.1.1.33 Multi Currency, Bullet Repayment 896 ID: MULTI-CCY-BULLET Type: Primary Composition: 1 currency choice, 3 interest, 1 principal © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates Linked To: Transaction Description: Use this template for rainbow coupon structures. At each interest payment, one of up to three coupon flows may be nominated. A currency choice event is linked to them which allows the user to choose the coupon, that is, the coupon in the preferred currency. The principal cashflow is standard. B.2.1.1.34 Revisable, Bullet Repayment ID: REVISABLE-BULLET Type: Primary Composition: 1 interest, 1 principal, 1 revision Linked To: Transaction Description: Revisable cashflow structure. Generates revision events which allow the interest/repayment structure to be changed later. B.2.1.1.35 Revisable, Open-ended, Bullet Repayment ID: REVISABLE-OPEN-END-BULLET Type: Primary Composition: 1 interest, 1 principal, 1 revision Linked To: Transaction Description: Same as above, but with open ended maturity. B.2.1.1.36 RPI-Linked Interest and Capital, Annuity Repayment ID: RPI-FIXED-ANNUITY Type: Primary Composition: 1 interest, 1 principal, 1 interest premium, 1 principal premium Linked To: Transaction Description: Retail Price Index linked structure, annuity repayment. Both interest and nominal are linked to the index. B.2.1.1.37 RPI-Linked Interest and Capital, Bullet Repayment ID: RPI-FIXED-BULLET Type: Primary Composition: 1 interest, 1 principal, 1 interest premium, 1 principal premium Linked To: Transaction Description: Same as above, but with bullet repayment. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 897 B Schedules B.2 Templates B.2.1.1.38 Swedish Index-Linked Bond ID: BOND-SE-RO Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template to define a Swedish Index-Linked Bond. B.2.1.1.39 Swedish Index-Linked ZC Bond ID: BOND-SE-RO-ZERO Type: Primary Composition: 1 principal Linked To: Transaction Description: Use this template to define a Swedish Index-Linked Zero Coupon Bond. B.2.1.1.40 Target Redemption ID: TARGET-REDEMPTION Type: Primary Composition: 1 floating interest, 2 redemption, 3 accumulator, 4 triggered redemption, 5 trigger Linked To: Transaction Description: Schedule template for standard target redemption transactions, i.e. early redemption occurs when a certain accumulated coupon amount is reached, and the accumulated coupon amount is capped. B.2.1.1.41 Target Redemption, Fixed Then Floating ID: TARGET-REDEMPTION-FIXED-THEN-FLOATING Type: Primary Composition: 1 fixed interest, 1 floating interest, 2 redemption, 3 fixed accumulator, 3 floating accumulator, 4 triggered redemption, 5 trigger Linked To: Transaction Description: Similar to the TARGET-REDEMPTION schedule template, with the exception that there is an initial fixed interest period before the floating interest period. The possible early redemptions start at the beginning of the floating interest period. B.2.1.1.42 United Kingdom Index-Linked Gilt (3M) 898 ID: BOND-UK-IG-3M Type: Primary Composition: 1 Coupon, 1 Redemption, 1 Ex Dates © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates Linked To: Transaction Description: Use this template to define a United Kingdom Index-Linked Gilt (3M). See 3.6.16 UK index-linked gilt on page 287. Note: These templates correspond to rounding down to 4 decimal places. B.2.1.1.43 United Kingdom Index-Linked Gilt (8M) ID: BOND-UK-IG-8M Type: Primary Composition: 1 Interest, 1 Redemption, 1 Ex Dates Linked To: Transaction Description: Use this template to define a United Kingdom Index-Linked Gilt (8M). See 3.6.16 UK index-linked gilt on page 287. Note: These templates correspond to rounding down to 4 decimal places. B.2.1.1.44 US Treasury Inflation Protected Security ID: BOND-US-TIPS Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template to define a US Treasury Inflation Protected Security. B.2.1.1.45 XAU, Unknown FX Rate, Fixed ID: XAU-UNKNOWN-FX-FIXED Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template for gold deposit instruments. B.2.1.1.46 Zero-Coupon ID: ZERO-COUPON Type: Primary Composition: 1 interest, 1 principal Linked To: Transaction Description: Use this template to generate a zero coupon cashflow structure. B.2.1.1.47 Zero-Coupon Swap Leg ID: ZERO-COUPON-SWAP-LEG Type: Primary Composition: 1 redemption, 1 redemption premium Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 899 B Schedules B.2 Templates Linked To: Transaction Description: Use this template to generate a cashflow structure for the zero-coupon leg of an IR swap, where the redemption amount is split into pseudo redemption and payable redemption premium. B.2.1.2 Secondary templates Secondary templates are listed hereafter in alphabetical order. B.2.1.2.1 Accreting Dates ID ACCRETING-DATES Type: Secondary Composition: 1 principal Linked To: TBC Description: TBC B.2.1.2.2 Amortization ID AMORTIZATION Type: Secondary Composition: 1 principal Linked To: Principal, Interest Description: Use this template to add an additional amortization structure with a fixed amortization rate. B.2.1.2.3 Amortization, Floating ID FLOATING-AMORTIZATION Type: Secondary Composition: 1 principal Linked To: Principal, Interest Description: Same as above, but with a floating amortization rate (linked to a market variable). B.2.1.2.4 Amortization, To Propagate to Other Legs ID AMORTIZATION-TO-PROPAGATE Type: Secondary Composition: 1 principal Linked To: Principal Description: Use this template for swaps. The amortization structure will automatically be propagated to the other legs of the swap (avoid duplicating amortization structure on both legs). 900 © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates B.2.1.2.5 Call/Put ID CALL-PUT Type: Secondary Composition: 1 transaction event Linked To: Principal, Interest Description: Use this template to generate a call schedule. Effective dates are either copied from the coupon dates (call schedule using Reference method) or generated from the call schedule start date / end date / method (e.g. times per year) / frequency (e.g. 1) For each Effective Date (D) when using offset and offset max: • Event From (EF) = D - Max Offset where Max Offset defaults to Offset if smaller. • Event To (ET) = D - Offset where Offset defaults to 0 if not provided. For each Effective Date (D) when using notification offset and notification max offset: • Notification From = EF - Notification Max Offset where Notification Max Offset defaults to Notification Offset if smaller. • Notification To = ET - Notification Offset where Notification Offset defaults to 0 if not provided. B.2.1.2.6 Call/Put, Referenced ID CALL-PUT-REF Type: Secondary Composition: 1 transaction event Linked To: Interest Description: Same as above, but in this case, the call dates are calculated from the effective dates which are copied from the coupon dates generated off the interest schedule it is linked to. B.2.1.2.7 Capitalizing ID CAPITALIZING Type: Secondary Composition: 1 principal, 1 interest Linked To: Interest, Payment Method Description: Use this as a payment method or as a secondary template in order to capitalize interest. B.2.1.2.8 Capitalizing, with Amortization ID CAPITALIZING-WITH-AMORT Type: Secondary Composition: 2 principal, 1 interest Linked To: Interest Description: Same as above, but with amortization. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 901 B Schedules B.2 Templates B.2.1.2.9 Compounding ID COMPOUNDING Type: Secondary Composition: 1 interest Linked To: Interest, Payment Method Description: Use this template to compound interest. B.2.1.2.10 Compounding, with special Fixing Offset ID COMPOUNDING-FIXING-OFFSET Type: Secondary Composition: 1 interest, 2 Payment Dates Linked To: Interest, Payment Method Description: Use this template to compound interest with a different Fixing Offset for floating cashflows ending on payment dates. B.2.1.2.11 Convertible Conversion ID: CONVERTIBLE-CONVERSION Type: Secondary Composition: 1 transaction conversion Linked To: Transaction Description: Use this template to add a transaction conversion option to a convertible bond. B.2.1.2.12 Currency Conversion ID CURRENCY-CONVERSION Type: Secondary Composition: 1 event Linked To: Principal, Transaction Event Description: Use this template to add a currency conversion option on redemption or call events. B.2.1.2.13 Delaying 902 ID DELAYING Type: Secondary Composition: 1 interest, 1 principal Linked To: Interest Description: This template is similar to Capitalizing, except that the interest does not become capital. © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates B.2.1.2.14 Ex Dates ID EX-DATES Type: Secondary Composition: 1 dates Linked To: Principal, Interest Description: Use this in order to compute ex coupon and/or principal dates. The Offset field holds the number of calendar days on which the ex date occurs before the value date. B.2.1.2.15 Fixing Dates ID FIXING-DATES Type: Secondary Composition: 1 date Linked To: Interest Description: Use this to compute additional set of fixing dates for a set of interest flows. This is useful to model floating rate / unknown FX rate dual currency structures. B.2.1.2.16 Interest, Fixed ID FIXED-INTEREST Type: Secondary Composition: 1 interest Linked To: Interest Description: Creates an additional interest schedule. When several interest schedules are present, they can be in parallel, in sequence, overlapping, and so on. B.2.1.2.17 Interest, Fixed Annuity ID FIXED-ANNUITY-INTEREST Type: Secondary Composition: 1 interest Linked To: Interest Description: Creates an additional interest schedule for a fixed annuity. B.2.1.2.18 Interest, Fixed, In Sequence ID FIXED-INTEREST-SEQ Type: Secondary Composition: 1 interest Linked To: Interest Description: Creates an additional interest schedule for fixed interest in sequence. This can be used to move from a floating rate to a fixed rate from a specified date. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 903 B Schedules B.2 Templates B.2.1.2.19 Interest, Fixed, Referenced ID FIXED-INTEREST-REF Type: Secondary Composition: 1 interest Linked To: Interest Description: Same as above, but in this case, the dates are copied from the parent schedule and cannot be changed. The two parallel interest schedules have the same dates and periods. B.2.1.2.20 Interest, Fixed, Up-Front ID FIXED-UP-FRONT-INTEREST Type: Secondary Composition: 2 interest Linked To: Interest Description: Use this template to create an interest schedule where all the coupons are paid at the beginning of the deal. B.2.1.2.21 Interest, Fixed, Up-Front, Referenced ID FIXED-UP-FRONT-INTEREST-REF Type: Secondary Composition: 2 interest Linked To: Interest Description: Same as above, but with referenced dates. B.2.1.2.22 Interest, Floating ID FLOATING-INTEREST Type: Secondary Composition: 1 interest Linked To: Interest Description: Same as fixed interest, but for floating rates. B.2.1.2.23 Interest, Floating, In Sequence ID FLOATING-INTEREST-SEQ Type: Secondary Composition: 1 interest Linked To: Interest Description: Same as above, but in sequence with the reference schedule. This means that the interest flows take effect when the reference schedule stops. 904 © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates B.2.1.2.24 Interest, Floating, Referenced ID FLOATING-INTEREST-REF Type: Secondary Composition: 1 interest Linked To: Interest Description: Same as above, but in this case, the additional floating schedule is strictly parallel. B.2.1.2.25 Interest, LPI-Linked ID LPI-INTEREST Type: Secondary Composition: 1 interest Linked To: Interest Description: Same as interest floating, except that the expression is related to the Limited Price Inflation Index. B.2.1.2.26 Interest, LPI-Linked Annuity ID LPI-ANNUITY-INTEREST Type: Secondary Composition: 1 interest Linked To: Interest Description: Same as Interest LPI-Linked, except that it is used for an annuity. B.2.1.2.27 Interest, RPI-Linked ID RPI-INTEREST Type: Secondary Composition: 1 interest Linked To: Interest Description: Same as above, except that the expression is related to the Retail Price Index. B.2.1.2.28 Knock-In ID KNOCK-IN Type: Secondary Composition: 1 event Linked To: Interest, Transaction Event Description: This template has to be used to model activating barriers. When it is attached to a schedule, the linked cashflows become inactive and in-triggerable. Activating barriers can be used with call/puts, swaptions, caps, floors, and collars, or transaction conversions. If the expression includes a condition such as "rate > x", this means it is an "up-in". If the expression includes a condition such as "rate < x", this means it is a "down-in" barrier. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 905 B Schedules B.2 Templates B.2.1.2.29 Knock-In with Rebate ID KNOCK-IN-REBATE Type: Secondary Composition: 1 event, 1 rebate Linked To: Interest, Transaction Event Description: Same as above, but with a linked rebate. The rebate will be triggered out if the barrier is activated, otherwise it remains active. B.2.1.2.30 Knock-Out ID KNOCK-OUT Type: Secondary Composition: 1 event Linked To: Interest, Transaction Event Description: Same as Knock-in, but for a de-activating barrier. B.2.1.2.31 Knock-Out with Rebate ID KNOCK-OUT-REBATE Type: Secondary Composition: 1 event, 1 rebate Linked To: Interest, Transaction Event Description: Same as above, but with a rebate. The rebate becomes active as soon as the barrier condition is met. B.2.1.2.32 Margin ID MARGIN Type: Secondary Composition: 1 margin Linked To: Interest Description: Enables the calculation of margin results for long term loan transactions. When this schedule is used, the transaction margin results in a (Not Payable and Not Bookable) Margin cashflow being created for the transaction. B.2.1.2.33 Payment Dates ID PAYMENT-DATES Type: Secondary Composition: 1 interest Linked To: Principal, Interest, Payment Method Description: Use this secondary template in order to shift the payment dates for a set of cashflows. This template can be used, for example, to pay annually or quarterly coupons. 906 © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates B.2.1.2.34 Principal Increase ID PRINCIPAL-INCREASE Type: Secondary Composition: 1 principal Linked To: Principal, Interest Description: Use this template in order to generate principal increase flows with a fixed amount. B.2.1.2.35 Principal Increase, Floating ID FLOATING-PRINCIPAL-INCREASE Type: Secondary Composition: 1 principal Linked To: Principal, Interest Description: Same as above, but the principal increase amount is floating. B.2.1.2.36 Principal Increase, RPI-Linked ID RPI-PRINCIPAL-INCREASE Type: Secondary Composition: 1 principal Linked To: Principal, Interest Description: Same as above, but the principal increase amount is floating and linked to the UK Retail Price Index. B.2.1.2.37 Principal Increase, with Amortization ID PRINCIPAL-INCREASE-WITH-AMORT Type: Secondary Composition: 2 principal Linked To: TBC Description: This template is the same as Principal Increase, but with amortization. B.2.1.2.38 Redemption Premium ID REDEMPTION-PREMIUM Type: Secondary Composition: 1 principal Linked To: Principal, Interest Description: Generates a redemption premium flow with a known fixed amount. B.2.1.2.39 Redemption Premium, Floating ID FLOATING-REDEMPTION-PREMIUM Type: Secondary Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 907 B Schedules B.2 Templates Composition: 1 principal Linked To: Principal, Interest Description: Same as above, with a floating amount. B.2.1.2.40 Referee, Floating ID FLOATING-REFEREE Type: Secondary Composition: 1 cashflow event Linked To: Event Description: This template allows you to specify a floating market reference which is used in the expression of the linked cashflow. If this template is used, it is possible to have several market references taken into account to fix the effective interest flow. B.2.1.2.41 Transaction Conversion, to Fixed Interest ID TRANSACTION-CONVERSION-FIXED Type: Secondary Composition: 1 transaction event Linked To: Principal, Interest Description: This template generates an optional transaction conversion to a fixed interest structure. B.2.1.2.42 Transaction Conversion, to Fixed Interest, Referenced ID TRANSACTION-CONVERSION-FIXED-REF Type: Secondary Composition: 1 transaction event Linked To: Principal, Interest Description: Same as above, except that the transaction conversion dates are copied from the original cashflow structure. B.2.1.2.43 Transaction Conversion, to Floating Interest ID TRANSACTION-CONVERSION-FLOATING Type: Secondary Composition: 1 transaction event Linked To: Principal, Interest Description: This template generates an optional transaction conversion to a floating interest structure. B.2.1.2.44 Transaction Conversion, to Floating Interest, Referenced 908 ID TRANSACTION-CONVERSION-FLOATING-REF Type: Secondary © Wall Street Systems IPH AB - Confidential B Schedules B.2 Templates Composition: 1 transaction event Linked To: Principal, Interest Description: Same as above, but the transaction conversion dates are copied from the original cashflow structure. B.2.1.2.45 Trigger ID TRIGGER Type: Secondary Composition: 1 Event Linked To: Interest, Event Description: Links an event (typically a call event) to a trigger. If the trigger condition is fulfilled, the linked event is executed automatically. B.2.1.2.46 Up-Front Discounting ID UP-FRONT Type: Secondary Composition: 1 interest Linked To: Interest, Payment Method Description: TBC B.2.1.2.47 Value Dates ID VALUE-DATES Type: Secondary Composition: 1 interest Linked To: Interest, Principal Description: Use this template to shift value dates for a set of cashflows. B.2.2 User-defined templates TRM is delivered with a set of system-defined templates. However, it is also possible for users to define their own templates but with some constraints: • User-defined templates must be derived from a system template • The default setup for system-defined templates cannot be changed when the user templates are created. There are two advantages to creating user templates from system templates: • Ability to customize templates by pre-defining some parameters • Possibility of pre-packaging complex structures by combining primary and secondary templates. (This is necessary for the definition of bonds, as dynamic packaging is not available.) When a user template is defined, it initially inherits all the values from the system template on which it is based: cashflow structure, defaulting rules, and frozen parameters. Apart from frozen values which cannot be modified, the default and optional standard system values within the system template can be changed by the user, for example, they can be set to frozen or made mandatory. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 909 B Schedules B.3 Schedule template groups The system template’s parameters are copied to the user template. This means that there is no dependency between the structures. This is also the case when a template (system-defined or user-defined) is applied to a deal or an instrument. All the information contained in the template is copied at instrument or deal level. If a template is changed or deleted at a later date, there is no impact on any of the instruments or deals that are already in the system. Note: Setting up user templates is not a mandatory step. It is possible to set up all instruments using system templates alone. B.3 Schedule template groups Schedules can be organized into groups according to their category or function. There are two main advantages to grouping schedules: schedule groups can be used to restrict availability of the templates, and also can be used to make the template list easier to navigate. When a schedule group is defined, it is possible to restrict the availability of the group to instrument setup only. This ensures that the group (and therefore the schedules within the group) is not available for selection at transaction level. At instrument setup, a schedule-related feature can be added to the instrument. This allows the user to assign one or more schedule groups to the instrument. When this is done, only the schedules that belong to those groups are accessible at deal entry. Groups can also aid navigation of the schedule template list, especially at deal entry. When a user wishes to apply a schedule to a transaction, only the names of the available groups are displayed initially. This means that instead of needing to search through an extensive list of individual template names, the user can simply navigate to the appropriate group and then select the required schedule. Note: Any schedules that have not been organized into a group are placed into an unclassified group. 910 © Wall Street Systems IPH AB - Confidential Appendix C Option schedules In TRM, an option schedule drives the creation of the exotic structure of an FX Option. Option schedules are directly used to generate the structure cashflows for instruments belonging to the FX Option/Exotic instrument class. The option schedule can be associated to the instrument (setup level) or at deal entry. An option schedule contains a number of values that determine how a set of cashflows are generated. The information that can be defined in an option schedule is explained in the following section. C.1 Option schedule parameters This section describes the information that can be specified at option schedule level to determine how a set of cashflows or events are generated. Not all parameters are relevant to all types of cashflows. Information Description Id Unique identifier of the option schedule, it is automatically assigned by the system. Reference Schedule ID of the parent schedule from which the current option schedule is derived. Category Category of the cashflow: Payback (for Rebate cashflow). Description Descriptive name for the option schedule, provided by the user. Group Logical group the option schedule belongs to: if the option schedule is deleted, all members of its group are deleted too. Option/Trigger Type Category of the event: In: If the trigger level is reached (expression valid), the option is activated. Out: If the trigger level is reached, the option expires. Main Type Main type of the cashflows to be generated: Event, Transaction Event, Cashflow (P/L for Rebate), and so on. Type Generated cashflow type belonging to the main type, for example, for example: Knock, Exercise, Rebate. Additional cashflow types can be added using Cashflow Type Editor. Kind Kinds to be set on the generated cashflows; each cashflow can have one or more of the following kinds attached: • Inactive: Cashflow is not taken into account. • In-Triggerable: If the Trigger In is activated, the cashflow becomes active. • Out-Triggerable: If the Trigger Out is activated, the cashflow becomes inactive. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 911 C Option schedules C.1 Option schedule parameters Information Description Method Used to define the frequency of the generated cashflows (to be used with Frequency) • Bullet: Only one flow at the end of the option schedule period • Business Days: One flow every Frequency business day • Days: One flow every Frequency day • Last of Month: One flow the last day of every Frequency month • Months: One flow every Frequency month • Times/Year: defined Frequency determines how many times per year • Weeks: One flow every Frequency week • Years: One flow every Frequency year Frequency Number of time units (to be used with Method). Roll From Start Yes or No. When set to Yes, dates are calculated from Start Date rather than End Date. Rate Type Convention Rate type is used to interpret the value in the Rate field. Convention to follow to adjust payment date: • Backward: Previous business day • Business Days: Next business day (same as Following) • Following: Next business day • Modified Backward: Previous business day except if not in the same month (next in this case) • Modified Following: Next business day except if not in the same month (previous in this case) • None: No adjustment Calendar Calendar used for adjustment purposes. Holiday Calendar Additional calendar to supplement the calendar you specify in the Calendar field. Fixing Date Method Impacts the calculation of fixing dates: • In Arrears: Fixing occurs at the end of the interest/event period, i.e.; fixing from/to dates are calculated from the period end date • In Advance: Fixing occurs at the beginning of the interest/event period, i.e.; fixing from/to dates are calculated from the start date • Entire Period: Fixing occurs during the interest/event period, i.e.; fixing from is calculated from start date and fixing to from end date • Based on Previous: Fixing occurs at/around the previous similar event, i.e.; fixing from/to calculated as of the date of the previous event (or schedule start date for the first event). Fixing Offset Minimum number of days’ offset allowed for fixing (default is 0). Fixing Max Offset Maximum number of days’ offset allowed (default is Fixing Offset above). Expression Expression used to specify the barrier. Fixing Rate Currency pair to be used for fixing. Fixing Period Length of time for which fixing is to be executed (for example, SPOT). Fixing Subscenario Subscenario from which the exchange rate is retrieved. 912 © Wall Street Systems IPH AB - Confidential C Option schedules C.2 Templates C.2 Templates Option Templates are used to create the exotic structure of a FX Option deal. These templates can be attached to the transaction or associated to an instrument. Assigning a template defines an additional cashflow structure of the deal. In addition to the cashflow structure and some default schedule parameters, templates also contain information about the availability of the parameters, if the parameters are mandatory, and if any rules default from these parameters. TRM is delivered with a set of system-defined templates. However, it is also possible for users to define their own templates but with some constraints: • User-defined templates must be derived from a system template • The default setup for system-defined templates cannot be changed when the user templates are created. C.2.1 System-defined templates TRM provides some pre-packaged templates which need to be used as a basis for creating user-defined templates. System-defined templates can be divided into two logical categories: • Barrier templates are used for defining Barrier on FX Option (Knock) • Option Exercise templates are used to generate events for exercise of exotic options. C.2.1.1 Up-In ID UP-IN Category: Barrier Composition: 1 event Linked To: Transaction Description: Should be used to define an up and in barrier option. C.2.1.2 Down-In ID DOWN-IN Category: Barrier Composition: 1 event Linked To: Transaction Description: Should be used to define a down and in barrier option. C.2.1.3 Up-Out ID UP-OUT Category: Barrier Composition: 1 event Linked To: Transaction Description: Should be used to define an up and out barrier option. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 913 C Option schedules C.2 Templates C.2.1.4 Down-Out ID DOWN-OUT Category: Barrier Composition: 1 event Linked To: Transaction Description: Should be used to define a down and out barrier option. C.2.1.5 Up-Out with Rebate ID UP-OUT-REBATE Category: Barrier Composition: 1 event Linked To: Transaction Description: Should be used to define an up and out barrier option with a rebate. C.2.1.6 Down-Out with Rebate ID DOWN-OUT-REBATE Category: Barrier Composition: 1 event Linked To: Transaction Description: Should be used to define a down and out barrier option with a rebate. C.2.1.7 Rebate for Knock-In ID REBATE-FOR-KNOCK-IN Category: Barrier Composition: 1 event Linked To: Transaction Description: Should be used when you want to associate a rebate payment to the non realization of any knock in barrier. C.2.1.8 Exercise 914 ID: EXERCISE Category: Option Exercise Composition: 1 exercise Linked To: Transaction Description: Should be used to define a Bermuda FX Option. © Wall Street Systems IPH AB - Confidential C Option schedules C.3 Option schedule template groups C.2.1.9 Compound Exercise ID: COMPOUND-EXERCISE Category: Option Exercise Composition: 1 exercise Linked To: Transaction Description: Should be used to define a Compound FX Option. C.2.2 User-defined templates TRM is delivered with a set of system-defined templates. However, it is also possible for users to define their own templates but with some constraints: • User-defined templates must be derived from a system template • The default setup for system-defined templates cannot be changed when the user templates are created. Note: Note that setting up user templates is not a mandatory step. It is possible to set up all instruments/deals using system templates alone. There are three advantages to creating user templates from system templates: • Ability to customize templates by pre-defining some parameters • Possibility of pre-packaging complex structures • Possibility to create composite template structures like double barriers, in and out barriers (corridors), with or without rebates, bermuda barrier options and so on. When a user template is defined, it initially inherits all the values from the system template on which it is based: cashflow structure, defaulting rules, and frozen parameters. Apart from frozen values which cannot be modified, the default and optional standard system values within the system template can be changed by the user, for example, they can be set to frozen or made mandatory. The system template’s parameters are copied to the user template. This means that there is no dependency between the structures. This is also the case when a template (system-defined or user-defined) is applied to a deal. All the information contained in the template is copied at deal level. If a template is changed or deleted at a later date, there is no impact on any of the deals that are already in the system. Note: It is also possible to create these complex structures by combining several simple templates at deal entry: It is possible to add as many templates as you want to a deal. C.3 Option schedule template groups Option Schedules can be organized into groups according to their category or function. There are two main advantages to grouping option schedules: option schedule groups can be used to restrict availability of the templates, and also can be used to make the template list easier to navigate. When an option schedule group is defined, it is possible to restrict the availability of the group to instrument setup only. This ensures that the group (and therefore the schedules within the group), are not available for selection at transaction level. At instrument setup, an option schedule-related feature can be added to the instrument. This allows the user to assign one or more option schedule groups to the instrument. When this is done, only the option schedules that belong to those groups are accessible at deal entry. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 915 C Option schedules C.3 Option schedule template groups Groups can also aid navigation of the option schedule template list, especially at deal entry. When a user wishes to apply an option schedule to a transaction, only the names of the available groups are displayed initially. This means that instead of needing to search through an extensive list of individual template names, the user can simply navigate to the appropriate group and then select the required option schedule. Note: Any option schedules that have not been organized into a group are placed into an unclassified group. 916 © Wall Street Systems IPH AB - Confidential Appendix D Expressions D.1 Expression syntax Expressions need to be logically formulated. If the expression syntax is incorrect, an error message is displayed. The maximum expression length is 256 characters. D.2 Market references in expressions Market references can be used in expressions either with or without Fixing Quote. Fixing Quote is the market variable quote taken from Rate Monitor, and is used to calculate the cashflow fixing price and amount. D.2.1 Using Fixing Quote Only one of the below-mentioned market references can be used, either once or several times, in the expression. This is because these references share the Fixing Quote value. The Fixing Quote value is populated on fixing from the rates as they can be seen in Rate Monitor. D.2.1.1 Interest rate market reference - ir (same as r) ir (‘Fixing Rate’,’Fixing Period’[,’Subscenario’[, rounding]]) • ir Uses cashflow Fixing Rate, Fixing Period, Subscenario, no rounding (that is, 0) • ir (rounding) As above but using the specified rounding (for example, 0.0001) D.2.1.2 Constant maturity swap rate market reference - cms The syntax is the same as ir (see previous). The difference is on the valuation side only (convexity adjustment). D.2.1.3 Interest rate market reference interpolation - iri iri (‘Fixing Rate’,’Fixing Period_1’, ’Fixing Period_2’, [rounding[,’Subscenario’[, factor]]]) • iri Uses cashflow Fixing Rate, Fixing Period, Fixing Period_2, Subscenario, no rounding (that is, 0) and calculates the factor • iri (rounding) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 917 D Expressions D.2 Market references in expressions D.2.1.4 FX spot market reference - fx fx (‘Currency_1’, ‘Currency_2’ [,’Subscenario’[, rounding]]) • fx Uses cashflow Fixing Rate, Subscenario, no rounding (that is, 0), Fixing Rate is entered like EUR/USD • fx (rounding) As above but using the specified rounding (for example, 0.0001) Note: Specifying EUR/USD in Fixing Rate for an expression like fx (or fx(‘EUR’,’USD’)) returns the inverse of when USD/EUR (or fx(’USD’,‘EUR’)) is specified. D.2.1.5 Index market reference - ix ix (‘Fixing Rate’[,’Subscenario’[, rounding]]) • ix Uses cashflow Fixing Rate, Subscenario, no rounding (that is, 0), Fixing Rate like EURSTOXX50 • ix (rounding) As above but using the specified rounding (for example, 0.0001) D.2.2 Not using Fixing Quote Several of the market references described below can be used in the expression, however, the Fixing Quote is not used. This is because each reference gets its value on fixing directly from the rates as seen in Rate Monitor. The rates cannot be modified. Note: "m"-suffixed market variables should not be combined with non "m"-suffixed ones. D.2.2.1 Interest rate market reference - irm irm (‘Fixing Rate’,’Fixing Period’[,’Subscenario’[, rounding]]) For example: – Libor Spread: factor*max(0,irm('EUR-EURIBOR','6M')-irm('EUR-EURIBOR','3M')) D.2.2.2 Constant maturity swap rate market reference - cmsm The syntax is the same as irm. The difference is on the valuation side only. For example: – CMS Spread: factor*max(0,irm('EUR-CMS','10Y')-irm('EUR-CMS','2Y')) D.2.2.3 Interest rate market reference interpolation - irim irim (‘Fixing Rate’,’Fixing Period_1’, ’Fixing Period_2’, [rounding[,’Subscenario’[, factor]]]) 918 © Wall Street Systems IPH AB - Confidential D Expressions D.3 Constants in expressions D.2.2.4 FX spot market reference - fxm fxm (‘Fixing Rate’[,’Subscenario’[, rounding]]) For example: – FX basket linked: fxm('EUR','JPY')/110-1+fxm('EUR','USD')/1.2-1+fxm('EUR','GBP')/1.5-1 D.2.2.5 Index market reference - ixm ixm (‘Fixing Rate’[,’Subscenario’[, rounding]]) D.3 Constants in expressions Constants can be used in the expression where they are basically replaced by their value given in the cashflow: • spread • factor • divider • cap • floor • face_value Units * Trading Unit Size of the transaction (cashflow) • nominal The Nominal Amount of the transaction • origin The amount that when multiplied by the Nominal Rate gives the amount: (outstanding_nominal * days/basis for Interest types, nominal for Principal types) • q (same as quote) The Fixing Quote, used for an expression-based (but known from the outset) cashflow amount For example: • – Plain-vanilla floater: ir+spread% – Reverse floater: max(floor%,spread%-ir) years, days Functions 'years' and 'days' can be used in expressions to provide the time between the From When and Until When dates of the cashflow, according to the date basis used. For example, 'origin/years' provides the (outstanding) Nominal Amount based on which the amount on an Interest cashflow is calculated. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 919 D Expressions D.4 Functions in expressions D.4 Functions in expressions D.4.1 Basic functions • % Divides by 100 • mod(i, j) (resp div(i, j)) Provides the result of the integral division (in respect to the quotient) • round(value, rounding[, rounding_method]) Rounds according to specified rounding: for example, 0.0001, Rounding Method = 0: nearest, 1: upwards, -1: downwards (default is 0) For example: – • round(1.234, 0.01) = 1.23 whereas round(1.234, 0.01, 1) = 1.24 round(value, “amount_rounding”) Rounds according to the specified cashflow amount rounding. Amount Rounding and Rounding Method work together. For example: – round(1.234, "amount_rounding") = 1.23 where the Amount Rounding column at (Bond) Schedule level is 0.01 • round_by_unit(value, rounding[, rounding_method]) or round_by_unit(value, "amount_rounding") Returns: – Value if not denominated, that is, no rounding – “units” * round(value / “units”, “amount_rounding”) if denominated For example: – For an RPI Redemption premium: -round_by_unit(face_value*(ixuk/divider-1),"amount_rounding")/face_value = 1,000*round(10M*1.234%/1,000, 0.01)/10M = 1,000*round(123.4546) assuming face_value is 10M, ixuk 101.234, divider 100, amount rouding 0.01 and Trading Unit 10,000 (so units = 1,000) • min(value_1, value_2[, value_3, …]), max(value_1, value_2[, value_3, …]) • if(test_condition, value_1[, value_2]) test_condition like ir==2%, ir>2% (can include and, or) • abs() Returns the absolute value (without its sign) of the constant or expression. For example: – To return the absolute value of the amount in the previous cashflow, use the expression abs(previous_amount). • year("value_date") extracts the year from a date. • month("value_date") extracts the month from a date. • day("value_date") extracts the day from a date. 920 © Wall Street Systems IPH AB - Confidential D Expressions D.4 Functions in expressions D.4.2 Referring functions D.4.2.1 previous_* Referring back within the schedule cashflows, for example, to refer to a previously fixed value to enable a sticky type of comparison (such as, sticky coupons). When there is no previous value (for example, when it is the first cashflow), a NULL value is returned. When this expression is added to another, this also results in a NULL value. However, this does not happen when used as follows: isnull(previous, 0) or max(0, previous). • previous = Previous Nominal Rate • previous_q = Previous Fixing Quote • previous_amount = Previous Amount • previous_sum = Sum of all previous Nominal Rate(s) • previous_q_sum = Sum of all previous Fixing Quote(s) • previous_amount_sum = Sum of all previous Amount(s) For all of these functions, you can use (nth-back) to go back n steps rather than just 1 (for example, (previous(1) + previous(2))/2). Note that previous is equivalent to previous(1). For example: – Sticky capped and floored reverse floater: max(previous+floor%, min(previous+cap%, ir+spread%)), ensuring that each price is not lower than the previous price plus a floor% and not higher than the previous price plus a cap%. – Payoff linked to an Index performance: ix/isnull(previous_q,factor)-1. As for the first interest, there is no previous_q factor (initial index) used. D.4.2.2 referee_* and reference_* Referring to the reference or referee schedule cashflow/event. • • referee_* gets the value of a specific cashflow/event of the referee schedule containing the expression. – referee = Nominal Rate (=fixing_price) – referee_q = Fixing Quote (=fixing_quote) – referee_amount = Amount (=amount) – referee_origin = Origin Value (=origin_value, that is, the transaction's Nominal Amount for principal cashflows, or the average outstanding nominal amount for interest cashflows) reference_* same as referee_*, but works in the opposite direction. In other words reference_* gets the value of a specific cashflow/event of the reference schedule containing the expression. – reference – reference_q – reference_amount – reference_origin Note that in the case of chains of reference schedules or multiple direct referee schedules, it is possible to use numbers to define the exact reference or referee schedule. For example, 'reference(2)' gets the value of a specific cashflow/event of the reference schedule of the reference schedule (i.e. the system looks for a cashflow/event two levels up in the chain of reference Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 921 D Expressions D.4 Functions in expressions schedules). Note that reference(1) is equivalent to reference. For example, ’referee(2)' gets the value of a specific cashflow/event of the referee schedule that was created as the second direct referee schedule. Note that referee(1) is equivalent to referee. For example: – Payoff linked to the average of Libor at beginning and end of period: (ir+referee)/2 where the referee expression is ir and fixed in arrears. – Payoff linked to a Libor times range accrual on Libor: referee*range where the referee expression is ir and both the range and the referee ir are linked to the same Libor reference. – Propagated amortization to leg 2 in a swap: reference_amount*origin/reference_origin, reference_amount/reference_origin is the amortized % and multiplied by origin it gives the leg 2 amount pro-rata the leg notional. D.4.2.3 “ ” operator Referring to a field within the cashflow. This function is available for numeric and date types. The database ID of the field needs to be given, not the column label. For example: – “units”, “amount_rounding”, and so on. D.4.3 Special functions D.4.3.1 UK RPI index market reference - ixuk The only difference between ix() and ixuk, is that ixuk implies an eight month time lag between the cashflow Until When date and the observation date. • ixuk or ixuk(months lag, ['Fixing Rate'[,'Subscenario'[, rounding]]]) Where months lag defaults to 8. Uses the cashflow Fixing Rate, Subscenario, no rounding (that is, 0), Fixing Rate such as GBP RPI. The observation date is calculated as the first calendar day of the month being "months lag" months before the Until When date. For example: – interest period [15/06/2006, 15/12/2006], Expression ixuk, Fixing Offset 210 calendar days, the observation date is 01/04/2006. The Fixing To date here is independent and the date on which the quote will be read, typically set on 15/05/2006. • ixuk_f or ixuk_f(months lag, [‘Fixing Rate’[,’Subscenario’[, rounding]]]) Where months lag defaults to 1. This calculates the time lag back from the Fixing To date. The observation date is calculated as the first calendar day of the month being “months lag” months before the Fixing To date. This is typically used when the index is to be observed once a year, but valid for two semi-annual interests. In this case, the expression would be ixuk_f. However, one flow would have 210 days fixing offset, but the next one would have 390 days, so they get fixed on the same date. 922 © Wall Street Systems IPH AB - Confidential D Expressions D.4 Functions in expressions For example: – interest period [15/06/2006, 15/12/2006], Expression ixuk_f, Fixing Offset 210 calendar days. The Fixing To date here is 15/05/2006 so the observation date is 01/04/2006. • ixukm and ixukm_f for multiple indices Note: – The feature INDEX-UK has to be applied to the instrument: see A.2.216 Index - UK Index Function on page 822). – In the Trading Yield page, INDEX-UK must be selected as the Yield Convention to obtain the prevailing price/yield conversion. – In the Fixed Setup page, Expression Estimate must be selected in the Amount Estimation Method field in order to obtain the estimated figure amount. D.4.3.2 Index lag This function is used to read an index quotation and enables the time lag to be specified. • ixlag(n) Identifies an index value with a lag of n months from the until_when date (normally the same as the value_date) of the cashflow. • ixlagm(n) Same as above but allowing multiple index references in a single expression in a similar style to "irm" versus "ir". • ixlag_f(n) Identifies an index value with a lag of n months from the fixing_to date of the cashflow. • ixlagm_f(n) Same as above but allowing multiple index references in a single expression in a similar style to "irm" versus "ir". • ixlag_d(n) Identifies an index value with a lag of n days from the until_when date (normally the same as the value_date) of the cashflow. For example: ixlag_d/divider*price where ixlag_d = lagged index value of one day, divider = index value on the transaction’s opening date inserted on deal capture, and price = quoted bond price • ixlagm_d(n) Same as above but allowing multiple index references in a single expression in a similar style to "irm" versus "ir". • ixlag_d_f(n) Identifies an index value with a lag of n days from the fixing_to date of the cashflow. • ixlagm_d_f(n) Same as above but allowing multiple index references in a single expression in a similar style to "irm" versus "ir". For example: Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 923 D Expressions D.4 Functions in expressions – Using the 1 month backward index from the cashflow value date, where the fixing is in arrears: ixlag(1) providing the index in the Fixing Rate column – Using the delta between the 3M and the 1M backward index (floored at 0) from the cashflow value date, where the fixing is in arrears: max(0, ixlagm(3,'IX-US') - ixlagm(1,'IX-US')) providing the index in the Fixing Rate column Note: ixlag_d is automatically present in the schedule used to define Brazilian FX-Linked (NBC) instruments (see 3.6.7 Brazilian FX-linked NBC-E/NTN-D on page 271). For other instruments, the feature INDEX-LAG needs to be applied to the instrument setup: see A.2.209 Index - Lagged Index Function on page 818). D.4.3.3 FX lag This function is used to read an FX quotation and enables the time lag to be specified. It is used in the same way as the Index lag function (see D.4.3.2 Index lag on page 923). • fxlag(n) Identifies an FX value with a lag of n months from the until_when date (normally the same as the value_date) of the cashflow. • fxlagm(n) Same as above but allowing multiple FX references in a single expression in a similar style to "irm" versus "ir". • fxlag_f(n) Identifies an FX value with a lag of n months from the fixing_to date of the cashflow. • fxlagm_f(n) Same as above but allowing multiple FX references in a single expression in a similar style to "irm" versus "ir". • fxlag_d(n) Identifies an FX value with a lag of n days from the until_when date (normally the same as the value_date) of the cashflow. • fxlagm_d(n) Same as above but allowing multiple FX references in a single expression in a similar style to "irm" versus "ir". • fxlag_d_f(n) Identifies an FX value with a lag of n days from the fixing_to date of the cashflow. • fxlagm_d_f(n) Same as above but allowing multiple FX references in a single expression in a similar style to "irm" versus "ir". For example: – max (0, fxlagm (3, 'EUR', 'USD') - fxlagm (1, 'EUR', 'USD')) Note: – 924 The feature FX-LAG has to be applied to the instrument: see A.2.179 FX - Lagged FX Function on page 799). © Wall Street Systems IPH AB - Confidential D Expressions D.4 Functions in expressions D.4.3.4 Index Ratio - ixratio Function ixratio calculates the ratio between the current CPI value and the instrument's issue index value. D.4.3.4.1 Generic calculation Current CPI value is: Equation D-1 Current CPI value dc – 1 v c = v 1 + -------------- ( v 2 – v 1 ) m 5 where • v1 is the CPI index value for the month three months before the month where the value date of the cashflow falls • dc is the day number of the value date of the cashflow • m is the number of days in the month that is three months before the value date • v2 is the CPI index value for the month that is two months before the value date • []5 means rounding to 5 decimal places. The value of ixratio is then: Equation D-2 ixratio value v ----cv0 5 where v0 is the value in the divider column of the cashflow. D.4.3.4.2 Calculation for Australian index-linked bonds If the instrument has feature Australian Index Linked, Australian Index Linked Annuity, or Australian Index Linked Annuity (Round to 3), then ixratio is calculated differently. The formula is: Equation D-3 ixratio - Australian index-linked bonds Π [ [ 0.5 ( v i ⁄ v i – 2 – 1 ) ] 4 + 1 ] 4 where the product is taken over all quarters starting from the quarter that is two quarters before the first coupon's value date and ending at the quarter that is two quarters before the value date of the cashflow, and v2 is the CPI value for the ith quarter. Note: The rounding (to four decimal places) is carried out on real numbers, not percentage, corresponding to rounding to two decimal places on percentage. D.4.3.4.3 Calculation for Israeli index-linked bonds If the instrument has the feature Index Rebase (Index-Linked Bond), the Index Ratio takes into account the rebased index at issue and and the latest index value. For Israeli index-linked bond the Index Ratio is rounded to 7 decimals Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 925 D Expressions D.4 Functions in expressions The index ratio is calculated as the current index value (Index column) divided by the rebased Index at Issue (Index at Issue column): Equation D-4 ixratio - Israel index-linked bonds Where – V1 is the current value of the reference index on the transaction's value date (Index column). – ixrb1 is the the rebased Index at Issue. D.4.3.5 Instrument-specific index - iix This is used to retrieve the index price from Rate Monitor for a specific instrument. It functions in the the same way as function ix, except that iix fetches the index value instead of the price. Note: iix should only be used with Brazilian LFT instruments. Example – To use the index value to fix the redemption flow of a Brazilian LFT Bond: iix/trading_unit D.4.3.6 Swedish CPI market reference - ixse Calculates the CPI reference for the end date of the fixing period of the cashflow. Equation D-5 ixse - Swedish CPI market reference d–1 v = v 1 + ------------ ( v 2 – v 1 ) 30 where • v1 is the index value for the month that is three months before the given date • v2 is the index value for the month that is two months before the given date • d is the day of the month number of the date. D.4.3.7 Price - price Returns the fixing price of the cashflow. D.4.3.8 Instrument quotes - iq This is used to define expressions that refer to instrument quotes (that is, prices or rates). For example: – Using the price of an equity as the reference rate in the definition of a triggered convertible bond. This can be used when conversion of a bond (to equity) occurs "automatically" if the price of the equity reaches a certain level: iq>cap where the instrument quote (equity) = Reference Rate, and the triggering price = Cap. 926 © Wall Street Systems IPH AB - Confidential D Expressions D.4 Functions in expressions D.4.3.9 Range accrual - range This is used to verify that a market reference is within a range over a period of time. range ( observation_offset bounds floor cap sub_expression offset used to read the market quote backward from a given date in the interest period, defaults: 0, specifies whether each range boundary is included or excluded, values: ii (floor incl. and cap incl.), ie, ei, ee, defaults: ii defines the lower boundary of the range (as a plain number so 1% is to entered as 0.01), defaults: cashflow floor value, defines the upper boundary of the range (as a plain number), defaults: cashflow cap value, expression which output is compared to the range boundaries, defaults: [ir] ) Alternative shorter syntaxes are: 1- range () or range + Fixing Rate, Fixing Period, Fixing Subscenario, Floor, Cap from the Cashflow fields. The following defaults apply: Offset = 0, Bounds= ii or 2- range (offset), all the rest as in 1or 3- range (offset, bounds), all the rest as in 1or 4- range (offset, bounds, floor, cap, expression), nothing taken from the Schedule fields Bounds = [ii, ie, ei, ee] Expression, surrounded by "[]", for example, within a range function: range(0, ii, floor%, cap%, [irm('JNS-ERB','O/N','')]) For example: – Range on a cms spread 10Y vs 2Y with no observation offset, including boundaries being [floor%, cap%]: factor%*range(0,ii,floor%,cap%,[cmsm('EUR ZERO DEPO/SWAP','10Y')-cmsm('EUR ZERO DEPO/SWAP','2Y')]) Note: – Cap and Floor are taken as they are in range(), that is, as plain numbers. Therefore, for a rate of 3% you must enter 0.03, not 3. – Fixing Subscenario is not yet implemented for range(). It is only available using syntax 4- by plugging it in the expression within the range. – The feature RANGE-ACCRUAL must be applied to the instrument (see A.2.276 Range Accrual on page 852). – Fixing Date Method must be set to In Arrears. – Only 1, 2, or 5 parameters are supported: a message is displayed if an incorrect number of arguments is given. Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 927 D Expressions D.4 Functions in expressions D.4.3.10 Compound This is used to compound a market reference over a period of time. compound ( observation_offset observation_offset_calendar reset_period = compounding_period compounding_factor_rounding sub_expression factor ) , , , , , , defaults: defaults: defaults: defaults: defaults: defaults: 0, currency calendar, 1, 1e-14, [ir+spread] 1 Also using the fields: fixing_rate, fixing_period, fixing_offset (and fixing_convention, fixing_calendar), spread, and so on. Note that Fixing Date Method should be set to In Arrears. Note: – Therefore, you can write the following as an expression: compounding or compounding(1) or compounding(1,‘SEK’,1) – Period is expressed as a number with a “special” meaning: [0, 7[ = business days [7, 30[ = calendar days (that is, 14 = 2 weeks) [30, …[ = months (that is, 180 = 6 months, 720 = 2 years) – sub_expression MUST be written with no quotes, within [ ] – factor is multiplicative: To calculate the compounding factor for one period: C = 1 + rate * years To multiply part over 1 by factor: C_with_factor = (C-1) * factor + 1 – If the cashflow's Rate Type is an interest rate (for example, Periodic or Annually Compounded), the compound function returns the interest rate. – If the cashflow's Rate Type is not an interest rate (for example, Price %), the compound function returns the value: compound factor - 1. D.4.3.11 Average This function is used to average a market reference over a period of time. • Averaging using rate periods (for example, Friday’s O/N rate valid from Friday until Monday) average ( observation_offset observation_offset_calendar reset_period rounding (not used in this context) sub_expression ) , , , , , defaults: defaults: defaults: defaults: defaults: 0, currency calendar, 1, 1e-14, [ir+spread] Also using the fields: 928 © Wall Street Systems IPH AB - Confidential D Expressions D.4 Functions in expressions fixing_rate, fixing_period, fixing_offset (and fixing_convention, fixing_calendar), spread, and so on. Note: Fixing Date Method should be set to In Arrears. On fixing action execution, the last quote observed on Fixing To date is used as many times as needed to have enough observations (typically Period Days - 1). • Averaging using direct quotes (for example, Friday's O/N rate counts for 1; Saturdays, Sundays and any bank holiday are ignored). average_q() with the same syntax as average(). D.4.3.12 Dual This function is used when the fixing expression that is to be used for fixing purposes is too complex to be handled by the valuation engine or library, for which a simplified one is provided. • dual([sub-expression-fixing], [sub-expression-valuation]) where sub-expression-fixing is replaced by the relevant expression to be used for fixing purposes (for example, to calculate the Nominal Rate) and sub-expression-valuation is replaced by the relevant expression to be used for valuation purposes. For example: – dual(ir+isnull(previous_q,0),ir) which fixes to: ir+isnull(previous_q,0) but valuation uses: ir D.4.3.13 ixau This function is used to fetch the index value with the correct lag. It also takes into account the publication date of the index value. D.4.4 Special characters D.4.4.1 @ The special character "@" is used to replace a function parameter that you wish to keep at the default, in order to be able to provide a parameter further in the parameter list: @. For example: – Instead of writing: compound(2,'SEK', 1, 1e-10, [ir]) where the second and third parameters are as per the default, you can write: compound(2, @, @, 1e-10, [ir]) Transaction & Risk Management Module (TRM) Instruments: Processing and Calculations 929 D Expressions D.4 Functions in expressions 930 © Wall Street Systems IPH AB - Confidential
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