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Core Interest Rate
Derivatives FX Futures The forex future contracts are usually used by exporters and importers to hedge their foreign currency payments from exchange rate fluctuations. By using FOREX future contracts, investors can protect costs on products and services purchased abroad or protect profit margins on products and services sold abroad lock-in exchange rates as much as a year in advance. Quanto Himalayan Option Himalayan options are a form of European-style, path-dependent, exotic option on a basket of equity underliers, in which intermediate returns on selected equities enter the payoff, while the equities are subsequently removed from the basket. Hull-White Convertible Bond Based on the Hull-White single-factor tree building approach, respective trinomial trees are constructed for the short-term interest rate and stock’s price processes. Using the Hull-White two-factor tree building procedure, a combined tree is constructed by matching the mean, variance and correlation corresponding to each combined tree node. The convertible bond price is given from the combined tree by backward induction. Bonus Coupon Note Bonus coupon notes typically benefit investors who are moderately bullish the short-term prospects of particular shares or index and who are looking for a guaranteed cash flow. Investors feel also comfortable being put stock at maturity if the asset price is below the strike. The note pays a series of coupons based on the weighted performance of all assets in the basket on each Coupon Determination Date. The coupons are usually capped and floored. Bond Futures Investors use bond futures to hedge an existing bond portfolio against adverse interest rate movements or enhance the long-term performance of the portfolio. Arbitrageurs profit from the price difference between the spot bonds and the bond futures. Accelerated Share Repurchase Shareholders usually prefer accelerated share repurchase programs as the company generates higher returns due to less dilute and spreading the same market cap. As a share repurchase program boost the earnings per share of the company, the stock prices are boosted as well. Historical VaR Value at Risk is vital in market risk management and control. Also regulatory and economic capital computation is based on Value at Risk results. Although Value at Risk measure is objective and intuitive, it doesn’t capture tail risk. There are three commonly used methodologies to calculate Value at Risk – parametric, historical simulation and Monte Carlo simulation. Quanto Total Return LIBOR Swap The payoff of the leg based on the return of the foreign exchange rate is a payoff of a European call option. Its present value is given by Black’s formula for futures with the discounting factor equal to the Canadian zero-coupon bond and the future price given as Constant Proportion Portfolio Insurance A stream of Partial Principal Repayments (PPR) may be paid out of the CPPI structure at PPR Pay Dates over the life of the product. The size of these payments is determined as a fixed percentage of the Fund Account Value (FAV) excluding PPR or a fixed percentage of the Notional on each PPR Valuation Date. Collateral Risk The collateralized exposure is measured as the valuation difference between the derivative portfolio and collateral assets. In this collateral method, derivative trades and the collateral assets are handled similarly. They are deemed as two “sub-portfolios” with opposite trade direction. Their future value distributions are calculated under the same Monte Carlo simulation framework. All risk factors are simulated simultaneously and consistently. Credit Loss Calculator The purpose of the credit risk calculator is to ensure that the expected loss that can occur from the guarantor’s (CMHC’s) perspective is covered by the guarantee fee. From CMHC’s perspective, the risk of loss will occur if an AAA/AA swap counterparty fails instantaneously without any rating migration to a lower state (i.e., AA to A). Under a normal rating migration, the swap counterparty to the Trust would have to collateralize its exposure. Convertible Bond Features A convertible bond pays the holder periodic coupon payments from the issuer, but can also convert it into the issuer’s stock. The model uses a two-factor trinomial tree for pricing the convertible bond BGM Model BGM is an interest rate model based on evolving LIBOR market forward rates under a risk-neutral forward probability measure. In contrast to models that evolve the instantaneous short rates or instantaneous forward rates, which are not directly observable in the market, the objects modeled using BGM are market observable quantities. Credit Risk Calculation The purpose of the credit risk calculator is to ensure that the expected loss that can occur from the guarantor’s (CMHC’s) perspective is covered by the guarantee fee. From CMHC’s perspective, the risk of loss will occur if an AAA/AA swap counterparty fails instantaneously without any rating migration to a lower state (i.e., AA to A). Under a normal rating migration, the swap counterparty to the Trust would have to collateralize its exposure. Collateral Approach In this collateral method, derivative trades and the collateral assets are handled similarly. They are deemed as two “sub-portfolios” with opposite trade direction. Their future value distributions are calculated under the same Monte Carlo simulation framework. All risk factors are simulated simultaneously and consistently. CCR Backtest Backtesting is the comparison of forecasts to realised outcomes. This comparison is either the comparison of a distribution with a single realised value at a point in time, as for market risk factor or exposure distribution backtesting, or the comparison of a single predicted value against some realised value at a point in time, as for backtesting EPE or pricing models. Capital Charge Supervisory Guidance on Market Risk requires that all new models and material model modifications be approved by the FRB prior to implementation for use in the calculation of minimum regulatory capital. Banks are required to establish and maintain a Board-approved definition of materiality to assess modifications to regulatory capital models. The definition of materiality should reflect the Bank’s view of what constitutes a material change, must include quantitative and qualitative factors, and meet FRB’s principles. Credit Risk Limit The key difference between monitoring for reporting versus monitoring for limits is that only for limits will the exposure of trading activity be compared to the allowable bounds or rules and have a breach (violation or excess) created if the bounds or rules are exceeded. Thus this section covers both aspects, with the part in common referred to as an ‘Exposure Definition’ and the allowable bounds for the ‘Exposure Definition’ referred to as a Limit. Credit Risk Job A job spec is configuration data which defines all choices about how pricing and simulation are to be performed. Multiple job specs may exist in the system reflecting the different configurations required for different types of jobs. For example, all counterparty credit risk (CCR) production jobs will reference a single job spec which defines the appropriate models, calibrations and time buckets for CCR production requirements, whilst value at risk (VaR) will use a different job spec. Mortgate Swap A mortgate swap is a swap with two legs. In contract, party A receives a fixed amount and makes a single variable payment at swap maturity. The payment amount can be modeled as the value of a European discrete Asian call option on a basket of indices. CDS Term Structure On the credit default swap market, a series of spreads with corresponding maturities can be obtained every business day. These CDS spreads at different maturities are called CDS spread term structure.
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