Interest Rate Derivatives & Currency Swaps

Course overview Despite the recent economic downturn, organisations with interest rate and FX exposures need a mechanism to hedge. Thus by June 2012, the size of OTC derivatives market was just over $640 trillion USD (measured in terms of notional amount outstanding). This represents an expansion of 18% in the previous 6 months. To meet the precise requirements of end-users, the derivative markets are still evolving to provide a wide range of innovative structures. This course provides the latest practical developments in the structuring, pricing and hedging of OTC derivatives (swaps and options) plus a variety of embedded combinations. Summary of course content: Convexity adjustments for swaps and CMSs Correctly valuing foreign assets using cross-currency basis swaps How to build your funding cost into your pricing How to price a Bermudan callable swap How to price a path dependent structure Methodology A range of modelling approaches will be used, such as analytic models, numerical trees and Liborbased simulation. This course will discuss how these approaches may be modified to fit the current market conditions such as volatility smiles, and how the simulations may be calibrated. Computer-based exercises There are a wide range of realistic computer-based exercises, which may be taken away after the course, to reinforce the learning. Delegates should bring a laptop installed with Microsoft Excel in a Windows environment, not a Mac lookalike, (full version loaded with Analytics and Solver add-ins) for the exercises and case studies. A calculator would also be useful. Who should attend? Members of swap desks and other structuring teams Risk managers Experienced marketers, responsible for providing risk management, financial structuring, and treasury services to end-users End-users, to understand how banks are pricing and hedging swap structures Course prerequisite The course assumes that delegates are familiar with basic concepts such as: Operations of the cash, FRA, futures and swap markets Use of discount factors to fair price swaps Basic swap structures Basic interest rate option pricing Supporting publication:
Day 1: Brief revision of swaps Pricing off a futures strip Building a discount curve Adjusting for the convexity bias Fair pricing of a short-term swap Demonstrating hedge effectiveness Computer-based exercise: Price a swap Derivation of zero coupon discount factors and forward rates Brief reminder: Bootstrapping and estimation of forward rates When does bootstrapping breakdown? Practical issues: interpolation, blending and smoothing What represents a “good” curve: An alternative approach Building a curve from a sparse market Demonstrating blending and smoothing algorithms Computer-based exercise: Imply the discount factors from a swap curve Should your funding cost effect your valuation? Pricing a collateralised swap Overnight indexed swaps (OISs) such as EONIAs and RODS Building a 30-year curve using overnight-indexed swaps Pricing off the curve Pricing a range of non-generic IR swaps Pricing forward start and amortising swaps Yield curve swaps such as constant maturity swaps Risk management characteristics Computer-based exercise: Pricing a CMS Building convexity into swap pricing How does convexity manifest itself? Convexity adjustment of normal swaps Convexity adjustment of CMS Day 2: Asset packaging and a brief revision of IR options Asset packaging Creating different packages: premium, par, discount Creating a par maturity package What’s really going on? Arbitrage between bond and swap valuation methods: the credit implications Subsidisation effects Forward valuing: How to include your cost of funding Practical details Computer-based exercise: Price an asset package Simple caps and floors A fundamental knowledge of Black’s model for pricing European-style interest rate options is assumed Generic, digital and spread caps Floors, collars, forward swaps and put-call parity Volatility surfaces and smiles Swaps with embedded caps and floors Computer-based exercise: Price a swap with embedded options Taking advantage of the multi-period structure: barriers, choosers and periodic caps Swaptions Pricing swaptions Swaption smile spaces Compatibility with cap pricing Swaps and embedded swaptions: Pricing extendible and retractable swaps Computer-based exercise: Price an extendible step-up Swap Structured securities A very brief overview of the structured securities market Description of some of the more common structures Day 3: Cross-currency swaps and structured securities Cross-currency (CC) swaps CC basis swaps: a building block for CC swaps CCBSs and off-balance loans Outline of pricing CCBSs How to value a foreign asset correctly Incorporating the CCBS curve into the bootstrapping process Swapping a bond issue: building a tailored CCS Conversion factors Creating a foreign asset package Computer-based exercise: Swapping a foreign bond issue into domestic floating rate Pricing of diff and quanto diff swaps with convexity effects Valuation of CCS Rebalancing a CCS due to movement in the FX rate Structured securities A very brief overview of the structured securities market Description of some of the more common IR and FX structures Discussion of more advanced modeling methodologies This section will be supported by computer demonstrations Analytic modelling Example: Swapping a range accrual note Numerical modelling Outline: Building an arbitrage-free forward interest rate tree Brief discussion on the inclusion of a smile effect Using the tree to model a complex security such as a Bermudan swap Computer-based exercise: Modelling a callable swap Simulation Building a BGM simulator Using the simulation to model a range of complex securities, such as: Path-dependent floating notes TARNs Index amortising swap Callable snowball Brief discussion on calibration and other techniques Computer-based exercise: Modelling a structured security Day 4: Risk management of swap and option portfolios A fundamental knowledge of IR risk management is assumed How do IR curves behave? Some empirical results Risk management reporting: Construction of a delta and gamma reports for different curve movements The concept of an equivalence Construction of a volatility report Hedging swap and option portfolios The use of Taylor’s theorem Delta hedging Delta-gamma hedging Delta-gamma-volatility hedging Assessing hedge effectiveness using shocks and simulation Construction of a theta report Running a portfolio: Funding and other issues Control frameworks Computer-based exercise: Creating an effective hedge for a portfolio An outline of Value-at-Risk (VaR) Measuring VaR for a single risk factor Extending this to two, and multiple, risk factors Measuring VaR for a mixed swap/option portfolio Computer-based exercise: Building a minimum-VaR hedge for a portfolio Summary of course