swap exposure calculation

The primary risks of a single currency swap are: 1. Swaps Risk and Exposure.

The Peak Exposure (PE) is the maximum amount of exposure expected to occur on a future date at a given level of confidence. In FINCAD Analytics Suite 2009, a 1-factor short rate model implemented on a trinomial tree is used in order to estimate the range of possible future values for a portfolio of interest rate swaps, each of which can be non-amortizing or amortizing. All Rights Reserved, New York Institute of Finance Terms of Use. Commonly, a time horizon of six months to a year is used, with contract values calculated at various times over the time horizon. Actual simulations would use the mean-reverting process of short-term rates, after calibration of the mean-reversion parameter X.

If there is only one swap with the counterparty, then the same functionality can be used by setting up a portfolio containing just a single swap. We will pay collateral to the counterparty. January 1, 2012 Abey Francis. Between payment dates, if we are paying the fixed rate and the rate goes up… we are losing money. Contracts that are traded on an exchange are not affected by counterparty risk, because the exchange guarantees the cash flows promised by the derivative to the counterparties [2]. Contracts that are traded on an exchange are not affected by counterparty risk, because the exchange guarantees the cash flows promised by the derivative to the counterparties [2]. © 2020 New York Institute of Finance. Potential credit exposure is an estimate of the replacement cost of the contract at various times in the future. The great bulk of swap activity of date has concentrated on currencies and interest rates, yet these do not exhaust the swap concept’s applicability.

The variations of the value of the IRS are entirely due to its fixed-rate leg, since the floating rate leg has a constant value. These variables will have a direct effect on the Initial Margin of a Swap. Only the current exposure is known with certainty, while the future potential exposure is uncertain. This curve is the current risk, not the potential exposure, since we are at date 1, and we use the current rate 8%. 1. The peak exposure is defined by confidence level for which we want to calculate the peak exposure. Assuming that netting agreements are in place, the Potential Future Exposure is. 0 Comment. We are receiving the quarterly cash flow twice as often as we are paying our semi-annual cash flow. The EEE can be calculated as. The New York Institute of Finance has a faculty of industry leaders and offers a range of program delivery options, including self-study, online courses, and in-person classes. With 2.5 years to maturity, MPE will come in at approximately 1.24 years.

3. This is known as the replacement cost of the swap, and is a commonly used measure of credit loss. The longer the tenor of the swap, the larger the initial margin. 4. Our convention for calculating present values of each leg is that the interest flows at the current date have been paid, and we discount only subsequent flows. In practice, this maximum is taken over all the tree time step dates up to the exposure horizon end date. There is also a utility function, aaCE_SwapPort_dgen_dist, that can be used to calculate the cumulative probability distribution at a given time in the future. The last line is the PFE of the swap. 7 swaps in 5 trading days). Between payment dates, if we are paying the fixed rate and the rate goes down… we are making money. Viewed 506 times 7 $\begingroup$ How to calculate the exposure of a recoupon swap (when the MTM of an i.r. The EEPE can be calculated as. For determining the potential exposure we make the interest rate shift downward starting from date 2, and using, Table 44.2 shows the time profile of such lower bounds of interest rates using annualized volatility 1%. The IRS gains value when the floating rate declines. Privacy Policy. It declines because the swap amortizes, meaning that there are fewer flows when getting closer to maturity. Effective Expected Positive Exposure (EEPE) is the weighted average over time of effective expected exposure. Its annual volatility is 1.0%. In practice, this integral is approximated by a sum over all the tree time step dates up the exposure horizon end date. The value of the swap is the discounted value of all future flows. Under these assumptions, the value of the IRS at different dates is the present value calculated with the prevailing (flat) rate. The Peak Exposure declines after this date because the swaps are getting closer to maturity and there are fewer remaining cash flows. Figure 1: Screenshot of inputs to aaCE_SwapPort_dgen_tbl. – Bilateral Contracts require the ISDA Master Agreement and Annex A, additionally, they require a Standard Initial Margin Method (SCSA) and nowadays the General Master Repurchase Agreement (GMRA). those cash flows. 3.

Actually, potential risk of IRS usually peaks between one-third and half of the residual life (Figure 44.4). The image below illustrates Credit Risk Exposure of a 5 year Swap as time passes: 1.

2. A swap rate is a rollover interest rate, which XM credits to or debits from clients’ accounts when a position is held open overnight. Interest rate swaps are a type of plain vanilla swap. Having netting agreements in place reduces the overall credit exposure for the portfolio. We are at date 1 (end of year 1). If the floating rate is above the fixed rate, then the floating rate payer will make a payment to the floating rate receiver based on the difference between the two rates. ©Copyright 2020 FinancialCAD® Corporation. Active 1 month ago. 1. Effective Expected Exposure (EEE) is the maximum expected exposure which occurs over the exposure horizon time interval. – Cleared Contracts require the documentation of the clearinghouse, additionally, they require a collateral document (i.e., third party Repo) to show the CCP the counterparty can post collateral.

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