financial risk fitness gmbh

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Works and features of modern interest rate derivatives, key features on pricing instruments (2 Days)

The post financial crisis financial environment has imposed significant challenges to derivatives traders: banking books and trading books managers alike. As most derivatives contain a fixed income feature and since the Interest Rate and FX derivative markets continue to represent the bulk of exchange traded and OTC contracts in most markets, a thorough understanding of the trading mechanics, pricing algorithms and risk management features of Interest Rate Derivatives has become pivotal to succeeding in capital markets and treasury activities throughout the financial industry.

Indeed, as most OTC derivative transactions are completed under ISDA CSA features including bilateral collateral clauses and daily margining settlements (beyond various netting provisions), the business has changed significantly, which has led to the “futurisation” of the Interest Rate Swap markets– as aligned with the key features included in the Dodd Frank and other regulatory stipulations. As a consequence, since the collateral (or margin surplus) earns the overnight rate (best represented by the federal funds rate) and most derivatives are 3 to 6 months LIBOR based, most practitioners are swapping their exposures to the OIS (overnight index swap) rate – something that hasn´t been the case prior to 2008.

This course will provide attendees with a practical understanding on the works and features of modern interest rate derivatives along with key features on pricing instruments in today´s highly volatile markets.

Who should attend

  • Interest Rate Derivatives Traders, Sales and Structuring Professionals
  • Market and Counterparty Risk Managers
  • Internal/ External Auditors

Key Topics

  • Interest Rate Models
  • The Libor Market Model
  • Cash vs Derivative Markets
  • Interest Rate futures and the convexity Adjustments
  • Swaps and Swap Variants
  • Constant Maturity Swaps
  • Interest Rate Options
Day One
  • The Black Scholes Merton Options Pricing Framework
    • Adapted Processes, filtrations and Martingales
    • Risk Neutral Pricing – a consequence of hedging
    • Brownian Motion – quadratic Variation: a measure of volatility
    • Markov Processes & the Feynman Kac Formula
      • The Black-Scholes Option Model
      • The Vasicek Term Structure Model (and other Equilibrium Models)
      • The Cox Igersoll Ross Term structure Model
      • No Arbitrage Models
  • Girasnov´s Theorem
    • The construction of a risk neutral measure
    • Pricing via risk-neutral measure
    • The Martingale Representation Theorem
    • The Fundamental theorem of Asset Pricing
    • No Arbitrage and the existence of a risk neutral measure
    • Hedging and the uniqueness of the risk neutral measure
  • The Heath Jarrow Morton Model
    • No Arbitrage Condition
    • Implementation in Practice
  • The Change of Numeraire
    • Numeraires and the Risk Neutral Measures
    • FX Models
      • Foreign and domestic risk neutral measures
      • The Gaman Kolhagen Pricing Formula
      • Call-Put duality
  • Equilibrium Models
    • The Vasicek Model
    • The “Log-Normal”Model
    • The Cox Ingersol Ross Model
  • No Arbitrage Models
    • The Ho-Leee Model
    • The Hull & White Model
    • The Heath Jarrow Morton (“HJM”) Model
  • Forward Measures
    • The Merton Option Pricing Formula
    • Brace Gatarek Musiela (LIBOR Market) Family of Models
    • Application for a Caplet Pricing
    • The Black Caplet formula
  • Local volatility Models
  • Stochastic Volatility Models
    • Specifying the Instantaneous Volatility of Forward Rates
    • Applications
  • Cash Products
    • Bond Markets and Trading Conventions
    • Securitized Debt Markets
    • Mortgage Markets and ABS Products
    • Syndicated loan Markets
  • Deriving the “Yield Curve”
    • Bootstrapping algorithms
    • Interpolation Methods
    • Deriving, bootstrapping the OIS Curve and linking to the LIBOR curve
  • Interpolating OIS Rates
    • The short end Interpolation
    • The Medium Segment Interpolation
    • The Long end Interpolation
    • Excel Example Workshop
  • Bootstrapping LIBOR Curves in the “OIS World”
    • Excel Workshop
  • Case Study: Linking the OIS $ and € Curve to the respective LIBOR Curves
    • Two teams case study in Excel
  • Generating an OIS curve when collateral is posted in a different currency
  • Discounting Cross Currency Basis Swaps
    • Excel Spreadsheet Example
  • Interpolation Methods for various Currency Yield Curves – Best Practices
    • Linear Methods
    • Quadratic Splines
    • Cubic Splines (Hermitian Polynomials)
    • The Monotone Convex Method
    • Excel Exercise
Day Two

Derivative Products

  • Linear Products: IR futures and Forwards
    • IR Swaps – Trading Mechanics
    • IR Swap Variations: Accreting, Amortizing, roller Coaster Swaps
    • IR Swaps in Arrears
    • Basis Swaps
    • FX & Cross Currency Swaps
    • IR Futures Markets – Eurodollar Futures
    • The Convexity Adjustment of Interest Rate Futures
    • Applications – Linear Hedging strategies
    • CMS Swaps
  • Excel Case Studies and Valuation:
    • Hedging a Bond with an Interest Rate Swap
    • Quantifying the Convexity Effect
    • Hedging a Swap with a Eurodollar Futures contract
    • Hedging a Swap in Arrears with Eurodollar Futures contract – Evaluation of Basis Risk
  • Non linear Products
    • Caps, Floors, Collars
    • Exotic IR Options
    • Swaptions & Spreadlocks
    • Spread Options
    • Callable/ Puttable Bonds
    • Convertible Bonds
    • Hedge Parameters (“the Greeks”)
    • Price Sensitivity Matrices
    • Local Volatility Models
    • Stochastic Volatility Models
    • Excel Case Studies:
      • Pricing a simple Cap/ Collar Structure
      • Pricing a Swaption with a constant Volatility Model
      • Pricing IR Options with CEV Volatility Models
      • Pricing and Hedging exotic IR Options
  • Counterparty Risk and CVA in OTC Interest Rate Derivatives:
    • CVA (Credit Value Adjustments) – Basics
    • Historical Perspective and recent market developments
    • Calculating the CVA of a simple Interest Rate Swap
    • Impact of Recovery
    • CVA formulas: standardized and approximate
  • Pricing Derivatives with counterparty Default risk (CVA)
    • “Collateral Period of risk”
    • Add on Methods
  • Portfolio Simulations
    • With and without margin agreements
  • CVA (Credit Value Adjustment)
    • Unilateral basis
    • Bilateral Basis