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  • CA-4.6 CA-4.6 Derivatives

    • CA-4.6.1

      Banks which propose to use internal models to measure the interest rate risk inherent in derivatives will seek the prior written approval of the Central Bank for using those models. The use of internal models to measure market risk, and the Central Bank's rules applicable to them, are discussed in detail in Chapter CA-9.

      October 07

    • CA-4.6.2

      Where a bank, with the prior written approval of the Central Bank, uses an interest rate sensitivity model, the output of that model is used, by the duration method, to calculate the general market risk as described in Section CA-4.5.

      October 07

    • CA-4.6.3

      Where a bank does not propose to use models, it must use the techniques described in the following Paragraphs, for measuring the market risk on interest rate derivatives. The measurement system should include all interest rate derivatives and off-balance-sheet instruments in the trading book which react to changes in interest rates (e.g. forward rate agreements, other forward contracts, bond futures, interest rate and cross-currency swaps, options and forward foreign exchange contracts). Where a bank has obtained the approval of the Central Bank for the use of non-interest rate derivatives models, the embedded interest rate exposures should be incorporated in the standardised measurement framework described in Sections CA-4.7 to CA-4.9.

      October 07

    • CA-4.6.4

      Derivative positions will attract specific risk only when they are based on an underlying instrument or security. For instance, where the underlying exposure is an interest rate exposure, as in a swap based upon interbank rates, there will be no specific risk, but only counterparty risk. A similar treatment applies to FRAs, forward foreign exchange contracts and interest rate futures. However, for a swap based on a bond yield, or a futures contract based on a debt security or an index representing a basket of debt securities, the credit risk of the issuer of the underlying bond will generate a specific risk capital requirement. Future cash flows derived from positions in derivatives will generate counterparty risk requirements related to the counterparty in the trade, in addition to position risk requirements (specific and general market risk) related to the underlying security.

      October 07

    • CA-4.6.5

      A summary of the rules for dealing with interest rate derivatives (other than options) is set out in Section CA-4.9. The treatment of options, being a complex issue, is dealt with in detail in Chapter CA-8.

      October 07