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  • CA-4.7 CA-4.7 Calculation of derivative positions

    • CA-4.7.1

      The derivatives should be converted to positions in the relevant underlying and become subject to specific and general market risk charges as described in Sections CA-4.2 and CA-4.3, respectively. For the purpose of calculation by the standard formulae, the amounts reported are the market values of the principal amounts of the underlying or of the notional underlying. For instruments where the apparent notional amount differs from the effective notional amount, banks should use the latter.

      October 07

    • CA-4.7.2

      The remaining Paragraphs in this Section include the guidelines for the calculation of positions in different categories of interest rate derivatives. Banks which need further assistance in the calculation, particularly in relation to complex instruments, should contact the Central Bank in writing.

      October 07

    • Forward foreign exchange contracts

      • CA-4.7.3

        A forward foreign exchange position is decomposed into legs representing the paying and receiving currencies. Each of the legs is treated as if it were a zero coupon bond, with zero specific risk, in the relevant currency and included in the measurement framework as follows:

        (a) If the maturity method is used, each leg is included at the notional amount.
        (b) If the duration method is used, each leg is included at the present value of the notional zero coupon bond.
        October 07

    • Deposit futures and FRAs

      • CA-4.7.4

        Deposit futures, forward rate agreements and other instruments where the underlying is a money market exposure will be split into two legs as follows:

        (a) The first leg will represent the time to expiry of the futures contract, or settlement date of the FRA as the case may be.
        (b) The second leg will represent the time to expiry of the underlying instrument.
        (c) Each leg will be treated as a zero coupon bond with zero specific risk.
        (d) For deposit futures, the size of each leg is the notional amount of the underlying money market exposure. For FRAs, the size of each leg is the notional amount of the underlying money market exposure discounted to present value, although in the maturity method, the notional amount may be used without discounting.
        For example, under the maturity method, a single 3-month Euro$ 1,000,000 deposit futures contract expiring in 3 months' time will have one leg of $ 1,000,000 representing the 8 months to contract expiry, and another leg of $ 1,000,000 in the 11 months' time-band representing the time to expiry of the deposit underlying the futures contract.
        October 07

    • Bonds futures and forwards bond transactions

      • CA-4.7.5

        Bond futures, forward bond transactions and the forward leg of repos, reverse repos and other similar transactions will use the two-legged approach. A forward bond transaction is one where the settlement is for a period other than the prevailing norm for the market.

        (a) The first leg is a zero coupon bond with zero specific risk. Its maturity is the time to expiry of the futures or forward contract. Its size is the cash flow on maturity discounted to present value, although in the maturity method, the cash flow on maturity may be used without discounting.
        (b) The second leg is the underlying bond. Its maturity is that of the underlying bond for fixed rate bonds, or the time to the next reset for floating rate bonds. Its size is as set out in (c) and (d) below.
        (c) For forward bond transactions, the underlying bond and amount is used at the present spot price.
        (d) For bond futures, the principal amounts for each of the two legs is reckoned as the futures price times the notional underlying bond amount.
        (e) Where a range of deliverable instruments may be delivered to fulfil a futures contract (at the option of the 'short'), then the following rules are used to determine the principal amount, taking account of any conversion factors defined by the exchange:
        (i) The 'long' may use one of the deliverable bonds, or the notional bond on which the contract is based, as the underlying instrument, but this notional long leg may not be offset against a short cash position in the same bond.
        (ii) The 'short' may treat the notional underlying bond as if it were one of the deliverable bonds, and it may be offset against a short cash position in the same bond.
        (f) For futures contracts based on a corporate bond index, the positions will be included at the market value of the notional underlying portfolio of securities.
        (g) A repo (or sell-buy or stock lending) involving exchange of a security for cash should be represented as a cash borrowing - i.e. a short position in a government bond with maturity equal to the repo and coupon equal to the repo rate. A reverse repo (or buy-sell or stock borrowing) should be represented as a cash loan - i.e. a long position in a government bond with maturity equal to the reverse repo and coupon equal to the repo rate. These positions are referred to as 'cash legs'.
        (h) It should be noted that, where a security owned by the bank (and included in its calculation of market risk) is repo'd, it continues to contribute to the bank's interest rate or equity position risk calculation.
        October 07

    • Swaps

      • CA-4.7.6

        Swaps are treated as two notional positions in government securities with the relevant maturities.

        (a) Interest rate swaps will be decomposed into two legs, and each leg will be allocated to the maturity band equating to the time remaining to repricing or maturity. For example, an interest rate swap in which a bank is receiving floating rate interest and paying fixed is treated as a long position in a floating rate instrument of maturity equivalent to the period until the next interest fixing and a short position in a fixed rate instrument of maturity equivalent to the residual life of the swap.
        (b) For swaps that pay or receive a fixed or floating interest rate against some other reference price, e.g. a stock index, the interest rate component should be slotted into the appropriate repricing or maturity Category, with the equity component being included in the equity risk measurement framework as described in Chapter CA-5.
        (c) For cross currency swaps, the separate legs are included in the interest rate risk measurement for the currencies concerned, as having a fixed/floating leg in each currency. Alternatively, the two parts of a currency swap transaction are split into forward foreign exchange contracts and treated accordingly.
        (d) Where a swap has a deferred start, and one or both legs have been fixed, then the fixed leg(s) will be sub-divided into the time to the commencement of the leg and the actual swap leg with fixed or floating rate. A swap is deemed to have a deferred start when the commencement of the interest rate calculation periods is more than two business days from the transaction date, and one or both legs have been fixed at the time of the commitment. However, when a swap has a deferred start and neither leg has been fixed, there is no interest rate exposure, albeit there will be counterparty exposure.
        (e) Where a swap has a different structure from those discussed above, it may be necessary to adjust the underlying notional principal amount, or the notional maturity of one or both legs of the transaction.
        October 07

      • CA-4.7.7

        Banks with large swap books may use alternative formulae for these swaps to calculate the positions to be included in the maturity or duration ladder. One method would be to first convert the cash flows required by the swap into their present values. For this purpose, each cash flow should be discounted using the zero coupon yields, and a single net figure for the present value of the cash flows entered into the appropriate time-band using procedures that apply to zero or low coupon (less than 3%) instruments. An alternative method would be to calculate the sensitivity of the net present value implied by the change in yield used in the duration method (as set out in Section CA-4.5), and allocate these sensitivities into the appropriate time-bands.

        October 07

      • CA-4.7.8

        Banks which propose to use the approaches described in Paragraph CA-4.7.7, or any other similar alternative formulae, should obtain the prior written approval of the Central Bank. The Central Bank will consider the following factors before approving any alternative methods for calculating the swap positions:

        (a) Whether the systems proposed to be used are accurate;
        (b) Whether the positions calculated fully reflect the sensitivity of the cash flows to interest rate changes and are entered into the appropriate time-bands; and
        (c) Whether the positions are denominated in the same currency.
        October 07