introduction to derivative instruments link “n” learn · © 2018 deloitte 8 linear instruments...

Introduction to Derivative InstrumentsLink “n” Learn25 October 2018

2© 2018 Deloitte

Speaker & Agenda

Guillaume Ledure – Senior ManagerAdvisory & Consulting, Capital MarketsDeloitte LuxembourgEmail: [email protected]: +352 45145 4701

Agenda

Definition and use of derivatives

Classification of derivatives

Linear instruments

Swaps

Non-linear instruments

Structured products

Hybrid products

Recent trends in derivatives markets

OIS discounting

Credit Valuation Adjustment

Illustration: Swap trading in the past and nowadays

Conclusions and key messages

1

2

3

4

Fabian De Keyn – DirectorAdvisory & Consulting, Capital MarketsDeloitte LuxembourgEmail: [email protected]: +352 45145 3413

3© 2018 Deloitte

Contents



Linear instruments

Swaps


Structured products

Hybrid products


OIS discounting




4© 2018 Deloitte

Definition of derivatives


• A derivative can be defined as a financial instrument whose value depends on (or derives from) the value of other basicunderlying variables (e.g. stocks, bonds, commodities…)

• Derivatives themselves can be traded on organized markets, or alternatively agreed-upon between two counterparties (“over-the-counter” or “OTC” transactions)

Organized market: a derivative has a market observable price

OTC: a derivative has no observable price, but a value that can be computed using a model

• The uses of derivatives can be split in three different categories (see chart on the right-hand side):

Hedging

Speculation

Arbitrage

5© 2018 Deloitte

Contents



Linear instruments

Swaps


Structured products

Hybrid products


OIS discounting




6© 2018 Deloitte

Derivative instruments can be split into 5 major families

Classification of Derivatives

5

Linear

Swaps

Non Linear Products

Structured Products

Hybrid Products

• Value of these products is linearly related to their underlying

• OTC or exchange-traded (with clearing house)

• Provide a leverage with limited investment

• Usually OTC contracts that exchange two series of cash flows over a period in the future

• Cash flows can be fixed, floating, in various currencies

• Cash flows can be conditional on certain events

• Typically any kind of options

• Value of the products evolves non-linearly with the value of the underlying

• OTC or exchange-traded

• Combination of options can lead to specific strategies

• Issued by a BankStructured on two different products:• Bond to provide full or

partial protection• Derivative (e.g. option)

to increase performance• OTC product (ad-hoc

payoff)• Built on investor’s needs

that are not covered by standard products

• Enable personal investors to take exposures they would usually have no access to

• Products that constitute a mix of several exposures

• More than just the sum of several components

• Example: convertible bonds that may behave as a bond or as an equity following the market conditions

Their technical complexity is increasing but each of them can still lead to financial disasters if manipulated without care

7© 2018 Deloitte

• Linear products are instruments that see their value directly related to the market price of the underlying variable

− In case of a move in the underlying asset, the value of the derivative will move with a nearly identical quantity

− Often called “Delta-One” products because there is a 1:1 relationship between the values of the underlying and derivative in case of market move

• Such products are not particularly complex mathematically but they may still provide high leverage and give exposure to high risks

Classification of Derivatives

Futures Contract

Forward Exchange Contract

Contract For Difference

(CFD)

Linear Instruments

8© 2018 Deloitte

Linear Instruments

• Bilateral contract in which two counterparties agree to buy/sell an underlying at a predetermined price at a specified date in the future

• Futures are traded on organized markets (exchanges), so they are standardized contracts

Futures Contract

Intervenes as counterparty of all trades to mitigate counterparty

credit risk

Broker Broker

Seller

Clearing

House

Both counterparties must contribute collateral when entering into the trade

(initial margin)

Afterwards, the counterparty with negative MtM must contribute daily

margin calls

Buyer

Seller

9© 2018 Deloitte

Linear Instruments

• Bilateral contract in which two counterparties agree to buy/sell an underlying at a predetermined price at a specified date in the future

• Contrarily to Futures, Forwards contracts are Over-The-Counter (“OTC”) instruments traded directly between two counterparties

Forward Exchange ContractThis sounds

familiar!

No clearing house (no intermediary) between the

counterpartiesNo initial margin, no margin call

Seller

Both counterparties are potentially subject to counterparty credit risk

In practice, only the one with a positive MtM supports the credit risk

Buyer

Seller

10© 2018 Deloitte

• Swap contracts consist in the exchange by two counterparties of two streams of cash flows (legs) at future dates

− Nowadays, swaps represent the biggest part of global derivatives volumes

− Swaps are usually traded OTC, so share the following characteristics with forwards

Can be highly customizable

Subject to counterparty credit risk

• Main categories of swaps

Swaps

Total Return Swap

Credit Default Swap

Interest Rate Swap

(incl. Cross-Currency)

© 2018 Deloitte 11

Swaps

• IRS example

• CCIRS example

Interest Rate Swap and Cross-Currency Swap

Party BParty A

2% × 10,000,000 = 𝐸𝑈𝑅 200,000, paid every year

𝐿𝑖𝑏𝑜𝑟6𝑀 + 0.15% ×6

12× 10,000,000, paid every 6

months following fixing of the Libor6M rate

Party BParty AParty

B

Party A

Party B

Party

A

JPY 130,000,000

(JPYLIBOR6M + Spread) x 6

12x 130,000,000

Paid semi-annually

© 2018 Deloitte 12

• IRS: notional of 10,000,000 EUR, 3-year maturity, fixed rate 1% versus EURIBOR12M

• An IRS can be viewed as a strategy involving a pair of securities:

− Fixed Rate leg: Purchase of a fixed rate note ("Bond") for EUR 10,000,000 paying annual fixed interest and receiving principal at maturity

− Floating Rate leg: Sale of a floating rate note paying floating annual interest (EURIBOR12M) and repaying principal at maturity

Swaps

Valuation: Discounted Cash Flows Method

Dec18 Dec19 Dec20

PayFloating

EUR -1,9K

PayFloatingEUR ???

PayFloatingEUR ???

Receive Fixed

EUR 100K

Receive Fixed

EUR 100K

Receive Fixed

EUR 100K

TimeDec17

Valuation date

notional × 1%× 1𝑦

notional × 𝐸𝑈𝑅𝐼𝐵𝑂𝑅12𝑀 × 1𝑦

Floating Leg

Fixed Leg

© 2018 Deloitte 13

Swaps

• Step 1: Estimation of the forward rate from zero coupon yield curve


Dec17 Dec18 Dec19

𝑅1 𝒇𝟏,𝟏 𝒇𝟏,𝟏 = 𝟎, 𝟎𝟑%

𝒇𝟐,𝟏 = 𝟎, 𝟒𝟑%

𝑅2

Dec20

𝒇𝟐,𝟏

𝑅3

Dec18 Dec19 Dec20

PayFloating

EUR -1,9K

PayFloating

EUR 0,3K

PayFloating

EUR 4,3K

Receive Fixed

EUR 100K

Receive Fixed

EUR 100K

Receive Fixed

EUR 100K

TimeDec17

Valuation date

Floating Leg

Fixed Leg

Bloomberg Interest Rates Curve

© 2018 Deloitte 14

• Step 2: Discounting the future cash flows (cf. time value of money)

Swaps

PV of cash-flow

Cash-flow

DiscountingFactor

0 T

Swap value = 1,9K + 100K × 𝐷𝐹1 + −0,3𝐾 + 100𝐾 × 𝐷𝐹2 + (−4,3𝐾 + 100𝐾) × 𝐷𝐹3

1 2 3

2 3

PayFloating

EUR 4,3K

Dec18 Dec19 Dec20

PayFloating

EUR -1,9K

Receive Fixed

EUR 100K

Receive Fixed

EUR 100K

Receive Fixed

EUR 100K

TimeDec17

Valuation date

PayFloating

EUR 0,3K

1


Floating Leg

Fixed Leg

Bloomberg Interest Rates Curve

© 2018 Deloitte 15

Swaps

A Credit Default Swap (CDS) is some kind of insurance contract

• One party pays a premium leg (fixed or floating) to obtain protection against the default of a reference asset

• Objective: transfer the credit risk exposure of the reference asset from the risk-averse party to the protection seller

Credit Default Swap

Protection seller

Protection buyer

Delivery of Bond2

Scenario 2The reference bond defaults

Protection seller

Protection buyer

Pays par value of the Bond1

Protection seller

Protection buyer

2

Pays premium

Pays regular payments to the

seller until maturity or default

Reference asset(Bond)

Investment

1

Reference bond

The buyer loses the premium and receives bond performance

Scenario 1The reference bond performs without default

Reference bond

At contract date

© 2018 Deloitte 16

Swaps

A Total Return Swap (TRS) exchanges two streams of cash flows

• A total return leg that pays cash flows corresponding to the total return on the period of a specified asset (including any capital appreciation/depreciation and interest/coupon payments)

• A premium leg that pays cash flows indexed on a fixed rate or floating rate index

• No notional exchange at maturity of the swap

• Objective: transfer the total economic exposure (market and credit risk) of the reference asset without having to purchase or sell it

Total Return Swap

Pays: Libor + Spread1

Total Return(Performance of the reference asset)

4

Reference asset(Bond, Index, Equity, Fx rate,

Commodity)

Total ReturnPurchase

2 3

Payer of Total

Return

Receiverof Total Return

© 2018 Deloitte 17

Non-Linear Instruments

• Non-linear products are instruments that see their value related to the market price of the underlying variable, but under a non-linear relationship

− The payoff of such products varies with the value of the underlying, but also with other elements (interest rates, volatility, dividends, etc.)

− Non-linear products are often referred to as “options” but this is a global name for a wide range of different payoffs

• Various underlying assets: stocks, indices, funds, fx rate, interest rates, bonds, etc.

• These products can be exchange-traded or OTC

Vanilla American

option

Bermudan option

Vanilla European

option

Exotic options

(Asian,Digital, Barrier)

…etc.

© 2018 Deloitte 18


• Definition: “The right to buy/sell an underlying asset at a certain price at a future maturity date”

• European vanilla options: positive payoff if the underlying value at maturity is higher/lower than a specified value (strike) and 0 otherwise

− Call option: payoff = max(0, 𝑆𝑇 − 𝐾)

− Put option: payoff = max(0, 𝐾 − 𝑆𝑇)

• To enter into an option, a certain premium must be paid by the option purchaser

• P&L profile of vanilla options

Vanilla Options

PutCall

Buyer

Seller

Exercise Price

Profit

SpotPrice

Exercise Price

© 2018 Deloitte 19


Profile of the option’s P&L (MtM – premium) and impact of time to maturity

-40

-20

0

20

40

60

80

100

10 30 50 70 90 110 130 150 170 190

Payoff Maturity=1Y Maturity=3Y Maturity=5Y

Increasein time

to maturity

Vanilla Options

© 2018 Deloitte 20

Vanilla Options

Time Value

• Let’s assume that a call option has these characteristics:

− Strike is 100 USD

− Underlying spot price is 90 USD

− Maturity is 1 year

(assume no rates, no dividends for simplicity)

• What is the option value?

Intrinsicvalue

Timevalue

Spot Price

Optionvalue

• Option value = Intrinsic Value + Time Value

The payout if the option were

maturing immediately

The additional premium due to the remaining time-to-

maturity of the option

© 2018 Deloitte 21

Vanilla Options

Volatility

Volatility is a measure of dispersion of the price of the underlying asset around the trend

Two assets may exhibit different

levels of volatility

Microsoft / SP500 Index (source: Bloomberg)

© 2018 Deloitte 22

Vanilla Options

Impact of Volatility

An increase in volatility leads to an increase of the option value due to the higher probability to get a high payoff for a given date

• In case of decrease of the underlying: a higher volatility leads to a stronger fall, but no loss for the call holder

• In case of increase of the underlying: a higher volatility leads to a stronger rise, so a higher profit for the call holder

The call value increases with volatility!

-40

-20

0

20

40

60

80

100

10 30 50 70 90 110 130 150 170 190

Payoff Volatility=10% Volatility=20% Volatility=30%

Increasein volatility

© 2018 Deloitte 23

Vanilla Options

Valuation

• Assume we want to value a call option on a stock that will pay a certain cash flow only if the stock price matures above a certain level 𝐾

− The payoff at maturity can be written as follows:max 𝑆𝑇 − 𝐾, 0

− The value of the option will equal:Value Option = 𝐸[max 𝑆𝑇 − 𝐾, 0 × 𝐷𝐹𝑇]

• The critical aspect is to determine what is the probability distribution of 𝑆𝑇, i.e. the different possible values of 𝑆𝑇 and their respective probabilities

− For that purpose, make use of a model!

− For instance, the famous Black-Scholes formula enables to value vanilla calls and puts:

European Call value = 𝐟𝐮𝐧𝐜𝐭𝐢𝐨𝐧(spot price,strike,volatility, time−to−maturity, dividend yield, risk−free rate)

© 2018 Deloitte 24

Vanilla Options

Valuation with Monte Carlo simulations

Given a model, you can compute the expectation 𝐸 using a numerical method like the Monte Carlo simulation

Steps to follow

1. Simulate the random walk from the valuation date

to maturity date

2. Calculate the option payoff for this simulation

3. Repeat the steps 1 and 2 (a lot of times)

4. Calculate the average payoff of all simulations

5. Take the present value of this average

40

60

80

100

120

140

160

0 0,2 0,4 0,6 0,8 1

25© 2018 Deloitte

Structured Products

Credit Linked ProductsThis family covers products such as ABSs, MBSs, CDOs, CLOs, CLNs

Capital-Guaranteed Products This family covers products that provide full reimbursement or at least some protection on the invested capital (airbag)

Callable Products This family covers structured products that, at certain points in time, can be early terminated following the choice of one of the parties (issuer or noteholder)

Interest Rates products This family covers products providing exposure on interest rates markets such as CMS products, snowball, range accruals,...

Auto-Callable ProductsThis family covers products than might be early terminated automatically as soon as specific conditions are fulfilled. Examples cover Phoenix notes and all related

Structured Products

Capital-Guaranteed Products

Callable Products

Interest Rate products

Structured products are financial instruments that are the result of the combination of several basic instruments, all wrapped together to provide specific payoffs and exposures

© 2018 Deloitte 26

Hybrid Products

• A hybrid product combines several characteristics and may exhibit different behaviors according to the market conditions

• Typical example: “convertible bond”

− Behaves roughly like a bond (subject to interest and credit risk) if the underlying stock price is low

− Behaves roughly like an equity if the underlying stock price is high

50

70

90

110

130

150

170

190

10 30 50 70 90 110 130 150 170 190

EquityFixed-income Hybrid

27© 2018 Deloitte

Contents



Linear instruments

Swaps


Structured products

Hybrid products


OIS discounting




28© 2018 Deloitte

Summary

Recent Trends in Derivatives Markets

DERIVATIVES (SWAPS) VALUATION

COUNTERPARTY CREDIT RISKTRANSPARENCY

29© 2018 Deloitte

Counterparty credit risk

OIS Discounting

Counterparty risk is typically defined as arising from two broad classes of financial products:

• Securities financing transactions e.g. repos and reverse repos and securities borrowing and lending

• OTC derivatives including interest rate swaps, FX forwards and credit default swaps

How to deal with counterparty credit risk in derivatives valuation?

• Require the party with negative MtM to post collateral in guarantee in case it goes into default

• Adjust the valuation to incorporate credit exposure

Collateral management can be burdensome and introduce operational risk

Counterparty credit risk

The risk that an entity with whom one has

entered into a financial contract (the

counterparty) will fail to fulfil their side of

the contractual agreement

By far the most significant class due to the size and diversity of OTC market

30© 2018 Deloitte

Before the credit crisis

OIS Discounting

Before the credit crisis, valuation was performed in a “Single-Curve

Framework”

• Libor, the short-term borrowing rate of AA-rated banks was seen as a proxy for the risk-free rate

• Counterparty credit risk was a minor concern and collateral agreements were far from systematic

• Yield curves calibrated on instruments of any tenor were more or less identical

• A yield curve calibrated on the market prices of the most usual liquid swaps was used to forecast floating cash flows

• The same curve was used to discount cash flows when the swap was collateralized or when the counterparty was “sufficiently solid” (i.e. well-rated)

Consequences on swap valuation

1

2

31© 2018 Deloitte

During the credit crisis

OIS Discounting

1

2

3

The onset of the crisis (esp. the collapse of Lehman) raised questions about the liquidity and creditworthiness of big banks, even well-rated:

• Regulators and public opinion called for increased transparency and regulation of OTC markets

• Collateralization with daily margin calls became a necessity

Strong criticism of LIBOR as fair and risk-free reference rate

• LIBOR, the rate of unsecured borrowing, denoted the risk of AA-rated banks, but no more the absence of counterparty credit risk

• Suspected manipulations of the LIBOR fixing procedures led to a distrust of LIBOR

• LIBOR6M was riskier than LIBOR3M, itself riskier than LIBOR1M, etc.

Central banks continued to provide abundant liquidity via their bank lending window

• Fed funds (“cash”) and short-dated T-Bills were the sole remaining assets considered as more or less free of credit risk, since dealt with highest-quality government entities and for the shortest maturity (1-day)

• These short-dated “risk-free” assets were the only acceptable deliverable assets for collateral maintenance

32© 2018 Deloitte

Consequences of the credit crisis on valuation

OIS Discounting

3M EUR LIBOR-OIS spreadClose to 0 until credit crisis

Sub-prime crisis(2007-2010) Euro sovereign

debt crisis (2011-2012)

StartMid-2007

• Behaviours of dealers on swap markets changed dramatically:

− Apparition of non-negligible tenor basis

− Large differences between yield curves calibrated on instruments of different tenors

• Consequences on swap valuation:

− Forecasting floating cash flows requires the use of the yield curve calibrated on instruments of the corresponding tenor

− Discounting cash flows of collateralized swaps requires the use of a “risk-free” yield curve

Best proxy: a curve calibrated on instruments with a 1D tenor (i.e. “Overnight-Indexed Swaps”), the “OIS curve”

Since the credit crisis, valuation is performed in a “Multi-Curve Framework”, with discounting under the OIS curve, considered as an “almost risk-free” curve

33© 2018 Deloitte

Multi-curve framework

OIS Discounting

An Overnight-Indexed Swap is a fixed-floating IRS where the floating rate is calculated using the daily compounded overnight rate index

For collateralized regular IRSs (e.g. in EUR: 1Y fixed vs. EURIBOR6M), two curves are necessary

• Effective federal funds rate in USD, Euro Overnight Index Average (EONIA) in EUR, Sterling Overnight Index Average (SONIA) in GBP, etc.

• Forecasting the floating rate of a non-liquid OIS requires a curve calibrated on a 1D tenor (i.e. liquid OISs)

• Discounting collateralized cash flows requires the risk-free curve, i.e. the curve calibrated on liquid OISs

• The OIS curve calibrated beforehand as above to discount the cash flows

• The “LIBOR6M curve”, i.e. a curve calibrated using liquid swaps indexed on LIBOR6M

An Overnight-Indexed Swap can be valued under a Single-Curve framework

This enables to calibrate this OIS curve using liquid OISs

Regular IRSs need to be valued under a “Dual-Curve framework” with OIS discounting

The multiplicity of tenors (1D, 1M, 3M, 6M) results in the “Multi-Curve framework”

Valuation results may be very different than in the pre-crisis “Single-Curve”

world

34© 2018 Deloitte

Issues of the multi-curve framework

OIS Discounting

Practical valuation

issues

Open debate: how to discount uncollateralized

trades?

Reporting issues

• The transition from LIBOR to OIS curves may cause large portfolio MTM changes resulting in greater income statement volatility

• Hedge accounting: hedge may prove less effective (or fail hedge effectiveness test) if e.g. hedge is discounted at OIS while the hedged item is not

• Active OIS markets do no exist for all currencies and may be limited to short to medium-term maturities (which makes it difficult to calibrate a complete discounting yield curve)

• Calibration of all yield curves should be a fully integrated process, since swaps used as calibration instruments have influence of several curves, especially when dealing with cross-currency swaps • Discounting using a LIBOR yield curve

(represents a standard AA-rated banking counterparty)?

• Discounting using the OIS yield curve shifted by some credit spread (depending on the counterparty)?

• Discounting using the OIS yield curve and account for valuation adjustments?

No market

consensus so far

35© 2018 Deloitte

Summary



Incorporation of new market realities into pricing

Multi-curve framework (depending on collateralization)

COUNTERPARTY CREDIT RISK

Importance of proper collateral management

Inclusion of Credit Support Annexes (CSA) in swap contracts

TRANSPARENCY

Essential to know precisely the exposures of the bank with respect to each individual counterparty

High standards of transparency to guarantee investors protection and best execution within MiFID; Benchmark regulation




StartMid-2007

Since the crisis, rate ofcollateralized Overnight-Indexed Swaps is seen as the true risk-free rate instead of LIBOR

The yield curve built upon OIS is the new standard for discounting

Challenges of collateral include the operational costs, the complex management of threshold and netting agreements, the determination of cheapest-to-deliver assets, etc.

36© 2018 Deloitte

Quantification of credit risk


Traditional management methods of counterparty risk tend to work in a binary fashion:

• For example the use of a credit limit – if the limit is breached, financial institution would refuse to enter into a transaction

• Problem with this is that only the risk of a new transaction is being considered – but potential profit of the new transaction should also be a factor in the decision making process

By pricing counterparty risk, one can move beyond a binary decision making process :

• The question of whether to enter a transaction becomes simply whether or not it is profitable once the counterparty risk component has been priced in

• In other words we adopt the following equation:

Risky price = Risk-free price + CVA

Price assuming no counterparty risk

“Credit Valuation Adjustment” = Price of counterparty risk

37© 2018 Deloitte

Quantification of credit risk



CVA = Present Value[Loss in case of counterparty default × Probability of default]

= (1-Recovery rate) × Exposure at default × Probability of default × Discount Factor

• The transaction type i.e. is it an interest rate swap or an FX forward

• Whether there are other offsetting positions with the counterparty that will result in a netting effect (and is there a netting agreement for this to apply)

• Whether of not the transaction is collateralised

• Any hedging aspects of the underlying transaction

38© 2018 Deloitte

Challenges


Common challenge for all entities computing CVA is obtaining the necessary market data:

• Requires some degree of judgement in coming up with proxy data in order to compute CVA

• Whether or not credit spreads are available

Regardless of methodology used to compute CVA, a certain level of expertise and management judgment is required to ensure that CVA has been considered and appropriately applied

CVA valuation methodologies are still not standardised:

• Can range from relatively simple to highly complex methods

• Methodology used largely driven by sophistication and resources available to market participant

• Depending on a particular participant, CVA can be quite large

1Standardi-

sation

Skills

3

2MarketData

39© 2018 Deloitte

Summary



Incorporation of new market realities into pricing

Multi-curve framework (depending on collateralization)

COUNTERPARTY CREDIT RISK

Importance of proper collateral management

Inclusion of Credit Support Annexes (CSA) in swap contracts

Inclusion of proper valuation adjustments

TRANSPARENCY

Essential to know precisely the exposures of the bank with respect to each individual counterparty

High standards of transparency to guarantee investors protection and best execution within MiFID




StartMid-2007

Since the crisis, rate ofcollateralized Overnight-Indexed Swaps is seen as the true risk-free rate instead of LIBOR

The yield curve built upon OIS is the new standard for discounting

Challenges of collateral include the operational costs, the complex management of threshold and netting agreements, the determination of cheapest-to-deliver assets, etc.

VALUATION ADJUSTMENTSCVA (Credit) accounts for the counterparty credit risk if no collateral

DVA (Debit) accounts for own counterparty credit risk if no collateral

40© 2018 Deloitte

Example of cross-currency swap


Before the 2007 crisis…

Classical valuation

frameworkTwo yield curves are required:

- 1 single “standard” curve for forecast

and discount in ccy1

- 1 single “standard” curve for forecast

and discount in ccy2

… and after the crisis

Multi-curve valuation frameworkFour yield curves are required:

• 1 forecast curve in ccy1 corresponding to the right

LIBOR tenor

• 1 discount curve in ccy1:

- OIS if collateralized

- Standard Libor curve otherwise

• 1 forecast curve in ccy2 corresponding to the right

LIBOR tenor

• 1 discount curve in ccy1:

- OIS if collateralized

- Standard LIBOR curve otherwise

- Cross-currency and maybe tenor basis adjustments

Ccy1 is the collateral currency, ccy2 is the other one!

Regulatory and practical obligations• Report to a trade repository (EMIR)

• Ensure there is a Credit Support Annex for

collateral definition and practical details

• Fulfil MiFID transparency obligations

• Collateral management: operations, netting

agreement, thresholds, etc.

• If not collateralized trade:

- Compute CVA/DVA

- Take netting into account

- Consider other trades in portfolio

42© 2018 Deloitte

Key Messages

1Definition and use of derivatives

• A financial instrument whose value depends on (or derives from) the value of other basic underlying variables

• Derivatives may be used for hedging, speculation or arbitrage, but always as a mean to transfer risk exposure

2

Derivatives can be classified in 5 categories:

• Linear instruments: essentially Futures and Forwards

• Swaps, valued under the Discounted Cash Flows methodology

• Non-linear instruments: essentially options

• Structured products

• Hybrid products

3Increased care for transparency and management of credit risk have led to new valuation techniques,even for instruments as simple as IRSs

• Multi-curve valuation framework (with OIS discounting)

• Inclusion of valuation adjustments such as CVA and DVA

43© 2018 Deloitte

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Topic – RPA (Robotics) in the Investment Management Industry

© 2018 Deloitte

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introduction to derivative instruments link “n” learn · © 2018 deloitte 8 linear instruments...

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