Valuations

Valuations Overview
Functions

 Collect, scrub and integrate prices and valuation input data from
multiple pricing data vendors
 In-house model valuations capability through Model Library
analytics
 Daily valuations for P&L and Collateral Management purposes
 Valuation reconciliation, tolerance analysis and independence
ratings for NAV dates
 Assist clients in building robust valuation policies
 Governance and Valuation Control structure including the Fund
Services Management Committee
 Online valuation reporting for client review
OTC Derivatives valuation capabilities

Equity
Fixed income derivatives Credit derivatives
derivatives/commodities

 Interest rate swap  Equity / commodity option  Credit default swap (CDS) – single
name, index, LCDX & baskets
 Forward rate agreement (FRA)  Index option
 Fixed recovery swap
 Overnight index swap (OIS)  Total return equity / commodity
swap- single name & baskets  Index tranche
 Basis swap
 Index swaps  Loan
 Zero coupon swaps
 Commodities swap  Total return swap
 Constant maturity swap (CMS)
 Property swap
 Amortizing swap
 Dividend swap
 Cross currency swaps
 Option on variance
 Cap/floor
 Variance swap
 Swaption  Forward volatility agreements
 Bond options  Correlation swap
 Asset swaps  Single stock and index options
 Total return swaps  Equity index futures
 Convertible bond
 Equity forwards
 Equity swaps
OTC Derivatives valuation capabilities

Inflation (IL) related

FX derivatives Structured products
derivatives

 FX forwards / spot  Inflation linked zero coupon swap  Structured commodities swaps
 Non deliverable forwards  Inflation linked asset swap  Bi-lateral loans
 FX option vanilla, digital & barrier  Bank loan swaps
 FX variance swap
 FX correlation swap
 FX swap
 FX volatility swap
Exchange traded and OTC securities capabilities

FX, equity and commodity Fixed income and interest rates

 Equity index option  US treasury

 Equity index future  Sovereign bond
 Agency bond
 Preferred equity
 Agency pass through / pool / TBA
 Index warrant  Non agency CMO / RMBS
 FX future  CMBS
 CDO
 FX option
 CLO
 Commodity future
 CBO
 Commodity physical  Bond warrant
 Cross currency equity CFD  Money market fund
 Interest rate future
 Preferred equity CFD
 Interest rate future option
 Cross currency preferred equity  Bond future
 Bank loan
 Whole loan
 Bond
 Bond CFD
Valuations Process Workflow
Cross Functional Dependencies

 Accurate trade entry – Valuations relies on correct booking

 Partial terminations

 Corporate actions, credit events, pay-downs

 Restructuring of trades
Valuations relies on  This may or may not be straight forward, so verbal communication should be
initiated.
other Operations
teams for:  Positions Reconciled

 By identifying trade breaks, this can justify the difference in MV

 Reset / Cash maintenance

 Resets, especially for trades not valued through k+, it is important for the valuation
group to be in sync with how and when operations performs the reset/cash
maintenance

 Not being in sync, can cause incorrect valuations

Cross Functional Dependencies - 2

 Price trades accurately - Daily

 The Collateral group relies on the OTC Valuations to pull the MV values into
GoCredit to calculate daily exposures used to reconcile the margin calls produces

 Send values for trades/positions to accounting and collateral

management system

 Regardless of the MV source, the Collateral and FA teams rely on Valuations to

Collateral Management perform the margin reconciliations and P&L reporting

& FA relies on
 Help troubleshoot P&L discrepancies
Valuations team:
 MV + Realized Cash = P&L. Fund accounting performs their due diligence and works
with the Valuation and operations team to troubleshoot

 Provide valuation reconciliation for NAV date

 FA and Investor Relation teams can proceed with a final sign off up until the OTC
Valuations AND the Client have signed off
Valuation Reconciliation

Counterparty/Prime Manager provided

SS&C GlobeOp Independent Sources
Broker prices

 Model Library  Bloomberg Terminal

 Bloomberg  Reuters Eikon Terminal
 IDC  Other pricing specialist
like
– SuperDerivatives
– Markit valuations
Products Overview
Introduction to Futures

 A futures contract is a standardized agreement to buy or sell an

asset in the future. Futures contracts are publicly traded on major
exchanges, where contracts (rather than the actual assets) are
bought and sold. The underlying asset in a futures contract is usually
a financial instrument or commodity.
 Specific standards for futures contracts are established by the
respective exchanges. These standards include the contract size
(i.e. the unit amount traded in one contract, expressed in dollars or
volumes), the asset quality to be delivered against short futures
contracts, and the contract maturity, expressed in delivery months.
Trading Futures Contracts

 In a futures transaction, an order is placed through an exchange,

where buyers and sellers are anonymously matched. If the order
cannot be filled (there is no buyer for a seller, or vice versa), the
exchange returns the order for adjustment or cancellation.
 At the end of each trading day, each futures position is marked-to-
market, or valued using that day's closing prices.
Margin

 All financial futures contracts require a good faith deposit, or margin, that can be drawn
upon to cover losses incurred in the course of futures trading. Margins are set by the
exchanges and brokerage houses to minimize credit risks leading to defaults. Because an
investor can short a futures contract without actually ever owning the underlying asset,
margins are particularly critical in futures trading.

 When a futures position is opened, an initial margin is deposited. The exchanges also
establish a maintenance margin level. As the account is marked-to-market daily, gains and
losses are credited and debited. If the margin falls the below maintenance level, a margin
call is triggered. The required deposit, called a variation margin, brings the margin account
back to its initial level.

 Any credit balance in a margin account can be withdrawn.

 For example, an investor buys ten $10,000.00 futures contracts at a market price of
96.00%. The exchange requires 9.00% of the contracts' par value in a margin account, or
$9,000.00. The maintenance margin required is 8.00%, or $8,000.00. When the margin
account balance falls below this maintenance level, a margin call requires a variation
deposit to bring the balance of the margin account back to $9,000.00.

 When the margin account balance increases to $9,500.00, it shows a surplus of $500.00
over the required initial margin amount of $9,000.00. The investor may withdraw this
$500.00 in part or total.
Introduction to Options

 An option is a standardized contract offering the right, but not the obligation, to
buy or sell an asset at a predetermined price. The asset that is bought or sold in
the option contract is called the underlying asset. Underlying assets of options
may be any of a number of securities, including individual stocks, stock indices,
futures contracts, foreign currency, or bonds.
 The price that is paid to buy an option contract is known as a premium.
Exercising an option converts the right to an actual purchase or sale of the
underlying asset.
 European options can only be exercised on their expiration date. The expiration,
or maturity date, is the day the option buyer's right to exercise the option (and
the seller's obligation to perform) ends. American options can be exercised at
any time up to, and including, the expiration date. The terms "American" and
"European" do not refer to the location of the option or the exchange. Some
options trading on North American exchanges are European.
In, At- and Out-of-the-Money

 The type of option and the relationship between the spot price of the
underlying asset and the strike price of the option determine whether an
option is in-the-money, at-the-money or out-of-the-money.

 Exercising an in-the-money call or in-the-money put will result in a payoff.

Neither a call nor put that is at-the-money or out-of-the-money will produce
a payoff
What is a Bond

•A loan represented by an IOU, allowing it to be bought and sold.

•Interest is usually paid at predetermined intervals - The coupon

and usually for a set period of time until maturity at which time the
loan (Principal) is usually repaid.
Why Bonds?

The Company
•Still own the company and doesn’t dilute ownership of the
company or profits
•Cheaper than equity
•Don’t have to meet stock exchange criteria
•Quicker that an equity IPO or secondary listing

The Investor
•Only a loan
•Receive interest (Degree of certainty around cash flows)
•Priority in capital structure in the event of default
Bond Pricing

C C CP
PV    ... 
1  r (1  r ) 2
(1  r ) n

C – Defining the coupon

P - Principal
1 + r – Credit spread and risk free rate
Credit Default Swaps - Definition

A Credit Default Swap (CDS) is a contract in which the writer offers the buyer protection
against a credit event in a reference name for a specified period of time in return for a
premium payment.

 Typical CDS cash flows

–The contract pays par in return for 100 nominal of debt if the reference name suffers a
credit event before the maturity of the deal.
–The buyer pays a premium quarterly in arrears.
Credit Default Swap - Credit events

 Credit event: Credit event is a trigger that causes the buyer of protection to terminate and settle the
contract. Credit events are agreed upon at the time the trade is entered into and are part of the
contract.
Major types of Credit event are:
 Reference Entity bankruptcy
 Failure to pay
 Obligation acceleration
 Repudiation/Moratorium
 Restructuring
 Information regarding credit event/default can be found in ISDA website, the ISDA Credit
Derivatives Determinations Committees determines whether a Credit event has occurred or not.
Information can be found in below link: http://dc.isda.org/.
 An email is also sent by the Internal docs team to the OTC valuation in the event of default along
with the list of clients and deals affected.
 DC determines a event determination date which indicates the date from which the credit event is
effective. It also gives the Auction date and Auction settlement date.
 When a failure to pay/ bankruptcy credit event has occurred it is certain that the underlying has
defaulted and market stops quoting spreads, only recovery rate is quoted in the market till the
auction date.
Credit Default Swap Structure

Pre-default
Quarterly premium
in arrears

Protection Protection
Buyer Seller

Post-default
Defaulted debt of
reference name

Protection Protection
Buyer Seller
Loss payment
 Types of Credit Default Swap Trades
1 . Single Names : Protection bought on corporate debt
(a) Old Style (legacy trades) – these trades are very few after the standardization of CDS contracts
done post 2008 crisis.
(b) SNAC – Standard North American Contracts, trading at Fixed Coupons of 100 or 500 bps
(c) SEC - Standard European Contracts, trading at Fixed Coupons of 25, 100, 500 or 1000 bps
(d) Other Standard CDS’s – trading at Fixed Coupons of 100 or 500 bps
2 . Index CDS Trades : Protection bought on a basket of Credit entities– trades are done on a
fixed coupon which is predefined at the time when a new series are rolled out, generally in
March and September.
3. Index trades : CMBX/ ABX / Primex trade: these index’s are created and maintained by Markit
referencing a basket of commercial mortgage-backed securities, these are valued in excel sheet on
the basis of price return, since we receive price instead of spreads as for other single name and
index trades.
 These Index’s have a monthly accrual period, usually 25th of the month, all index ABX/ Primex
trades follow a modified following convention, while CMBX trades have a fixed convention.
4. Cleared CDS trades: these are same as any normal single name and Index trades, however these
are cleared thru a clearing house such as ICE CREDIT, CME etc, these have started trading
recently .

2
Credit Default Swap - Trade specific attributes

Trade Date, Instrument, Buyer / Seller, Folder, Counterparty, Paying / Receiving Leg,
Trade Currency, Adjusted for Roll Convention, Notional Amount, Payment Frequency,
Fixed Rate, Begin Date, Maturity Date, Reference Asset, Recovery Rate, Credit Event,
Settlement Mode, Day Count Basis, Calendar, Upfront Fee.
 GoPricing Trade details page:
Credit Default Swap Valuation
 Pricing of CDS is now standardized in the market. ISDA CDS standard model is
generally accepted as a standard model for pricing. ISDA CDS standard model is
maintained by Markit.
 Gopricing CDS model replicates the ISDA standard model.
 One of the most important data required for CDS valuations is the Credit Spreads which
we receive from different sources: Markit/Fitch/CMA/Manager/ Counterparty
 The credit spread of default-free bond with that of the defaultable debt instruments
provides valuable information in the following ways.
-Conveys Probability of default
-As a leading economic indicators
-As an efficient allocator
 Another input required is the Yield curve for discount factors, we used the ISDA
Standard CDS yield curve rates which are published with one day lag. These can be
found in Standard CDS yield curve Manifold in Gopricing.
 We receive spreads on a daily basis from Markit/Fitch/CMA via FTP which gets loaded
into GlobeOp’s CDS Pricer in GoPricing to calculate the daily Market Values for all CDS
positions of Client’s Portfolio.
 Valuation is generated based on net of present value of Premium leg and contingent leg.
Interest Rate Swap (IRS)

An Interest Rate Swap (IRS) is an exchange of future cash-flows

generally based on Fixed versus Floating interest payments.
IRS trades are used to:
 Manage interest rate exposure
 Restructure debt (Fixed to Float)
Trade on a view of rising/ falling interest rates

 To value an IRS we need to:

 Generate forward cash-flow schedules on both legs of the swap
 Discount the forward cash-flows to present value
 Net both legs of discounted cash-flow stream
 IRS trade economics

The following are the economic trade details required for booking an IRS
trade. This information is used to generate cash-flow schedules in the
system.
Trade Notional
Fixed and Floating rates
Reset and Payment frequency cash-flows
Date Schedules (Begin and Maturity dates)
Conventions for each leg of the trade (Basis, Reset Lag on Floating rate, Day
Count convention)
Calendar conventions
 IRS Valuation

The IRS cash-flow calculation is based on the following formula

Interest = Notional x Rate% x Day Count Fraction

Day Count Fraction (DCF) = Number of days in calculation period / Basis

Basis is currency specific

USD is A/360 Quarterly on Float and 30/360 Semi-Annual on Fixed
DCF is used to convert the annualised Fixed rate into the appropriate
period
Example : Notional 10m, Rate 0.95% semi-annual payment for USD will
give an Interest cash-flow of 10m x 0.95% x 180/360 = USD 47,500
DCF of 180/360 is generated based on the calculation parameters of a
semi-annual payment (6x30=180) and a basis of 30/360
Swap Curve

IRS valuations depend on discounting future cash-flows to present value

using the appropriate discount curves. Forward and Discount curves
are generated using the Swap (Yield) curve.
The Swap curve is constructed using liquid observed market rates.
 Short end of the curve (up to 2Y) uses Libor rates, Deposits, FRA,
Currency Futures or can be FX implied.
 Long end of the curve (2Y onwards) use Swap Rates or Deposits
 The input par rates into the curve are used to generate
 Implied par rate
 Zero Coupon rate which are rates assuming no interim payments
(no re-investment assumptions required)
 Forward rates which are derived from the Zero Coupon rate

FV = PV x (1+R%) ^ N
IRS Valuation

 The discount factors based on the yield curve are applied to the
individual cash-flows forming part of the cash-flow schedule
 Discounted cash-flows are summed up to generate the Present Value
(PV) of each swap leg
 The Net Present Value (NPV) is a sum of the swap leg PV’s
 The swap NPV in Kondor can be accessed using the Global Risk Solver
option available at trade level. This screen displays the individual
components generating the NPV
 The NPV can be generated in a report format using the Kondor
Financial Report
 Total Return Swap Trade Economics

The following are the economic trade details required on EQS trade. This
information is used to generate valuations.

Traded Quantity & date

Underlying asset’s identifier (ISIN)
Reset frequency
Trade / Reset price
 Floating rate +/- spreads
 Buy / Sell
 Total Return Swap Valuation

EQS are priced based on the type of return :

Price Return – Here we would account only for the returns based on change
in the price of the underlying.
Price Return + Funding
Total Return - Here we would also take into consideration the Dividend on
the underlying equity.
Price Return + Funding + Dividend
 Total Return Swap Valuation (Contd..)

Price return –
Quantity x (Underlying price – Trade price OR Reset price)
Funding
Traded notional x day fraction x (floating rate +/- spread)
Dividend
Positions live on or before the ex-date (record date) is eligible
for dividend
Quantity x Dividend per share
 Equity OTC Option

EQUITY/INDEX OPTIONS:

The option contract offers the buyer the right, but not the obligation, to buy (call) or
sell (put) a security or other financial asset at an agreed-upon price (the strike
price) during a certain period of time or on a specific date (exercise date). The
underlying on an option could be any financial product E.g. Equity and Index
 Equity OTC Option Trade Economics

The following are the economic trade details required on EQO trade. This
information is used to generate valuations.

 Quantity
 Maturity & settlement date
Underlying asset’s identifier (ISIN/BBG ID)
Call / Put
Exercise Type
 Buy / Sell
 Strike
Equity OTC Option Valuation on excel model

We value EQO trades on the in-house excel based model using the Black
& Scholes built in the Model Library function.

 We require the underlying price, strike, risk free interest rate, implied
volatility, expected dividend yield, number of years to maturity, call/put.
The implied volatility is taken as per the call or put position.
Equity OTC Option Valuation on excel model

If the underlying is a commodity future than we need to use Blacks

model as we need to discount the current market value. For a commodity
future, the underlying price is actually a price as of the maturity of the
trade therefore we need to discount it to arrive at the current value to
use in the model.
If the strike is trading on the exchange we can take the market value
rather than calculating the theoretical price.
We also use 90 days historical volatility in case implied vol is not
available.
Equity OTC Option Valuation

 Look-alike exchange traded option prices are given priority over value
derived from excel pricer.

 GO valuation is used as final source only if implied vols are available

for deriving the value.

 GO valuation is used only as a reference source in case where modeled

or historical vols is used as a valuation input.
FX Options

A foreign-exchange option (commonly shortened to just FX option

or currency option) is a derivative financial instrument that gives
the owner the right but not the obligation to exchange money
denominated in one currency into another currency at a pre-agreed
exchange rate on a specified date.
FX Options

Example:
A GBP/USD put contract could give the owner the right to sell £1,000,000 and buy
$2,000,000 on December 31. In this case the pre-agreed exchange rate, or strike
price, is 2.0000 USD per GBP (or GBP/USD 2.00 as it is typically quoted) and the
notional amounts (notionals) are £1,000,000 and $2,000,000.
This type of contract is both a call on dollars and a put on sterling, and is typically
called a GBPUSD put, as it is a put on the exchange rate; although it could equally
be called a USDGBP call.
If the rate is lower than 2.0000 on December 31 (say at 1.9000), meaning that the
dollar is stronger and the pound is weaker, then the option is exercised, allowing
the owner to sell GBP at 2.0000 and immediately buy it back in the spot market at
1.9000, making a profit of (2.0000 GBPUSD – 1.9000 GBPUSD)*1,000,000 GBP =
100,000 USD in the process. If they immediately convert the profit into GBP this
amounts to 100,000/1.9000 = 52,631.58 GBP.
 FX Option Valuation

In 1983 Garman and Kohlhagen extended the Black–Scholes model to cope with the presence of two interest rates
(one for each currency). Suppose that is the risk-free interest rate to expiry of the domestic currency and is the
foreign currency risk-free interest rate (where domestic currency is the currency in which we obtain the value of
the option; the formula also requires that FX rates – both strike and current spot be quoted in terms of "units of
domestic currency per unit of foreign currency"). The results are also in the same units and to be meaningful need
to be converted into one of the currencies.

Then the domestic currency value of a call option into the foreign currency is:
Valuation Control
 Valuation Policy

 Clear instruction on how the assets should be valued

 Data Source, Hierarchy, Tolerances, Methodology

 Clear delegation of authority

 Valuation Committee, Directors of the fund

Characteristics of a
good valuation policy  Evidence on board approval

 Independence

 Reflects the client’s current valuation workflow

4
Valuation Control

Essential Valuation Control Functions

• Check consistency between pricing system configuration and valuation procedures

• Assure all investments are priced according to price source hierarchy

• Objective assessment of price/valuation reasonableness using multiple price sources

• Seek additional evidence (price sources) to resolve tolerance breaks and other pricing
exceptions

• Sophisticated tolerance tests tailored to product type using analytical derived tolerance
thresholds – at position, instrument type and fund level

• Escalation process to senior pricing/valuation experts for unresolved exceptions

• Integration of support documents and other evidence to support valuations

• Multiple level management review/sign-off of pricing/valuation analyses and reports

Valuation control

Ultimate escalation body

Approval of policies/procedures
FSMC

Oversight from NAV perspective

CSG directors Post NAV exception reviews

6-eye reviews
Valuation Escalation of exceptions
AD/directors Review of controls and policies

Review exceptions and MIS

Valuation managers 4-eye reviews

Tolerance Analysis
Valuation analysts Compilation & compliance

Procuring vendor data

Market data management Scrubbing
Valuation Control Exceptions

 Not Priced Exceptions

 Not priced securities

 Missing mandatory price sources
 Single Source Exceptions
Note: All exceptions that persist
 Stale Price Exceptions into the NAV calculation must
 No Movement Exceptions be explained (in GoPricing)
 Tolerance Test Failures such that the final price used in
the NAV is adequately justified.
 Price Difference

 Materiality Difference
 Manager Price Overrides
Resolving Valuation Control Exceptions

Actions Applied to Resolve Responsible Department

Exceptions
Ensure all mandatory price sources applied Valuation Control

Challenge vendor sources Valuation Control

Apply contingent price sources Valuation Control

Seek additional vendor sources Valuation Control

Request broker/dealer quotes Fund Accounting

Request manager prices Fund Accounting

Escalation to Valuations.Escalation alias Valuation Control/Fund Accounting

Escalation to FSMC Valuation Control/Fund Accounting

Explaining Valuation Control Exceptions
If exception(s) are not resolved; exceptions must be explained:
 Vendor price challenges / transparency queries
 Event-driven discrepancies
 Preponderance of evidence, e.g., contribution depth
 TRACE (US corporate securities only)
 Transaction prices (Geneva Backtesting report)
 Shared holdings prices (GoPricing)
 Escalate to second level Valuation Control analysis team
Escalate to Valuations.Escalation alias
 Investment manager/valuation committee/fund director(s) pricing
instructions
 Escalate to FSMC (Fund Services Management Committee)
 Tolerance Analysis

OTC Derivatives
T1 Tolerance Test Secondary T1 Test
Instrument Type T1 Sensitivity Test Threshold Secondary T1 Test Tolerance Threshold
Swaps & FRAs (G10 DV01 test: Valuation Difference /
currencies) BPV 2 bps
Swaps & FRAs (non-G10 DV01 test: Valuation Difference /
currencies) BPV 4 bps
DV01 test: Valuation Difference / Vega test: Valuation
Swaptions BPV 3 bps Difference / Vega 1% shift in volatility
DV01 test: Valuation Difference / Vega test: Valuation
Caps / Floors BPV 3 bps Difference / Vega 1% shift in volatility
CR01 test: Valuation
CDS Difference/CR01 7.5% of par spread

OTC Securities
T1 Tolerance Test
Instrument Type T1 Price Test Threshold
Primary Source price - Reference
ABS: Other Source price 700 bps
Primary Source price - Reference
ABS (Credit Card, Auto) Source price 100 bps
Primary Source price - Reference
Agency CMO Source price 300 bps
Primary Source price - Reference
Agency Debt Source price 100 bps
Agency Pass- Primary Source price - Reference
through/Pools/TBAs Source price 15 bps
Independence Ratings
Final Value Source Reference value source(s) Fund valuation instruction
required
Independent (Note: where an
independent reference source price is
not available or is not in tolerance with
the primary source price, the
Independent Valuations department is responsible No
for confirming that the primary source
price is acceptable or recommending
an alternative source, subject to the
fund’s valuation policy)

Not independent Independent, in tolerance No

Potentially; contingent on
Not independent Not Independent, in tolerance
PPM/OM, valuation policy
Insufficient evidence, e.g., one broker
Not independent quote not independently received, Yes
and/ or not in tolerance

Not independent No third party evidence Yes

Thank you