19 June 2000

International Swaps and Derivatives Association

New York

Operations Training Course

Valuing, Unwinding, and Hedging Swaps

David Mengle
Vice President
J.P. Morgan Securities Inc.
Basic principle of financial instrument valuation

Value is equal to the present value of expected cash flows

Derivatives

Pricing and valuation

Unwinding
Hedging
Rates used for swaps pricing and valuation
Yield curves
Par curve
- Yields on full-coupon bonds, which pay periodic interest

Zero coupon (or spot) curve

-Yields on zero coupon bonds
-Used to calculate present values of expected swap cash flows

Forward curve
- Yields expected to prevail in future periods
- Used to estimate expected floating-rate payments
Yield curves

Find zero coupon rates from par-bond yield curves

Calculate implied forward rates from ZC rates

Forward rates

ZC Rates
f'ah
Rates Yields

Maturity
 Zero coupon rates

Example: Five-year bond priced at par

Present value of coupon bond cash flows = Present value of zero coupon cash flows

The zero-coupon yield curve is derived from the coupon bond yield
curve by the 'bootstrapping' process
- Coupon bond cash flows can be divided into series of zero coupon bonds for
each year.
- Bootstrapping involves solving for a set of zero coupon rates that satisfy the

no-arbitrage conditions.

No-arbitrage condition is equality between:

- Present value of coupon bond
- Sum of present values of zero coupon bonds
 Bootstrapping: Calculating zero coupon rates
-

The par bond yield curve implies a set of zero coupon rates

Par Bond Cash Flows

(annual coupons)
1Yr 2Yr 3Yr 4Yr
Maturity .
-
Yield 6.12 % 6.52 % 6.72 % 6.87 %
'

1 Year 6.12 % 106.12 6.52 6.72 6.87

2 Year 6.52 % 106.52 6.72 6.87
3 Year 6.72 % 106.72 6.87
4 Year 6.87 % 106.87
 Bootstrapping: Calculating zero coupon rates
Discount cash flows using zero coupon rates
Step 1:
Step 2: Discount Year I cash
One-year rate is Par Bonds (annual flows at one-year zero coupon
also the one-year coupons) rate (6.12%)
zero coupon rate

Maturity \ YieM

1 Year 6.12 %
2 Year 6.52 %
3 Year 6.72 %
4 Year 6.87 %

Par value: 100.00 /100.00 100.00 100.00

Step 3: Present values of cash flows must add up to par value, which means present value of

-
Year 2 cash flow must be $93.86. What 2-year zero-coupon rate produces this present value?
Answer: 6.53%, which can now be used to discount Year 2 cash flows.
Repeat step for each year. Resulting zero coupon rates on next page
 Where do forward rates come from?
No-arbitrage conditions

Arbitrage occurs if one investment choice guarantees profit

compared with other investment choice

$106.00

What ~ n e - ~ erate,
a r one
year from now (1 2x24
forward rate), would make
6.00% $106.00 grow to $1 14.49?
X..XX% = 8.01%
= RlZxz4

Today 1 year 2 years

.I I' .,
From zero coupon rates to implied forwards

Returning to our original example, we can now derive implied

forward rates by means of no-arbitrage conditions.

Mat Yield ZC Rate Fwd

For example, investing at 6.53% for two years should produce the
same result as investing for one year at 6.12% and reinvesting at
6.95%.
 Pricing a swap
You pay fixed
rate
Forward rates used to estimate
expected future floating payments forward curve

Fixed rate is weighed average of J 3

forward rates
Par (market rate) swap:
fixed rate
-PV floating = PV fixed payment
- Present value of net payments in
area A = Present value of net
receipts in area B
- Present values calculated using zero maturity
coupon rates 0 = forward rate
From forwards to swap (fixed) rate: example

Calculate expected floating payments ($1 MM notional), take PV,

and solve for fixed rate with same PV:

Mat Yield ZC Rate' Fwd

Fixed rate that makes fixed payments equal to floating

payments is 6.87, which is the (weighted) average of
forward rates.
 From forwards. to swap (fixed) rate: solution
You pay fixed
Fwd Floating Fixed Fixed
- -
Mat.
ZC Period. -
Fwd P-nt -
PV C
n- Payment -
PV

Total $234,245 ($234,245)

Net = 0

.,., .., ..
 What happens when rates change

rate
Assume interest rates rise
Forward curve shifts upward
But swap rate remains fixed
Par (market rate) swap: fixed rate

-PV of floating receipts is now greater

than PV of fixed payments
- Present value of net receipts in area B
> Present value of net payments in
area A
maturity
To fixed rate payer, swap now has
0 = forward rate
positive value
I t ,
Effect of rate change on yield curve

The new yield curve:

Mat Yield ZC Rate Fwd

So floating rates increase, but the fixed rate stays constant. What is
the net present value (or "mark to market value") of the swap now?
 Marking the swap to market
You pay fixed
Fwd Floating Fixed Fixed
- -
ZC
Mat. Period -
Fwd P-ent -
PV Coupon Payment -
PV

1 Yr 6.62% 0 x 1 6.62 % $66,200 $62,090 6.87 % ($ 68,663) ($64,397)

2 Yr 7.03 % 1 x 2 7.45 % $74,498 $65,028 6.87 % ($ 68,663) ($59,932)
3 Yr 7.25 % 2 x 3 7.67 % $76,667 $62,156 6.87 % ($68,663) ($55,664)
4 Yr 7.40 % 3 x 4 7.88 % $78,753 $59,186 6.87 % ($ 68,663) ($5 1,601)
Total $248,460 ($23 1,594)

Mark-to-market value to you has increased to $16,865 Net $16,865

&*a

16
 What are the potential sources of value in a
derivatives transaction?

Source of value Management Name

Credit analysis Credit spread

Custom tailoring Origination

Bid-offer spread Market making

Hedging and position taking Portfolio management

 What is Initial Net Present Value ("INPV")?

Credit spread Gross

Transaction
Origination INPV Value
Market making

Portfolio management

INPV reflects the difference between the credit risk adjusted rate on the
transaction and the prevailing mid-market rate
 Understanding INPV: Example

US$30 million three year interest rate swap (at-the-money) with an

A-rated counterparty where JPM pays fixed @ 6.50%.
Environment: Yield curve as of May 29, 1996

Economics (in US$)

Gross Transaction value 29,973

-

Credit spread (1,041) = CRE

INPV 28,932
Market Making (16,126)
Origination 12,806
Basic principle of option pricing

Option price is equal to the present value of the

expected in-the-money cash flows
 Probability concepts

Probabilities
- Degree of belief (30% chance of rain)
- Relative frequency (5% of students fail)

Properties of probabilities
- Each probability must be a non negative fraction
- Probabilities for all possible random events must sum to

one <

Events
- Mutually exclusive
.. - Independent - 2 -#& & L k ? - M W -,&~aof&
 Normal distribution
Distribution associates random events with probabilities'

-
Distribution
.
suggests 20%
probability of
Probability observing -1.3

-3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0
Outcome
Statistical measures

Central tendency (location) of a probability distribution

- Mean (average)

- Expected value is the average of all potential outcomes

Dispersion
- Variance (02) is average of squared deviations of potential outcomes from
mean, weighted by probability
- Standard deviation (o) is square root of variance
Time aggregation: Annual s = (Daily o) x SQRT(day count)

Interaction
- Covariance (o,,) measures how much two random variables move together

- Correlation coefficient (pI2),which always lies between -1 and +1, is a more

commonly-used measure
c T 2
19, =-
cTo2
Normal distribution
Confidence interval (two-tail test)

'50 1 Mean = 0 95% confidence interval:

Option pricing and valuation
Notation

F = forward price or rate .- *P""

X = strike price or rate
T = maturity date of underlying
t = time to option's expiration
s = volatility L ~ gS#>
R
ITM, ATM, OTM = in-the-money, at-the-money,
out-of-the-money
 What influences the value of an option?
The "Greeks"

Delta (6) = Change in value of an option in response to a change in

the underlying price. Positive for calls, negative for puts.
Gamma (r)= Change in the delta of an option in response to a
change in the underlying price

Theta (T) = Change in value of an option for passage of time; also

called time decay. Always positive.

Vega = Change in option value from a change in volatility;

occasionally called Kappa (K). Always positive.

Rho (p) = Change in;value of an option for a given change in the

, ,
rate used to discount cash flows.
Option pricing and valuation
Option Value = Intrinsic Value + Time Value

Intrinsic value C W
- Amount option would pay out if exercised immediately, that

IS ...
- Amount by which option is in the money

For call, intrinsic value = max (F-X,O)

For put, intrinsic value = max (X-F,O)
Time value
- An out-of-the-money option has value so long there is a

possibility that it will be exercised

- Time value is difference between total option value and
intrinsic value .
Intrinsic value

Forward price compared with strike price

For call option or cap, intrinsic value = max (F-X,O)
Option payoff

Price
Out of
the In the
money money
Determining option value
Present value of expected in-the-money cash flows

For call option, present value (C) is equal to:

- Probability that call will expire in the money

TIMES
- Expected underlying price, GIVEN that option expires in the
money, MINUS strike price
TIMES
- Discount factor

That is, C = p(FT>X) * [E(F,IFT>X) - XI *D

All option pricing models seek to find solution to this equation.
Types of option pricing models

Closed-form (analytic) solutions && "P"

'

- Plug in inputs, come out with a solution

- Black-Scholes model

Numerical solutions
- Approximate value through computation &&a&m
- Binomial tree

Simulation
- Monte Carlo simulation
- Calculate value from a set of randomly-generated price
scenarios
Derivatives

Pricing and valuation

Unwinding
Hedging
Unwinding swaps

Assignment
- A counterparty transfers to another counterparty his rights and

-
Termination
An agreement to extinguish the original swap obligation.
-
-

&5 1% M
'I/,&
Offsetting swaps
- Entering an "opposite" swap, which offsets the original position
 Unwinding a swap: Offsetting swaps

Period 1
c ~ n n ,
- J.4U70
4
Investor $100 million notional Dealer

T.IROR
*
Period 2 (rates fall 10 bps over next day)
LlBOR + 10

Investor $100 million notional Dealer.

5.40%
*
Derivatives

Pricing and valuation

Unwinding
Hedging
 How dealers hedge the directional risk of swaps
Dealer pays fixed and receives floating

Hedge strategy can consist of

Offsetting swap
Buy treasury securities, financed with repurchase agreement
Buy Eurodollar futures
I, ., Leave position open 4 a FL$tftak Ubae LJ$!
ry
I t

-
 Hedging interest rate swaps
Execute offsetting swap - ~&~ibdt& or- M? &,q7 &A?-

-
-
LIBOR LlBOR
W Interdealer
Counterparty Dealer
< market
Fixed Rate (5.4%) Fixed Rate (5.5%)
*

Provides substantial offset of interest rate risk if executed

immediately
- Here, dealer locks in 10 bp profit
But swap spreads can change suddenly, which could wipe out the
dealer's profit on the swap
- If spreads narrow, so dealer receives 5.4%, profit will vanish
Derivatives dealers take advantage of liquid markets to
create new contracts
Example: Hedging a USDIDEM cross-currency swap
-

E US$ Loans
$100 million
DM 180 million

6 8%

I
German Bank
-
a

4
Initial principal exchange

6.1% (US$)
b
v

Dealer
4.8% (DM)
A
Payments during swap
4.8%
Final principal exchange
r
US$100 million
D M Note DM 180 million
A cross-currency swap can be managed as three
separate risk components
Each risk is highly liquid, so product liquidity is not important

USD interest rate risk: USD Swap Rate

Plain vanilla USD interest
rate swap
German Bank .........................
USD Libor

Currencyrisk: USD Libor

USDIDEM cross- .........................
currency basis swap
German Bank ........................
(with principal exch.) DEM Libor

DEM interest rate risk:

Plain vanilla DEM interest
rate swap
German Bank
- DEM Libor
.........................

DEM Swap Rate

18
 Hedging a cross-currency basis swap ..

3-month
.................. ..................
currency *..................
3-month 3-month
DEM Libor DEM Libor
+ 10

The cross-currency basis swap is in effect a set of 'parallel loans' in two

currencies and priced at Libor
The currency risk is offset by the FX swap, which is a matched spot and
forward FX transaction
The FX swap hedge is rolled over every period when the rates are reset (here,
every 3 months)
 Managing NDFs -p L'~&~&~F

Because of the limited availability of hedging instruments, dealers generally

manage NDF portfolios on a matched counterparty basis.
- This tends to limit liquidity because each transaction requires dealers to find

someone willing to take the other side of the transaction.

- To the extent laws and regulations allow, dealers attempt to hedge NDF

exposures using local currency cash instruments.

- Restrictions on short sales are a common obstacle to hedging.

, Conditions for development of ability to hedge in local markets

- Liberalization of exchange and capital controls

- Development of active interbank money markets, which would provide

market-determined benchmark interest rates (e.g., Libor)

- Development of well-defined yield curves across longer maturities
 Basis risk - ~ y e $ 4
w

Definition
- The uncertainty that results from changes in the relationship

between two or more rates

Examples of basis risk
- Hedge and underlying price change differently

- Spot and forward (or futures) prices change differently

- Yields on different maturities change in different directions or by

different amounts (yield curve risk)

- Yields of corporate securities change differently from yields of
government securities (spread risk)
- The reference rate in a non-deliverable currency forward might
differ from the actual rate available in the local market
- The yield on one corporate bond issue might change in a different
,
% 1 .

way from those of other bonds (specific risk)

 Basis risk arises when hedging swaps using Eurodollar
futures

Counterparty
- Fixed rate
Market

Basis risk arises when swap payment dates do not correspond exactly to
Eurodollar settlement dates

Swap prices have convexity, while Eurodollar futures do not

Another example: Using heating oil futures to hedge jet fuel
 - Uncertainty resulting from non-parallel shifts of the yield curve
Curve risk arises when the hedge and underlying are of different
maturities
Examples
- Using Libor borrowing to fund investment in 20-year German
government bonds (Bunds)
- Selling short 10-year Japanese Government Bond to hedge long 20-
year JGB position
- Yield-curve swap, in which dealer receives 10-year rate and pays 2-
year rate plus spread
 Non-parallel shifts of the yield curve
Duration assumes only parallel shifts

U.S. Treasury rate

750% 1

-1 Upward shift ofso bps /

/ Initial yield curve

5.50%
l year 2 year 3 year 4 year 5 year 6 year 7 year 8 year 9 year I0 year 15 ycar 20 year 25 ycar 30 year

Maturity
; ,.,
 Curve risk arises from non-parallel shifts of
the yield curve
Example: U.S. dollar 1993 - 1994

6 -

5 -

4 -

3 I I I I I I I I I I I I I I I

3mo 1 2 3 4 . 5 6 7 8 9 10 12 20 25 .30
Maturity
Spread risk

Definition
- The uncertainty that results from changes in the difference between

yields on two different instruments

Examples
- Changes in swap spreads

- Changes in credit spreads (difference between corporate bond and

comparable government bond)

Causes
- Changes in market supply and demand for the two instruments

- Differences and changes in credit quality

Spread risk affects the hedging of swaps and other derivatives...

 How spread risk affects swap hedging

Hedge swap by buying Treasury securities, financed with repurchase

agreement

LlBOR Repo Rate

* * Treasury
Counterparty Dealer
Securities
4 4
Treasury Rate
Swap Rate =Treasury
Rate + Swap Spread ' .

If swap spreads were constant, this hedge would be fully effective

But swap spreads can change, so changes in rates might have different effects on
value of hedge and on value of underlying swap
Result: Directional risk hedged out, but not spread risk (or credit risk)
Hedge funds: September 1998

Hedge funds engaged in 'relative value trades'

- Long position in high-yield, corporate, or emerging market

securities (Yield = Treasury yield plus spread)

- Short position in Treasury securities of same maturity

- No directional interest rate exposure

- Fund profits if credit spreads decrease

August - September 1998

- Spreads increased because of credit concerns (Asia, Russia,
generally high volatility in world markets)
- Yields on Treasury securities fell
- Result: Losses on both long and short positions
Basic principle of option pricing

Option price is equal to the present value of the

expected in-the-money cash flows
 Delta and gamma

Option value

1 A X Underlying price (F)

Delta (6) measures how much value of option changes as value of

underlying changes (slope of the option price curve)
Gamma (r)measures how much delta changes as value of underlying
changes (curvature of the option price curve)
,,. t... ,,. Formula: AC = 6(AF) + 0.51-(AF)2
54
Delta and gamma

Delta measures how much value of option changes as value of

underlying changes
-Delta approaches zero for deep out-of-the-money options
-Delta ap roaches one for deep in-the oney options
2i?&
l l l - u d h
What delta tells us
-Probability of option finishing in the money
-Hedge ratio: Percent of underlying asset needed to hedge
option 1
$-s &.hq&Aq
U & ' l d *
Delta and gamma

Gamma measures how much delta changes as value of

underlying changes
- Largest for at-the-money options

-Zero for deep in-the-money and deep out-of-the-money

options
-Positive for long options, negative for short options
-Higher for short-dated options than for long-dated options
Gamma risk measures how quickly an option can become
unhedged
 Local measures of gamma underestimate the effect of
large market moves

T A deep out-of-the-money option can suddenly go in-the-money

Option value
I
Actual value

Gamma measured at A will

underestimate effect of increase in
underlying price to B

A B Underlying price (F)

1 Implication: Full revaluation of options is necessary when options are a

. . ,
large part of a portfolio
How dealers hedge options
Gamma risk is of particular relevance to options hedging

When writing (selling) an option, it is uncertain whether the

option will be exercised at maturity
If the dealer hedges the short option by buying or selling the
underlying asset, it is uncertain whether the hedge position will
have been needed to offset the obligation to perform on the option

Dyrzanzic hedging strategies use frequent adjustments to the hedge

position to anticipate whether an option will be exercised or not
- Stop-loss
- Delta hedging
 Hedging options
Hedging an interest rate cap

Libor
4
Interest rate
Counterparty - 4 Dealer
swap
Max (L-Strike,O) b
Swap Rate

...but, how large a swap?

Counterparty 4
Market
Max (L-Strike,O)

...but, how many futures contracts?

IS
Hedging options
Hedging an short put option on gold

-4
Max (Strike - G,O)
Dealer
. Libor

b
Short sale of
gold
Lease rate

-
...but, how large a short sale?

market
Max (Strike - G,O)

...but, how many futures contracts to sell?

J6
Dynamic hedging strategies

Stop-loss strategy commits the option seller to buy or sell

underlying asset when underlying price passes a designated level
- For short call option, buy underlying if option goes in the
money, sell if out of the money
Delta hedging bases hedge position on delta of option
- Option delta is measure of probability that option will finish
in the money
- Buy or sell underlying as delta changes
- For short call option, dealer would buy more underlying as
option goes in the money and delta goes to one
- Delta hedging attempts to replicate the payoff of the option
using the underlying asset
How gamma risk affects delta hedging

Gamma risk arises from hedging difficulties caused by

- Nonlinear changes in option prices, and
- Linear changes in underlying prices

Ganima risk means that a significant move in underlying markets can leave a
positioi~underhedged or overhedged, either of which is costly
At-the-money options are the most difficult to delta hedge because they have
high gamma
- High gamma means small changes in underlying price have large effects on
probability of exercise (delta)
- This effect becomes especially pronounced just prior to expiry

Other hedging concerns from gamma risk

- Out-of-the-money options

- Market gapping
 What influences the value of an option?
The "Greeks"

Delta (6) = Change in value of an option in response to a change in

the underlying price. Positive for calls, negative for puts.

Gamma (y) = Change in the delta of an option in response to a

change in the underlying price
Theta (z) = Change in value of an option for passage of time; also
called time decay. Always positive.

Vega = Change in option value from a change in volatility;

occasionally called Kappa (K). Always positive.

Rho (p) = Change in value of an option for a given change in the

rate used to discount cash flows.
, , . ..
Volatility concepts
Historical volatility
- Variability (dispersion) of underlying asset about its average
over historical period
- Measured as standard deviation of percentage changes in
underlying price or rate, i.e., SD[ln(Pt/Pt-1)] over chosen
observation period.
- Multiply volatility by square root of time to project over
time period

Implied volatility
- Measure of uncertainty about future underlying price
implied in market price of option
- Not observed directly

- Given market price of option, use option pricing model to

solve for implied volatility
 Historical volatility versus implied volatility

Using option pricing model to solve for option premium:

Underlying price -+ 1 I
Strike price -+
Time to maturity -+
option + (Implied) option price
Discount rate -+
model
Historical volatility -+ I I
Using option pricing model to solve for implied volatility:

Underlying price -+
Strike price -+ Option pricing
Time to maturity + + Implied volatility
Discount rate +
model
Observed option price +
Volatility risk

The greater the volatility, the greater the possible range of

rates, which means a greater number of both
- In-the-money outcomes, with positive option payouts

- Out-of-the-money outcomes, with zero payoffs

The greater the number of positive payoff scenarios that

get paired off with zero payout scenarios

Because option price is the expected value of in-the-

money cash flows, higher volatility means higher value
Volatility risk refers to uncertainty regarding changes in
option value resulting from changes in market volatility of
the underlying asset
Volatility (vega) risk

Risks associated with options

- Long options are long volatility because they gain value if volatility
increases
- Short options are short volatility

Vega risk is more significant for

- Long-dated options
- At-the-money options

Vega risk related to time decay because uncertainty decreases if either

volatility or time to expiry decreases
Time decay (theta)

The greater the time to expiry of an option, the greater the

possible range of rates for a given level of volatility
- The decrease in option value as maturity approaches is

known as time decay

Time decay risk refers to loss of value as maturity
approaches
- Most important for short-dated options

- Closely related to gamma (for at-the-money options)

because gamma and time decay are high as expiry

approaches
19 June ZOO0
International Swaps and Derivatives Association
New York

Operations Training Course

The Structure of a Derivatives Business

David Mengle
Vice President
J.P. Morgan Securities Inc.
How a deal gets done
Where do you fit in?
Organization structure

Until the mid- 1990s, financial institutions typically conducted swaps

business in a derivatives business organization
- The swaps group would be responsible for interest rate, currency,

equity, and other forms of derivatives

Over the past few years, separate derivatives businesses have yielded to
organization by underlying risk
- For example, fixed income derivatives and fixed income cash
instruments would be part of the same organization
Getting the deal started
What comes first?

Existence of a credit line

Marketing relationship with client

NO DEAL SHOULD BE DONE WITHOUT PROPER

CREDIT AUTHORIZATION
Front office: Marketing
Contact with ...
Client
- Watch the market
- Indicate prices
- Propose deals

Trader
- Request firm prices

- Request new structures

Credit
- Ensure proper line in place or obtain credit approval

Legal
- Ensure documentation in place

Operations
- Ensure confirmation went out
Front office: Trader or portfolio manager
Responsible for ...

Provide firm price for marketers

Market making with brokers and interbank market
Hedging portfolio of deals
Proprietary trading (position-taking)
Senior traders monitor compliance with policies and limits
Credit

Alternative approaches
- Preapproved lines
- Case-by-case authorization

What to do when credit exposure exceeds preapproved line

Analyze collateral and other credit enhancement
How much is your firm willing to trade off information about
the counterparty with credit protection?
Two forms of credit business
- Traditional 'buy and hold' lending
- Credit portfolio- G- o/ d5
Financial control

Verify and explain positions, prices, P&L, and risks

calculated by Middle Office
Provide independent verification of market prices and
parameters used by Middle Office
Monitor compliance with limits and report violations
Review model accuracy and risk

Send value at risk (VAR) reports to senior management

Set aside loss reserves
Submit required reports to regulators
Salesltrading support

Input trade into system (deal capture )

Calculate mark-to-market values
Calculate front office P&L
Calculate value at risk
Monitor credit lines
Operations

Back office

Send out confirmations

Make premium and fee payments and principal exchanges
Make entries to general ledger

Monitor collateral
Investigation of problems
Trade processing

Two types

Event-driven

Execution (new deals)

I Amendments (deal revisions)
I
Terminationlmaturity
Result in . . .
Data capture (deal forms)
I Confirmations
I
II Premiumlfee payments
Principal exchanges
II
Accounting entries
Trade processing

Two types
Event-driven Periodic (Trade maintenance)

Execution (new deals) Ratelprice refixings

Amendments (deal revisions) . Monitor exercise (options)

Termination/maturity
Result in ...
Data capture (deal forms)
Confirmations
Premiundfee payments
Principal exchanges
Accounting entries
-
Amortization
Payments (recurring)
Collateral revaluation
Polling dates
Payments and confirmations and
accounting entries plus . ..
Collateral exchanges

12
Corporate risk management
r

Responsible for...

Management information
- Gathering position and risk information
- Assembling risk reports for senior management

Setting and approving limits

Development and oversight of policies and procedures
Approval of new products

Development of risk measurement methodologies

Future trend: Combining market risk management with
credit risk management
Legal

Executes master agreements

Tracks documents
Follows up on non-payment
Netting opinions
Compliance
Internal audit

Monitor control policies

Test adequacy of control procedures
Verify compliance with
- Internal policies

- Limits
- External regulations
So where do we all fit in?

Derivative transaction execution has significant time

discrepancies
- Execution - microseconds
- Documentation and follow-up - years

A deal is an integrated process over many areas

For your firm to make money, your function is necessary
How a deal gets done
Where do you fit in?