VANILLA INTEREST RATE SWAP CASH-FLOW MAPPING AND VALUE-AT-RISK CALCULATION PROCEDURE

IDENTIFICATION OF STANDARD MATURITY ZERO-COUPON BONDS FOR AGGREGATION-CORRELATION-MATRIX POPULATION

1. The rationale for using standard maturity bonds is that these are usually actively traded in deep and liquid markets and therefore reliable market-consistent data for valuation parameters such as bond returns volatilities and correlations is readily available. Decomposing cash-flows from our instrument and mapping them to standard maturity zero coupon bond cash-flows therefore makes the output from our calculations market-consistent.
2. The standard maturity bonds chosen for cash-flow mapping should ideally be the ones that closely straddle the swap contract payment times, or where possible match the swap contract payment times.
3. To understand the language used in this application, suppose we have a bond that pays a coupon at time T(i) whose value-at-risk we want to calculate. We have chosen standard maturity times for zero coupon bonds in our market as T(0),T(1),T(2),T(3), and T(4) in ascending order. In this application, the shortest standard maturity time T(0) is called the zero-indexed sorted time, and T(4) is called longest standard maturity time. Suppose that after sorting the coupon payment time T(i) and standard marturity times, we get the following array of values in ascending order: T(0), T(1), T(i), T(2), T(3), T(4). The time T(1) to the left of T(i) is called the left adjacent time for this particular coupon payment time and the time T(2) to the right of T(i) is called the right adjacent time. If the time T(1) is of the same value as T(i), T(1) will then be called the matching time . When the system displays output allocation for coupon payment at T(i), it will allocate them between T(1) and T(2) then display values at other standard maturity times as zero. The process will be repeated for all other bond's coupon payments. This is for curious users who may want to understand intermediate output data.
4. Volatilities and zero-rates are assumed to be flat for maturities below the shortest standard maturity domestic bond, and flat for maturities above the longest standard maturity domestic bond.
5. If the swap payment time is shorter than the shortest standard maturity domestic bond, the bond with maturity equal to the swap payment time is the first adjacent domestic bond and shortest standard maturity domestic bond becomes the second adjacent domestic bond.
6. If the swap payment time is longer than the longest standard maturity domestic bond, the longest standard maturity domestic bond becomes the first adjacent domestic bond and the bond with maturity equal to the swap payment time becomes the second adjacent domestic bond.
7. The system automatically checks for standard maturity bonds matching swap payment times where possible and calculates cash-low allocating proportions based on that.

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1. The vanilla interest rate swap is the same as a customised fixed-domestic-rate cross-currency swap. The floating rate bond is the foreign bond. The exchange rate is set to 1, and exchange rate volatility is set to zero, and standard maturity zero coupon bonds are the same for both domestic and foreign bond cash-flow mapping process and value-at-risk calculation. This explains the existence of foreign-bond wording in MVC views, and database records.
2. Log into your account or if you are a new user, register your account and enable two factor authentication.
3. Click on the [Vanilla interest rate swap value-at-risk] button, this will take you to the Dynamic-text-blocks parameters page.

Dynamic text-blocks parameters page

1. Select to enter pairwise-flat or pairwise-varying correlations between domestic maturity zero-coupon bonds.
2. Enter number of outstanding swap payment times.
3. Enter number of domestic zero-coupon bonds standard maturity times.
4. Enter time till next swap payment in years.
5. Enter swap payment frequency per year.
6. Click the submit button, this will take you to the array populating page.

Array populating page

1. Enter domestic zero-rates at indicated swap payment times. The zero rates are used to calculate forward rates and then future coupon payments under the assumption that forward rates are realised. The future coupons are then cash-flow mapped to standard maturity times. It is possible to assume that the floating rate bond is just the coupon and principal payable on the next coupon payment and map the cash-flow to standard maturity times. This approach, although it gives an accurate answer when valuing the floating rate bond, will give an inconsistent result when calculating value at risk especially if maturity time differs significantly from time of next coupon payment. This is because by assuming payment occurs on next payment we under-state the duration and therefore the volatility of the floating rate bond which is crucial in calculating value-at-risk. In this application, we use the forward-rates-are-realised assumption to map floating rate bond cash-flows for the purpose of value-at-risk calculation.
2. Enter values of domestic zero-coupon bonds standard maturity times.
3. Enter zero-rates at domestic standard maturity times.
4. Enter domestic standard maturity zero-coupon bonds daily volatilities.
5. Enter pairwise correlations between domestic standard maturity zero-coupon bonds.
6. Click the submit button, and this will take you to the Vanilla interest rate swap value-at-risk calculation parameters page.

Vanilla interest rate swap value-at-risk calculation parameters page

1. Select the name of domestic currency of valuation from drop-down list.
2. Enter the fixed domestic swap rate convertible swap-payment-frequency times per year.
3. If the time till next swap payment is less than or equal to the tenor period, enter the observed floating rate convertible swap-payment-frequency times per year resulting in next swap payment.
4. Enter domestic notional principal value.
5. Foreign principal value is set by the system to equal the domestic notional principal.
6. The spot-exchange-rate: domestic currency units per unit of foreign currency is set by the system to equal 1.0.
7. The exchange rate daily volatility is set by the system to 0.
8. Enter the confidence level for value-at-risk calculation.
9. Enter number of days for value-at-risk calculation horizon.
10. Click the submit button and this will take you to the output display page.

Output display page

1. You can view pricing model output together with input parameters you entered.
2. At the bottom of the page you can click on the button to create database record for the current model output. This will take you to the create database record page where you should click on the create button to create the database record.
3. After clicking on the create button to create the database record, you will be taken to the database records view page, where you can scroll vertically or horizontally to view database records including the one you just created.
4. You can filter database records according to the currency of valuation using the filter box. You can click on the details link on the extreme right of a particular database record, this will take you to the particular database record details page.