Numerix Blog

How to Use Swaps to Hedge Interest Rate and Inflation Risk in Muni Bond Portfolios

ivitale — Tue, 23 Apr 2024 15:31:36 +0000

Title:

How to Use Swaps to Hedge Interest Rate and Inflation Risk in Muni Bond Portfolios

Publication Date & Time:

Tue, 04/23/2024 - 21:00

For investors looking to diversify their portfolios with potentially lower risk, municipal (muni) bonds are becoming an increasingly attractive investment option. In this blog, we explain how muni bond investors can use swaps to hedge their exposure to interest rate fluctuations and inflation expectations, which have been the main drivers of muni bond market performance in 2024. We also show how FINCAD Analytics Suite from Numerix can help muni bond investors price and risk manage their bonds and swaps in a consistent and reliable manner.

Assessing the Risks

A main source of market risk for muni bond investors is interest rate risk, which arises from the inverse relationship between bond prices and interest rates. When interest rates rise, bond prices fall, and vice versa. Inflation risk is another source of market risk affecting muni bond investors, which occurs when the purchasing power of money declines over time due to the general increase in the prices of goods and services. Inflation reduces the real value of future cash flows from bonds, leading to lower returns for investors.

Hedging

One way that muni bond investors can hedge against interest rate and inflation risk is by using interest rate and inflation swaps, which are derivative contracts that allow two parties to exchange interest payments based on a notional principal amount. As an example, by using interest rate swaps, muni bond investors can effectively convert their fixed-rate receivables into variable-rate payments that are linked to a market index, such as SIFMA or SOFR.

It’s worth highlighting that when hedging, fixed rate investors pay fixed and receive float. This way, if interest rates and inflation rise, investors will receive higher payments from the floating leg of the swap, which will offset the lower value of their bonds. Conversely, if interest rates fall, investors will receive lower payments from the floating leg in the swap, but their bonds will increase in value.

When encountering other interest rate exposures, such as receiving a floating bond coupon, investors may enter into an interest rate swap in order to receive a fixed coupon and hedge against a declining interest rate. Thus, swaps can help muni bond investors reduce their interest rate and inflation risk and protect their portfolio value.

However, entering into swaps also involves some challenges, such as finding a suitable counterparty, negotiating the terms of the contract, and managing the collateral and counterparty risk. Moreover, swaps require sophisticated valuation and risk management tools, as they are complex and customized instruments that depend on various factors, such as market conventions, interest rate indices, and swap structures. To help understand the impact these different factors have on the price and the cashflows of a swap, it helps to analyze some initial assumptions and see the impact.

Simplifying Muni Bond Investing

FINCAD Analytics Suite for Excel is a powerful, flexible tool that supports the diverse and evolving needs of the muni bond market. Key solution highlights include:

Easy calculation of key metrics for muni bond portfolios, including yield, convexity, cash flows, option values, and risk sensitivities, such as DV01 and duration

Comprehensive coverage for muni bond valuation models, including tax-adjusted discounting, option-adjusted spread, and binomial tree methods

Support for various types of muni bonds, such as general obligation, revenue, pre-refunded, callable, puttable, and convertible bonds

Ability to define customized payoffs, incorporate curve or market data scenarios, carry out par rate or yield analysis for a series of bonds, perform forward valuation scenarios, and observe historical basis to relevant benchmarks

Shown above: Swap pricing product workbook with pricing, risk and projected cashflow analytics

FINCAD Analytics Suite from Numerix elegantly handles complex and customized swap structures, such as floating-to-floating, amortizing, accreting, step-up, inflation and basis swaps. Investors can be confident that different market conventions are accounted for, such as day count, compounding, and payment frequency, as well as various interest rate indices, such as FedFunds, SOFR, and SIFMA. Evaluating the fair value, sensitivity, and risk profile of swaps, as well as performing scenario analysis, stress testing, and hedge effectiveness assessment are all simplified using the solution. Plus, FINCAD Analytics Suite empowers investors to measure and manage their exposure to counterparty credit risk and collateral requirements.

Recapping our Muni Bond Recommendations

There is growing appeal in muni bonds as a diversification strategy for investors seeking lower risk. Swaps can be used to mitigate the main risks facing muni bond investors, namely interest rate and inflation risks. However, navigating the complexities of swaps involves challenges such as finding suitable counterparties and employing sophisticated valuation and risk management tools. Through solutions like FINCAD Analytics Suite, muni bond investors can effectively price, manage risks, and simplify their investment strategies, despite the complexities involved in swaps and market conventions.

FREE Trial: FINCAD Analytics Suite

Would you like to begin gaining deeper insight into the performance and risk of your muni bond portfolio? Get started today. We’d like to extend you the opportunity to try FINCAD Analytics Suite for Excel free for 14 days. Experience how easy it is to value and risk manage muni bonds and swaps in a consistent and reliable way using our award-winning analytics library.

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How to Use Swaps to Hedge Interest Rate and Inflation Risk in Muni Bond Portfolios

Using Cloud Computing to Simplify XVA

jwilkiewicz — Tue, 16 Apr 2024 14:24:27 +0000

Title:

Using Cloud Computing to Simplify XVA

Publication Date & Time:

Tue, 04/16/2024 - 19:45

The capital markets have always been at the forefront of adopting innovative technologies—among these is cloud computing. Cloud usage is surging with capital markets participants because they rely on fast information processing, the analysis of huge data sets, complex risk management, and effective execution of real-time trades, which are all strong suits of cloud.

Cloud technology is also ideal for complex pricing and risk analytics functions, including valuation adjustments such as XVA. Leveraging cloud computing for computationally intensive XVA calculations enables firms to benefit from increased scalability, cost-effectiveness, flexibility, data accessibility, regulatory compliance, and other tangible benefits.

Complexity of XVAs

As the capital markets see an increasing need for tougher risk safeguards, a premium is being placed on XVAs. The changing landscape over the last decade or so, significantly driven by new regulations, means XVAs have grown in size and complexity.

Additionally, widening credit spreads and funding spreads are bringing XVAs back into the fold, as the costs associated with XVAs are now typically being incorporated into the prices of trades. However, the calculation of XVAs is highly complex, combining the particularities of derivative pricing with the computational challenges of managing related risk.
Simplifying XVA Calculations

It’s fair to say that calculating XVAs is one of the largest computational challenges banks face on a daily basis. The issue, though, is more than just calculating numbers. You need to be able to have good decision support capabilities within your system—and you need to be aware of the real costs of executing a trade, ideally before you even initiate the trade.

Pre-trade XVAs and XVA Greeks demand even greater computing resources because of the near real-time requirements of trading desks. As banks look to optimize XVA usage, they are making strategic choices in regard to their XVA capabilities in an attempt to solve the computational challenge of simulating a full universe of risk factors. A modern cloud architecture supports the heavy calculation demands of XVA pricing—a significant benefit when dealing with complex portfolios. It’s worth noting that Numerix’s XVA solution, Oneview for XVA, has been specifically built for handling complex calculations, is scalable and cloud-native—enabling unparalleled accuracy, real-time calculations and dynamic custom reporting and analysis capabilities.

Flexibility & Scalability of the Cloud

The inherent agility and configurability of cloud services enable a financial services firm to select or design a cloud service that meets its specific business, risk management, compute power, elasticity, resilience, and operational needs. This flexibility is ideal for managing XVA and a myriad of other pricing and risk functions that firms deal with daily.

As cloud increasingly enables business agility, outsourced cloud compute services are becoming more prevalent across the financial services industry. In this regard, one cloud model that a growing number of firms are embracing is Software as a Service (SaaS), a software delivery model whereby software is hosted on a cloud infrastructure and made available to users via web-based APIs. Cost-effective, accessible, secure, and scalable to address changing demands, SaaS software solutions enable financial organizations to streamline operations, improve collaboration, and place greater focus on driving business growth.

Cloud Computing White Paper

For deeper insights and an exploration of additional use cases for cloud computing in the capital markets, download our insightful white paper, If More Convincing Is Needed, Here are 4 Essential Reasons to Make More Use of the Cloud

Header Subtitle:

Using Cloud Computing to Simplify XVA

Numerix & PolyPaths: A Combined Powerhouse in Capital Markets Analytics

jwilkiewicz — Tue, 02 Apr 2024 15:38:32 +0000

Title:

Numerix & PolyPaths: A Combined Powerhouse in Capital Markets Analytics

Publication Date & Time:

Tue, 04/02/2024 - 19:45

In August 2023, Numerix acquired PolyPaths, the leading provider of analytics and risk management solutions for financial institutions. Because PolyPaths and Numerix share similar quantitative DNA, this partnership has been a natural fit, bringing together two of the industry’s most preeminent independent providers of capital markets analytics.

In today’s blog, we’d like to share an overview of PolyPaths’ powerful structured finance offering, including a featured highlight of PolyPaths’ proven solution benefits.

What Sets PolyPaths Apart

The PolyPaths application encompasses a wide range of functionalities, including pre-trade analysis, portfolio risk assessment, asset liability management (ALM) with and without accounting considerations, hedge analysis, value at risk, and related functionality. It offers comprehensive coverage of fixed-income instruments, spanning bonds, structured notes, mortgages, MSRs, loans, asset-backed structured products, non-maturity deposits, and derivatives. PolyPaths’ suite of integrated solutions are used for both trading and risk management, along with asset liability management— catering to clients of all sizes, from small hedge funds through to major market dealers.

The Rundown: PolyPaths Offering Highlights

Comprehensive Instrument Coverage

PolyPaths covers a wide variety of fixed-income securities, loans, and derivatives, including, but not limited to, MBS, ARM, CMO, ABS, CMBS, treasuries, corporates, municipal bonds, structured notes, agency debt, options, currency options, futures, swaps, cross currency swaps, and foreign currency-denominated securities. In addition, users can load and value mortgage servicing rights and whole loan portfolios.

Speed & Scalability

PolyPaths’ Distributed Processing system is designed to handle large scale calculation jobs. The robust parallel processing architecture can support grids with thousands of processors and comes with a web-based management console that continuously monitors the status of the entire grid, greatly reducing administrative overhead.

Comprehensive Risk & Return Analytics

The PolyPaths solution employs leading-edge interest rate models for pricing and risk analytics. A wide array of risk and return measures are used daily by active market participants for trading and hedging decisions. The solution can also perform credit analysis with user assumptions or third-party credit models. Historical return and return attribution analytics for buy-side applications are available. Stress testing via PolyPaths’ powerful Scenario Analysis tool offers both instantaneous and customized forward time horizons. Additionally, the ability to forecast cashflows and assess returns can be achieved either through a deterministic or stochastic evolution of market conditions tied to the passage of time.

Ease of Use

PolyPaths offers a simple, intuitive and flexible interactive user interface that does not require programming. Constructing portfolios, entering pricing assumptions and viewing reports can all be performed quickly and easily. For automation, a command-line interface and job scheduler are also available, enabling all analytics to be run via automated jobs, with transparency, stability, and minimal maintenance. PolyPaths also automates routine risk reporting jobs and simplifies maintenance.

Broad User Applications

Whether actively trading or analyzing pre- or post-trade data, PolyPaths boosts efficiency, performance, and investment results for a broad range of users across a financial institution, including traders, hedge fund managers, portfolio managers, risk managers, research analysts, model validation teams, and asset liability managers.

Ease of Integration

PolyPaths easily integrates the many user-supplied models and data found in most trading environments through straightforward APIs and/or file-based approaches. In addition, outputs from the system can be easily exported and fed into other systems.

Real Time Accounting

PolyPaths facilitates real time accounting with a range of accounting treatments that are both elective and visible on one screen. Users can change accounting elections on the fly and see reports in just minutes.

Limits and Rules

Limits have a wide variety of uses and flexibility in achieving a target. Rules can call limits directly to use pre-calculated values or to invoke the full limit process. This mixes the best of limits with the wide range of rules capability. With the PolyPaths application, rules can be specific to strategies, scenarios, and/or conditional on market conditions and simulation results.

Portfolio Optimization

In all facets of portfolio analysis and bank asset/liability management, there are circumstances where the level of complexity makes it difficult or very time-consuming to find an answer that meets your style and/or policy constraints. ALM supports the capability to solve for a solution to meet a wide range of constraints, such as rebalancing a hedge while minimizing transaction costs or maximizing income while subject to risk and portfolio composition constraints.

Revolutionizing Risk and Portfolio Management

We at Numerix are excited to have joined forces with Polypaths in order to offer clients an unrivaled suite of solutions that deliver deeper insights, greater precision and enhanced risk mitigation capabilities across a wide spectrum of financial instruments. Together our combined company is poised to revolutionize how financial institutions navigate the complexities of today’s markets, providing a holistic and comprehensive approach to managing risk, optimizing portfolios, and making informed investment decisions.

For further information about the PolyPaths offering, please reach out to us.

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Numerix & PolyPaths: A Combined Powerhouse in Capital Markets Analytics

Top Takeaways from the World’s Largest Structured Finance Event

jwilkiewicz — Tue, 19 Mar 2024 19:46:08 +0000

Title:

Top Takeaways from the World’s Largest Structured Finance Event

Publication Date & Time:

Tue, 03/19/2024 - 19:45

Numerix and PolyPaths recently attended SFVegas 2024, the premier global capital markets conference hosted by the Structured Finance Association (SFA). The event featured timely subject matter developed by industry leaders and geared at a range of market participants including investors, issuers, financial firms, regulators, law firms, technology firms and more.

We were thrilled to have a booth presence at the event, as it afforded us the opportunity to chat with numerous attendees about various hot topics in structured finance. Our team was also able to attend several sessions dealing with a range of different topics on mortgage servicing rights, the global securitization markets and credit card ABS — just to name a few. Today, we’d like to share a few takeaways we gleaned from this educational event.

Takeaway #1: Changes in the MSR Market

The session, Market Beat: Mortgage Servicing Rights (MSRs) delved into the complexities of risk within this unique market. The industry is transitioning towards a more dynamic, multi-dimensional hedging strategy for MSRs, where the prominence and volatility of T&I float have reached unprecedented levels. In this changing environment, hedging strategies need to address both rate and prepayment risks, in addition to shorting the IO. There’s also been a distinct change in the ecosystem of MSR players, which has been transitioning from traditional banks to non-bank, non-federally connected institutions.

The nuanced nature of MSRs presents a dichotomy: they act as pure interest-only instruments on one hand, yet they bear unhedgeable credit risks on the other. This has prompted a call for tighter regulations on these institutions, emphasizing the need for enhanced oversight and capital adequacy measures.

A significant shift in interest rate dynamics has further complicated the landscape. The previous very low interest rate regime begat a universe of mortgages with very little prepayment optionality. The current higher rate regime introduces the risk of rates decreasing, and much more prepayment optionality, cutting short the duration of and impairing the value of MSR portfolios. Consequently, there is a growing emphasis on cost-effective hedging strategies, with a growing need to accurately quantify the associated risks.

Takeaway #2: Trends in ABS

We also attended a panel discussion on global securitization, which offered some enlightening insights on the Canadian and Chinese asset-backed securities (ABS) markets, highlighting their yield opportunities for investors despite hedging risks.

In the Canadian market, characterized as fairly conservative, the predominant ABS types are auto loans and credit cards. Notably, Canadian banks issue USD-denominated cards, and the market features few complex instruments.

Conversely, the Chinese ABS market is relatively new but has experienced significant growth since 2013. Concerns surrounding issuance include the impact of quantitative easing by the Chinese central bank. Additionally, there are growing concerns regarding data disclosure and increasing regulatory measures. The Chinese ABS market primarily operates domestically, with limited opportunities in USD-denominated assets.

Takeway #3: Changing Credit Card ABS Landscape

Another key session dug into the challenges market players face with credit card asset-backed securities (ABS) in the aftermath of the pandemic. Despite increasing delinquencies and charge-offs, existing models fail to adequately capture these trends as they are calibrated off low unemployment rates.

However, it's argued that inflation should be a more predictive factor, necessitating better integration into models. The pandemic accelerated the shift towards cashless transactions, leading to higher outstanding credit card balances. Furthermore, the government's pandemic relief efforts led to a phenomenon dubbed FICO inflation, which disrupted risk pricing by credit card companies, resulting in over-lending in 2021 and 2022. Addressing these challenges requires recalibrating risk models and adjusting lending practices to adapt to the changing landscape.

Related White Paper Download

Get insight into what’s in store for the structured credit markets for the remainder of the year. Download our white paper, based on a webinar hosted by Numerix and Risk.net, that discusses the risks, opportunities and outlook for structured credit in 2024.

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Top Takeaways from the World’s Largest Structured Finance Event

Numerix Podcast: Brand-New Season Now Available

jwilkiewicz — Tue, 12 Mar 2024 14:13:49 +0000

Title:

Numerix Podcast: Brand-New Season Now Available

Publication Date & Time:

Tue, 03/12/2024 - 19:45

We’re delighted to announce Season Two of the popular Numerix podcast series, Trading Tomorrow: Navigating Trends in Capital Markets, a place where insights, innovation, and expertise in the Capital Markets converge. The series is hosted by James Jockle, CMO of Numerix. Episode One drops this Thursday and features Adam Hyland, PhD student in the Computer Supported Collaboration Lab at the University of Washington, for an exciting conversation around society’s fascination with AI and what we can expect for the future of this technology.

Check out a sneak preview below, available on Apple Podcasts. You can also visit the Podcast area of the Numerix website to catch up on previous episodes you may have missed.

Upcoming Episodes

With the capital markets in a state of rapid transformation, we at Numerix are committed to better understanding how the complex dance of market trends and innovative technology is impacting and even redefining the industry.

In our podcast series, you can expect to hear from financial industry experts sharing their views on current and future technologies and processes you need to be aware of as a capital markets participant. We are excited to share an extensive line-up of thought-provoking topics and insights with you each season. Here are the first few episodes you can expect in Season Two:

As we make our way through 2024, the global finance landscape continues to rapidly transform before our eyes - influenced by technological innovations, regulatory changes, and evolving market dynamics. Kevin McPartland of Coalition Greenwich joins us to discuss market structure trends for this year.
Is ChatGPT the next Blockbuster video[GM1] ? Despite the recent, explosive popularity, we’ll debate whether ChatGPT will become a staple of our future in finance or fizzle out over time. Hear insights from Adam Hyland, PhD student, University of Washington.
Dive into the promises and risks of AI in the financial markets. Get perspectives on this hot topic from Professor Michael Wellman, Division Chair of Computer Science and Engineering, University of Michigan.
And so much more...

Don’t miss this…

Don't miss out on key market and technological insights that may help shape your financial strategies. Stay tuned with us through the Podcast section of the Numerix website or through Apple Podcasts. We also post notifications of weekly episode launches through our social media channels on LinkedIn and Twitter to ensure you get access to new episodes as soon as they publish.

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Numerix Podcast: Brand-New Season Now Available

Exploring 3 Major Challenges of the SOFR Transition

jwilkiewicz — Fri, 01 Mar 2024 19:06:51 +0000

Title:

Exploring 3 Major Challenges of the SOFR Transition

Publication Date & Time:

Mon, 03/04/2024 - 20:45

In June of last year, the five remaining U.S. dollar LIBOR settings were officially published for the last time. This date marked the final stages of the LIBOR phase out and heralded a new future with alternative risk-free rates, such as SOFR for dollar-denominated derivatives and loans. The market has responded favorably, with daily transaction volume underlying SOFR averaging more than $1 trillion, according to a report by the U.S. Department of the Treasury.

However, the transition has not been all smooth sailing. As expected, working with SOFR is producing many operational, workflow and market-readiness challenges for financial institutions. Below we share three of the top issues firms are encountering as they navigate SOFR adoption.

1 Need for Upgraded Analytics

Early in the transition away from LIBOR, there was significant buzz around the technology challenges and changes financial institutions would face as they moved to new benchmark rates like SOFR. These included concerns over updates and replacements of trading systems, risk management models and valuation practices. The good news is that the majority of firms Numerix works with have now met these operational and technology-related requirements.

One area, however, where firms are likely to need to invest further in is modernizing their analytics. “To effectively handle the evolving landscape of nonlinear Risk-Free Rate (RFR) instruments, an upgrade and enhancement of the analytics library is imperative,” commented Ping Sun, PhD, Senior Vice President, Financial Engineering at Numerix. “For example, the widely used LIBOR Market Model (LMM) must be adapted to the very different Forward Market Model (FMM). Furthermore, all short-rate models must be capable of calibrating to the RFR-based swaption volatility surface/cube and/or cap volatility surface.”

2 Calculating the SOFR Rate

The transition to SOFR has had a distinct impact on the bond and loan markets. One noted challenge is that daily SOFR, which is paid in arrears, complicates calculating the coupon for bonds and loans, as there is a possibility, for example, that the rate may not be published on the day of a loan payment. This would make it difficult to calculate the coupon and prepare the payment in time. Thus, we might question how vast of a disparity is there when calculating SOFR versus LIBOR?

The reality is that there are significant differences between the calculation methodology for SOFR and LIBOR. Most of the SOFR rates in use follow the compounding-in-arrears approach, which contrasts with the forward-looking LIBOR rate. “Lookbacks and lockout conventions were designed to help solve for these differences,” said Russell Goyder, PhD, Chief Analytics Officer at Numerix. “Persistent challenges in fixing and settling payments referencing SOFR illustrate the tradeoff that the industry has chosen—in exchange for the benefits of IOSCO compliance and protection against manipulation, some cost is paid in operational complexity by users of the new rate.”

3 Liquidity Concerns

Another challenge to the introduction of SOFR and its use as an RFR has been the need for increased SOFR liquidity. While some current headlines in the financial media suggest SOFR liquidity has been improving steadily in recent years, others say it is still an issue. So, is the SOFR liquidity concern behind us or not? The answer may depend on the product you’re trading.

Liquidity in linear instruments, such as swaps, is notably robust, but for non-linear products like swaptions, the story is still evolving. Many consider enabling the use of forward-looking Term SOFR to be a crucial next step, as it is anticipated to enhance associated liquidity. This is attributed to the fact that, in contrast to the daily compounded SOFR rate, forward-looking Term SOFR closely mirrors the nature of LIBOR. Also, forward-looking SOFR rates are often easier to use in financial planning and accounting purposes for market participants.

Get Further SOFR Insight

For more detailed insight on SOFR adoption, including exclusive perspectives from financial derivatives experts, download our related paper: Is Your SOFR Readiness Being Put to the Test? Let’s Talk About Post-Transition Issues and Challenges

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Exploring 3 Major Challenges of the SOFR Transition

Navigating Real-Time Pricing and Risk of Same-Day Options

jwilkiewicz — Wed, 14 Feb 2024 15:25:53 +0000

Title:

Navigating Real-Time Pricing and Risk of Same-Day Options

Publication Date & Time:

Thu, 02/15/2024 - 20:45

Over the past year, options trading volumes hit a record high. What’s more, nearly 50% of all S&P 500 options are now associated with zero day to expiration (0DTE) options specifically, surpassing those of all other options maturities*.

To look deeper into this topic, we recently held a solution webinar exploring the unique risk characteristics of same-day options against the backdrop of uncertain markets and fluctuating rates. Technical expert, Peter O’Connor of Numerix, provided market context and demonstrated how to use FINCAD Analytics Suite for Excel to assess same-day option pricing and obtain precise risk analysis. You can view the full on-demand webinar here: FINCAD Analytics Suite: Real-Time Pricing & Risk of 0DTE Options

0DTE Options: Meeting a Market Demand

A narrow bid-ask spread and low transaction costs make 0DTE options an appealing investment choice. Offering a strong liquidity profile and an efficient way to invest in or hedge large intraday moves in the S&P 500 and other underlyings, 0DTE options are becoming popular amongst institutional investors and really any investor with active options books.

Response to increased activity in the 0DTE options market has been seen in Nasdaq’s recent decision to introduce short-term options in new asset classes, tracking exchange-traded funds (ETFs) investing in gold, silver, natural gas, oil and long-term Treasuries. This move is expected to bring further liquidity and trading activity to the exchange platform and shows Nasdaq’s commitment to expansion in this market.

In the webinar, Peter explained that he also sees the potential for further growth in 0DTE options tied to ETFs and crypto, and the increasing use of algo trading in the 0DTE market as well.

FINCAD Analytics Suite for 0DTE Options  

With a shortened investment lifecycle, 0DTE options have unique risk characteristics and require diligent monitoring. Same-day options trading hinges on a strategy of taking very short-term views on an underlying’s direction and volatility, essentially betting on the option’s in-the-money or out-of-the-money status within a trading day. FINCAD Analytics Suite for Excel, as well as the Software Development Kit (SDK) can be used to facilitate this assessment with same-day option pricing and precise risk analysis, including detailed Greek monitoring.

With FINCAD Analytics Suite, 0DTE options can be valued in real-time to a specified millisecond, ideal for making the most up-to-date trading decisions possible. In the webinar, Peter gave a live demo of how pricing and risk assessment can be done using FINCAD Analytics Suite.

Demo Highlights: FINCAD Analytics Suite for Excel

Pricing analysis: In his demo, Peter showed how FINCAD can be used for accurate pricing analysis based either on a price or implied volatility, building a volatility smile, and by calibrating a Heston model. However, he noted that the Heston model may not be the best fit for zero-day options trading due to model calibration issues with extremely short-dated options.

Real-time valuation: Peter highlighted how FINCAD can be used for real-time valuation and scenario analysis, and applied to any type of option or underlying, with the potential for cloud deployment and the use of the SDK's Python interface for building robust applications outside of Excel.

Easy-to-use functions: FINCAD Analytics Suite for Excel is an extensive analytics library offering over 2,000 functions that enable users to easily create workflows by passing the outputs of one function to another, supporting current curve requirements and market models.

Defining position types: Using FINCAD, users can easily define 28 different position types and strategies, and quickly price each strategy. Peter also spoke about the use of popular options trading strategies such as Iron Butterfly and Iron Condor as they relate to the 0DTE market.

Outlook for 0DTE Options

Before concluding the webinar, Peter remarked that he foresees continued growth in the 0DTE markets and thus an increased need for a holistic set of data and pricing and risk tools. "Understanding the behavior of market data is crucial for downstream processes. With FINCAD Analytic Suite for Excel, we can create workflows, conduct horizon analysis, and even calibrate models. This powerful tool is not just for pricing analysis, but also for real-time valuation and scenario analysis, applicable to any type of option or underlying," he commented.

For detailed examples and to see the FINCAD Analytics Suite for Excel interface in action, watch our full on-demand webinar: FINCAD Analytics Suite: Real-Time Pricing & Risk of 0DTE Options

GET YOUR FREE TRIAL

Would you like to try FINCAD Analytics Suite for yourself – free for 14 days? Simply fill out our intake form and we will be in touch shortly to set up your trial and provide you with a complimentary 0DTE options pricing worksheet.
Free Trial

* Volatility Insights: Much Ado About 0DTEs - Evaluating the Market Impact of SPX 0DTE Options (cboe.com)

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Navigating Real-Time Pricing and Risk of Same-Day Options

3 Factors Transforming Mortgage-backed Security (MBS) Investing

jwilkiewicz — Thu, 08 Feb 2024 18:49:32 +0000

Title:

3 Factors Transforming Mortgage-backed Security (MBS) Investing

Publication Date & Time:

Tue, 02/06/2024 - 20:45

Managing MBS investing is growing more complex by the day, placing risk concerns at the forefront for the buy-side and redefining the MBS landscape. But despite all the complexity, a recent Coalition Greenwich study finds that 67% of buy-side fixed-income professionals are poised to increase their MBS volume in 2024.
There are distinct macro and market factors that are fueling the pronounced shift we’re seeing in buy-side investment behavior in the MBS space. Below we touch on three leading factors, as reported by Greenwich Coalition in their recent report: Managing Mortgage Market Risk Becomes More Complex.

Factor 1: Heightened Rates

In early 2020, the COVID-19 pandemic created numerous strains in the market, resulting in rising costs for goods and services—much of which stemmed from tightness in the labor market. Sharp inflation growth precipitated higher benchmark rates at the same time as mortgage stimulus was being withdrawn by the Fed. What’s more, the average 30-year mortgage rate jumped nearly 400 basis points in a 10-month time frame, from 3.22% in January to 7.08% in October 2022. At the time of writing this blog post, the average 30-year fixed mortgage interest rate remains fairly high at 7.06%.

In terms of economics, some market participants feel the soft-landing narrative is still in play as recent U.S. GDP prints and jobs reports come in strong. In Q3 2023, the GDP grew at 4.9% annually, outperforming the expected 4.7%. The fourth quarter of 2023 saw lesser, but still significant GDP growth at 3.3%.

Mortgages have been an interesting space to watch because volatility has been causing spreads to widen compared to corporate bond spreads. The Fed’s aggressive tightening and uncertainty about the potential timing for rate cuts will continue to fuel volatility, and more trading and activity is expected to follow.

Factor 2: Challenged Liquidity

Another force driving the transforming MBS landscape is the need for greater liquidity, evidence of which can be seen with “To-Be-Announced" securities (TBAs). TBAs are a type of MBS representing a forward contract for the purchase or sale of agency MBS that have not yet been issued or specified.

In normal market conditions, there are typically three actives in the 30-year TBA space predicated on a current or prevailing coupon. As a consequence of the spike in rates, several changes to the current coupon resulted in about eight to nine tradable coupons circulating in the TBA market that dealers must stand ready to price and risk-manage on behalf of their clients. While buy-side investors may be ready to take on additional trading, the effects of numerous changes to the current coupon, bank risk-management practices, and market uncertainty and volatility have resulted in challenged liquidity.

Despite the challenges, funds and advisors remain committed to MBS investing. Although sell-side firms have been more reluctant to provide liquidity as a group, the path toward more electronification may be the answer to overcoming current conditions.

Factor 3: Lack of Market Transparency

There’s no denying that rapidly rising rates have had a knock-on effect on mortgage indices. These indices once comprised of 1.5%–3.5% coupons have now shifted to include coupons north of 6% in less than a year. Both index providers and investors struggled to keep pace with the speed of increased rates. As mortgage rates soared, current coupons and convexity in the market weren’t reflected right away. These conditions created opaqueness in a market that is typically more transparent, leading to pricing issues and heavier reliance on modeling and evaluative analytics that may also suffer from data inaccuracies.

The current environment may lend itself well to active management of bond portfolios, given a wide variety of mispriced instruments and very wide spreads compared to the last quantitative easing period. While high rates lead to a much more challenging environment in some ways—particularly in areas like commercial real estate—the “right” bets could see managers outperforming the index.

Looking Forward

It’s clear that the latest dynamics in the mortgage market have created challenges not seen since the financial crisis, as the need for more robust trading, risk and portfolio management becomes more apparent. As a result, buy-side investment managers are turning to improved data sources, advanced technology and analytical tools to successfully navigate the MBS market ahead of an anticipated bump in investment and trading as we move further into 2024.

Complimentary Greenwich Report Download

For a deeper dive into how today’s fixed income investors are navigating MBS amidst a volatile marketplace and record-high rates, download this detailed report by Greenwich Coalition: Managing Mortgage Market Risk Becomes More Complex.

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3 Factors Transforming Mortgage-backed Security (MBS) Investing

These 2023 Themes Will Continue to Dominate in 2024

jwilkiewicz — Tue, 06 Feb 2024 14:58:57 +0000

Title:

These 2023 Themes Will Continue to Dominate in 2024

Publication Date & Time:

Tue, 02/06/2024 - 20:45

Based on recent background conversations among various experts here at Numerix, we were able to paint an early picture of where the capital markets industry will likely focus its attention heading into 2024, in terms of specific market and business themes. There was much talk around risk, the post-Libor world, trends in technology, and the regulatory environment. This inspired us to take a look back at the some of the top stories we published and produced in 2023—whether in the form of a white paper, a webinar, or a podcast—and determined which of those identify with the hot topics that we believe will continue to be very relevant moving forward.

Here’s our compilation. We hope you find some worth in giving these resources a look and we are committed to continue delivering high-value thought leadership that both informs and maybe even helps you succeed more.

For the Capital Markets, Every Risk Playbook Needs to Implement These 6 Themes
Risk will never disappear and regardless of what form any next crisis takes, we can be sure there will be one. Do you feel confident that the risk management systems and processes your organization has in place today will be sufficient to ensure resiliency into the future?
This white paper outlines 6 risk management themes that we think should be a part of any risk playbook and which can serve financial institutions well in preparation for what may be faced ahead. Access Paper
Is Your SOFR Readiness Being Put to the Test? Let’s Talk About Post-Transition Issues and Challenges
The June 30, 2023 deadline for publishing the five remaining US dollar Libor rates marked a critical milestone in the Libor transition process. This date signified the final stages of the Libor phase out and triggered a future with alternative risk-free rates, such as SOFR for dollar-denominated derivatives and loans. In this Q&A, five Numerix experts discuss the challenges tied to SOFR that are impacting the market. Access Paper
If You Work in the Capital Markets, You Need to Track these Four Tech Trends
Many innovative technologies are gaining traction in the capital markets today, and some of them will prove to be quite disruptive and/or impactful over time. This Numerix podcast provides expert insights on how low code, no code, and blockchain asset tokenization are reshaping the financial industry, and includes a discussion regarding the vast impact AL/ML has and will have on the capital markets. Listen Now
A Step-by-step Guide to Using ChatGPT to Build a Simple Risk Application
Does ChatGPT have a place in the capital markets? In this webinar, we unravel the power of ChatGPT in building a simple risk application. Watch as we walk you through a step-by-step example of utilizing this ground-breaking technology for running Value-at-Risk (VaR) calculations. Watch Now
As Action Time Nears, Be Aware of These 3 Big FRTB Issues
The Fundamental Review of the Trading Book (FRTB) represents the beginning of a new era for market risk management, introducing measures intended to enhance the resilience of banks and the stability of the global financial system. Read this white paper to learn about three of the core issues capital markets participants face when dealing with FRTB. Access Paper

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These 2023 Themes Will Continue to Dominate in 2024

Webinar Recap: Using PnL Explain Analytics to Fuel Trading and Risk Decisions

jwilkiewicz — Thu, 18 Jan 2024 15:27:02 +0000

Title:

Webinar Recap: Using PnL Explain Analytics to Fuel Trading and Risk Decisions

Publication Date & Time:

Thu, 01/18/2024 - 20:45

How can we better understand the key drivers of profit and loss –and use that information to fuel improved decision-making? To tackle this question, Numerix hosted a solution-based webinar, PnL Explain: Strategic Trading Book Insights for Traders, Risk Managers & Other Stakeholders. In case you missed our live session, we've packaged up the top takeaways in today’s blog.

Moderated by Udi Sela, SVP, Product & Field Marketing and featuring, Krupal Rachh, Executive Director, Market Risk Product Management, the webinar showcased how Numerix’s PnL Explain analytics in Oneview provide valuable insights that can inform daily trading and risk decisions.

What are Profit and Loss (PnL) Explain analytics?

PnL Explain is a method used to understand the key drivers of profit and loss, and their significance in risk management, hedging, portfolio management and model reconciliation. PnL Explain analytics have been used by traders and risk managers for years across the buy and sell side alike. With the rise in multi-asset class portfolios and the need to navigate volatile markets, firms are finding that closely monitoring the various risk factors that impact PnL is a major priority.

Why are PnL Explain analytics important?

PnL Explain is typically based on risk values, particularly Greeks of the underlying trading instruments or portfolio. One can estimate the change in the present value of the portfolio from one period to the next by computing Greeks and using market differences.

The distinction between the explained PnL and the actual mark-to-market PnL represents the ‘unexplained’ or residual PnL. The goal is to minimize the unexplained PnL, ensuring that Greeks explain away most of the changes in the actual PnL.

Relevant Use Cases

PnL Explain helps traders identify the key drivers of risk, enabling them to distinguish between risk factors and random events. This understanding is crucial for assessing performance and selecting the right trading strategies. In the webinar, Krupal discussed specific use cases for PnL Explain, which we outline below.

Actionable Hedging: Robust Greeks are essential for effective hedging and risk management. PnL Explain provides a granular view of risk factors, allowing traders to determine which points on the risk curve need hedging. It also helps allocate liquidity based on vulnerable risk factors.
Portfolio Management and Asset Allocation: Correlations between different asset classes are essential for asset management. PnL Explain helps measure how risk factors move and their impact on the portfolio. It allows for informed decision-making in terms of position sizing and asset allocation.
Model Reconciliation: PnL Explain can identify model differences between front office and back/middle office models. By comparing explained PnL with mark-to-market PnL, organizations can determine which model is more accurate and make informed choices about model selection.

Key Highlights: Numerix’s PnL Explain Functionality

Further in the webinar, Krupal gave attendees a first-hand look at Numerix’s PnL Explain functionality with a live demo of how the solution can display component PnL, risk factors, granular PnL attribution and underlying Greeks. With Numerix Oneview, users are able to customize their views and make ad hoc adjustments for detailed analyses.

Reports can then be viewed through the user interface, in CSV, Excel and PDF formats, or accessed through APIs. Key differentiators of the Numerix offering are transparent calculations, extensive model coverage across asset classes, distributed computing for scalability, as well as robust data cleansing and management processes.

An overview of Numerix’s technology and delivery is as follows:

Scalable Architecture: Numerix's scalable architecture enables you to measure risk at a granular level rather than relying on bucketed sensitivities, ensuring accurate PnL Explain results.
SaaS-Based Model: Numerix operates as a fully cloud-based Software as a Service (SaaS) model hosted on AWS, providing security, availability and convenience, without requiring you to set up or invest in maintaining infrastructure.
Powerful APIs and Workflows: The solution offers a rich set of APIs for clients to interact with the platform, enabling data loading, calculation triggering, report generation and more. Additionally, sophisticated workflows support daily, weekly and end-of-month batch runs.
Round the Clock Support: With 24-hour support and offices worldwide, Numerix ensures continuous operations and the highest caliber assistance.

Get the Full Picture

Watch our on-demand webinar to see Numerix's PnL Explain analytics in action, complete with a live demo and a dynamic Q&A session: PnL Explain: Strategic Trading Book Insights for Traders, Risk Managers & Other Stakeholders.

Header Subtitle:

Webinar Recap: Using PnL Explain Analytics to Fuel Trading and Risk Decisions