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Repricing Swaps & OIS Discounting

Repricing Swaps & OIS Discounting. USING FED FUNDS RATE TO DISCOUNT P&L TO CALCULATE V.MARGIN. Pricing Swaps - Review. USE GOAL SEEK TO SET THE SUM OF THE NET PVS TO ZERO BY CHANGING THE FIXED RATE.

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Repricing Swaps & OIS Discounting

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  1. Repricing Swaps & OIS Discounting USING FED FUNDS RATE TO DISCOUNT P&L TO CALCULATE V.MARGIN

  2. Pricing Swaps - Review USE GOAL SEEK TO SET THE SUM OF THE NET PVS TO ZERO BY CHANGING THE FIXED RATE Recall an at-market swap rate is the rate where the fixed and floating cash flows equal a net present value of zero 7/1/17 7/1/17 7/1/18 7/1/19 DATES FOR FWD SPOT FWD RATES, DATES NPV -0- FLOATING FV, DF, PV FV * DF = FV

  3. Review – Pricing Interest Rate Swaps • Repricing US Dollar Interest Rate Swaps – Two Curves • LIBOR is used to calculate P&L • OIS Discounting to calculate collateral FRA one period swap ED future Interest Rate Swap Portfolio of FRA’s

  4. Repricing Swaps Using LIBOR - review EFFECTIVE DATE 7/1/17 7/1/17 7/1/18 7/1/19 NEW FORWARD RATES NEW LIBOR RATES 1 YR 7.25% 2 YR 8.00% 3 YR 8.50% 6.25% 8.755% 9.507% NEW FORWARD RATES 12 x 24 8.755% 24 x 36 9.507% 7.445% 7.445% 7.445% MTM 7.445% PAYER FRA’s LIBOR -1.195% 1.31% 2.06% ($11,142) CALCULATE PRESENT VALUES 11,232.84 NPV = $16,233.44 $16,142.78

  5. Reprice Swaps Using OIS Swaps • What is OIS? • OIS stands for Overnight Index Swap • OIS Swap = LIBOR is swapped for Effective Fed Funds Rate • What is the Effective Fed Funds Rate? • Fed Funds are unsecured loans of excess reserves held by the Fed on behalf of member banks • The member bank with excess reserves can lend to other commercial banks with insufficient reserves • The weighted average of transactions in a given day is called the Fed Funds Effective Rate (EFF)

  6. Reprice Swaps Using OIS Swaps PAY Fed Funds REC 3 Mo.LIBOR PAY EFF FED FUNDS RECEIVE LIBOR • The 3 month LIBOR leg is reset as normal, every three months s new 3 month reset rate is given to the counterparty. • Effective Fed Funds rate is an average of the daily rates during the reset period (one month or three months) • In this way, it’s a daily rate but paid periodically.

  7. Reprice Swaps Using OIS Swaps EXAMPLE OF AN OIS SWAP: The Effective Fed Funds rate 2.35% LIBOR rate for same term 3.00% The OIS Swap is trading at 65 bps 2.35% would be used as the Effective Fed Funds rate to discount The new forward rates to present value

  8. Review – Pricing Interest Rate Swaps • Cleared and un-cleared derivativesuse the same repricing process • The LIBOR curve is used to calculate the market-to-market • The OIS curve is used to calculate collateral calls.

  9. Reprice Swaps Using OIS Swaps • Why don’t we just use the Effective Fed Funds Rate? • Because Fed Funds are a short term lending market. • Fed Fund loans can only be made with a bank’s excess reserves. • These two reasons make them inefficient to use for repricing • Also, OIS Swaps are so very liquid out past 10 years.

  10. Reprice Swaps Using OIS Swaps • Hedge Funds use interest rate swaps as a synthetic financed bond position. • But the 3 month LIBOR leg, operating as their financing leg – similar to repo – was too long term for the hedge funds to manage risk • They wanted swaps where bonds were financed with overnight rates instead of 3 month LIBOR • Thus was born the OIS Swap: and their financing was converted to fed funds

  11. Reprice Swaps Using OIS Swaps

  12. Reprice Swaps Using OIS Swaps

  13. Reprice Swaps Using OIS Swaps

  14. 7/1/18 7/1/19 7/1/17 NEW FWD RATES 6.25% 8.755% 9.507% EFFECTIVE DATE 7/1/17 $1,000,000. Reprice swaps w/ LIBOR rates - Review FRA COUPON 7.445% 7.445% 7.445% MTM FRA -1.195% 1.31% 2.062% LIBOR (11,950) $13,102 $20,619 LIBOR DISCOUNT RATES 7.25% 8.00% 8.50% NEW LIBOR FWD RATES 1 YR 7.25% 2 YR 8.00% 3 YR 8.50% ($11,142) CALCULATE PRESENT VALUES 11,232.84 PV = $16,233.44 $16,142.78

  15. Reprice Swaps Using OIS Swaps LIBOR E.F.F. OIS NEW LIBOR FWD RATES 1 YR 7.25% 2 YR 8.00% 3 YR 8.50% EFF. FED FUNDS 1 YR 6.60% 2 YR 7.35% 3 YR 7.85% OIS SWAP 1 YR .65% 2 YR .65% 3 YR .65%

  16. Reprice Swaps Using OIS Swaps THIS IS THE INTER-DEALER BROKER’S SCREEN FOR OIS SWAPS

  17. Reprice Swaps using OIS Swaps

  18. REPRICE SWAP versus LIBOR Discounting

  19. REPRICE SWAP w/ OIS Discounting

  20. REPRICE SWAP W/ OIS Discounting

  21. LIBOR versus OIS Discounting

  22. LIBOR versus OIS Discounting

  23. LIBOR versus OIS Discounting

  24. Repricing Interest Rate Swaps • Both cleared and uncleared Interest Rate Swaps use OIS swaps to reprice all swap positions for collateral • The dollar amount may differ, but the metrics will be: • The actual collateral posted and metrics such as • The bond’s liquidity, • The bond’s price, • The bond’s credit rating, • The haircut charged by the CCP versus the OTC counterparty • The currency in which collateral is denominated

  25. Thank You • I hope this slide show explained OIS Discounting clearly • And will serve your purposes. • Thank you for registering to use the site’s resources • If you’d like to learn more about pricing and repricing interest rate derivatives check out our online course catalogue • Give MHDS a call to discuss blended learning solutions for your organization

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