Target accrual redemption forwards

Target Accrual

Redemption Forwards

Date Tuesday 7 July 2015

Time 6:30 pm to 7:15 pm

By Dr. LAM Yat-fai, Doctor of Business Administration (Finance)CFA, CAIA, FRM, PRM

E-mail address: faiylam@caplogic.com

� Characteristics of the TARFs

� Analytics of the TARFs

� Case study: Citic Pacific 2008

Outline

Simple financial products

� Spot

� Linear derivatives

� Forwards and futures

� Vanilla options

� European and American, call and put

� Trading strategies

� Bull spread, bear spread, butterfly, straddle

Complex financial products

� First generation exotic options

� Binary, one-touch, no-touch, barrier options

� Second generation exotic options

� Corridors, faders, step-up, step-down options

� Fixed income with embedded options

� Currency linked deposits

� Principal protected notes

� Multiple fixings

� Accumulator, decumulator, TARF

An ideal financal product

� Investor

� Large upside potential

� Small downside loss

� No initial cash outflow

� Issuer

� Large commission income

� Low hedging cost

Functional purposes

� Investor

� To hedge a currency exposure at a lower initial

� To speculate in the direction of a currency rate

with a lower upfront cash outflow

� Issuer

� To earn a high profit at origination

� To exit the position in a sure loss situation

Structuring

� A series of call options with payoff function

� Max[Current rate - Strike rate, 0]

× Call notional principal

� A series of put options with payoff function

� Max[Strike rate - Current rate, 0]

× Put notional principal

� An early termination feature

Bull TARF

Multiple fixing

Bonus target

Cash inflows from

call options

TARF specification

Full paymentTreatment to termination bonus10.

USD 136,000Bonus target9.

MonthlyFixing frequency8.

19 December 2014Maturity date7.

USD 1.3500 per EURStrike rate6.

Domestic currencySettlement approach5.

EUR 2,000,000Put notional principal4.

EUR 1,000,000Call notional principal3.

EURForeign currency2.

USDDomestic currency1.

ValueParameter

Zero value TARF

� A TARF with zero value at origination is

most welcome

� No cash outflow from acquirer

� No cash outflow from issuer

� Long in-the-money (ITM) option

� Moderate cost x 1

� Short out-of-the-money (OTM) option

� Small revenue x N

Zero-value TARF

Loss probability

ss amo

Revenue model

� Investment bank

� Synthesize a TARF with vanilla call and put options

� Mark up a profit

� Sell to a commercial bank

� Commercial bank

� Acquire a TARF from investment bank

� Mark up a profit

� Sell to an investor

Sales and marketing

� The attractive product features of a TARF

� The professional sales team which performs

the marketing

� The price of a TARF

� The post sales customer services

Bull and bear TARFs

Dual-strike and survival gap TARFs

Pivot TARFs

Outline

Valuation� TARFs are custom-made instruments

� have no liquid secondary market

� have no market price

� Price of a TARF ≠ Value of a TARF

� Value of a TARF� The raw material cost for synthesizing a TARF in the

currency market with the underlying currency, forwards and/or options

� Price of a TARF� Value of a TARF + Mark up profit

Major valuation factors

(for the common construction where the

put notional principal is substantially

larger than the call notional principal)

Volatility

+Spot currency rate

-Aggregated bonus

+Bonus target

-Strike rate

-Put notional principal

+Call notional principal

Bull TARF

Valuation with

Monte Carlo simulation

Theoretical value

� The raw material cost of synthesize a TARF

with vanilla call and put options under certain

model assumptions

TV = Average(Simulated TARF values)

Market risk of investor

� Capped upside potential

� Unbound downside loss

� Present value-at-risk (PVaR)

� PVaR = Average(Simulated TARF values)

- Percentile(Simulated TARF values, 1%)

Credit risk of issuer

� The risk that an investor fails to pay the issuer

on a payment day when the investor is subject

to a loss

� Margin as a credit risk control

� What is the margin amount on portfolio basis?

� Too small, insufficient protection

� Too large, losing customer

� A very difficult topic

Standardized portfolio analysis of risk� Standardized portfolio analysis of risk (SPAN)

� Used by many derivatives exchanges

� All TARFs with the same foreign currency grouped into one sub-portfolio

� A worst scenario approach

� A = The maximum potential change of the rate of the underlying currency between two margin calculation days

� B = The maximum potential change of the volatility of the underlying currency between two margin calculation days

Scenario values (1)

Currency volatility - BSpot rate + 2A/38.

Currency volatility + BSpot rate + 2A/37.

Currency volatility - BSpot rate - A/36.

Currency volatility + BSpot rate - A/35.

Currency volatility - BSpot rate + A/34.

Currency volatility + BSpot rate + A/33.

Currency volatility - BSpot rate2.

Currency volatility + BSpot rate1.

VolatilityCurrency rate

Scenario values (2)

Currency volatility Spot rate - 3A16.

Currency volatilitySpot rate + 3A15.

Currency volatility - BSpot rate - A14.

Currency volatility + BSpot rate + A13.

Currency volatility - BSpot rate + A12.

Currency volatility + BSpot rate + A11.

Currency volatility - BSpot rate - 2A/310.

Currency volatility + BSpot rate - 2A/39.

VolatilityCurrency rate

Maximum scenario loss

� Scenario loss

= Scenario value – origination value

� Margin

= Maximum of

� Scenario losses for scenario 1 to 14; and

� 32% of scenario losses for scenarios 15 and 16

Other risks and analytics

� Operational risk

� Liquidity risk

� Legal risk

� Derivative accounting

Outline

2008 AUD losses controversy

� Prospective expenditure AUD 1.6 bn

� TARFs AUD 9 bn

� Loss USD 2 bn

2008 AUD losses controversy

� Share price dropped 55% to HKD 6.52 from HKD14.52

� SFC sought compensation up to 4,500 investors

� Chairman Mr. Larry YUNG stepped down

� General manager Mr. Henry FAN stepped down

Suitability assessmentSuitability

assessment

Investor profiling Product assessment

Product risk level

Product features

Risk tolerance level

Know your client

Target accrual redemption forwards

Business

Transcript of Target accrual redemption forwards

ACCRUAL ACCOUNTING

Cost Accrual Processing

Oracle Accrual Formula.doc

Accrual Accounting - Romania

R12 Accrual Reconciliation Upgrade Challenges and … SIG Minutes/R12 Accrual... · • Insert database trigger in MTL_MATERIAL ... • 11i10 Accrual Reconciliation with Oracle core

PTO Accrual (Everything)

Accrual Plan

Pay it forwards

Shyli lanai forwards

Accrual in Canada

Calling all Connecting - Now Media · 2017-02-17 · 24 legal IATA connecting timeSabi Sabi Bush Lodge 25 Sabi Sabi Earth Lodge 26 • Accrual and redemption of Voyager Miles are

Accrual Accounting 2

Developing Forwards

Forwards Outline

SKM C3850171019085600 · 2017-02-09 · Payroll accrual Payroll accrual ADMINISTRATIVE SERVICE Payroll accrual Payroll accrual ... GOODING CHILD NUTRITION PROGRAM GROVER'S PAY & PACK

Accrual Accounting & Income

LEAVE ACCRUAL AND REPORTING - oregon.gov · LEAVE ACCRUAL AND REPORTING TABLE OF CONTENTS Leave Accrual and Reporting 1 TABLE OF CONTENTS ...

ACCRUAL BUDGETING DAN ACCRUAL ACCOUNTING PADA …portal.kopertis3.or.id/bitstream/123456789/506/1/B2-Accrual... · l panjang bangsa-bangsa menunjukkan perubahan teknologi penganggaran

Accrual Engine Overview

ACCRUAL PERSISTENCE AND ACCRUAL ANOMALY A …