Valuation In A World Of Cva, Dva, And Fva : A Tutorial On Debt Securities And Interest Rate Derivatives

by Donald J Smith

Overview

CVA, DVA, and FVA, which are the acronyms for credit, debit, and funding valuation adjustments, have become widely used by major banks since the financial crisis. This book aims to bridge the gap between the highly complex and mathematical models used by these banks to adjust the value of debt securities and interest rate derivatives, and the end users of the valuations, for example, accountants, auditors, and analysts. The book, which is essentially a tutorial, demonstrates the types of models that are used using binomial trees that are featured in the CFA® fixed income curriculum and allows readers to replicate the examples using a spreadsheet.

Product Details

ISBN-13:	9789813224162
Publisher:	World Scientific Publishing Company, Incorporated
Publication date:	09/11/2017
Edition description:	New Edition
Pages:	228
Product dimensions:	6.00(w) x 8.90(h) x 0.60(d)

Table of Contents

Introduction ix

About the Author xvii

Chapter I An Introduction to Bond Valuation Using a Binomial Tree 1

I.1 Valuation of a Default-Risk-Free Bond Using a Binomial Tree with Backward Induction 1

I.2 Pathwise Valuation of a Default-Risk-Free Bond Using a Binomial Tree 7

I.3 Recommendations for Readers 9

I.4 Study Questions 11

I.5 Answers to the Study Questions 11

Chapter II Valuing Traditional Fixed-Rate Corporate Bonds 13

II.1 The CVA and DVA on a Newly Issued 3.50% Fixed-Rate Corporate Bond 19

II.2 The CVA and DVA on a Seasoned 3.50% Fixed-Rate Corporate Bond 23

II.3 The Impact of Volatility on Bond Valuation via Credit Risk 28

II.4 Duration and Convexity of a Traditional Fixed-Rate Bond 31

II.5 Study Questions 39

II.6 Answers to the Study Questions 40

Endnotes 44

Chapter III Valuing Floating-Rate Notes and Interest Rate Caps and Floors 47

III.1 CVA and Discount Margin on a Straight Floater 48

III.2 A Capped Floating-Rate Note 54

III.3 A Standalone Interest Rate Cap 56

III.4 Effective Duration and Convexity of a Floating-Rate Note 61

III.5 The Impact of Volatility on the Capped Floater 63

III.6 Study Questions 65

III.7 Answers to the Study Questions 67

Endnotes 71

Chapter IV Valuing Fixed-Income Bonds Having Embedded Call and Put Options 73

IV.1 Valuing an Embedded Call Option 73

IV.2 Calculating the Option-Adjusted Spread (OAS) 78

IV.3 Effective Duration and Convexity of a Callable Bond 80

IV.4 The Impact of a Change in Volatility on the Callable Bond 83

IV.5 Study Questions 86

IV.6 Answers to the Study Questions 88

Endnote 92

Chapter V Valuing Interest Rate Swaps with CVA and DVA 93

V.1 A 3% Fixed-Rate Interest Rate Swap 94

V.2 The Effects of Collateralization 103

V.3 An Off-Market, Seasoned 4.25% Fixed-Rate Interest Rate Swap 106

V.4 Valuing the 4.25% Fixed-Rate Interest Rate Swap as a Combination of Bonds 111

V.5 Valuing the 4.25% Fixed-Rate Interest Rate Swap as a Cap-Floor Combination 114

V.6 Effective Duration and Convexity of an Interest Rate Swap 119

V.7 Study Questions 127

V.8 Answers to the Study Questions 127

Endnotes 136

Chapter VI Valuing an Interest Rate Swap Portfolio with CVA, DVA, and FVA 137

VI.1 Valuing a 3.75%, 5-Year, Pay-Fixed Interest Rate Swap with CVA and DVA 138

VI.2 Valuing the Combination of the Pay-Fixed Swap and the Hedge Swap 142

VI.3 Swap Portfolio Valuation Including FVA - First Method 145

VI.4 Swap Portfolio Valuation Including FVA - - Second Method 150

VI.5 Study Questions 155

VI.6 Answers to the Study Questions 155

Endnotes 161

Chapter VII Structured Notes 163

VII.1 An Inverse (Bull) Floater 163

VII.2 A Bear Floater 172

VII.3 Study Questions 178

VII.4 Answers to the Study Questions 179

Endnote 182

Chapter VIII Summary 183

References 189

Appendix: The Forward Rate Binomial Tree Model 193

Endnotes to the Appendix 206