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  • Interest Rate Swap-Derivative Pricing in Excel
    An interest rate swap (IRS) is a financial derivative instrument that involves an exchange of a fixed interest rate for a floating interest rate.  More specifically,An interest rate swap's (IRS's) effective description is a derivative contract, agreed between two counterparties, which specifies the nature of an exchange of payments benchmarked against an interest rate index. The most common IRS is a fixed for floating swap, whereby one party will make payments to the other based on an initially agreed fixed rate of interest, to receive back payments based on a floating interest rate index. Each of these series of payments is termed a 'leg', so a typical IRS has both a fixed and a floating leg. The floating index is commonly an interbank offered rate (IBOR) of specific tenor in the appropriate currency of the IRS, for example LIBOR in USD, GBP, EURIBOR in EUR or STIBOR in SEK. To completely determine any IRS a number of parameters must be specified for each leg; the notional principal amount (or varying notional schedule), the start and end dates and date scheduling, the fixed rate, the chosen floating interest rate index tenor, and day count conventions for interest calculations. Read moreThe above description refers to a plain vanilla IRS. However, interest rate swaps can come in many different flavors. These include, (but are not limited to)Amortizing notional IRSCross-currency swapFloat-for-float (basis) swapOvernight index swapInflation swap etc.Interest rate swaps are often used to hedge the fluctuation in the interest rate. To value an IRS, fixed and floating legs are priced separately using the discounted cash flow approach.Below is an example of a hypothetical plain vanilla IRSMaturity: 5 yearsNotional: 10 Million EURFixed rate: 3.5%Floating rate:  EuriborThe values of the fixed, floating legs and the IRS are calculated using an Excel spreadsheet. Table below presents their valuesClick on the link below to download the Excel spreadsheet.Article Source Here: Interest Rate Swap-Derivative Pricing in Excel
  • Valuing an American Option Using Binomial Tree-Derivative Pricing in Excel
    In a previous post, we provided an example of pricing American options using an analytical approximation. Such a pricing model is fast and accurate enough for risk management purposes. However, sometimes more accurate results are required. For this purpose, the binomial (lattice) model can be used. Wikipedia describes the binomial tree model as follows,In finance, the binomial options pricing model (BOPM) provides a generalizable numerical method for the valuation of options. The binomial model was first proposed by Cox, Ross and Rubinstein in 1979. Essentially, the model uses a "discrete-time" (lattice based) model of the varying price over time of the underlying financial instrument...The binomial pricing model traces the evolution of the option's key underlying variables in discrete-time. This is done by means of a binomial lattice (tree), for a number of time steps between the valuation and expiration dates. Each node in the lattice represents a possible price of the underlying at a given point in time.Valuation is performed iteratively, starting at each of the final nodes (those that may be reached at the time of expiration), and then working backwards through the tree towards the first node (valuation date). The value computed at each stage is the value of the option at that point in time.We utilized the lattice model previously to price convertible bonds. In this post, we’re going to use it to value an American equity option. We use the same input parameters as in the previous example. Using our Excel workbook, we obtain a price of $3.30, which is smaller than the price determined by the analytical approximation (Barone-Andesi-Whaley) approach.[caption id="attachment_561" align="aligncenter" width="335"] American option valuation in Excel using Binomial Tree[/caption]Click on the link below to download the Excel Workbook.Originally Published Here: Valuing an American Option Using Binomial Tree-Derivative Pricing in Excel
  • Credit Risk Management Using Merton Model
    R. Merton published a seminal paper [1] that laid the foundation for the development of structural credit risk models. In this post, we’re going to provide an example of how it can be used for managing credit risks.Within the Merton model, equity of a firm is considered a call option on its asset, and it is expressed as follows,where    E denotes the equity of the firm,               V is the firm’s asset,                is the asset volatility,                B is the notional amount of the debt,               r is the risk-free interest rate, andWe note that both asset (V) and its volatility are not observable. However, the asset volatility can be related to equity and its volatility through the following equation,where denotes the volatility of equity.These 2 equations can be solved simultaneously in order to obtain V and its volatility which are then used to determine the credit spreadHaving the credit spread, we will be able to calculate the probability of default (PD).  Loss given default (LGD) can also be derived under Merton framework.Graph below shows the term structures of credit spread under various scenarios for the leverage ratio (B/V).[caption id="attachment_541" align="aligncenter" width="564"] Term structure of credit spread[/caption]It’s worth mentioning that the Merton model usually underestimates credit spreads. This is due to several factors such as the volatility risk premium, firm’s idiosyncratic risks and the assumptions embedded in the Merton model.  This phenomenon is called the credit spread puzzle.  Research is being conducted actively in order to improve the model.References[1] Merton, R. C. 1974, On the Pricing of Corporate Debt: The Risk Structure of Interest Rates, Journal of Finance, Vol. 29, pp. 449–470. Originally Published Here: Credit Risk Management Using Merton Model
  • Trump says China wants to make a trade deal, Dow jumps
    From Dan Mangan:  President Donald Trump said Friday that China “wants to make a deal” on trade with the United States, but he also said any pact has to be reciprocal. Trump’s comments sent the Dow Jones Industrial Average to… Read more ›
  • FDA Seeking “Nationwide Ban” Of Menthol Cigarettes
    From Zacks: Earlier this month, the FDA outraged American teenagers by banning flavored nicotine vaping products used with the increasingly popular Juul.  And while many cynical observers quickly attributed the vape crackdown to heavy lobbying by Big Tobacco, as it turns out,… Read more ›
  • KB Home Slumps on Guidance Cut, Drags Down Other Home Builders
    From Zacks: Shares of KB Home KBH decreased 15.3% yesterday, after the company trimmed its guidance for fourth-quarter fiscal 2018. It also underperformed the industry in a year’s time.  The stock has lost 38.8% compared with the industry‘s 32.7% decline. For fourth-quarter fiscal 2018,… Read more ›
  • Transport ETFs Surge on Busy Thanksgiving Travel
    From Sweta Killa: A higher number of Americans are gearing up for Thanksgiving travel by road or air encouraged by a booming economy, higher wages, rising consumer confidence and increasing levels of household wealth.  The frenzy for trips during the… Read more ›
  • Retail Sales came in better than expected but near-term technicals are weak
    Market technician Dave Chojnacki of StreetOne Technical Analysis Retail Sales came in better than expected and Initial Claims came in where expected.  Equities opened lower and it looked like we were headed for the sixth straight down day for the… Read more ›
  • Is the re-monetization of Gold much closer than we think?
    From Brandon White : Monetary policy is largely responsible for the market conditions we have today. Whether we like it or not, central planning in the capital markets will remain with us for the foreseeable future. Capital flows will be… Read more ›
  • Large Outflows Detected, iShares iBoxx $ Investment Grade Corp. Bond ETF (LQD)
    From ETF Channel: Looking today at week-over-week shares outstanding changes among the universe of ETFs covered at ETF Channel, one standout is the iShares iBoxx $ Investment Grade Corporate Bond ETF (Symbol: LQD).  We have detected an approximate $823.6 million dollar… Read more ›
  • CIA concludes Saudi prince ordered Khashoggi killing
    Reports say US agency has no direct evidence but believes operation would have had top level approval
  • Switzerland gives green light to first cryptocurrency ETP
    Launch comes as bitcoin drops to lowest level for more than a year
  • Rampant investor interest pushes ESG funds past $1tn
    Assets under management in popular products increase 60% in just 6 years
  • Market rotation offers glimpse of hard Brexit playbook
    Backdrop to turmoil was a volatile pound and weaker share prices for UK-exposed groups
  • Bank bribe claim shakes Polish politics
    Ruling Law and Justice party has emphasised fight against corruption
  • Nasdaq contains losses as Nvidia woes hit chipmakers
    Group’s unexpectedly weak sales guidance adds to fears electronics demand could slow
  • China cuts US Treasury holdings by most in 8 months in September
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