Quantitative Analyst

Learning Objectives

  1. Understand new market conventions for SOFR, SONIA, ESTR, HONIA and SARON – Compounding/Averaging, Lookbacks, Lockouts, Observation Period Shift, Payment Gaps.
  2. Review of Collateralized Pricing Assumptions and Multi-Curve building with OIS.
  3. Define detailed curve configurations and instrument recommendations – Flat forwards between FOMC meetings, Hermite interpolation, Overlapping 1M and 3M futures.
  4. Incorporating most recent developments – CMS fallback definitions, cap/floor with SOFR term rates and reset in advance.
  5. Market liquidity and volumes of derivatives and cash instruments.
  6. Deriving volatilities for SOFR options based on implied LIBOR volatilities and skew for normal, shifted lognormal and SABR model.
  7. Quantifying economics and structural differences between LIBOR term rates and RFRs.
  8. Define and use algorithms to compute adjustment spreads for ISDA fallbacks and Cash Instrument fallback waterfalls.
  9. Adjustments to existing models including futures convexity adjustments, average swaps, shifted log-normal and Libor Market Model.
  10. Quantifying P&L Impact on Fallback Date and Its Implications for Derivatives, Fixed Income, Loans and Structured trades such as CLOs.

Course Framework

1. P&L Impact on Fallback Date and Its Implications

  • Significance of value transfer for existing Libor contracts
  • Impact on counterparty exposure, collateral and xVA measures
  • Impact of tax treatment on the decision- making process for transition timing
  • Limits and risk mitigation on potential fallback P&L impact
  • Exposure measures and hedging of LIBOR SOFR basis spread

2. LIBOR Market Model Introduction and FMM

  • Difference of Transition Impact on Hull&White and LMM
  • Review of LMM and it’s Underlying Behavior
  • Issues with LMM and Reset in Arrears Backward Looking Rates
  • Model Changes based on Lyashenko and Mercurio
  • Deterministic Volatility Decay Function and Ease of Implementation

3. Impact on Existing Model Libraries

  • Fixed Income models and methodologies
  • Derivatives models and methodologies
  • Modifying and adjusting for RFR replacement differences
  • Managing model risk management workflow

4. Comprehensive Components of Model Documentations

  • Fixed Income models and methodologies
  • Derivatives models and methodologies
  • Modifying and adjusting for RFR replacement differences
  • Managing model risk management workflow

5. Regulatory Guidance on Model Risk Management

  • US – FED’s SR 11-7: Guidance on Model Risk Management
  • Basel and EU Guidelines
  • Applicability to LIBOR Transition

6. Principles of Quantitative Model Validation and Model Risk Management

  • Definitions of Model, Model Risk and Input/Output/Engine components
  • Model Uses across the Enterprise using Practical and Closed Form Calculations
  • Required Processes for Model Validation for Fundamental Changes or Rates
  • Apply Quant Culture with IT Discipline to Manage Transition

7. New Model Risk Contributing Factors

  • Econometric Model Changes for the the new Risk-Free Rates
  • Backward and Forward Looking Term Rates and Shift of Effective Dates and Accrual Dates
  • FAS133 Hedge Effectiveness Testing Changes for new Benchmarks and Transition
  • Statistical Behavior of the new Rates and Credit Components
  • Model Risk Contributing Factors and Changes in Market Regime
  • New or Untested Model Type or Class

8. Model Users and their Expectations

  • Behavior and Expectations of Traders and Business Decision Makers
  • Risk Management across Enterprise and Desk level
  • Financial Controls and Accounting
  • Regulators and Policymakers and Expectations on Transition

9. Vanilla/Static, Dynamic and Credit Models

  • Term Structure Models for Interest Rates
  • Market-Implied PD and LGD Models
  • Actuarial-Statistical PD, Risk Migration and Loss Models
  • Stochastic Models for Equity,FX and Commodity

10. LIBOR Usage and Major Components of Required Model Changes

  • Compounding, Averaging and Daily Observation Impact
  • Curve and Collateral Dependency Revision across all Currencies
  • Move from HJM/LMM to FMM Model
  • Convex Accrual Function across all Asset Classes
  • Funding and Loan Index Recommendations to Account for Credit Component of LIBOR
  • Timeseries Considerations and Historical SOFR model to have data back to 1998

11. Dynamic Mortgage Models with Current Coupon, Prepayment and Credit

  • Stochastic Interest Rate Models and CMS Rates as Inputs
  • Current Coupon Model and lack of SOFR History
  • Prepayment, Default, Loss Severity Models
  • Structured Securities and Collateral LIBOR assumptions

12. Hands-on New Payment and Accrual Conventions for FRN and Swaps for Reconciliations

  • Differences among 1M SOFR, 3M SOFR, Eurodollar and Fed Fund future
  • Reasons for calculation differences
  • Differences of payment and accrual conventions among fixed income, lending and derivatives
  • Listing of reliable rate calculation engines for reconciliation of payments
  • Detailed examples of payment gap, lockout, observation shift and observation period shift
  • Reset in Advance SOFR option products

13. Build the Short End of the RFR Curve and Cross-Currency Basis

  • Instruments to define LIBOR, RFR, OIS curves and their relationships
  • Interest rate parity for FX forwards and if RFR will have an impact on FX projections
  • Impact of RFR on the cross-currency basis in the short end of the curve
  • Implementation of the short end of the curve and implied likelihood of Fed Fund rate
  • changes
  • Multiple different overlapping futures contracts in a single curve
  • SOFR term rate and futures

14. Build the Long End of the RFR Curve and Cross-Currency Basis

  • Many alternatives to build the long end of the curve
  • Removal of LIBOR dependency on the SOFR curve
  • Long end discussion with SOFR outright vs basis to OIS or LIBOR
  • Necessity for multi-curve bootstrapping when SOFR swap discounts on SOFR

15. Deriving Volatilities for A Proxy Index

  • Generalized dynamic model of Mercurio
  • Deriving SOFR volatilities from LIBOR volatilities
  • Numerical examples of shifted lognormal
  • Numerical examples of SABR replication

16. Impact of small SOFR convention discrepancies to discount factors

  • Curve dependency examples and how it affects errors in zero rates
  • Pricing examples for swaps and it’s curves and reconciliation impact
  • Payment and accrual convention impact on zero rates
  • Pricing examples for swaps and it’s curves and reconciliation impact

17. Smooth Interpolation with Various Interpolation Techniques

  • Desirable features of any interpolation techniques
  • Quite comprehensive view of interpolation techniques
  • Different interpolation methodologies on zero, forward rates and discounting factors
  • Can linear methods have continuity in forward rates?
  • Spline methods and mentioning of Hermite interpolation as well as Hagan’s monotone convex method

18. Pitfalls of Flat Daily One Day Forward Rates and FOMC Meeting Dates

  • Implied jumps in forwards due to FOMC meeting and future expiration dates
  • Curve generation algorithm in detail combining overlapping futures
  • Can you build a good forward rate curve with bootstrapping or do you need an optimization across instruments
  • Large spikes in forwards close to FOMC meeting dates