When we talk of IR #Interest #Rate #Risks we must understand the markets in which this product operates, and the fundamental pricing, trading, and hedging dynamics of this financial #derivative asset class.
Banks normally use IR Derivatives and Structured Products for on and/or off-balance-sheet ALM Asset Liability Management and Immunization, Bond Risk Hedging, NII Risk Hedging, Arbitrage Opportunity Exploration using the treasury based fixed income desks, Rate Speculation, etc.
Of course, we have other financial market participants such as Pension Funds, Hedge Funds, Insurance Companies, and several other specialized asset management firms, that have strategies and asset allocation models, which use IR derivative for both Macro and Micro-hedging.
Of course, IR Risk Management and Product Development have been influenced heavily by BASEL III compliance and the work done in major financial centres such as the City, NYC, and other heavyweight leveraged finance markets.
@BIS focuses on the analysis of risk weights.
In the past, and even today Capital Arbitrage has been used as a method by financial markets to reduce economic capital filing requirements.
Capital footprint reduction is a task assigned to the risk managers, like tax avoidance, which is done by the accountants at banks.
The break-even swap price or the mid-rate is normally used as a reference rate or benchmark for pricing and performance measurement IR Derivatives such as IR #Swaps.
Credit Counterparty Risk weights vary from 2% to 50% due to BCBS Compliance led reforms introduced in the form of Basel 3 Accord/ Guidelines after the #GFC.
Hence, the more obligors the bank has on its creditors' list, the more capital it needs to put aside to hedge against default risk as part of the counterparty active credit management requirements.
Basel Accords have significantly reshaped the following areas within the banking markets =>
Netting of Derivatives
Exposure Management
Active Portfolio Management
Capital Cost Estimation includes pricing of contracts such as IR Swaps
Valuation Models and Adjustments
The biggest back and middle office concerns regarding derivative risk management of exposures is the revaluation of exposures.
The Reval System has the potential to knock out the traders P&L as a result of valuation adjustments introduced via Basel 3
#XVA, DVA, MVA family of models and other related counterparty risk management drove valuation adjustments are opaque and complex accounting and mathematical modalities.
the LTCM Crisis, the USA Flash Crash of 1987, and the Baring Bank Failure (Nic Neilson Rogue Trader) and the GFC led Risk Events are poignant reminders of how certain classes of derivatives have contributed to Systemic Risk and Contagions across the Global Financial Markets.
If I am not mistaken LTCM had a combined leverage ratio of 1:600!!
All of these were primarily positions acquired via derivative trades based on certain mathematical assumptions which Nobel Prize winners were using to exploit arbitrage.
For e.g. a Bond Fund Manager has to hedge against IR Risk in different ways.
Fi can split its risks based on the interpolated yield curve and its segments.
The Shorter end of the curve is ST IR Risk
Middle Chunk is the MT IR Risk
The longer end of the curve is the LR IR Risk
The IR #Derivative Market and the FX Derivative Markets are closely linked to one another.
IR Revaluation will affect your FX Swaps and Swap point calculation by the rates/cross rates desk trader.
Since the #LIBOR Market Scandal, came to an end, the Global Money Market has steadily started to replace the IR Pricing Benchmark, with #SONIA.
The LIBOR Manipulation affected IR Derivative Revaluations across the City, with effects extending beyond the UK Markets.
Traditionally the IR Derivative, which Includes Vanilla Swaps, Forwards, Futures, Options, and highly complex index & another Interest rate aka LIBOR linked Structured Products,mostly used Index Swap point aka bootstrapped rates for discounting the PV of the exposures for quoting
Standard price quoting terminologies used by rate/fixed income desks in the City, were 3x6, 9x6, 8x4, etc FRA Forward Rate Agreements, based on the Stripped Rates, bootstrapped, using an on-the-run curve, annualized, offered in a bid-ask environment, & exchanged using #ISDA docs
IR derivatives such as #Swaps are #OTC Products.
They were heavily customized and are traditionally structured as fixed versus floating rate paying and receiving and in vice-versa formats
#Swaptions and structured products are numerous which has made the IR Market Complex
One common Misconception about IR Derivative Market is that these products are misconstrued as capital raising instruments.
Yes, derivatives do provide leverage like bank loans, but, its accounting treatment is done off-balance sheet.
IR Derivatives are not offered via IPOs ;)
Since Basel Accord Reforms post-GFC, the IR derivatives market alongside the other hedging products which exposes a Fi to Wrong Way Risk and Specific Risks, has become highly computationally intensive and with elevated Mtm marked to market treatment conventions.
The recent developments in the regulatory spheres especially within derivative markets have been the requirement of furnishing collaterals,& the collateralization done via the exchanges.
This has brought additional problems in derivative market trading due to the regularization
You can read more on CSA here
Basel III and CCP Promotion

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More from @SAH16928046

19 Apr
What factors are considered by banks when assessing credit risk to customers?
Credit Risk Management is part of IRA - Integrated Risk Assessment that is carried out by banks to measure transaction and obligor default risks.
The credit risk assessment goes through stages =>
Front Office (RMs at the branches and/or Head Office prepare the credit application/ Clp for further processing).
Middle Office (Financial Risk Management Analysis for checking the Basel Pillar 1/2 Compliance Requirements, to check the BRMC - Board Risk Management Approved and Assigned Risk Appetite Limits etc.)
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19 Apr
What is better for working in the banking and financial services industry, a Master’s in #Economics or #Finance?
@CFAinstitute @LSEEcon @LBS
A very broad question!

How would you define Finance Roles across FI and Non -Fi Settings?
Finance work is required both within and outside the financial services industry. I can share my collective understanding of roles(that might require Economics or Finance related skillsets) based on my experiences, that I have collected on my CV.
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10 Apr
Does #risk management involve a lot of maths?
Yes and No!

It's a well-rounded discipline.
For #Actuarial, Insurance, Financial Engineering, Quantitative Finance and Investment Management, Mathematical Trading, and Financial Risk Assignments, you might require a lot of Maths and Statistics.

Is like asking whether we need milk and sugar for making ice cream ;)
Read 9 tweets
8 Apr
Highlights "Winsemius in Singapore's Economic History" via @YouTube
We must remember what Lee Kuan Yew used to say about the prospects of political system democracy in underdeveloped societies.
This American or UK Style one man one vote political system has no cultural, political, societal, economic, or dialectical antecedents in several of the Asian, Latin American or African Countries.
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7 Apr
Are we ready for the next crisis? | DW Documentary via @YouTube
you must read history to get a perspective of how things went wrong or might go wrong in the foreseeable future. I have always implored students to take more courses in Economic History, and the History of Economic Thought, instead of blindly selecting mathematical economics,
financial engineering, and econometrics style courses in the third year of their honours degree.

I would advise students to read #Minsky's Hypothesis and how he predicted that financial stability will lead to instability sometimes!
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What are new graduates doing to be attractive to banks entry-level analyst programs?
@ABABankers @TheBanker @CIOonline @RiskDotNet @FT
Interesting question.
Banking sector MTO - Management Trainee Officers Program vary from country to country.
In my country Bank Staff Colleges train young graduates to become bankers.
The hired graduates have to undergo an intensive training course by attending several In-house boot camps or lecture hall workshops before they are moved into the formal workplace.
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