dudes - one of the traders here as stuck on a CCS, non-deliverable therefore no exchange of notional on BRL/USD with a Brazilian bank.
The notional is US$100m (BRL equiv) and it’s a 10yr swap which cover the term of hte underlying bond instrument which has been issued a private placement.
The trades is mtm on a daily basis a 0 MFL.
What i don’t understand is how the hell they can make 8m P&L on this trade. The first margin call was for 8m which is basically a front load of the p&L. How is this price mechanism working, how do they value this swap and why is it front loaded?..
Your trader can’t figure out cross currency swap valuation? That’s not a good sign…
Anyway, it sounds like you got a margin call for the economic value of the derivative, $8 million. The swap is should be easy to value. In USD terms, it’s just worth the sum of strike prices minus market forward prices, discounted in USD rates, and then multiplied by the notional amount. That should answer your first two questions.
As for “front loaded”, I’m not sure if that is relevant if the margin is only a collateral payment on the market value of the swap.
If you have a generic version of the swap’s actual terms, I should be able to give you a very concrete analysis.
Yes. Those strikes and rates are chosen such that the initial swap value is close to zero, although it is usually not exactly zero, due to dealer bid/ask.
In the swap above, the USD payment at each period by Party A (subject to periodicity) is 5%*$100 million = $5 million. The BRL payment by Party B is 10%*326 million = 32.6 million BRL. In other words, in economic terms, at each interest payment, Party A is long BRL on an NDF with a strike of 5/32.6 million = 0.1533 BRLUSD. If BRLUSD is higher than 0.1533 at the fixing date of any coupon, Party A will receive USD from Party B and vice versa.
How do we value these payments? As I mentioned earlier, there is a market forward price for NDFs with each of the same fixing dates as those coupon payments. The economic value of each payment is simply the strike price minus forward price, times notional, then discounted in USD.
For the principal payment, it looks like Party A is long a $100 million BRLUSD NDF with a strike of 0.326 BRLUSD.
I am not sure why you are recording a $7 million valuation difference on day 1. That seems odd. Is this actually a variation difference, or is this “initial margin” intended to accommodate future volatility in mark to market?
What do you mean by the “BRL rate”? Is this the spot rate, and then you will price all forward prices on bases to this rate? If you are 1.4% off market, you will certainly see a valuation difference of close to 1%. Probably higher…
I think this is what has happened. They’ve put on the swap off market spot rate by c140bps then they’re recording a large valuation of the swap on day 1. We’re getting paid 7m for 1 sticking CCS which is margined daily… damn dog… this guy gonna make PL at year end.