Equity Derivatives, FX, Credit and xva

Enhance your knowledge of equity derivatives & FX options

This course represents Module 2 of Advanced Derivatives

Module 2 – Equities, FX, Credit and XVA

• Day 3 Equity and FX options, exotics, structured products and trading the volatility surface
• Day 4 Credit derivatives, CDOs and structured credit
• Day 5 Funding, XVA, and the new regulatory world

The emphasis is on a healthy mix of theory and client applications, and is illustrated throughout with real-life examples and case-studies.

Agenda

Day 3 Options, Exotics and Structured Products

Option fundamentals

• The basic payoff diagrams
• Cash versus physical settlement
• Popular option combinations and strategies
• Volatility - what it is and why it matters

Option pricing

• Intuitive drivers of the premium
• Binomial trees
• Monte Carlo
• Black-Scholes

Option risk-management

• The delta hedge
• The fundamental role of gamma
• Gamma versus theta

Understanding and trading volatility

• Defining implied volatility
• Defining the vol surface, smile and skews
• Hedging smile and skew risk, risk-reversals and butterflies
• The role of stochastic vol in understanding smile and skew
• Quantifying the risk - vanna and volgamma
• Introduction to local and stochastic vol models

Exotics and structured products

• Digitals and range-accruals
• Barrier options and client applications
• Static hedging of barrier options
• Autocallables and accumulators
• Cliquets and the problem of forward vol

Day 4

Credit Derivatives

Mechanics of a CDS contract

• Defining a credit event
• CDS setttlement

Pricing and risk

• The credit triangle – relating credit spreads to default probability (PD), exposure (EAD) and expected recovery (LGD)
• Risky discounting
• Standard contracts, fixed spreads, computing the upfront
• CS01 and convexity

• Hedging bond positions

• Constructing the hedge – default risk or spread risk?

• Trading the cash-CDS basis

• Drivers of the basis

CDS indices (iTRAXX and CDX)

• Mechanics and settlement
• Intrinsic spread and skew
• Sub-indices

Tranching and correlation

• Synthetic single-tranche CDOs
• Credit correlation and why it matters
• Understanding the tranche delta

Structured credit trading

• Tranche trading and convexity
• Nth-to-default baskets

Day 5 Counterparty Risk, Funding and XVAs

Key concepts and metrics of counterparty exposure

• When exposure is non-static – why derivative are tricky
• Key metrics of exposure for derivatives: EL, EE, EPE, PFE

From exposure to Expected Loss

• Monte carlo simulation and semi-analytical methods
• Computing EL for some simple positions: IRS, forward FX

Pricing for default risk

• The traditional approach versus the CVA approach

Computing the CVA charge for the most common positions

• Shortcut calculational tricks
• Mitigating the exposure on cross-currency swaps

Wrong-way risk

• Examples of wrong-way (and right-way) risk
• Computing the CVA charge with wrong-way risk
• The new CVA capital charge in Basel III

DVA – adjusting for your own risk

• DVA for some common positions
• Is DVA real? Why it remains controversial

CSAs and collateral

• The importance of netting
• CSA key terms
• The dual role of the CSA – collateral as funding

Building a funding curve

• The choice of OIS as a core discount curve
• What is meant by ‘CSA discounting’
• The ‘cheapest-to-deliver’ option in collateral posting

Understanding the Funding Valuation Adjustment (FVA)

• Adjustment for asymmetric collateral terms
• Avoiding the trap of double-counting FVA and DVA

Other XVA adjustments

The new regulatory world

• Central clearing
• Regulatory legislation: Dodd-Frank, EMIR, MiFiD and the rest
• What can we expect from Basel IV?