Swap Box Enhancement | Weekly Release 9/4/20

Enhanced weighting options by adding “Change to Key Risk (cashflow) Weight”

Traders can now adjust the weighting for a strategy to the Key Risk (cashflow) weight.

Key Risk (Cashflow) Weight


Applies to spread & butterfly strategies. Only supported for butterfly strategies with a combination of bonds & bond futures.


Product 1/Product 2/Product 3

(Product can be either bond or bond future)


Calculate the key risk of product 2 with the product 1 and product 3 as the key risk buckets.


Wings of the butterfly strategy (Product 1 and Product 3)

  • For bond product as risk bucket, the key rate curve is built based on bond’s cash flow with the bond’s dirty price.

  • For bond future product as risk bucket, the key rate curve is built based on the spot CTD bond’s cash flow with the CTD bond’s dirty price.

Body of the butterfly strategy (Product 2)

  • For bond product as the body, it is treated as a spot settled bond.

  • For bond future product as the body, it is treated as a forward CTD bond with the settle date on future last delivery date, notional as contract size / conversion factor, and CTD forward price as future price * conversion factor.

Risk 1 = Key risk of product 2 at bucket of product 1

Risk 2 = Key risk of product 2 at bucket of product 2

Weight1 = -1 * Risk1 / (Risk1 + Risk 2)

Weight2 = 1

Weight3 = -1 * Risk2 / (Risk1 + Risk 2)


Example: butterfly trade 2/5/10


Two wings 2 and 10 are bond products, CT2 and CT10. Therefore, the key rate curve is built on two fitting points, CT2 and CT10


First, building the key rate curve such that:


  1. PV of CT2 bond cash flow discounted by this key rate curve equals to the CT2 spot dirty price.

  2. PV of CT10 bond cash flow discounted by this key rate curve equals to the CT10 spot dirty price.

Second, construct the shift curve of the key rate curve on each bucket. That is, for each fitting point, bump the yield 1bp down and calculate the corresponding dirty price. Use those shifted dirty prices to construct the shifted key rate curve with the same method on the first step.


Hence, we have 2 shifted key rate curve in this example, one is shifted on CT2, and the other is shifted on CT10.


Finally, calculate the key rate hedge the body, a CT5 bond, on each bucket by calculating the PV difference between the shift key rate curves discounted PV of the bucket and the base key rate curve discounted PV.


Suppose we get the risk distribution as below.

Total

Total 48661.0

2y 42302.0

10y 6359.0


The weight = -1 * 42302 / 48661 : 1 : -1* 6359 / 48661

= -0.87 : 1 : 0.13

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