Practical Applications from the Experts - January 2010

categories: Product Documentation, general

Multi-Model Positions

RiskManager 4 allows users to model complex financial instruments by combining different instruments into a single position. For instance, users can now create an Equity Collar in RiskManager by combining an equity model with two equity options. Another example is the combination of an equity and cash position to model a CFD. Clients can also use the multi-model position to handle structures that mimic payoffs not handled by our standard models – for instance, users can use a generic bond together with an equity option (to model a short put) to mimic the payoff associated with a reverse convertible bond (which can not be handled by the standard convertible bond model). The payoff of the reverse convertible bond and the replicating portfolio of a bond plus a short put option are identical (because when the issuer decides to exercise the put, the bond holder would have to pay the strike price to take the delivery).

Below we examine a Dual Currency Investment(DCI) which can be modeled as a single position with 2 models – an FX option and a generic bond. The position examined had the following terms:

One can see that the risk of the DCI is picked up with FX, interest rate and vega risk components. Currency delta is dominant here (as compared to interest delta) as it is the major risk – proceeds at maturity can be paid in either the primary or alternate currency. On the other hand, interest payments occur in the primary currency, leading to the minimal interest rate risk.

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