Structured Note Pricer: Valuation of Structured Financial Products

In the financial world, structured interest rate products become more and more exotic. Additionally, the number of data to be processed is growing. Hence, we are looking for more powerful solutions in order to valuate these products.

As a solution to meet these requirements the Department of Financial Mathematics has developed the Structured Note Pricer (SNP).

Currently used valuation tools often come along with a complex input and often the user has to provide this input manually for complex products. This results in a time-consuming valuation when considering big data sets. Futhermore, a manual input is fault-prone and should always be double-checked.

SNP: Methods and Models

The SNP allows to model market scenarios in different ways. Nowadays products depend on all kind of different market aspects and hence should be viewed from various point of views. Therefore, we have implemented the following methods and models:

The user can choose between:

  • Pricing via Tree
  • Closed-Form-Valuation
  • Monte Carlo (MC) Methods
The advantages of the SNP at a glance.
© Fraunhofer ITWM
The advantages of the SNP at a glance.

These methods can be used in the context of various models. Currently implemented are the

  • Standard Black model
  • LIBOR market model
  • One- and two factor Hull-White models

Compared to the Black model, the LIBOR market model also considers correlation structures of the interest rates. The advantage is a more appropriate modelling of the market structures. Disadvantages are longer running times. The valuation with the Hull-White models is of interest, as they also consider negative interest rates. This is an appropriate assumption in the currently observed low-interest-rate phase.

SNP Follows the Principles in Order to Deal with the Huge Data Sets:

  1. Single-Run Principle:
    Complex calculation methods are optimized such that these methods only need to be performed once for all valuations. For example while one single trade takes 60 seconds to be valuated, three trades of a similar kind take 62 seconds in total.

  2. Stable-Run Principle:
    The LIBOR market model and the Hull-White models are calibrated immediately before the valuation of the products. After the valuation the parameters of each calibration are provided with the output. Hence, it is possible to reproduce the data as well as to compare results. Futhermore market conventions are suggested for use if parameters are missing.

  3. Modular Construction:
    Pricing library and building library are separated from each other and are connected via a joined application programming interface (API). The advantage is the simple connection of the SNP calculation kernel to any databases, Excel formats or similar.
Swap rates traded on the market
© Fraunhofer ITWM
Swap rates traded on the market. From these, the SNP derives a yield curve using bootstrapping.

Sample List of Structured Financial Products That the Snp Can Valuate:

  • Interest Rate Swaps
  • Constant Maturity Swaps (CMS)
  • CMS Caps / CMS Floor / CMS Collar
  • CMS Spreads / CMS Steepener
  • European Swaption
  • Bermuda Swaption
  • CMS Swaption

Due to the already implemented Monte Carlo method, we can easily extend this list. Furthermore optional features, e.q. amortization schedules, can be provided with the product.