Valuation of IR Derivatives in a new Regulatory Environment Speakers: Eduardo Pereira Risk and Regulation Specialist: Bloomberg L.P Bernardo Santos Andrade Senior Manager, Toyota Motor Finance (Netherlands) B.V Dutch Association of Corporate Treasurers Event: Hotels Van Oranje, Noordwijk, The Netherlands. 11th November 2013.

OIS Discounting: A new valuation framework; CSA Agreements; CVA; CSA Agreements – Bloomberg ‘MARS’ solution; TMFNL: Collateral Operation Case Study. Agenda

OIS Discounting

Overview of OIS Framework Prior to Credit Crisis credit & liquidity effects were largely ignored in IR derivatives pricing Subsequent to Credit Crisis Stronger Focus on Counterparty Risk (Credit) Evaluating Exposure Risk Management Stronger Focus on Funding (Liquidity) Divergence between “risk free” rates and funding levels Funding arbitrage opportunities New framework required as credit & liquidity effects can no longer be ignored in pricing Overview of OIS Framework

26th Oct 2005: 10MM EUR 7yr Pay 3.10%, q/q

IR swaps can have both negative or positive values If market value is positive Counterparty owes money And if counterparty defaults Loss for everything that can’t be recovered........ Credit mitigation very important Changes in Regulation Banks to be penalised for uncollateralised swaps Counterparty Risk

Swaps in the Interbank Market Mitigating credit exposure (interbank) Netting Agreements Credit Support Annex (CSA) agreement Central Counterparty (CCP) clearing CSA: Collateral posted between counterparties CCP (e.g. LCH.Clearnet): “Variation Margin” paid (or received) each day by clearing member (in addition to “Initial margin”) Both CSAs & CCP define how interest accrues on funds (collateral or margin payments) Swaps in the Interbank Market

Credit & Liquidity Premium in Euribor LOIS EUR <GO>

Credit & Liquidity Premium in Euribor Credit Crunch: Market First Fears

Credit & Liquidity Premium in Euribor Bear Stearns ‘Bailout’

Credit & Liquidity Premium in Euribor Lehman Bankruptcy

Credit & Liquidity Premium in Euribor Ireland Crisis

Counterparty Risk IR swaps can have both negative or positive values If market value is positive Counterparty owes money And if counterparty defaults Loss for everything that can’t be recovered........ Credit mitigation very important Banks generally have agreements to post collateral to each other Credit Support Annex (CSA) agreement Central Counterparty Clearing (CCC) Generally corporates do not wish to sign CSAs or agree to CCCs Both parties exposed to counterparty risk Counterparty Risk

Counterparty Valuation Adjustments

Webinar Poll 2 - Question For a swap how do you currently determine what you are being charged for your credit risk? By using the Bloomberg CVA/DVA calculator  My relationship banks provide full disclosure on these charges  Unaware of any such charges  We calculate using other methods   We do not get charged   Webinar Poll 2 - Question

Webinar Poll 2 Results

Calculating Credit Spreads CVA/DVA Calculator

Calculating Credit Spreads Calculate Exposure from Counterparties Perspective

Calculating Credit Spreads Market Information: Credit, Rates & Volatility

Calculating Credit Spreads DVA: Cost to Bank of Corporate Defaulting

Calculating Credit Spreads CVA Calculation: Cost to Corporate of Bank Defaulting

Calculating Credit Spreads Bilateral Calculation

Bilateral Calculation Exposure Graph Bilateral Calculation

Charting Net Cash Flows Net Cash Flows affect Exposures