Negative Interest Rates

Negative interest rates are a new and strange phenomenon. This concept causes a lot of head scratching, particularly regarding option valuation and VAR calculation, since the lognormal paradigm, applied for the last thirty years, breaks down.  In a lognormal world, the next period’s rate is calculated as this period’s rate multiplied by e (2.718…) raised to the sum of the drift (a certain number) plus the diffusion (volatility multiplied by a normal random number).

Lognormal Model: Rate Next Period = Rate Today * e Drift+Diffusion

No matter what the diffusion is, e is positive and therefore the rate next period cannot cross zero.  If this period’s rate is positive then the next period’s rate must be positive and vice-versa.

For example, consider the valuation of the right to lend to the US Government at 0% interest for the whole of 2018 (an interest rate floor).  Under a lognormal model, the loan rate cannot be negative and therefore the option has no value. If this were the case, you would always choose to let the option expire and lend to the US government at the prevailing rate rather than exercise the option. However, if you believe it is possible (no matter how unlikely) for rates to become negative then the option to lend the US Government at 0% is valuable, and your model must reflect this. Under the normal model, however, the next period’s rate is determined as this period’s rate plus a drift and diffusion coefficient.

Normal Model: Rate Next Period = Rate Today + Drift + Diffusion

This means that the rate can go negative and the above option would still have value.

Imagine Fair Valuation of the above T-Bill Floor under the normal and lognormal models.

tbill

A further point of interest is the volatility (the diffusion multiplier) between the two models is not equivalent. For example, suppose the rate in question is 1%, and we assume no drift, and an annualized volatility of 5% in a lognormal setting. This implies the two standard deviations range of rates with two standard deviations is approximately 0.91% and 1.1%.  However, in a normal model a volatility of 5% would imply this range to be approximately -9% to 11%. Clearly, it is very important to adjust the volatility between the two.

At Imagine, we let our users choose to value their options using a lognormal or normal model for both option valuation and VAR calculation. In addition, for our risk calculation, we handle the conversion and provide the lognormal equivalent volatility so the earlier-mentioned issues do not occur. Please contact Imagine if you would like to know more about how we can help.

______
About the Author
Jack Goss has been a Consultant at Imagine for six months. Previously, over the course of  five years, he gained financial experience as both an investment manager at a large British pension fund and analyst for a hedge fund at Henderson Global Investors. During this time he earned both his  CFA and CAIA. Jack received his bachelor’s in economics from Cambridge University and is currently studying for a master’s degree in mathematical trading and finance from CASS business school. Outside of finance he enjoys bridge and cycle touring. He can be reached by email and phone: +44 (0) 20 7440 0713.

Brexit: Imagine the Consequences

At Imagine, our job is to help clients better understand risk. We enable our clients to estimate risks to their positions and portfolios ahead of both known and unknown critical market events. For example, historical simulations formed from previous significant shocks (crash of 1987, September 11, etc.) allow for a visualization of the effects of sharp changes in market conditions that, by definition, are hard to predict. These simulations, however, are not just determined from past events.

This month, June 23rd to be precise, is set to deliver a potentially very large shock to financial systems in the UK, across Europe, and globally too. Both the buy and sell side point to sharp falls in risk asset valuations in the event of a Brexit. The probability of a Leave outcome changing sharply from one day to the next, means prices will also sharply change. Imagine’s real-time risk engine and customizable analytics allow shock inputs to be defined from either market data held in your system, or from data you can set manually and adjust “on the fly”.

Highlighted below are some typical market scenarios from both Leave and Remain outcomes, and how they can be used as inputs to help offer insights and estimate exposures:

Probability 0.6 0.4
Asset Class UK Remains UK Leaves
Sterling 5.00% -9.00%
UK Equities 4.00% -11.00%
European Equities 3.00% -6.00%
Global Equities 1.50% -3.00%
UK Bond Prices 1.50% -3.00%
European Bond Prices 0.30% -2.00%
US Bond Prices -0.50% 3.00%
Gold -2.00% 5.00%

You can enter the above hypothetical shocks into Imagine as the values to shift respective underlying asset prices. Imagine’s analytics applies historical statistical relationships between your positions and the shocked input instruments you define to generate the estimated effect on your holdings. Our Dashboards allow you to define an aggregation of shocked positions into a multitude of combinations to better describe, and uncover, pockets of risk nested within your portfolios. Once you identify the risk, you can drill in to see what parts of your strategies are most exposed with expectations of Brexit. And, crucially, this does not just apply to an event such as the UK’s referendum. Any event that your business or your investors require stress testing against can be calibrated for under your own assumptions, research, and analysis. Contact Imagine and we will create the stress test your business or investors need to help you evaluate your exposure.

Report Example

brexit1

Strategy View

brexit2

Portfolio View

brexit3

Example of Aggregation (Industry)

brexit4

(Currency)

brexit5

Disclaimer

The stresses described in this blog post illustrate one possible scenario and are intended to be used in general as guidance towards risk management of market events.

______
About the Author
David White worked as an equity trader and portfolio manager in derivatives for more than five years before joining Imagine’s London office as a Consultant in 2015. David’s roles are to advise and offer consulting services for systematic applications of risk management and derivatives pricing. David leads and is the project manager for EMEA client implementations. David holds a bachelor’s degree from Bournemouth University. He can be reached by email and phone: +44 (0) 7440 0743.

Imagine’s Pre- and Post-trade Compliance Solution

Imagine empowers users to make informed, risk-compliant decisions in the ever-changing regulatory environment with its robust Pre- and Post-trade Compliance Solution.

With Imagine’s development of a dedicated limit monitoring dashboard, users can monitor limit utilization levels of pre-defined rules across multiple portfolios from a single dashboard view. This provides useful insight into the positions which are breaching, or almost breaching, limit rules defined by the user.
LimitsScreenshot
The dashboard also allows clients to upload test trades to an existing set of positions to see if this would create any limit breaches.

Drawing on Imagine’s expertise we have developed a Pre-Trade Compliance module fully integrated with an Execution Management System (EMS) used by many of our users.

The pre-trade compliance workflow is:

  • Imagine’s Consulting Team helps clients create and implement rules to be used in compliance checks
  • EMS sends Imagine a pre-trade order message to Imagine’s powerful REST platform
  • An Imagine App performs the necessary compliance calculations and checks limit breaches against the client-specified rules
  • Imagine returns a REST message to the EMS which displays the outcome for the pre-trade orders. If a trade will cause a breach, the returned status is Rejected, otherwise, its status is OK
  • Trades designated as OK go out to market for execution; rejected trades go into a pending authorization queue along with the reason for rejection

The Pre- and Post-trade Compliance Solution is enabling clients to generate orders in an EMS, while still managing their compliance calculations, using Imagine’s rich universe of data and analytics. The end result being: more informed and compliant investment decision-making by Imagine users when meeting both investor and internal requirements.

Contact us to find out more about our cutting edge Pre- and Post-trade Compliance Solution.

______
About the Author
Bill Daher has been with Imagine for six years and is currently a team leader in Consulting for Imagine’s APAC region. Bill has been heavily involved in the architecture of quantitative solutions in Imagine. He holds a Masters of Actuarial Studies from Macquarie University in Sydney, Australia.

Bill can be contacted by email or phone: + 61 2 9350 8832

An Industrial Strength Recon System

In the wake of the 2008 Financial Crisis, another layer of complexity in regulatory requirements has been added to the operational structure of investment management firms.  Market-shifting events like the Madoff Ponzi scheme and Lehman Brothers bankruptcy created a need for checks and balances to ensure reconciliations are done by an outside party to further protect investors. In the light of these developments, it has become increasingly important for managers to have access to trade and position level information at all times. Therefore, managers have been investing more time and effort into their operational processes and infrastructure around data and analytics as the demand for reporting and regulatory scrutiny has dramatically increased. In our view, a sound infrastructure armed with on-demand tools provides the best defense against regulatory breaches and operational failure.

The new Imagine Reconciliation System is a web-based solution that is made to fit perfectly into any operational infrastructure and is capable of addressing the entire reconciliation life cycle. With automated matching and exception processing, our reconciliation product lowers operational risk while at the same time reducing operational costs. As we have observed with many managers in the industry, manual reconciliation can take several hours a day while creating a higher risk of potential of errors. Our reconciliation system infrastructure sits on a complex backbone directly hooked up to your Imagine account, where your positions reside. Our system is on-demand, reliable, and can process thousands of trades within a matter of seconds while offering a simple, intuitive end-user experience.

Imagine Does the Heavy Lifting

Imagine consultants offer a no-impact implementation with a product that is scalable for any size business. By managing approximately 80% of the workflow, this product will reduce your team’s efforts significantly.

reconart_workflow

Our reconciliation product provides canned dashboards that are tailored to delivering immediate views and easy drill-downs of your important data providing you with operationally critical analytics.

With a super low-impact implementation, an on-demand, web-based product with a robust reconciliation engine might be what you need to make your operational infrastructure stronger. Imagine can make this easier to achieve than you might think.

______
About the Author
Murat Sen is a Consultant in Imagine’s New York office working on consulting engagements and client-facing product management projects. A native of Istanbul, Turkey, Murat holds an MBA from Cornell University.

Murat can be contacted by email or phone: 646.827.4433

A Client Pain Point, Adding Securities, Solved

Did you know the most common request our clients send to our Data Support team is to add securities to the shared (or global) security master?  A client’s typical workflow is:

• Attempt to book a position
• Discover a security is missing
• Send an email requesting the security be added
• Wait for response
• Re-book the position

So Heeran Patel, Ilker Ozturk, and Peter Loizou from our UK office recognized that this was a frustrating and time consuming process for our clients, and built a web service solution, the Security Uploader.  This web service puts the power back into the client’s hands—they’re able to create securities quickly and efficiently. And clients who have automated the booking of trades into Imagine can add this functionality directly into their process avoiding breaks and rejection management.

How Does this Web Service Work?

The client runs the Security Uploader web service with a file containing a list of identifiers (e.g., CUSIP ). The list of security identifiers is passed to the Security Uploader web service,  which leverages Imagine’s integration with market data vendors to query the corresponding security terms and conditions, and automatically loads it into Imagine’s global security master. Previously, each request could take an hour or more depending on the number of securities to be added. Now? This entire process is reduced to three to four minutes.

If the security cannot be added for any reason a case is automatically created and assigned to the Data Team. The Data Team investigates and reaches out to the client with a resolution or an explanation of the error.

I Want to Run This Web Service!

You can! The web service is currently available and accepts any combination of these identifier types: ISIN,CUSIP,SEDOL or RIC. Contact us to have it enabled for your use. Our consultants will provide you with a quick demonstration on how to run the web service.

______
About the Author
Brendan Hayes has been with Imagine for more than seven years; first in Sales and now in Consulting. He has been involved with IFP since its initial phase. Brendan holds a bachelor’s degree in Computer Engineering from Rochester Institute of Technology.

Brendan can be contacted by email or phone: 212-317-7629

SITKA I/O Services Dashboard Demo

Imagine’s I/O Service users will delight in using the SITKA I/O Services Dashboard. This dashboard has the ability to easily setup and run I/O services without dealing with command lines and batch files while showing real-time progress. Check out this short video that demonstrates the SITKA I/O Dashboard. Also, for more information, read our Q&A with Michael Moncada here.

If Imagine clients want to learn more about the SITKA I/O Services Dashboard, they can email info@sindexsystems.com or fill out this form to be contacted by Sindex.

’40 Act Dashboard Demo

Clients needed a solution to handle both portfolio and risk management while maintaining government compliance. The liquid alternative investment arena has grown rapidly, catching the attention of the SEC. Imagine’s ’40 Act Solution provides critical information managers want (and need) to view within a flexible, customizable dashboard.

Watch our short demo to see the dashboard in action.

If Imagine clients want to learn more about the ’40 Act Dashboard, they can email consulting@imagine-sw.com.

The ’40 Act Solution: Easily Monitor Compliance for Liquid Alternatives

Imagine maintains a comprehensive database of their client’s portfolio data. What we’re best at is figuring out how to aggregate that data for an investor or the government in a way that allows us to provide limit data and transparency. We’ve become adept at reacting to the government and clients quickly with new aggregations of information.

One way Imagine has recently reacted is the development of our ’40 Act Solution. Bridging the gap between traditional and mutual fund requirements, this innovation provides flexible risk management solutions for a highly-regulated investment environment.

Clients were looking for a solution that handled both the functions of portfolio and risk management while maintaining government compliance. The liquid alternative investment arena has grown rapidly, catching the attention of the SEC. Imagine’s ’40 Act Solution provides critical information managers want (and need) to view within a flexible, customizable dashboard. The dashboard performs essential functions like:

  • Drills down to see and correct real-time limit breaches
  • Creates alerts for positions that are nearing limits
  • Tracks trades that keep the fund in compliance
  • Creates a watch list to capture risk across an entire portfolio
  • Stresses the portfolio against many historical market events to see how they would impact the portfolio

We collaborated with Larch Lane Advisors to address the technological challenge of implementing a flexible system that could monitor compliance with specific regulations for liquid alternatives. Our focus was to provide a solution that combined traditional risk management with accounting capabilities, a combination not typically found in most risk management software.

We’ve been doing this for twenty-one years and Imagine really leads the way in reacting and evolving to the constant changes occurring in the market. Our consultants make sure clients turn those changes into opportunities.

______
About the Author

Trever Evans has been with Imagine Software for eleven years and has been participating in scoping, development, and implementation of larger scale initiatives for Imagine. He holds an MS in Quantitative Financial Economics from Oklahoma State University. He is currently Director of Consulting for Imagine.

Contact Trever by email or phone: 646-827-4483.

Monitor Limits with the UCITS Dashboard–Flexible, Transparent, Customizable

A Q&A with Anatoliy Salman
What is UCITS?
Investment funds authorized for sale in Europe are governed by a set of regulations. These regulations are called Undertakings for the Collective Investment of Transferable Securities (UCITS).

Why did you create the UCITS dashboard?
It just made sense for us to do this–Imagine is a trusted source for our clients. We created a dashboard that frees our clients to meet the challenges presented by UCITS (and other regulatory requirements). We see it as a great tool that provides transparency and flexible monitoring in one clean visual representation. Our dashboard eliminates the need for–and the potential risk involved with–using manual methods of limits calculations.

How does it work?
We customize the UCITS dashboard on a client-by-client basis. So there’s a quick set-up period where we create all the necessary custom reference tables, appropriate tagging, and the definition of limits the client wants to include–which by the way, don’t have to be UCITS-specific.

The dashboard is powered by an app that performs all the required aggregations and calculations. The data is pulled from your UCITS portfolio in Imagine. Once in Imagine, you load the dashboard like any of our dashboards. It updates in real time, providing intraday information with PDF reporting available for end of day reports.

How does this dashboard help clients?
This dashboard helps our clients:

  • Perform real-time, trade-by-trade risk analyses, including “what-if” simulations to add, reduce or increase positions to view portfolio and enterprise risk
  • Deliver daily UCITS-compliant reports on VaR, CVaR, relative VaR, leverage, counterparty risk and delta-adjusted exposures
  • Optimize allocations and strategies based on cross-asset class and pre-calculated market data (including derivatives) for selected time periods

With the dashboard, clients can:

  • Drill-down to view and correct limit breaches in real-time
  • Create alerts for positions that are nearing limits
  • Create a watch-list to capture risk across the entire portfolio
  • Efficiently monitor funds and fund expenses

______
About the Author
Anatoliy Salman is a consultant at Imagine’s New York office. He has been with Imagine for four years and is responsible for business intelligence. He was integral in the development of solutions for ’40 Act, AIMFD,  UCITS, and RRC. He holds a Bachelors in Business Administration with a major in finance from Baruch College.

Contact Anatoliy by email or phone: 646-827-4486

A Dashboard for any Imagine Implementation

A Q&A with Michael Moncada

Imagine’s I/O Services are an indispensable command line tool that invokes Imagine’s APIs for uploading, processing, and downloading data. This tool is a critical component of virtually every client’s use of Imagine, providing nearly one hundred different services. But have you heard about the SITKA I/O Services Dashboard? Mike Moncada, Senior Implementation Specialist for Imagine, says, “I would use this with any implementation.” We sat down with Mike to ask him a few questions about the dashboard.

Hey Mike, what is the SITKA I/O Services Dashboard and why would you use it so broadly?

It is a one-stop command center for running, monitoring, and reviewing results of I/O Services jobs. It is powerful, lets you come away from viewing the long and somewhat tedious batch files, and gives you a tool for setting up jobs and monitoring them. A partner of Imagine, Sindex Financial Systems, wrote this dashboard management program for our I/O Services.

Wait, what’s the problem with batch files?

Some people (like me) like using commands like this:

“%absPath%..\..\..\Bin\IOServiceClient.exe” -f %inpFile% -o %outFile% -ios %service% -log %logFile% -d

But I understand there are people who don’t care for that, and this tool lets them avoid that entirely. Here’s a screenshot of what they would get instead:

SITKA IO Service Dashboard

Click Image to Enlarge

What else does the Dashboard offer other than an escape from batch commands?

Lots of things. For example, it:

  • helps you set up new jobs, with search-as-you-type, to find the right I/O service,
  • gives you sample templates to help get the input files right with clickable links to online support for detailed help,
  • allows you to watch the progress that jobs are making, each input that’s successfully processed, or each item that’s rejected,
  • shows you the history of each job complete with when it ran, the input, output, and log files for that job,
  • and lets you re-run jobs by copying their setup with a single click.

If Imagine clients want to learn more about the SITKA I/O Services Dashboard, they can email info@sindexsystems.com or fill out this form to be contacted by Sindex.