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Picking the Right Valuation and Risk Solution for TARFs
By Nik Venema | July 30, 2015

On July 7, FINCAD, Ascent and PRMIA held a workshop in Hong Kong at the Central Plaza that explored key considerations for trading, pricing, and risk managing target accrual redemption forwards (TARFs). TARFs are becoming an increasingly popular structured product because they allow investors to hedge their currency exposure at a relatively low cost. As part of the Hong Kong-based event, Tony Webb, PhD, Director of Analytics at FINCAD gave a presentation advising financial institutions on how to select a TARF analytics solution.

Tony explained that the traditional method used for risk managing TARFs, “bump and grind”, is very slow. As a result, risk management often happens on a daily basis –not intra-day or even pre-trade. To optimize the process, firms will often reduce the number of calculations they run or apply additional hardware to the problem. Unfortunately, neither of these fixes are ideal.  

In his presentation, Tony went on to state that the "bump and grind" methodology has, for most intents and purposes, seen its day.  The current trend is toward using algorithmic differentiation (AD) for accurate risk management of structured products like TARFs. An increasing number of best-in-class firms are realizing the role AD can have in speeding up the resolution of complex risk and analytics problems. Therefore, they are adopting risk architecture that facilitates AD.

Tony went on to give five important elements financial firms should look for in a TARF valuation and risk solution:

  1. Speed: Solutions supporting AD offer staggering speed when compared to bumping.  In fact, many firms measure speed improvements in the hundreds or even thousands.  
  2. Accuracy: Bumping is approximate. However, analytics platforms that leverage AD instill greater accuracy into risk calculations. The result is improved asset and liability matching, and more efficient use of capital.
  3. Flexibility: In order to seize new investment opportunities, financial institutions need access to a enterprise valuation and risk platform that enables customizable curve building and broad multi-currency, multi-asset class coverage. 
  4. Transparency: Increasingly, investors are demanding greater transparency from their financial institutions. As a consequence, firms selling TARFs should look to adopt an analytics platform that offers full documentation for all models and an audit trail for all model changes.
  5. Holistic: To properly risk manage TARFs, banks need a holistic view of risk across the enterprise. Therefore, high performances risk architecture that facilitates consistent modeling and accurate valuation and risk across portfolios is extremely important.

FINCAD’S F3 embodies the five attributes listed above, including its sophisticated implementation of AD known as Universal Algorithmic Differentiation™ (UAD), which helps firms turn risk management into a competitive advantage. “Many firms selling TARFs are drawn to F3 because it is highly flexible. It allows AD to be available for a range of models and structures, including ones that you invent yourself. This is all possible without the need to write new code, easing the burden on busy quants,” said Tony.

He added, “Plus, FINCAD’s UAD gives you something not available in a lot of AD implementations. The F3 Model contains the full set of risk factors in your trading universe. So it doesn’t just tell you what the sensitivity is of a given quote, but rather what you specifically are sensitive to. Access to this information can drive better performance in risk management. ”

To learn how leading investment firms are generating value from advanced risk management platforms, view our on-demand webinar, Creating Competitive Advantage with Risk Management.