Trading and settling enhancements to the standard electronic futures exchange market model leading to novel derivatives including on exchange ISDA type interest rate derivatives and second generation bond like futures based in part or entirely on them

• US 20060224492A1
• Filed: 07/12/2005
• Published: 10/05/2006
• Est. Priority Date: 04/01/2005
• Status: Active Grant

• Current Assignee: LIFFE Administration and Management company
• Original Assignee: De Novo Markets Limited
• Inventors: Pinkava, Pavel
• Granted Patent: US 8,751,339 B2
• Time in Patent Office: Days
• US Class Current: 705/37
• CPC Class Codes: G06Q 40/00 Finance; Insurance; Tax strategies; Processing of corporate or income taxes
• CPC Class Codes: G06Q 40/02 Banking, e.g. interest calculation or account maintenance credit or loans G06Q40/03
• CPC Class Codes: G06Q 40/04 Trading; Exchange, e.g. stocks, commodities, derivatives or currency exchange
• CPC Class Codes: G06Q 40/06 Asset management; Financial planning or analysis

Abstract

A set of linked methods allows accessing derivative products other than traditional futures and options within an adapted electronic futures exchange type market model, rules and legal environment. One embodiment comprises a linkage of such new methods which provides exchange members with access to exact OTC ISDA type interest rate swap and FRA related exposures. Another embodiment is a method comprising another specific linkage of the new methods which gives exchange members access to exact OTC ISDA type overnight index swap related exposures. An additional embodiment provides exchange members with convenient access to credit spread and\or interest rate swap embodiments via deliverable credit rate linked and swap rate linked bond like futures.

Claims

1. A method of accessing exact OTC ISDA type interest rate swap exposures within an electronic futures exchange market model, rules and legal environment via a group of linked products known collectively as Adapted For Exchange New Interest Rate Swap Derivatives comprising:

a listed for trading derivative product in an electronic futures exchange type environment, known as the swap rate quotation product for trading which gives interest rate swap exposure;

executing a trade relative to the listed for trading swap rate quotation product pursuant to a user command;

creating positions based on the executed trade in one or more distinct expiries of two different types of post trade coupon for clearing products, wherein each distinct position so created consists of Fixed Coupon Products paired and offset with Floating Coupon Products of the same expiry, with each position created at zero price and in volumes based on the executed swap rate quotation product trade as determined by an algorithm comprising of a set of parameterized mapping formulae;

providing end of day valuation and risk management through the variation and initial margin calls of the central counterparty, wherein daily settlement prices for both fixed and Floating Coupon Products for clearing are set based on a parameterized bootstrapping algorithm using as its input an external stub rate plus the set of daily mark to market reference prices from the listed for trading swap rate quotation product market; and

using a standard floating rate benchmark such as 3 month BBA $ LIBOR to cash settle both the Floating and Fixed Coupon Products using their respective and distinct expiry day settlement formulae.

2. The method according to claim 1, wherein the executed trade in the listed for trading swap rate quotation product is passed as a give up marker through to the exchange'"'"'s post trade management system and ultimately the clearing house as if it were a normal exchange contract and is furthermore the only contract type available for give ups, wherein an executed trade marker that is given up by one member to another will act as a reference in the exchange'"'"'s post trade management system allowing the plurality of post trade coupon contracts for clearing based on the marker trade to be transferred along with it as a group, thereby guaranteeing no accidental large variation margin calls associated with the splitting of the paired fixed and floating product into different clearing accounts prior to their first daily settlements.

3. The method according to claim 1, wherein the parameterized mapping formulae of the algorithm used to turn the executed swap rate quotation product trade into the appropriate Fixed Coupon Product and Floating Coupon Product positions for clearing comprise;

for the floating leg;

—

All i=1 to m,

FCP_i Lot volume=T_m Lot volume

All i=1 to m, FCP_i Price=0

IF T_m=Buy THEN All FCP_i=Sell, ELSE

IF T_m=Sell THEN All FCP_i=Buy

where, FCP_i=The ith Floating Coupon Product contract expiry;

T_m=The executed swap rate quotation product trade;

m=The maximum expiry index corresponding to the term of the trade; and

for the fixed leg;

—

All i=1 to m,

XCP_i Lot volume=T_m Lot volume*A_i*T_m Price %*N

All i=1 to m, XCP_i Price=0

IF T_m=Buy THEN All XCP_i=Buy, ELSE

IF T_m=Sell THEN All XCP_i=Sell

where,

XCP_i=The i^th Fixed Coupon Product contract expiry;

T_m=The executed swap rate quotation product trade;

m=The maximum expiry index corresponding to the term of the trade;

A_i=The swap market accrual factor or year fraction that the number of days between the i^th effective date and the i^th notional maturity date represent

N=The notional lot size of the swap rate quotation product;

wherein the mappings have to be parameterised by the expiry calendar for the product in order to calculate the accrual factors, A_i.

4. The method according to claim 1, wherein the algorithm of parameterized mapping formulae, used to turn the external reference stub rate plus the daily mark to market reference prices in the listed for trading swap rate quotation products into the appropriate daily settlement prices for both types of coupon contracts, comprises;

1. using interpolation to determine any missing daily mark to market reference prices in the traded swap rate quotation product that will be required, such that a mark to market reference price is be available for every Fixed Coupon Product and Floating Coupon Product effective date i.

2. bootstrapping two series of forward zero coupon discount factors using the formulae;

$d_1=f_1=\frac{1}{1+A_1<br><br>C_1};<br><br>\mathrm{and}$

 

iteratively applying the formula

$d_1=\frac{1-C_i<br><br>\underset{j=1}{\overset{i-1}{\sum <br><br>}}<br><br>A_j<br><br>d_j}{1+A_i<br><br>C_i}<br><br>\text{\hspace{1em}<br><br>}<br><br>\mathrm{for}<br><br>\text{\hspace{1em}<br><br>}<br><br>i=2<br><br>\text{\hspace{1em}<br><br>}<br><br>\mathrm{to}<br><br>\text{\hspace{1em}<br><br>}<br><br>i=m;<br><br>\mathrm{and}$

 

the formula,

$f_i=\frac{d_i}{d_{i-1}}<br><br>\text{\hspace{1em}<br><br>}<br><br>\mathrm{also}<br><br>\text{\hspace{1em}<br><br>}<br><br>\text{\hspace{1em}<br><br>}<br><br>\mathrm{for}<br><br>\text{\hspace{1em}<br><br>}<br><br>i=2<br><br>\text{\hspace{1em}<br><br>}<br><br>\mathrm{to}<br><br>\text{\hspace{1em}<br><br>}<br><br>i=m$

 

where,

A_i=the swap market accrual factor or year fraction that the number of days between the i^th effective date and the i^th notional maturity date represent;

m=the expiry index corresponding to the longest term swap rate quotation product listed; and

C_i=the i^th daily mark to market reference prices in the traded swap rate quotation product that will be required; and

3. calculating the stub discount factor D₀ using the formula;

$D_0=\frac{1}{1+a_0<br><br>S_0}$

 

where,

a₀=the money market accrual factor or year fraction for the period from spot to the first effective date;

S₀=the money market stub reference rate for the period from spot to the first effective date;

4. calculating the daily settlement prices needed for variation margin calls according to;

$F<br><br>\text{\hspace{1em}<br><br>}<br><br>C<br><br>\text{\hspace{1em}<br><br>}<br><br>P_i=\left(\frac{1}{f_i}-1\right)*d_i*D_0$$X<br><br>\text{\hspace{1em}<br><br>}<br><br>C<br><br>\text{\hspace{1em}<br><br>}<br><br>P_i=d_i*D_0$

where,

FCP_i=The daily settlement price for the i^th Floating Coupon Product contract expiry; and

XCP_i=The daily settlement price for the i^th Fixed Coupon Product contract expiry.

5. The method according to claim 1, wherein the expiry day settlement formulae of the Fixed and Floating Coupon Product positions for clearing comprises;

for the floating leg;

—

$F<br><br>\text{\hspace{1em}<br><br>}<br><br>C<br><br>\text{\hspace{1em}<br><br>}<br><br>P<br><br>\text{\hspace{1em}<br><br>}<br><br>E<br><br>\text{\hspace{1em}<br><br>}<br><br>D<br><br>\text{\hspace{1em}<br><br>}<br><br>S<br><br>\text{\hspace{1em}<br><br>}<br><br>P=\frac{a*L}{1+a*L}$

and for the fixed leg;

—

$X<br><br>\text{\hspace{1em}<br><br>}<br><br>C<br><br>\text{\hspace{1em}<br><br>}<br><br>P<br><br>\text{\hspace{1em}<br><br>}<br><br>E<br><br>\text{\hspace{1em}<br><br>}<br><br>D<br><br>\text{\hspace{1em}<br><br>}<br><br>S<br><br>\text{\hspace{1em}<br><br>}<br><br>P=\frac{1}{1+a*L}$

where,

L=The relevant money market benchmark fixing rate;

a=The relevant money market convention accrual factor;

FCP EDSP=The expiry day settlement price for the Floating Coupon Product; and

XCP EDSP=The expiry day settlement price for the Fixed Coupon Product.

6. The method according to claim 1, wherein the electronic futures exchange type market provides, in addition to the listed swap rate quotation spot curve for trading, one or more listed for trading forward curves.

7. The method according to claim 1, wherein the listed for trading product constitutes a FRA quotation that (a) is so short dated in term that positions based on the executed trade create only one distinct expiry pair of the two different types of post trade coupon for clearing products, (b) uses the money market day count basis convention and not the swap one, (c) is not restricted to quarterly coupon terms, (d) has daily listing and delisting of on-the-run product for central matching, and (e) uses six different on-the-run stub rates to accommodate on-the-run FRAs and more than six stub rates to accommodate off-the-run FRAs.

8. The method according to claim 7, wherein different FRAs of different terms and stubs are displayed for trading on the same screen.

9. The method according to claim 1, wherein the electronic futures exchange market model, rules and legal environment eliminates the need for bilateral post trade confirmations that are essential in ISDA style interest rate swap and FRA transactions, in that the receiving of a filled order report from the exchange implies agreement on all product specification details.

10. A method of accessing deliverable bond futures type exposures linked to a product selected from the group consisting of swap interest rates alone and swap rates plus credit spreads, within an adapted electronic futures exchange market model, rules and legal environment comprising:

listing on exchange interest rate swap linked bond type futures in various currencies with notional coupons defined in their contract specifications;

also listing, credit rate linked bond type futures of various types depending on the credit exposure required, likewise with notional coupons defined in their contract specifications;

such additional products expiring at the same time as the swap linked bond futures of the appropriate currency;

providing access to exact OTC ISDA type debt related derivative exposures of the Adapted For Exchange New Interest Rate Swap type in the relevant currency;

hence having available the standard par interest rate swap quotation for trading products;

also providing, if needed, the appropriate exact OTC ISDA type debt related derivative exposures of the Adapted For Exchange New Credit Derivatives type;

hence having available the appropriate Credit Product Spread Quotation For Trading products;

defining a price to rate relationship algorithm from which the expiry day settlement price of each rate linked bond type futures can be used to calculate exchange delivery settlement rates for the standard par interest rate swap quotation for trading product and where relevant for the appropriate credit product spread quotation products; and

creating and assigning relevant and exact OTC ISDA type debt related derivative exposures into each rate linked bond type futures contract at the expiry, via executing one or more transactions not pursuant to user command;

—

i) in the swap rate quotation for trading product of the relevant currency; and

also

ii) for credit rate linked bond type futures the appropriate credit product spread quotation product,

such transactions being executed on behalf of exchange participants by reference to the rate linked bond type futures exposure they hold with;

—

a) prices defined by the rate relationship algorithm;

b) term defined by the maturity;

c) volumes defined in proportion to the number of those futures held; and

d) buy or sell side defined by the direction exposure, of the specific futures exposures held,

wherein the post trade products for clearing based on the executed trades at expiry are delivered to the same clearing accounts that held the expiring rate linked bond type futures contracts and with the same customer account references.

11. The method according to claim 10, wherein the rate relationship algorithm is the standard simplified yield to maturity formula from bond mathematics that links expiry price to expiry rate depending only on the notional coupon, the coupon frequency and the notional term to maturity, wherein the standard formula for semi-annual coupons and rate, S, takes the form:

—

$\mathrm{Bond}<br><br>\text{\hspace{1em}<br><br>}<br><br>\mathrm{Future}<br><br>\text{\hspace{1em}<br><br>}<br><br>E<br><br>\text{\hspace{1em}<br><br>}<br><br>D<br><br>\text{\hspace{1em}<br><br>}<br><br>S<br><br>\text{\hspace{1em}<br><br>}<br><br>P=\frac{C}{S}+\left(1-\frac{C}{S}\right)*{\left(1+\frac{S<br><br>\%}{2}\right)}^{\frac{1}{2*M}}<br><br>\text{\hspace{1em}<br><br>}<br><br>\mathrm{where},$

EDSP=The exchange delivery settlement price;

M=The notional term in years;

C=represents the notional coupon for the future, expressed in percent.

12. The method according to claim 11, wherein the interest rate swap quotation trade to be transacted and delivered into a credit rate linked bond type future is the standard yield to maturity at expiry of the respective interest rate swap linked bond type future.

13. The method according to claim 11, wherein the credit spread quotation to be transacted and delivered into a credit rate linked bond type future is its standard yield to maturity at expiry minus the standard yield to maturity at expiry of the respective interest rate swap linked bond type future.

14. The method according to claim 10, wherein occurrence of a credit event prior to expiry of a credit rate linked bond type future linked to the event via its credit spread quotation'"'"'s link to the defaulting reference entity, leads to early expiry of the credit rate linked bond type future and to early delivery based on its most recent daily settlement price.

15. The method according to claim 10, wherein dealers in a particular credit rate linked bond type future are insulated from complications caused by credit events prior to expiry by this product referencing either a resetting index credit spread quotation or a newly composed index at its expiry.

16. The method according to claim 10, wherein the post trade products for clearing normally based on the executed trades at rate linked bond type futures contract expiry are generated and delivered directly without a trade execution.

17. The method according to claim 16, wherein the standard par interest rate swap quotation and credit product spread quotation are not listed and so not made available for trading pursuant to user command until after the rate linked bond type futures contract expiries.

18. A method of accessing exact OTC ISDA type overnight indexed swap exposures within an electronic futures exchange type environment comprising:

a listed for trading derivative product in an electronic futures exchange type environment (swap rate quotation product for trading) which gives overnight indexed swap exposure;

executing a trade relative to the listed for trading swap rate quotation product pursuant to a user command;

creating positions based on the executed trade in two different types of post trade for clearing products, wherein each distinct position so created consists of a Fixed Rate OIS Product paired and offset with Overnight Indexed Products of the same expiry, with each position created at zero price and in volumes based on the executed swap rate quotation product trade as determined by an algorithm comprising a set of parameterized mapping formulae;

after a specified number of business days associated with the definition of spot in the relevant money market, using a standard overnight index rate benchmark such as the Fed Funds rate to augment via a parameterized formula the position sizes of the Overnight Indexed Products with additional contract positions created at zero price to simulate compounding;

providing end of day valuation and risk management through the variation and initial margin calls of the central counterparty, wherein daily settlement prices for both Fixed Rate OIS and Overnight Indexed Products for clearing are set based on a parameterized algorithm using as its input the set of daily mark to market reference prices from the listed for trading swap rate quotation product market; and

at expiry cash settling both the overnight indexed and fixed contracts to a price of 6%.

19. The method according to claim 18, wherein the executed trade in the listed for trading swap rate quotation product is passed as a give up marker through to the exchange'"'"'s post trade management system and ultimately the clearing house as if it were a normal exchange contract and is furthermore the only contract type available for give ups, wherein an executed trade marker that is given up by one member to another will act as a reference in the exchange'"'"'s post trade management system allowing the paired post trade contracts for clearing based on the marker trade to be transferred along with it as a group, thereby guaranteeing no accidental large variation margin calls associated with the splitting of the paired fixed and overnight indexed product into different clearing accounts prior to their first daily settlement.

20. The method according to claim 18, wherein the parameterized mapping formulae of the algorithm used to turn the executed swap rate quotation product trade into the appropriate Fixed Rate OIS and Overnight Indexed Product positions for clearing comprise:

for the overnight indexed leg;

—

OIP Lot volume=TOR Lot volume;

OIP Price=0;

IF TOR=Buy THEN OIP=Sell, ELSE; and

IF TOR=Sell THEN OIP=Buy;

where,

OIP=The relevant Overnight Indexed Product expiry;

TOR=The executed swap rate quotation product trade; and

for the fixed leg;

—

FRP Lot volume=TOR Lot volume*(6%+a*TOR Price %)

FRP Price=0

IF TOR=Buy THEN FRP=Buy, ELSE

IF TOR=Sell THEN FRP=Sell

where,

FRP=The relevant Fixed Rate OIS Product expiry;

T=The executed swap rate quotation product trade;

a=The money market accrual factor or year fraction that the number of days between the spot date and the expiry date represent;

wherein the mappings are parameterised by the expiry calendar for the product in order to calculate the accrual factors, a.

21. The method according to claim 18, wherein the parameterized augmentation formula used to simulate compounding of the Overnight Indexed Products comprises;

for compounding overnight indexed positions;

—

All i=1 to m,

Addition OIP_i volume=Old OIP_i position size*A_O/N*X %

All i=1 to m,

Addition OIP_i price=0

where,

OIP_i=The i^th Overnight Indexed Product expiry;

X=The daily overnight index rate e.g. Fed Funds rate; and

A_O/N=The accrual factor applied to the overnight index rate.

22. The method according to claim 18, wherein the algorithm of parameterized mapping formulae, used to turn the daily mark to market reference prices in the listed for trading swap rate quotation products into the appropriate daily settlement prices for both types of contracts, comprises;

1. using interpolation to determine any missing daily mark to market reference prices in the traded swap rate quotation product that will be required, such that a mark to market swap rate quotation reference price, O_i, is available for every Fixed Product and Overnight Indexed Product expiry date i; and

2. calculating the daily settlement prices needed for variation margin calls according to the following;

$O<br><br>\text{\hspace{1em}<br><br>}<br><br>I<br><br>\text{\hspace{1em}<br><br>}<br><br>P_i=100<br><br>\%$$F<br><br>\text{\hspace{1em}<br><br>}<br><br>R<br><br>\text{\hspace{1em}<br><br>}<br><br>P_i=\frac{1}{1+a_i<br><br>O_i}$

where, ii

OIP_i=The daily settlement price for the i^th Overnight Indexed Product;

a_i=The accrual factor for the relevant period;

O_i=The daily mark to market reference price for the relevant period; and

FRP_i=The daily settlement price for the i^th Fixed Rate OIS Product;

23. The method according to claim 18, wherein the electronic futures exchange market model, rules and legal environment eliminates the need for bilateral post trade confirmations that are essential in ISDA style overnight indexed swap transactions, in that the receiving of a filled order report from the exchange implies agreement on all product specification details.