A Heuristic Pricing and Hedging Framework for Multicurrency Fixed‐Income Desks. Issue 89 (May 2017)

• Record Type: Journal Article
• Authors: Giménez, Eduard; Elices, Alberto; Villani, Giovanna
• Is Part Of: Wilmott. Volume 2017:Issue 89(2017)
• Page Start: 45
• Page End: 51
• Publication Date: 2017-05
• Subjects: OIS -- multicurrency -- collateral -- cross‐currency swaps; Finance -- Periodicals; Financial services industry -- Periodicals; 332
• DOI: 10.1002/wilm.10593
• Languages: English
• ISSNs: 1540-6962

Abstract

Abstract : It is well known that traded foreign exchange forwards and cross‐currency swaps (CCS) cannot be priced by applying overnight cash and carry arguments, as these imply an absence of funding advantage of one currency to the other. This paper proposes a heuristic present‐value concept for multicurrency pricing and hedging, which allows taking into account the funding and therefore the collateral currency and its pricing impact. For uncollateralized operations, it provides more funding optionality to achieve either cheaper or more connected funding to the hedging instruments. When foreign exchange forwards get aligned with overnight cash and carry arguments, this method is naturally equivalent to the well‐established overnight indexed swaps (OIS) discounting, where each leg is funded in its own currency. A worked example compares this approach with a benchmark.