Tuesday, September 11, 2012

Measuring Delta in Derivative Portfolios

By Jasvin Josen

This article appeared in TheEdge Malaysia on June 23, 2012

In the previous article, I explained what delta is in the market risk context and illustrated the case of a bond dealer measuring the delta in a bond portfolio. After knowing his delta exposure, he next decides how to manage the delta.
In this article, I expand the previous example by introducing interest rate swaps to hedge the delta. Next I illustrate the delta measurement for options.

Bond and Swap Portfolio

Let us assume that the bond dealer mentioned in the previous article decides to hedge his simple 3-type bond portfolio with interest rate swaps. He decides only to hedge the delta in the 5-year maturity bucket. He enters into a 5-year bullet interest rate swap (IRS) with the following terms:

5 year bullet IRS:
Pay Fixed Rate:                       4.4%
Receive Floating Rate:             6m LIBOR + margin
Notional:                                  $50,000