Monday, July 22, 2013

Islamic Derivatives: Practical problems in valuing profit rate swaps

By Jasvin Josen
This article appeared in The Edge, Malaysia on June 10, 2013
Islamic derivatives have achieved impressive growth over the years worldwide and in Malaysia. The Islamic profit rate swap, for example is commonly used for risk management as well as for investment. It is frequently associated with the conventional interest rate swap.

Valuation of financial products is always challenging and Islamic derivatives are no exception. In this article I begin with how profit rate swaps can be used for risk management or investment and then discuss some practical problems in valuing the product.

The profit rate swap for risk management: an example
When companies finance their transactions by using Shariah compliant contracts, they may be exposed to the changing rental rates or profit rates over the contract term. These companies may want to hedge the uncertainty they face in these rates.

Leveraged Super Seniors – the valuation question

By Jasvin Josen
This article appeared in The Edge, Malaysia on Feb 11, 2013
In the last article, I explained what a Leveraged Super Senior trade is and the accompanying trigger points. It is important to note that Deutsche Banks’ alleged miss reporting of the losses from these products, stems from a valuation stand point. There were no cases of actual defaults or unwinding of the trades. The main issue was how these trades were priced in the books at the height of the crisis.
In this article I describe the main principles in valuing the trade and what can go wrong.

Leveraged Super Seniors of the pre credit crisis

By Jasvin Josen
This article appeared in The Edge, Malaysia on Feb 4, 2013

December 2012 wormed out another account of an interesting innovation in the financial world with the “Leveraged Super Senior” product. Deutsche Bank is being blamed of not having valued these products correctly in its financial statements, that otherwise would have recognised a loss about USD12 billion .

I would like to enlighten readers, as plainly as possible, on what a Leveraged Super Senior is and the complexities that could follow.

First, the Synthetic CDO
A Leveraged Super Senior is a credit derivative product. It is a part of a Collateralised Debt Obligation (“CDO”). A CDO is simply a basket of credit products (bonds and loans) where investors share the returns (i.e. the coupons and interest income) but also take hits when any of the credit products default. Not all investors share the losses proportionately, as the CDO basket is divided (or “tranched”) to cater for very risky investors, the not so risky investors and so on.