Transcript BSM: Fixed Income Portfolio Management Reference Curve Discussion For the Record • Risk Free Curves Do not Exist! • The Regulator should not.

BSM: Fixed Income Portfolio Management
Reference Curve Discussion
For the Record
• Risk Free Curves Do not Exist!
• The Regulator should not prescribed the
Curve, because swap and govie are both
acceptable strategies.
• The regulator should not dictate
investment or hedging strategy pursued by
investment professionals
• Quantify and Measure Basis Risk and apply
capital
The search for a “risk free” curve
• Definition of risk free
• Ability of the issuer or seller to meet obligations
• Guarantee that their will be a curve in a meltdown or
severe dislocation
• Only two options to consider, the government
(government bonds) or the banks (swap market)
• Europe does not have a euro government issued risk free
curve, hence the swap curve was chosen to span all
countries in the Euro area.
Considerations,
• Most life companies liabilities are funded, so is a government
bond purchase. There is a premium to be received for tying up
cash.
• A swap position only gets funded to the extend of the mark to
market change. Swaps by its nature is a geared position.
• Governments can raise taxes, banks can’t
• Systemic risks can develop if both insurance companies and
banks rely on the swap market.
• Why is SAM not concerned with Basis Risk (matching
premium)??
• Who will fund the government if swap is regarded as risk free
and what does it say about bank versus government risk.
• Illiquid inflation linked swap market.
Illiquid Inflation Swap Market
SASWIT10 Curncy
Date
PX_LAST PX_BID PX_ASK Bidoffer
2012/10/26
6.606
6.506
6.706 0.200
29/10/2012
6.693
6.290
6.790 0.500
30/10/2012
6.724
6.624
6.824 0.200
31/10/2012
6.833
6.733
6.933 0.200
01/11/2012
6.800
6.500
7.000 0.500
02/11/2012
6.829
6.729
6.929 0.200
05/11/2012
6.770
6.520
7.020 0.500
06/11/2012
6.843
6.743
6.943 0.200
07/11/2012
6.765
6.410
6.910 0.500
08/11/2012
6.675
6.575
6.775 0.200
09/11/2012
6.620
6.370
6.870 0.500
12/11/2012
6.657
6.557
6.757 0.200
13/11/2012
6.630
6.380
6.880 0.500
14/11/2012
6.667
6.567
6.767 0.200
15/11/2012
6.629
6.529
6.729 0.200
16/11/2012
6.620
6.370
6.870 0.500
19/11/2012
6.570
6.320
6.820 0.500
20/11/2012
6.490
6.240
6.740 0.500
21/11/2012
6.533
6.180
6.680 0.500
22/11/2012
6.705
6.350
6.850 0.500
23/11/2012
6.698
6.598
6.798 0.200
26/11/2012
6.686
6.586
6.786 0.200
If the ILB swap market was Liquid……
8.50%
8.00%
7.50%
7.00%
6.50%
6.00%
5.50%
5.00%
23/11/2042
23/11/2041
23/11/2040
23/11/2039
23/11/2038
23/11/2037
23/11/2036
23/11/2035
23/11/2034
23/11/2033
23/11/2032
23/11/2031
23/11/2030
23/11/2029
23/11/2028
23/11/2027
23/11/2026
23/11/2025
23/11/2024
23/11/2023
23/11/2022
23/11/2021
23/11/2020
23/11/2019
23/11/2018
23/11/2017
23/11/2016
23/11/2015
23/11/2014
23/11/2013
23/11/2012
Swap Breakeven
Bond Breakeven
As Oppose to the ILBs
Bond
R211
R212
R197
I2025
R210
R202
I2038
I2050
Maturity
BID
-0.070%
1.020%
1.150%
1.270%
1.550%
1.820%
1.910%
2.040%
ASK
Bidoffer
-0.120%
0.050%
0.970%
0.050%
1.100%
0.050%
1.220%
0.050%
1.500%
0.050%
1.770%
0.050%
1.860%
0.050%
1.990%
0.050%