When variation margin attacks: Difference between revisions

When variation margin attacks (view source)

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 At about the same time computer-based trading began to revolutionising the financial markets and the madcap spirit of 1980s free-love ''laissez-faire'' delivered their radical deregulation. It is not unreasonable to suppose these conditions contributed to an explosion in the market for OTC swaps during the 1980s.<ref>These three forces combined to create a mammoth. [http://faculty.citadel.edu/silver/IF/MBA_course/Chap9_Swap_Evolution.pdf Citadel] estimates USD interest rate swaps volumes went from from zero in 1981 to over half a billion dollars by 1987. </ref>
-=== Here come the regulators ===
+=== Risk management ===
-It did not take long for folks to realise that these new swap things presented a whole new class of risks.{{Sa}}
+It did not take long for folks to realise that these new swap things presented a whole new class of risks.<ref name="fwmd"/> Swaps provide unfunded exposure to assets — you don’t have to put down any cash up front — and if you trade in any great frequency, your total notional can quickly blow out of all proportion, especially given the typical notional size of individual swap transactions, which was in the millions of dollars. The market hit upon two neat tricks to manage these risks: [[netting]] and [[credit support]].
+We are not really concerned with netting here — the [[JC]] has plenty to say on that topic [[Close-out netting|elsewhere]] — so let’s quickly deal with it: just as you could offset the present value of the opposing legs of an individual swap to give yourself a [[mark-to-market]] value for that single swap, which could be positive or negative, so too could you offset opposing positive and negative [[mark-to-market]] values for individual swaps traded under a [[single agreement|single master agreement]] to arrive at a single net exposure for the whole {{isdama}}. This was a stroke of genius, and the brave commandos of {{icds}} encoded this [[single agreement]] concept into the {{1987ma}} and its successors. Enough said.
+Now, even having applied set-off and netting, either side of a swap contract could still be left with a large, volatile exposure. The exposure could move by hundred of millions of dollars in a single day, and could flip in or out-of-the-money quite suddenly.
+{{Sa}}
 * [[Variation margin]]