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How to Achieve a Competitive Advantage in Multi-Currency Rates Trading

Those working to generate alpha in the current environment need to be able to identify and capture opportunities—wherever they are available. For this reason, technology that enables financial institutions to model market currency rates is becoming a business imperative.

The reality is that being able to quickly adjust your curves and models to reflect new market dynamics is critical to maintaining a competitive trading advantage. Without this ability, you have an increased risk of mispricing trades and inaccurate hedging. Your capacity for seizing new trading opportunities is also limited. Below is insight into how you can maximize gains and achieve accurate hedging in a rapidly changing rates environment.

Get Your Curves Right

Getting you curves right is the most fundamental requirement for any rates trader. Having compete faith in your curves gives you the ability to execute trades without hesitation. By having a curve building framework that is on par with the brokers, you will no longer have to fish around to find the “best” price. Leave it to other traders to have the market move on them while they hesitate on their position.

The key to having a curve building framework that is on par with the brokers is flexibility. One must be able to quickly adapt to any changes in best practice.

Utilize Sophisticated Curve-Building Frameworks

The main issue with legacy curve building frameworks is that they were created on an ad-hoc basis for solving the problems of the moment, and therefore they have not stood the test of time.

On the other hand, sophisticated curve-building frameworks, like those available in enterprise portfolio and risk solutions, have been designed to allow you to quickly and easily change your curve-building approach at will.

Such frameworks use generic concepts to simplify your curve building problem into pieces of a puzzle. Each part of the puzzle can then be solved separately. Additionally, the pieces can be swapped out with minimal effort, and without impacting other parts of the solution. They can also be reused in combination with other different pieces to solve additional problems, or created new, which simply involves adding a new method to solve a subset of the overall problem in a restricted domain.

Improve Trading Agility

To avoid errors, it is imperative that you not hard code any market data assumptions in your curve-building framework. While you can build out the standard functionality that meets current requirements for best practice, it is also advantageous to have a low level facility in your framework whereby you can define any trade to be used in calibration. This low level facility should allow for quick updates to best practice, without core code changes.

It’s important to remember that the faster you can adjust your framework, the faster you can restore confidence in your curves, and in turn improve the overall agility of your trading.

Better Manage Risk

Having a granular, self-consistent view of interest rate and FX risk is the Holy Grail for a large enterprise. A single model for managing risk enables you to improve the effectiveness of enterprise-wide risk analysis. At the desk level, you can reduce the cost of hedging by netting out exposures that manifest when viewing risk at a multi-currency portfolio level.

To have this consistency, all trades need to be priced based on the same self-consistent and arbitrage-free curves. This is not an easy task, and when we consider the collateralization of trades and market data, this appears to make a complex problem even more complicated. However, correctly introducing collateral agreements into a curve building framework actually helps solve many of the practical problems of trying to stay arbitrage-free.

Interested in learning more about how to improve returns and carve out a competitive advantage in multi-currency rates trading? Download our eBook: Best Practices for Maximizing Returns in Multi-Currency Rates Trading.

About the author

James Gavin

Lead Derivatives Analyst and Head of Professional Services-Americas, FINCAD

As a Lead Derivatives Analyst and Head of Professional Services -Americas, James supports complex FINCAD implementations for clients. These implementations have included highly structured trades and portfolio level solutions such as VaR, CVA and P&L attribution. James also provides project management and quantitative input on project implementations. James comes to FINCAD with a B.Sc. in Financial & Actuarial Mathematics and an M.Sc. in Finance and Capital Markets from Dublin City University (Ireland).


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