PFE for IRS using HJM

About the Course

The course consists of two EXCEL files that demonstrate the calculation of Potential Future Exposure (PFE) for a fixed-for-floating non-amortizing Interest Rate Swap (IRS), one for a PKR denominated instrument, the other for a USD denominated swap. The model uses the Heath Jarrow Merton (HJM) interest rate model to value the IRS at each leg over its lifetime and simulate a distribution of PFEs across 1000 runs that can be used to assess counterparty default risk and set PFE limits.

Learning Objectives

After taking this course you will be able to:

• Bootstrap zero & forward rate curves
• Conduct a principle component analysis on the forward rates
• Build an HJM interest rate model
• Price a fixed for floating interest rate swap over its lifetime
• Determine the potential future exposure of the IRS
• Simulate PFE and plot a histogram of the results
• Calculate worst case PFE
• Assess the confidence levels & credit conversion factors for an associate level of risk

Prerequisites

Comfortable with basic mathematics and EXCEL (in particular the use of data table & Solver) and some familiarity with derivative pricing.

Target Audience

The course is aimed primarily at banking professionals and individuals responsible for risk management within banks.

Disclaimer

1. As a customer, you have purchased a license to use this product for your personal, non-commercial, illustrative or academic use.
2. A reference to a particular investment or security is not a recommendation to buy, sell, or hold such investment or security, nor is it considered to be investment advice.
3. This material is not intended for any specific investor and does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. You should consider whether it is suitable for your particular circumstances and, if necessary, seek appropriate, qualified, professional advice.
4. Before taking a financial decision based on academic and illustrative models please consult an appropriate professional for correct advice. The models or their results have not been tested for all market conditions and may be incorrect with significant margins if used inappropriately.
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