ALM Stochastic Process: Risk Free Rates Are Forecasted Only for the Reporting Currency (Doc ID 2305776.1)

Last updated on SEPTEMBER 08, 2017

Applies to:

Oracle Financial Services Asset Liability Management - Version 8.0.0 and later
Information in this document applies to any platform.
Oracle Financial Services Analytical Applications (OFSAA)
Oracle Financial Services Asset Liability Management (ALM)

Symptoms

On ALM 8.0.2, it appears that risk free rates are forecasted only for the Reporting Currency.

ACTUAL BEHAVIOR
After running an ALM stochastic process (static or dynamic) and checking the rates in the Audit output (FSI_INTEREST_RATES_AUDIT), noticed that only the valuation curve corresponding to the reporting currency is present there, meaning that for the other currencies the rates are not forecasted since the risk-free rates do not appear in this table.

It appears that only for the records/products having ISO_CURRENCY_CD same as reporting currency the EAR is correct because the corresponding risk-free curves for the other currencies are not forecasted, hence the indexes will not be forecasted.

EXPECTED BEHAVIOR
In Stochastic Rate Indexing definition, you can specify one valuation curve for each active currency and then define relationships between all non-risk-free curves (indexes) and the related valuation curve.
As specified in the user guide: “For example, if the Valuation Curve for US Dollars is US Treasury Curve, all US Dollar indexes will be associated with the US Treasury curve.”
In other words:
TRY : TRY Risk free curve -- all the TRY indexes will be linked to TRY Risk free curve
USD : USD Risk free curve -- all the USD indexes will be linked to USD Risk free curve
EUR : EUR Risk free curve -- all the EUR indexes will be linked to EUR Risk free curve
Etc.

It is therefore expected that risk free rates appears for all currencies and are used in forecasting.

Source Reporting ccy: TRY Reporting ccy: USD
1 Loan in TRY
1 Deposit in USD EAR for Loan seems correct
EAR for Deposit is incorrect meaning that New Business amounts are note properly generated (it stops at Maturity date)

In Audit table, only rates for TRY valuation curve appear, so USD curve used for pricing the deposit is not forecasted. EAR for Loan is incorrect meaning that there is no New Business amounts (it stops at Maturity date)
EAR for Deposit seems correct

In Audit table only rates only for USD valuation curve, so TRY curve used for pricing the loan is not forecasted.

The issue can be reproduced at will with the following steps:
1. Create two test data records with different ISO_CURRENCY_CD. In our example, we used the following records:
- One in TRY
- One in USD
Note: one of the records was defined as adjustable rate with an INTEREST_RATE_CD specified at record level. This curve will also be part of the Stochastic Rate Indexing definition.
2. Create setup:

Define interest rate curves
- Risk free curves: one for TRY, one for USD (parameters for the Term Structure Model have to be specified)
- Index curves (non-risk-free rates): one in TRY, one in USD
Note: the index curves are used at record level (INTEREST_RATE_CD field) for repricing purposes and in Product Characteristics for New Business Pricing/Repricing

Define Stochastic Rate Index
- Each currency (USD/TRY) has its own risk-free curve rate as specified before
- For each index curve (USD/TRY) define a relationship
For example: Index TRY = 1 * Risk Free rate TRY ^ 1 + 0
  Index USD = 1 * Risk Free rate USD ^ 1 + 0

Define Product Characteristics for the two products created in the source (both All Business + New Business)
Define Forecast Assumptions
- Forecast Balances: for simplicity Target Growth 0% can be used for both products
- Maturity Mix: for simplicity 10Y maturity can be used
- Pricing Margins: for simplicity 0 margin can be used
Define two ALM dynamic processes:
- The first one has reporting currency TRY
- The second one has reporting currency USD
- The two processes will contain the same source data (two records, one in USD and one in TRY) and the same assumptions (Stochastic Rate Indexing, Product Characteristics, Forecast Balances, Maturity Mix, Pricing Margins)
- Do enable Audit for rates
Note: We used Monte Carlo simulation but same results described below are applicable for Historical Simulations as well.
3. Run the first process (Reporting Currency=TRY)
- Check FSI_INTEREST_RATE_AUDIT: In this case only the risk-free curve for TRY is output in the table, the USD one does not appear
- In the corresponding EAR output tables it is also noticed that for the record having the currency different than the reporting currency, the New Business is not generated (since the index is not forecasted, no pricing occurs)
- EAR_LEAF_DTL
- EAR_LEAF_AVG
- EAR_TOTAL_DTL
- EAR_TOTAL_AVG
4. Run the second process
- Check FSI_INTEREST_RATE_AUDIT : In this case only the risk-free curve for USD is output in the table, the TRY one does not appear
- In the corresponding EAR output tables it is also noticed that for the record having the currency different than the reporting currency, the New Business is not generated (since the index is not forecasted, no pricing occurs)
- EAR_LEAF_DTL
- EAR_LEAF_AVG
- EAR_TOTAL_DTL
- EAR_TOTAL_AVG

Cause

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