This module describes the procedure for working with and managing Discount Method rules.
This chapter covers the following topics:
· Overview of Discount Method Rules
· Creating Discount Method Rules
· Defining Discount Method Rules
Discount Method rules allow users to define the method for discounting projected cash flows for market value and duration calculation purposes. For each combination of product and currency, you can choose one of the following discount methods:
The methodologies contained in the Discount Method rules are referenced by the Static Deterministic and Dynamic Deterministic ALM Processes. See Defining Discount Method Rules
The procedure for working with and managing Discount Method rules is similar to that of other Asset Liability Management business rules. It includes the following steps:
· Searching for Discount Method rules. For more information, refer to Searching for Rules section.
· Creating Discount Method Rules., For more information, refer to Creating Rules
· Viewing and Editing Discount Method rules. For more information, refer to Viewing and Editing Rules section.
· Copying Discount Method rules. For more information, refer to Copying Rules section.
· Deleting Discount Method rules. For more information, refer to Deleting Rules section.
As part of creating and editing Discount Method rules, you assign Discounting methodologies to applicable products.
NOTE:
Oracle Asset Liability Management provides you with the option to copy, in total or selectively, the product assumptions contained within ALM business rules from one currency to another currency or a set of currencies or from one product to another product or a set of products.
You create a Discount Methods rule to assign Discounting Methods to your products.
1. Navigate to the Discount Methods rule summary page.
2. Complete standard steps for this procedure.
Tip: In addition to the standard steps for creating rules, the procedure for creating a Discount Methods rule involves one extra step. After Standard Step 6, you need to select a product hierarchy. You can define methodologies at any level of the hierarchical product dimension. The hierarchical relationship between the nodes allows inheritance of methodologies from parent nodes to child nodes.
The definition of a Discount Methods rule is part of the Create or Edit Discount Methods rule process. When you click Save in the Create Discount Methods rule process, the rule is saved and the Discount Methods rule summary page is displayed. However, Discount Method assumptions have not yet been defined for any of your products at this point. Typically, you would start defining your Discount Method assumptions for product-currency combinations before clicking Save.
Defining Discount Methods Using Node Level Assumptions
Node Level Assumptions allow you to define assumptions at any level of the Product dimension Hierarchy. The Product dimension supports a hierarchical representation of your chart of accounts, so you can take advantage of the parent-child relationships defined for the various nodes of your product hierarchies while defining rules. Children of parent nodes on a hierarchy automatically inherit the assumptions defined for the parent nodes. However, assumptions directly defined for a child take precedence over those at the parent level.
Performing basic steps for creating or editing a Discount Methods rule
From the Assumption Browser screen, select the product(s) and the currency for which you want to define a discount method(s) and select the “Add New” button to launch the Discount Method Details screen.
NOTE:
Using the default currency to setup assumptions can save data input time. At run time, the calculation engine uses assumptions explicitly defined for a product currency combination. If assumptions are not defined for a currency, the engine uses the assumptions defined for the product and the default currency. If the assumptions are the same across some or all currencies for a specific product, you can input assumptions for the default currency. Be careful using this option on screens where an Interest Rate Code is a required input. In most cases, you will want to use a currency specific discount curve for discounting instruments within each specific base currency. The Default Currency option, if used will apply a selected Interest Rate Code across all currencies.
Select a method from the Discount Method list:
· Spot Input
· Spot Interest Rate Code
· Forecast (Original Term)
· Forecast (Remaining Term)
The following table describes the methods and rate choices:
|
Method |
Single Rate |
Yield Curve |
|---|---|---|
|
Spot Input |
Discounts all cash flows by the Input Rate |
Not applicable |
|
Spot Interest Rate Code |
Not applicable |
Discounts each cash flow period by the equivalent term rate on the base yield curve chosen (the yield curve as of the start date selected in your ALM Application Preferences). The term is defined by the remaining term of the cash flow. Refer Note |
|
Forecast (Original Term) |
Not applicable |
Discounts each cash flow period by the forecasted value of the point on the yield curve corresponding to each transaction record's original term. Refer Note |
|
Forecast (Remaining Term) |
Not applicable |
Discounts each cash flow period by the forecasted value of the point on the yield curve corresponding to the remaining term until each cash flow. Refer Note |
NOTE:
In the case of Spot Interest Rate Code, if term point is not available, engine will use linear interpolation to determine the interest rate to discount cashflows.
When Discounting method of Forecast (Original Term) and Forecast (Remaining Term) is used, if term point is not available, engine will use Interpolation method defined for Interest rate code within Forecast rate rule. If Interpolation method defined in Forecast rate rule is Linear, engine will use linear interpolation. If Interpolation method is cubic, engine will use Cubic interpolation to determine interest rate to discount cashflows.
The Cash Flow Definition Details section is used in unique instances to specify the portion of the cash flow that is used to calculate a market value. Select from the following:
· Interest Only - ignores all principal runoff for market value purposes. Use this option for off-balance sheet items where principal is equal to notional principal, and is therefore not a true cash flow.
· Principal & Interest - calculates principal and interest both for market value purposes.
· Ignore Origination Cash Flows for Forward-Starting Instruments – This feature allows the cash flow engine to ignore the origination principal cash flows of any forward-starting instrument. The corresponding market value, duration, convexity and yield calculations will not reflect the origination amount. Origination principal cash flow will still be reported.
· Use Principal in Market Value Calculations (Off-Balance Sheet Only) – This feature allows the cash flow engine to consider principal in the calculation of market value, duration, convexity and yield calculations, even if principal is not actually exchanged.
· Mature at Repricing - calculates a market value and YTM for a given transaction up to the repricing date. For market value and YTM purposes the transaction is assumed to mature on the repricing date. Duration is always calculated to the next reprice date, not to maturity, regardless of the mature at repircing selection.
The Cash Flow Interest Type determines which interest component is included in the cash flow definition. The Cash Flow Interest Type can be one of three values:
· Net Rate
· Gross Rate
· Transfer Rate
For typical processing, you will use the Net Rate for the interest component of the cash flow. Special processing objectives, such as valuation of the funding center, may require you to use the other cash flow interest types.
One of the following interest rate parameters is available depending on which discount method you select:
· Input Rate - available when you select Spot Input. Type the rate you want to use for market value calculations.
· Rate Spread - available when you select Spot Interest Rate Code, Forecast (Original Term) and Forecast (Remaining Term). Type the percentage difference (+ or -) between the selected rate index and the value you want to use for the discount rate(s) within market value calculations.
Define a Discount Methods rule for Total Loans using the spot IRC method.
1. From the Assumption Browser, select Currency (US Dollar) and Total Loans.
2. Select Add New to enter the Assumption Details page.
3. From the Discount Method list, select Spot IRC.
4. From Interest Rate Code list, select an appropriate Interest Rate Code.
The list of Interest Rate Codes depends on the selected currency. If the selected currency is the default currency, all Interest Rate Codes appear. For other currency selections, the list of interest rate codes includes only interest rate codes whose reference currency is the same as the selected currency.
5. Input a Rate Spread, type 1.0000.
A spread of 1% returns a discount rate of 1.00% above the reference interest rate. Type a negative number for a spread below the reference interest rate.
6. From Cash Flow Interest Type, select Net Rate.
7. Under Cash Flow Definition Details, use the default – Principal & Interest selection.
8. Select Apply to commit the assumption and return to the Assumption Browser page.
NOTE:
You can select more than one product at a time from the Assumption Browser page. After applying assumptions and returning to the Assumption Browser, that all of the children listed below the parent member have “inherited” the Spot IRC assumption.
9. When Discount Method assumptions are defined for all required product / currency combinations, select SAVE from the Assumption Browser page.
The following examples assume the interest rate has a format of zero coupon yield with annual compounding. The instrument used in each example is an annual-pay, 2-year instrument originated on the as_of_date. See the Oracle Financial Services Cash Flow Engine Reference Guide for details on discount factor derivation used in cash flow calculations.
In the Spot Input method, the discount factor does not vary with Forecast Rate - interest rate scenarios. The discount factor calculations assume the input interest rate to reflect a format of zero coupon yield, annual compounding, and actual/actual accrual basis.
Spot Input Rate = 6.00%
The formula for the market value of the account, for any rate scenario, is:
Market Value = Cash Flow1/ (1 + 0.06) + Cash Flow 2 / ((1 + 0.06)^2)
Cash Flow1 is the cash flow at the end of year 1. Cash Flow2 is the cash flow at the end of year 2.
In the Spot Interest Rate Code method, the discount factor depends on the term of the cash flow, but does not vary with interest rate scenario.
Interest Rate Code = Treasury Yield Curve
The formula for the market value of the account, for any rate scenario, is:
Market Value = Cash Flow1/ (1 + 1 Year Treasury) + Cash Flow2/ ((1 + 2 Year Treasury)^2)
Cash Flow1 is the cash flow at the end of year 1. Cash Flow2 is the cash flow at the end of year 2. The values for 1 Year Treasury and 2 Year Treasury reflect the values from the historical interest rate data, beginning with the as_of_date.
The Forecast Remaining Term method uses forecasted interest rate data to determine the discount factor.
Interest Rate Code = Treasury Yield Curve
The formula for the market value of this account is:
Market Value = Cash Flow1/ (1+ 1Year Treasury Rate at the 1 year point in the forecast) + Cash Flow2/ ((1+ 2 Year Treasury Rate at the 2 year point in the forecast)^2)
Cash Flow1 is the cash flow at the end of year 1. Cash Flow2 is the cash flow at the end of year 2. The values for 1 Year Treasury and 2 Year Treasury reflect the scenario specific values from the forecast rates - interest rate data. Cash Flow1 is discounted at the 1 year Treasury rate, from the 1 year point of the forecast and Cash Flow2 is discounted at the 2 year Treasury rate, from the 2 year point of the forecast.
The Forecast Original Term method uses the forecasted interest rate data to determine the discount factor.
Interest Rate Code = Treasury Yield Curve
The formula for the market value of the account is:
Market Value = Cash Flow1/ (1+ 2 Year Treasury Rate at the 1 year point in the forecast) + Cash Flow2/ ((1+ 2 Year Treasury Rate at the 2 year point in the forecast)^2)
Cash Flow1 is the cash flow at the end of year 1. Cash Flow2 is the cash flow at the end of year 2. Note that Cash Flow1 is discounted at the 2 year Treasury rate. The 2 Year rate is used with this method, because the Forecast Original Term method always uses the term equivalent to the original term of the instrument.