B.1.1 Example I - Interest Rate Options
To protect your bank from an increase in interest rates, you have decided to buy an interest rate cap with the following terms on a trade deal:
Table B-1 Example I
| Contract Type | Value |
|---|---|
|
Booking Date |
1-Feb-2000 |
|
Value Date |
31-Mar-2000 |
|
Maturity Date |
31-Mar-2003 |
|
Interest Payment (Arrears) Dates |
Sept 30 & Mar 31 |
|
Reference Interest rate |
6-Month LIBOR |
|
Rate Fixing Lag |
5 Days |
|
Reset Basis |
Period end Date |
|
Reset Date Movement |
Backward |
|
Strike Rate |
9% |
|
Contract Amount |
USD 50000 |
|
Contract Currency |
USD |
|
Option Premium |
2% of Principal |
|
Premium Currency |
USD |
|
Premium Pay Date |
15-FEB-2000 |
|
Fair Value at Inception |
1200 USD |
|
Numerator Method |
30-EURO |
|
Denominator method |
360 |
|
Denominator basis |
Per Annum |
|
Amortization Frequency |
Quarterly |
|
Amortization Month |
May |
|
Amortization Day |
31 |
|
Revaluation Frequency |
Quarterly |
|
Revaluation Month |
May |
|
Revaluation Day |
31 |
The accounting entries that are passed in the system are as follows:
Contract Booking (BOOK)
Table B-2 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
MKT_VAL_PUR_OP T |
PUR_OPTION_ PREM |
.02*50000 =1000 |
USD |
01- Feb-00 |
|
Cr |
OPT_PREM_PAY |
PUR_OPTION_PREM |
1000 |
USD |
01-Feb-00 |
|
Dr |
MKT_VAL_PUR_OP T |
PUR_INCEP_GAIN |
1200-1000 = 200 |
USD |
01-Feb-00 |
|
Cr |
PUR_IN_GAIN_DEF |
PUR_INCEP_GAIN |
200 |
USD |
01-Feb-00 |
Premium Payment (PRPT)
Actual premium payment happens on 15-Feb-2000
Table B-3 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
OPT_PREM_PAY |
PUR_OPTION_PREM |
1000 |
USD |
15-Feb-00 |
|
Cr |
CUSTOMER |
PUR_OPTION_PREM |
1000 |
USD |
15-Feb-00 |
Amortization of inception Gain/Loss (AMRT)
First Amortization and revaluation are performed on 31-May-2000
Inception Gain = 1200 – 1000 (Contract FV – Option Premium) = 200 USD
This amount is to be amortized from 31-Mar-2000 to 31-Mar-2003 (36 Months * 30) days.
Amortization is performed based on the actual number of days in a year. However, for this example you assume 360 days in a year and 30 days in a month.
Amortized inception gain till 31-May-2000 = 200 * (2*30) / (36*30) = 11.11 USD
Table B-4 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_IN_GAIN_DEF |
PUR_NET_INCEP_GAIN |
11.11 |
USD |
31-May-00 |
|
Cr |
PUR_IN_GAIN_OPT |
PUR_NET_INCEP_GAIN |
11.11 |
USD |
31-May-00 |
Next Amortization is on 31-Aug-2000
Amt to Amortize till date =200 * (5*30) / (36*30) =27.78 USD
Amt already Amortized = 11.11 USD
Current Amt to Amortize = 27.78 – 11.11 =16.77 USD
Table B-5 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_IN_GAIN_DEF |
PUR_NET_INCEP_GAIN |
16.77 |
USD |
31-Aug-00 |
|
Cr |
PUR_IN_GAIN_OPT |
PUR_NET_INCEP_GAIN |
16.77 |
USD |
31-Aug-00 |
Revaluation of Option (REVL)
Assume that the Contract Fair Value as on 31-MAY-20000 is 1100 USD.
Revaluation Gain on Inception was 1200 (Contract FV on Inception) – 1000 (Option premium) = 200 USD.
Table B-6 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
RV_GAIN_PUR_OPT |
PUR_LAST_REVL_GAIN |
200 |
USD |
31-May-00 |
|
Cr |
MKT_VAL_PUR_OPT |
PUR_LAST_REVL_GAIN |
200 |
USD |
31-May-00 |
|
Dr |
MKT_VAL_PUR_OPT |
PUR_ REVL_GAIN |
1100 – 1000= 100 |
USD |
31-May-00 |
|
Cr |
RV_GAIN_PUR_OPT |
PUR_REVL_GAIN |
100 |
USD |
31-May-00 |
Next Revaluation happens on 31-Aug-2000. Suppose the Fair Value of the contract on 31-Aug-2000 is 700 USD.
Last Revaluation Gain = 100 USD
Current Revaluation Loss = 1000 (Option Premium) – 700 (FV on 31-Aug-2000) = 300 USD
Table B-7 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
RV_GAIN_PUR_OPT |
PUR_LAST_REVL_GAIN |
100 |
USD |
31-Aug-00 |
|
Cr |
MKT_VAL_PUR_OPT |
PUR_LAST_REVL_GAIN |
100 |
USD |
31-Aug-00 |
|
Dr |
RV_LOSS_PUR_OPT |
PUR_REVL_LOSS |
300 |
USD |
31-Aug-00 |
|
Cr |
MKT_VAL_PUR_OPT |
PUR_REVL_LOSS |
300 |
USD |
31-Aug-00 |
Rate Fixing (RTFX) and Exercise of Option (EXER)
According to the Rate fixing Lag, Reset Basis and Reset Date Movement, Rate fixing event (RTFX) take places on 25-Sep-2000 and settlement amount are determined.
If 6M LIBOR is 11% on 25-Sep-2000 then
Settlement amount = 50000 * (11-9)% * 180 / (360*100) = 500 USD
Actual settlement for this amount happens on 30-Sep-2000.
Accounting entries passed on event EXER
Table B-8 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_OPT_SET_REC |
PUR_INTR_SETL_AMT |
500 |
USD |
25-Sep-00 |
|
Cr |
PUR_OPT_INCOME |
PUR_INTR_SETL_AMT |
500 |
USD |
25-Sep-00 |
Exercise Settlement (EXST)
Exercise settlement happens on the 30-Sep-2000 for the above exercise:
Table B-9 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
CUSTOMER |
PUR_SETL_AMT |
500 |
USD |
30-Sep-00 |
|
Cr |
PUR_OPT_SET_REC |
PUR_SETL_AMT |
500 |
USD |
30-Sep-00 |
The event RTFX is triggered on every rate fixing date. Event EXER and EXST is triggered depending on whether the option is in the money or not on the rate fixing date.
Final Settlement
Now suppose the option is in-the money on the last rate fixing date (Final settlement). The following events and accounting entries are processed.
Rate Fixing event (RTFX) is on 26-Mar-2003.
If 6M LIBOR is 12% on 26-Mar-2000 then
Settlement amount = 50000* (12-9)% * 180 / (360*100) = 750 USD
Revaluation on final Settlement is triggered @ Current FV (Settlement amount).
Last Revaluation Gain= 50 USD (Assumed)
Current Revaluation Loss= 1000 (Option premium) – 750 (Settlement amount) = 250 USD
Table B-10 Revaluation of Option (REVL) - Final Settlement
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
RV_GAIN_PUR_OPT |
PUR_LAST_REVL_GAIN |
50 |
USD |
26-Mar-03 |
|
Cr |
MKT_VAL_PUR_OPT |
PUR_LAST_REVL_GAIN |
50 |
USD |
26-Mar-03 |
|
Dr |
RV_LOSS_PUR_OPT |
PUR_REVL_LOSS |
250 |
USD |
26-Mar-03 |
|
Cr |
MKT_VAL_PUR_OPT |
PUR_REVL_LOSS |
250 |
USD |
26-Mar-03 |
Amortization of inception Gain/Loss (AMRT) - Final Settlement
Residual amortization of Inception Gain is done on final settlement
Total Amt to Amort = 200 USD
Amt already Amortized = 175 USD (Assumed)
Current Amt to Amort = 200 – 175 = 25 USD
Table B-11 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_IN_GAIN_DEF |
PUR_NET_INCEP_GAIN |
25 |
USD |
26-Mar-03 |
|
Cr |
PUR_IN_GAIN_OPT |
PUR_NET_INCEP_GAIN |
25 |
USD |
26-Mar-03 |
Table B-12 Exercise of Option (EXER) - Final settlement
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_OPT_SET_REC |
PUR_SETL_AMT |
750 |
USD |
26-Mar-03 |
|
Cr |
MKT_VAL_PUR_OPT |
PUR_SETL_AMT |
750 |
USD |
26-Mar-03 |
Moving Revaluation Gain/Loss to Income/Expense on Final Settlement
Table B-13 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_OPT_EXPENSE |
PUR_REVL_LOSS |
250 |
USD |
26-Mar-03 |
|
Cr |
RV_LOSS_PUR_OPT |
PUR_REVL_LOSS |
250 |
USD |
26-Mar-03 |
Moving Inception Gain to Income on Final Settlement
Table B-14 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_IN_GAIN_OPT |
PUR_INCEP_GAIN |
200 |
USD |
26-Mar-03 |
|
Cr |
PUR_OPT_INCOME |
PUR_INCEP_GAIN |
200 |
USD |
26-Mar-03 |
Exercise Settlement (EXST) - Final settlement
Exercise settlement happens on the 31-Mar-2003 for the above exercise:
Table B-15 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
CUSTOMER |
PUR_SETL_AMT |
750 |
USD |
31-Mar-03 |
|
Cr |
PUR_OPT_SET_REC |
PUR_SETL_AMT |
750 |
USD |
31-Mar-03 |
Termination (TERM)
Now suppose the above contract is terminated on 10-Oct-2000 after the first exercise.
Suppose the contract is sold back to the writer of the option for 800 USD whereas the Contract Fair Value on 10-Oct-2000 was 1100 USD
Contract FV on termination = 1100 USD
Termination Loss = 1100 – 800 = 300 USD
Table B-16 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
CUSTOMER |
PUR_TERM_FV |
1100 |
USD |
10-Oct-00 |
|
Cr |
MKT_VAL_PUR_OPT |
PUR_TERM_FV |
1100 |
USD |
10-Oct-00 |
|
Dr |
PUR_OPT_EXPENSE |
PUR_TERM_LOSS |
300 |
USD |
10-Oct-00 |
|
Cr |
CUSTOMER |
PUR_TERM_LOSS |
300 |
USD |
10-Oct-00 |
REVL at termination
Revaluation is triggered @ Contract Fair Value at termination
Last Revaluation Loss = 300 USD (As on 31-Aug-2000)
Current Revaluation Gain =1100 (FV at termination) – 1000 (Option premium) =100 USD
Table B-17 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
MKT_VAL_PUR_OPT |
PUR_LAST_REVL_LOSS |
300 |
USD |
10-Oct-00 |
|
Cr |
RV_LOSS_PUR_OPT |
PUR_LAST_REVL_LOSS |
300 |
USD |
10-Oct-00 |
|
Dr |
MKT_VAL_PUR_OPT |
PUR_REVL_GAIN |
100 |
USD |
10-Oct-00 |
|
Cr |
RV_GAIN_PUR_OPT |
PUR_REVL_GAIN |
100 |
USD |
10-Oct-00 |
AMRT at termination
Inception gain to Amortize = 200 USD
Amt amortized till date = 27.78 USD (As on 31-Aug-2000)
Amt to amortize on termination = 200 – 27.78 =172.22 USD
Table B-18 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_IN_GAIN_DEF |
PUR_NET_INCEP_GAIN |
172.22 |
USD |
10-Oct-00 |
|
Cr |
PUR_IN_GAIN_OPT |
PUR_NET_INCEP_GAIN |
172.22 |
USD |
10-Oct-00 |
Moving Revaluation Gain/Loss to Income/Expense on Final Settlement
Table B-19 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
RV_GAIN_PUR_OPT |
PUR_REVL_GAIN |
100 |
USD |
10-Oct-00 |
|
Cr |
PUR_OPT_INCOME |
PUR_REVL_GAIN |
100 |
USD |
10-Oct-00 |
Moving Inception Gain to Income on Final Settlement
Table B-20 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_IN_GAIN_OPT |
PUR_INCEP_GAIN |
200 |
USD |
10-Oct-00 |
|
Cr |
PUR_OPT_INCOME |
PUR_INCEP_GAIN |
200 |
USD |
10-Oct-00 |
Expiry (EXPR)
Now suppose the option is out-of-the-money on the last rate fixing date (Final settlement). The following events and accounting entries are processed.
Rate Fixing event (RTFX) happens on 26-Mar-2003
Expiry (EXPR) event is triggered on 31-Mar-2003
Event REVL (On Expiry)
Revaluation on Expiry is triggered @ 0
Last Revaluation Gain = 50 USD (Assumed)
Current Revaluation Loss = 1000 (Option premium) – 0 = 1000 USD
Table B-21 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
RV_GAIN_PUR_OPT |
PUR_LAST_REVL_GAIN |
50 |
USD |
26-Mar-03 |
|
Cr |
MKT_VAL_PUR_OPT |
PUR_LAST_REVL_GAIN |
50 |
USD |
26-Mar-03 |
|
Dr |
RV_LOSS_PUR_OPT |
PUR_REVL_LOSS |
1000 |
USD |
26-Mar-03 |
|
Cr |
MKT_VAL_PUR_OPT |
PUR_REVL_LOSS |
1000 |
USD |
26-Mar-03 |
Event AMRT (On Expiry)
Residual amortization of Inception Gain is done Expiry
Total Amt to Amort = 200 USD
Amt already Amortized = 175 USD (Assumed)
Current Amt to Amort = 200 – 175 = 25 USD
Table B-22 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_IN_GAIN_DEF |
PUR_NET_INCEP_GAIN |
25 |
USD |
26-Mar-03 |
|
Cr |
PUR_IN_GAIN_OPT |
PUR_NET_INCEP_GAIN |
25 |
USD |
26-Mar-03 |
Moving Revaluation Gain/Loss to Income/Expense on Final Settlement.
Table B-23 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_OPT_EXPENSE |
PUR_REVL_LOSS |
1000 |
USD |
26-Mar-03 |
|
Cr |
RV_LOSS_PUR_OPT |
PUR_REVL_LOSS |
1000 |
USD |
26-Mar-03 |
Moving Inception Gain to Income on Final Settlement.
Table B-24 Accounting Entries
| Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
|---|---|---|---|---|---|
|
Dr |
PUR_IN_GAIN_OPT |
PUR_INCEP_GAIN |
200 |
USD |
26-Mar-03 |
|
Cr |
PUR_OPT_INCOME |
PUR_INCEP_GAIN |
200 |
USD |
26-Mar-03 |
Parent topic: Examples