19.3 Deterministic Approach for Price Based Strike

For the Deterministic Approach, the Cash Flow Engine recognizes the option type, reads the exercise schedule of the Option, checks if the option is exercisable (Callable/Puttable), and outputs the Cash Flows accordingly.

• Depending on the Call/Put option, the corresponding cash flows are bucketed, the financial measures (market value, Duration, Modified Duration, and YTM) are calculated and the RES_DTL table financial elements are also calculated The required discount method to use for embedded option valuation is Forecast Remaining Term. The rationale detailed as follows: In the case of fixed-rate instruments when we create different scenarios, the difference in NPV would be from the changes in the discounting IRCs. For OFSALM to support this, spot input, effective Interest Rate, and spot IRC methods cannot be used, as the scenarios created through forecast rates are not applicable. Forecast Remaining Term and Forecast Original Term are the methods that retain the shock scenarios defined as part of the forecast rate scenarios and use them for discounts. However, in the case of Forecast Original Term, all cash flows are always discounted with the original term of the instrument, which would have a significant effect on the bond NPV. So, forecast remaining term in the discount rates rules is the viable solution.
• If the option is exercised, the RESULT_MASTER outputs such as Duration, Modified Duration, and Yield to Maturity are calculated with the cashflows between the as of the date and option exercise date and the maturity amount/call amount. YTM would be the Yield to Call (functional), rather than YTM.
• If the Embedded Option Decisioning is selected as Cashflows to Maturity – none of the FE's of Bonds with Embedded Options would be outputted in the RES_DTL and process cash flows. The process will ignore the embedded option and calculate cashflows to the maturity of the instrument.