5.3.11.1 Volatility Rate Management
As shown in the Transfer Pricing Process, the Rate Lock Option Cost calculation requires following two inputs:
- Discount Curve: This can be a standard Interest Rate Curve.
- Volatility Curve: This is a special form of Interest Rate Curve defined under volatility curve module, where the volatility rates have been selected as per the contractual and commitment terms.
Figure 5-130 Interest Rate Curve
To set up a volatility curve, while defining a new Interest Rate Curve, select the check box – 'Volatility Curve'.
Terms tab: For a Volatility Curve, the Terms tab displays two
types of terms – The Contract Term (Loan Term) and the Expiration Term (Rate Lock
(option expiry) Term). Users must provide the volatility inputs for all combinations of
Contract Term and Expiration Term.
Note:
In the moneyness dimension, associated with option volatility is not required, because Rate Lock Options are assumed to be granted at the money.The following steps are required to complete the setup of a volatility curve:
- Terms tab - Contract Term: Add rows and input terms for the
number of required Loan Terms. These are the maturity term of the loan. Select
APPLY to save the data.
Figure 5-131 Terms Tab – Contract Term
- Terms Tab – Expiration Term: Add rows and Input Terms for the
number of required Expiration Terms. These correspond to the number of Rate Lock
Terms offered. Select APPLY to save the data.
Figure 5-132 Terms Tab – Expiration Term
Historical Rates tab: After defining and applying the volatility
curve dimensions, navigate to the Historical Rates tab and input the volatility rates
for each combination of the loan term and rate lock term and for each effective date
that you wish to store historical volatility data.
Figure 5-133 Historical Rates Tab
Select Apply to save the data.