Spread-Based Pricing

The following questions relate to the use of reference curves (UST and LIBOR) for
pricing. Please review the section in the help file under Security-Level Assumptions>Pricing Assumptions->Pricing to Spread. Once you have reviewed this section, put
together responses for the questions below.
1 What is the difference between a cash flow spread and a yield spread?
What are examples of both that are available in PolyPaths?
Comparing two yield curves is the definition of a spread. But not all spreads are
calculated the same way. The difference between a cash flow spread and a yield
spread, is that a cash flow spread is the difference between the cashflow of the
instrument compared to the cash flows of the Treasury yield curve at the times the
cashflows are due. In short, a cash flow spread is the difference between an
instruments yield and the entire yield curve. A yield spread is based only on one spot of
the yield curve.
Z Sprd/UST, Sprd/LIBOR, and Sprd/ED are cash flows. Sprd/UST, Sprd/UST (nominal),
and Sprd/Swap are yield spread.
The Z-spread is the constant spread that makes the bond's price equal to the present
value of its cash flow along each point of the Treasury curve. The yield spread is simply
the difference between the yields of two instrumentsusually with the treasury curve as
the benchmark.

2 What is the difference between Sprd/UST and Sprd/UST Nominal?

The difference between the two is that the Sprd/UST nominal calculates a spread that is
relative to the nominal term to maturity, as opposed to the actual term to maturity.
Nominal in this case means the stated coupon rate, whereas the actual term is what the
current value on the market is (after taking into account any discounting).
Sprd/UST is the yield that uses the actual term to maturity, whereas sprd/UST nominal
uses the nominal term to maturity.
3 What field corresponds to the 'I' Spread in Bloomberg?
The field we use in polypaths is Sprd/UST.
5 How can I control which reference treasury is used to compute the
Sprd/UST and Sprd/Swap fields?

You simply modify the preset references under the UST Ref column. The default
appears to display AL as the reference point, you can change that to any UST
reference that is needed (ie 2Y, 5Y, etc).
If the UST Ref column is not displayed on your portfolio, it can be turned on by going
to layoutchange column settingSelect UST Ref AddOk.
6 Please set up a pf and add 4 copies of a 10year bond. Across the four
copies, use the same price and compute the Sprd/UST and Sprd/UST
Nominal values using AL, 2Y, 5Y, and 10Y as reference treasury points.
Attached as ex2A_Q5.pf. Specifically, rows 2-5.
7 Back out the Sprd/UST Nominal values for each of the four bounds in a
spreadsheet.
Attached as ex2A_Q6.xlsx, highlighted in blue.
8 What might someone look at Z Sprd/UST instead of Sprd/UST?
In calculating a Z-spread, each cashflow is discounted using its own particular zerocoupon rate. Meaning, a Z-spread uses the yield curve to calculate spread as opposed
to using only one spot rate. This makes the Z spread the more realistic spread to use.
8.
Add a 5Y Fixed Rate Bond and use Cashflow Analysis and a spreadsheet to
back out PV from the following spreads using 2Y and 5Y reference yields:
Sprd/ UST (Nominal) = 2 bps
Sprd/ Swap = 10 bps
This is attached as ex2A_Q6.xlsx, highlighted in orange. The cashflow analysis from
AppPort is attached in their as well. These are based on the bonds in rows 6 and 7 of
ex2A_Q5.pf.

I have attached the updated formula in the same excel file.

Floating Rate Bonds

1 How can the user control whether to use a fixed index
assumption for a floating rate bond or to use the

implied forward curve to project the index rates

through time?
This can be done by: Selecting Models Index Projection
Choose appropriate forward or constant models.
2 Can this be set only on the portfolio-level or is there a
way to do this at the instrument-level as well?
There is a way to do this at the instrument level as well. After
creating a bond, using the add bond option under the Bond
dropdown menu on the toolbar, select Bond Floating Rate
Info Select the desired index.

This can be done on the instrument level as well. Layout

Change column settings Add Index Pro
Change the index pro column setting to either F for forward, or C
for constant.

A user may add the Index Proj column by clicking on Layout and scrolling to Change
Column Settings Putting C in the Index Proj cell will give a constant index whereas F will give
a forward index

3 Create a 10-year floating rate bond that is indexed to

CMT1Y with a 2.5% margin.
Attached in row 10 of ex3_Q3.pf
4 Create several copies of the bond in (1) to reflect:
a a Cap of 3%
b a Cap of 5%
c a Floor of 1%
d a Floor of 2%

Attached in ex3_Q3.pf rows 11-14

5 How do the caps and floors above impact the cash
flows? How can you view the cash flows across
different interest rate shocks?
Caps and floors maintain a known range for what interest rates
can float between. You would view cash flows across different
interest rate shocks by first going to the analysis menu, selecting
Scenario analysis. Next, you can customize the shocks using the
scenario editor. Apply the scenario. Then the updated cash flows
will be displayed.
6 If you set Cap and Floor equal to the same value,
what happens to the cash flows for a bond?
The cash flows should be equivalent to the interest * the principle,
with the interest equivalent to the cap/floor value.
What I was trying to articulate here is that with a cap and floor of
the same value, the floating rate bond essentially works like a
fixed rate bond. Where the rate is fixed at the cap/floor level.

Scenario Analysis
1 Construct a set of parallel shifts representing
up/down shifts of 10bp, 25bp, and 50bp. Save the
scenario definition file and attach it to your response.
Attached as the ex4_Q1.scn file.
2.Construct a set of scenarios which capture the
following behavior:

a. 2Y rate increases by 25BP and the curve steepens

around it.
b. 2Y rate decreases by 25BP and the curve steepens
around it.
c. 10Y rate increases by 50BP and the curve flattens
around it.
d. 10Y rate decreases by 50BP and the curve flattens
around it. For this scenario, do not allow the shocked
rates to go negative
Attached as ex4_Q2.scn
3. What are your expectations of prices in the following
situations? Validate your expectations with AppPort and
save pf examples:
e. Run a fixed rate bond at Sprd/Swap = -10, 0, 10 bps
f. Run a floating rate bond at Sprd/Swap = -10, 0, 10 bps
g. Hold Sprd/Swap constant in Scenario Analysis on the
above bonds with -200, -100, unch, 100, 200 scenarios
Attached at ex4_Q3.pf and ex4_Q3.csv
You would expect the price for a fixed rate bond to go up when
sprd/swp is -10, remain unchanged at 0, and go down when at 10.
For a floating rate bond, price should go up when sprd/swp is -10,
unchanged at 0, and increase slightly at 10.
4 Explain the relative Price profiles shown below for
the attached Q4.pf:
The properties seen in the price profiles in Q4.pf all have to
do with the different caps and floors set to them. Bond 1
increases ordinarily past the 40 bps due to the interest floor
set. Bond 2s price is much lower because no floor is set, but
rises at the same rate until the 300bps cap.

Bond 3 has no cap, and so it increases rapidly past the

40bps floor. Bond 4 increases rapidly between the cap and
floor, but is flat at the cap value and above, and is flat at the
floor value and below.
Bond 5 is flat in price change, because the cap and floor are
the same.
I was hoping we can meet for a few minutes to discuss the
appropriate way of describing such curves. I understand that
my current explanation is messy and colloquial, without any
technical rigor.
5. Is there a way to configure the application so that
rates are floored by default when creating new
scenarios in AppPort? Do users have any control over
the way that the rate floor is applied in scenario
analysis?
Yes. Open up scenario analysis in the toolbar. Add a new scenario.
Click on the newly created tab, rename, check the floor negative
rates box, save the scenario, and close the dialog. Reload this
scenario to have this option set up by default.

This can also be done with PP_config. Where you can set
PP_SCENARIO_FLOOR_NEG_RATES = Y This will make the floor negative rate box
always checked by default, without having to do so manually anymore.
Users do have control over the way that the rate floor is applied, by using PP_config.
They must implement the PP_SCENARIO_FLOOR_RATE = x option into the
PP_config txt file.

6. How can a user verify that a +100 scenario has the

desired impact on the curve?

Change the spread/swap column to the yield +100 basis points.

If the results on the price are the same, which means the scenario
analysis works properly.
A user can verify that the +100 scenario has the right impact on
the curve by selecting the +100 tab in the scenario analysis popup. Then selecting view market ratesYield Curve Graph.

7.Is there any way to save a full .mr file corresponding to

the shifted scenario market rates?
You can do so by selecting a shifted scenario tab in the scenario
analysis window, then selecting save market rates in the upper
right corner.

Alternatively, batchcal can be used: (*straight from SalesForce*)

Yes, a full .mr file can be saved by using batchcal. /mrshift_scn
takes the scenario file name and the name of the scenario which
is within the .scn file as arguments. Then, its converted to xml
and back.
batchcal /mrshift_scn monthend.scn "[1]-200" /mrxml in.mr
out.xml
batchcal /xmlmr out.xml out_-200.mr

No, the above batchcal was not tested as of 09/14. Will be tested
by 09/15.
8.Customize your PolyPaths setup so that when you view
Analysis->Scenario Analysis on a blank portfolio, you see
+/- {100, 50, 25} shocks on the first tab, with a label of
Parallel (instead of YieldCurve1) for this tab; a 10%
change in the UST curve only and a 10% change in the

LIBOR Curve only on the second tab with a label of Basis

Shocks, and a set of steepening and flattening scenarios
(your choice) on tab 3 with a label of Curve Shape.
Please attach relevant files.
Ex4_Q8.scn
Updated_Ex4_Q8.pf
To save these settings, use PP_CONFIG. Implement
PP_SAVE_SCEN_FIELDS = Y. This will save the current scenario
settings.

9.[For this one, I will send you details on Batchcal separately. So you can hold
off on this until I send that information.] Create a CSV input file and
correspond Batchcal command that will replicate the scenarios you created in
numbers 1 and 2.

Attached in the email are the CSV input files (ex4_Q1.csv and ex4_Q2.csv).
Additionally, the commands are written in a script attached as well (ex4_Q9A.bat
and ex4_Q9B.bat).