Option and Swap Valuation on

Bloomberg

Chris Lamoureux, PhD

University of Arizona
 Philosophical Approach

Market makers (as opposed to long-term

traders), are especially concerned that the
“model” that they use to price derivative
securities be exactly calibrated to market
data. Black-Derman-Toy is a widely-used
model that does this calibration by
matching the forward rates and the
“volatility” curve.

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 Philosophical Approach –2
Fitting today’s yield curve exactly is achieved
at the cost of dynamic inconsistency. This
means that the “model” is inherently wrong
as a way to characterize the dynamics of
interest rates.
Nevertheless, market makers are concerned
about hedging and measuring risk exposure as
opposed to profiting by taking on risk (or
“predicting” future movements in underlying
fundamentals).
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 Bloomberg
Bloomberg allows users to apply several
calibration models to value a variety of
derivative securities. I obtained the following
screen by first selecting the underlying
security:
912828DM9 <GOVT> <GO>
Then get option valuation for this security:
OV <GOVT> <GO>

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 Resultant Screen

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 Screen Interpretation
The preceding screen is for at-the-money 90-
Day call and put options on the 4% 2/15/15
T-Note.
This screen uses Black’s model to value the
options. Assumptions include a constant
interest rate (oddly!), the note’s price follows
a geometric Brownian Motion (so that its
value on option expiration is lognormally
distributed), with mean equal to its forward
price, and constant (proportional) variance.

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 Screen --2
We get the model prices for both options. Also
the implied volatility of the note price:
• (Price I.Vol) (5.973)
The usual way volatility is expressed is on yields:
• Yield Vol (%) (17.732)
Note that the risk free rate (assumed constant) is
2.80% (Repo).
The forward price is 98-05 3/8.
(Also note that since these options are at-the-
money, all of their value is “time value” (i.e.,
intrinsic value is 0).)
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 OV 2

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 BDT Screen
The preceding screen looks at the same option, but
uses the BDT model to value and measure risk
exposures. Note that for BDT, we input the entire
yield curve and volatility curve. The only
additional information on this screen is the Z-
Spread, which is the yield differential between the
model and the market price for the T-Note.
Note that the prices of both options are lower under
BDT than Black, since the vol is low at the short
end.
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 Caps, Floors, Collars Calculator
Bloomberg has calculators for swaps, swaptions,
collars, floors, and caps. You can get there from
the <CRNCY> screen (US$).
The next 3 screens are for Cap valuation.

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 Cap Screen 1

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 Cap Screen 2

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 Cap Screen 3

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 Swaptions
A swaption is an option to enter a swap. The next
screen uses BDT to evaluate a swaption which
gives its owner the option to receive fixed and play
floating on $10 million notional principal, with
quarterly tenor. The option expires in 1 year and is
on a 5-Year swap.

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 Swaption Screen

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