Counterparty Credit Risk in Interest Rate Swaps

Counterparty Credit Risk in Interest Rate Swaps during Times of Market Stress Antulio N. Bom m Federal Reserve Board First Draft: September 27, 2002 This Draft: December 17, 2002 Abstract This paper examines whether empirical and theoretical results suggesting a relatively small role for counterparty credit risk in the determination of interest rate swap rates hold during periods of stress in the financial markets, such as the chain of events that followed the Russian default crisis of 1998. The analysis sheds light on the robustness of netting and credit enhancement mechanisms, which are common in interest rate swaps, to widespread turmoil in the financial markets. JEL Classication: G12, G13 Keywords: convexity adjustment, futures and forward rates,

a ne models Board of Governors of the Federal Reserve System, Washington, DC 20551; E-mail: abom m@frb.gov; Fax: (202) 452-2301, Tel.: (202) 736-5619. I am grateful to Je Dewynne and Pat White for helpful comments, to Emily Cauble and Joseph Rosenberg for excellent research assistance, and to seminar participants at the Federal Reserve Board for their insights. The opinions expressed in this paper are not necessarily shared by the Board of Governors of the Federal Reserve System or any other members of its sta . 1 Introduction Spreads of rates on interest rate swaps over comparable U.S. Treasury yields widened dramatically during the acute nancial market turmoil that followed the Russian default crisis of 1998 (Figure 1). While a signi cant portion of that widening in swap spreads likely reflected increased concerns about credit risk in general and greater demand by investors for the safety and liquidity of Treasury securities|corporate bond and LIBOR spreads over Treasuries had also moved substantially higher|it is conceivable that swap spreads were also affected by market participants’ worries about counterparty credit risk in swaps. This paper examines a well-known no-arbitrage relationship between interest rate swaps and eurodollar futures contracts to take a novel look at this issue. In particular, I examine whether the spread between swap rates quoted by dealers and synthetic" swap rates implied by the futures market| where counterparty credit risk is virtually absent|provided any indication that swap rates were signaling heightened concerns about counterparty risk in the swaps market at that time. Understanding the potential role that concerns about counterparty credit risk play in the pricing of interest rate swaps during times of nancial market stress is important for at least two reasons. First, while a vast academic literature has studied the issue both from a theoretical and an empirical per- spective, existing studies have not assessed the robustness of their fundings to episodes of turmoil in the financial markets. Second, the interest swap market has been increasingly taking on a benchmark role in the broader xed- income market that had previously virtually been the exclusive domain of U.S. Treasury debt securities. Given its greater prominence for the financial markets as a whole, the question of assessing the ability of the swaps mar- ket to continue to function without major impediments|such as heightened concerns about counterparty credit risk|when other (less liquid) markets are disrupted gains special significance for...

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Statement of Financial Accounting Standards No. 140 - GASB

Statement of Financial Accounting Standards No. 140 FAS140 Status Page FAS140 Summary Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125) September 2000 Financial Accounting Standards Board of the Financial Accounting Foundation 401 MERRITT 7, P.O. BOX 5116, NORWALK, CONNECTICUT 06856-5116 Copyright © 2000 by Financial Accounting Standards Board. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the Financial Accounting Standards Board. Page 2 Statement of Financial Accounting Standards No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments

of Liabilities a replacement of FASB Statement No. 125 September 2000 CONTENTS Paragraph Numbers Introduction and Scope................................................................................................. 1−8 Standards of Financial Accounting and Reporting: Accounting for Transfers and Servicing of Financial Assets............................... 9−15 Recognition and Measurement of Servicing Assets and Liabilities .................. 13 Financial Assets Subject to Prepayment ............................................................ 14 Secured Borrowings and Collateral.................................................................... 15 Extinguishments of Liabilities ................................................................................. 16 Disclosures ............................................................................................................... 17 Implementation Guidance ........................................................................................ 18 Effective Date and Transition ............................................................................ 19−25 Appendix A: Implementation Guidance ................................................................ 26−114 Appendix B: Background Information and Basis for Conclusions...................... 115−341 Appendix C: Illustrative Guidance....................................................................... 342–349 Appendix D: Amendments to Existing Pronouncements..................................... 350–363 Appendix E: Glossary .................................................................................................. 364 Page 3 Copyright ©2000, Financial Accounting Standards Board Not for redistribution FAS 140: Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities a replacement of FASB Statement 125 FAS 140 Summary This Statement replaces FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of Statement 125’s provisions without reconsideration. This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Those standards are based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. A transfer of financial assets in which the transferor surrenders control over those assets is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. The transferor has surrendered control over transferred assets if and only if all of the following conditions are met: a. The transferred assets have been isolated from the transferor—put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership. b. Each transferee (or, if the transferee is a qualifying special-purpose entity (SPE), each holder of its beneficial interests) has the right to pledge or exchange the assets (or beneficial interests) it received, and no condition both constrains...

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Glossary oF Accounting, Finance and Economic Terms Accounting

1 Glossary oF Accounting, Finance and Economic Terms Accounting – pages 1‐7 and 8 Finance – page 7 Economics – page 7 ACCOUNTING: http://www.alpineguild.com/glossary_of_important.htm Account ‐‐ a record of financial transactions; usually refers to a specific category or type, such as travel expense account or purchase account. Accountant ‐‐ a person who trained to prepare and maintain financial records. Accounting ‐‐ a system for keeping score in business, using dollars. Accounting period ‐‐ the period of time over which profits are calculated. Normal accounting periods are months, quarters, and years (fiscal or calendar). Accounts payable ‐‐ amounts owed by the company for the goods or services it has purchased from outside suppliers. Accounts receivable ‐‐ amounts owed to the company

by its customers. Accrual basis, system, or method ‐‐ an accounting system that records revenues and expenses at the time the transaction occurs, not at the time cash changes hands. If you buy a coat and charge it, the store records or accrues the sale when you walk out with the coat, not when you pay your bill. Cash basis accounting is used by individuals. Accrual basis accounting is used by most businesses. Accrued expenses, accruals ‐‐ an expense which has been incurred but not yet paid for. Salaries are a good example. Employees earn or accrue salaries each hour they work. The salaries continue to accrue until payday when the accrued expense of the salaries is eliminated. Aging ‐‐ a process where accounts receivable are sorted out by age (typically current, 30 to 60 days old, 60 to 120 days old, and so on.) Aging permits collection efforts to focus on accounts that are long overdue. 2 Amortize ‐‐ to charge a regular portion of an expenditure over a fixed period of time. For example if something cost $100 and is to be amortized over ten years, the financial reports will show an expense of $10 per year for ten years. If the cost were not amortized, the entire $100 would show up on the financial report as an expense in the year the expenditure was made. (See entries on Expenditure and Expense.) Appreciation ‐‐ an increase in value. If a machine cost $1,000 last year and is now worth $1,200, it has appreciated in value by $200. (The opposite of depreciation.) Assets ‐‐ things of value owned by a business. An asset may be a physical property such as a building, or an object such as a stock certificate, or it may be a right, such as the right to use a patented process. Current Assets are those assets that can be expected to turn into cash within a year or less. Current assets include cash, marketable securities, accounts receivable, and inventory. Fixed Assets cannot be quickly turned into cash without interfering with business operations. Fixed assets include land, buildings, machinery, equipment, furniture, and long‐term investments. Intangible Assets are items such as patents, copyrights, trademarks, licenses, franchises, and other kinds of rights or things of value to a company, which are not physical objects. These assets may be the most important ones a company owns. Often they do...

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Your Retirement Plan - Office of the New York State Comptroller

Your Retirement Plan Special 20- and 25-Year Plans For PFRS Tier 1, 2, 3, 5 and 6 Members (Sections 384, 384-d and 384-e) New York State Office of the State Comptroller Thomas P. DiNapoli New York State and Local Police and Fire Retirement System A Message From Comptroller Thomas P. DiNapoli As a member of the Retirement System, you are covered by a plan that provides important benefits. This publication explains some of those benefits and the services available to you as a member of our system, including: • Benefits you will receive at retirement if you meet the service and age requirements (service retirement benefits); • Benefits you may receive if you become permanently disabled (disability retirement benefits); •

Benefits your beneficiary may receive if you die while working for a public employer or, if eligible, after you leave public employment (death benefits); and • Benefits you may receive at a later date, even if you leave public service before you become eligible to retire (vested benefits). I am joined by a staff of dedicated professionals in my commitment to helping you make informed decisions about your future. I encourage you to contact us with any questions or suggestions you might have. Sincerely, Thomas P. DiNapoli Stat e Comptroller Contents About Your Membership. . . . . . . . . . . . . . . . . . . . . . . . . 3 Service Credit .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Final Average Salary (FAS) .. . . . . . . . . . . . . . . . . . . . . 15 Service Retirement Benefits .. . . . . . . . . . . . . . . . . . . 21 Choosing a Payment Option .. . . . . . . . . . . . . . . . . . . 27 Partial Lump Sum Payment (PLS) . . . . . . . . . . . . . . 32 Items That May Affect Your Pension .. . . . . . . . . . 34 Vested Retirement Benefit .. . . . . . . . . . . . . . . . . . . . 41 Disability Retirement Benefits . . . . . . . . . . . . . . . . . 43 Death Benefits .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 World Trade Center Presumption .. . . . . . . . . . . . . 57 Receiving Your Benefits .. . . . . . . . . . . . . . . . . . . . . . . . 58 How to Stay...

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Bank Bailouts and Sovereign Credit Risk - Carlson School

A Pyrrhic Victory? – 1 Bank Bailouts and Sovereign Credit Risk 2 3 Viral V. Acharya Itamar Drechsler NYU-Stern, CEPR and NBER NYU-Stern 4 Philipp Schnabl NYU-Stern J.E.L. Classification: G21, G28, G38, E58, D62. Keywords: financial crises, forbearance, deleveraging, sovereign debt, growth, credit default swaps First draft: August 2010; This draft: 6 December 2010 Preliminary and Incomplete 1 We are grateful to Isabel Schnabel (discussant) and seminar participants at Austrian Central Bank for helpful comments. Farhang Farazmand and Nirupama Kulkarni provided valuable research assistance. 2 Contact: Department of Finance, Stern School of Business, New York University, e-mail: vacharya@stern.nyu.edu. Acharya is also a Research Affiliate of the Centre for Economic Pol- icy Research (CEPR) and a Research Associate at the National

Bureau of Economic Research (NBER). 3 Contact: Department of Finance, Stern School of Business, New York University e-mail: Ita- mar.Drechsler@stern.nyu.edu. 4 Contact: Department of Finance, Stern School of Business, New York University e-mail: pschn- abl@stern.nyu.edu. A Pyrrhic Victory? – Bank Bailouts and Sovereign Credit Risk Abstract We develop a model in which financial sector bailout and sovereign credit risk are inti- mately linked. The bailout ameliorates the under-investment problem of the financial sector. However, as the bailout is ultimately funded through taxation of the future profits of the non-financial sectors, it weakens their incentives to invest. This can adversely affect the sovereign’s own credit risk which severely limits the size of the efficient bailout. In the short-run, the bailout is funded through issuance of government bonds, which erodes the value of existing bonds, including those held by the financial sector and potentially creates a “crisis spiral”. The model provides testable implications concerning the relation between the credit risk of the sovereign and its financial sector before the crisis, around the bailout announcement, and post-bailout. We provide supporting empirical evidence using data from the credit default swaps (CDS) market around the bailouts and bank stress tests conducted during the financial and sovereign crises of 2007-10. J.E.L. Classification: G21, G28, G38, E58, D62. Keywords: financial crises, forbearance, deleveraging, sovereign debt, growth, credit de- fault swaps 1 1 Introduction On September 30, 2008 the government of Ireland announced that it had guaranteed all deposits of the six of its biggest banks. The immediate reaction that grabbed newspaper headlines the next day was whether such a policy of a full savings guarantee was anti- competitive in the Euro area. However, there was something deeper manifesting itself in the credit default swap (CDS) markets for purchasing protection against the sovereign credit risk of Ireland and that of its banks. Figure 1 shows that while the cost of purchasing such protection on Irish banks – their CDS fee – fell overnight from around 400 basis points to 150 basis points, the CDS fee for the Government of Ireland’s credit risk rose sharply. Over the next month, this rate more than quadrupled to over 100 basis points and within six months reached 400 basis points, the starting level of its financial firms’ CDS. While there was a general deterioration of global economic health over this period, the event-study response in Figure 1 makes it clear that the...

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Statement of Financial Accounting Standards No. 159 - FASB

Statement of Financial Accounting Standards No. 159 The Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB Statement No. 115 NO. 289-A FEBRUARY 2007 Financial Accounting Series Financial Accounting Standards Board of the Financial Accounting Foundation For additional copies of this Statement and information on applicable prices and discount rates contact: Order Department Financial Accounting Standards Board 401 Merritt 7 PO Box 5116 Norwalk, Connecticut 06856-5116 Please ask for our Product Code No. S159. FINANCIAL ACCOUNTING SERIES (ISSN 0885-9051) is published monthly by the Financial Accounting Foundation. Periodicals—postage paid at Norwalk, CT and at additional mailing offices. The full subscription rate is $205 per year. POSTMASTER: Send address changes to Financial Accounting Standards Board, 401

Merritt 7, PO Box 5116, Norwalk, CT 06856-5116. Summary Why Is the FASB Issuing This Statement? This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the Board’s long-term measurement objectives for accounting for financial instruments. What Is the Scope of This Statement—Which Entities Does It Apply to and What Does It Affect? This Statement applies to all entities, including not-for-profit organizations. Most of the provisions of this Statement apply only to entities that elect the fair value option. However, the amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. Some requirements apply differently to entities that do not report net income. The following are eligible items for the measurement option established by this Statement: 1. Recognized financial assets and financial liabilities except: a. An investment in a subsidiary that the entity is required to consolidate b. An interest in a variable interest entity that the entity is required to consolidate c. Employers’ and plans’ obligations (or assets representing net overfunded positions) for pension benefits, other postretirement benefits (including health care and life insurance benefits), postemployment benefits, em- ployee stock option and stock purchase plans, and other forms of deferred compensation arrangements, as defined in FASB Statements No. 35, Accounting and Reporting by Defined Benefit Pension Plans, No. 87, Employers’Accounting for Pensions, No. 106, Employers’Accounting for Postretirement Benefits Other Than Pensions, No. 112, Employers’ Accounting for Postemployment Benefits, No. 123 (revised December 2004), Share-Based Payment, No. 43, Accounting for Compensated Absences, No. 146, Accounting for Costs Associated with Exit or Disposal Activities, and No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, and APB Opinion No. 12, Omnibus Opinion—1967 d. Financial assets and financial liabilities recognized under leases as defined in FASB Statement No. 13, Accounting for Leases (This exception does not apply to a guarantee of a third-party lease obligation or a contingent obligation arising from a cancelled lease.) e. Deposit liabilities, withdrawable on demand, of banks, savings and loan associations, credit...

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Financial Accounting Advisory Services - Ernst & Young

Ernst & Young Financial Accounting Advisory Services 1 Ernst & Young Financial Accounting Advisory Services Has never been more relevant to the market Ernst & Young Financial Accounting Advisory Services2 Ernst & Young Financial Accounting Advisory Services 3 Contents Financial Accounting Advisory Services ......................................................... 4 Scope and significance of Financial Accounting Advisory Services ................... 5 Why Financial Accounting Advisory Services is crucial to your business ........... 5 How you will benefit from Financial Accounting Advisory Services ................... 5 Ernst & Young key contacts. .......................................................................... 7 Ernst & Young Financial Accounting Advisory Services4 Financial Accounting Advisory Services All about the best people delivering focused and relevant services in an evolving business environment Around the world, the journey to success is governed

by increasingly complex and broadening regulatory requirements and stakeholder demands. Company reporting is entering beyond traditional financial statements, with organisations now confronted with complex changes like GAAP conversions, mergers and acquisitions, carveouts and IPOs that often require specialised accounting advice. You will need a tailored service and a consistent methodology to address these needs. Our methodology gives you the benefits of deep sector knowledge and the latest insights built on worldwide professional experience and expertise. Ernst & Young’s Financial Accounting Advisory Services delivers insightful solutions to its clients. Ernst & Young Financial Accounting Advisory Services 5 Scope and significance of Financial Accounting Advisory Services Financial Accounting Advisory Services is a part of our Assurance service line. It is streamlined to provide assistance on critical issues resulting from changes in accounting standards and regulatory requirements. This includes financial accounting advice covering: 1. GAAP conversion support 2. Transaction accounting 3. Financial reporting advice 4. Capital markets assistance (Including IPO) 5. Accounting and regulatory support 6. Accounting processes and controls support 7. Accounting compliance and reporting assistance 8. On-call financial reporting advice Why Financial Accounting Advisory Services is crucial to your business Enterprises are facing more risks and challenges, particularly in light of the increased complexities resulting from the ongoing changes and updates to the International Financial Reporting Standards (IFRS) and regulatory requirements. Ongoing changes and updates to IFRS and regulatory requirements will impact many aspects of your business operations, including financial reporting compliance and information technology that supports your financial reporting structure. The system and policy changes and modification process of this scale can generate new risks and challenges that your organization may need to monitor and control. This environment makes the role of Ernst & Young’s Financial Accounting Advisory Services more significant than ever before. Ernst & Young’s Financial Accounting Advisory Services professionals have a breadth of experience to deliver relevant business and industry insights to you. Through our commitment to thinking and being progressive, we strive to meet your needs in tune with the changes in the business environment that has a telling impact on your businesses operation and success. How you will benefit from Financial Accounting Advisory Services GAAP conversion support Financial Accounting Advisory Services extends full support for GAAP conversion and implementation by developing effective conversion and implementation plans. These include diagnostic reviews, selection of accounting policies, full conversions and advice on specific areas during a GAAP conversion,...

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