Financial Engineering Project Course

Lecture 3

• Object Oriented Design•Inheritance•Abstract Base Classes•Polymorphism

• Using XML to represent the swap agreement

• Lab Exercise – processing XML with JAXP

Using the Swap to transform a liability

Company A Company B

LIBOR

5%

5.2% LIBOR + 0.8%

Role of Financial Intermediary

Company A Company B

5.2% LIBOR + 0.8%

LIBOR 5.015%

LIBOR4.985%

FinancialInstitution

Source : John Hull

Class Name

Member data

Methods

SwapAgreement

double notional;double fixedRate;int numYears;int numPayments;

fixedCashFlow()floatCashFlow()

SwapAgreement

public class SwapAgreement {

double notional; double fixedRate; int numYears; int numPayments;

public SwapAgreement(double notional, double fixed, int years, int numPayments) { this.notional = notional; fixedRate = fixed / 100; numYears = years; this.numPayments = numPayments; } public double floatCashFlow() {

return (numYears / (double) numPayments) * Libor.getLIBOR()/100 * notional; }

public double fixedCashFlow() {

return (numYears / (double) numPayments) * fixedRate * notional;

}}

LIBOR

Static array of values

Static double getLibor()Static void nextLibor()

LIBORpublic class Libor {

//private static double values[] = { 4.2, 4.8, 5.3, 5.5, 5.6, 5.9, 6.4 }; private static int i = 0; private static double values[] = { 5.0, 5.0, 5.0, 5.0, 5.0, 5.0, 5.0 }; public static double getLIBOR() {

return values[i];

}

public static void next() {

i++; } public static void main(String a[]) {

System.out.println(Libor.getLIBOR()); }}

“is a” “is a”

InterestPayment

FloatInterestPayment FixedInterestPayment

loanAmountyearsnumPayments

abstract computeAmount

AbstractBaseclass

computeAmountuses LIBOR

basisPoints rate

computeAmountWorks with fixed rate

DerivedClasses

Abstract classesare incomplete.

InterestPaymentpublic abstract class InterestPayment {

private double loanAmount; private int years; private int numPayments;

public InterestPayment(double loanAmount, int years, int numPayments) {

this.loanAmount = loanAmount; this.years = years; this.numPayments = numPayments;

}

public abstract double computeAmount();

public double getLoanAmount() { return loanAmount; }

public int getYears() { return years; }

public int getNumPayments() { return numPayments; }

}

FloatInterestPaymentpublic class FloatInterestPayment extends InterestPayment {

private double basisPoints; public FloatInterestPayment(double loanAmount, int years, int numPayments, double basisPoints) {

super(loanAmount, years, numPayments); this.basisPoints = basisPoints;

}

public double computeAmount() {

double LIBOR = Libor.getLIBOR() / 100.0;

return getLoanAmount() *

( LIBOR + basisPoints * 0.01 * 0.01 ) *

(getYears() / (double)getNumPayments());

}

public static void main(String args[]) {

FloatInterestPayment f = new FloatInterestPayment(100, 1,

2, 80);

System.out.println(f.computeAmount());

}

}

FixedInterestPaymentpublic class FixedInterestPayment extends InterestPayment {

private double rate;

public FixedInterestPayment(double loanAmount, int years, int numPayments, double rate) {

super(loanAmount, years, numPayments); this.rate = rate / 100;

}

public double computeAmount() {

return getLoanAmount() * rate * (getYears() / (double)getNumPayments());

} public static void main(String args[]) {

FixedInterestPayment f = new FixedInterestPayment(100, 1, 2,10.0); System.out.println(f.computeAmount());

}}

“is a” “is a”

Party

FloatPayerParty FixedPayerParty

InterestPayment outside;SwapAgreement agreement;double balance;

abstract adjust()

AbstractBaseclass

Adjust() Adjust()

Fill in thedetails

constructor constructor

Party

FloatPayerParty FixedPayerParty

InterestPayment outside;SwapAgreement agreement;double balance;

abstract adjust()

Adjust() Adjust()

Calls outside.computeAmount()

Calls outside.computeAmount()

Party

FloatPayerParty FixedPayerParty

InterestPayment outside;SwapAgreement agreement;double balance;

abstract adjust()

Adjust() Adjust()

Calls outside.computeAmount()and asks the agreement in orderto adjust the balance

Partypublic abstract class Party {

protected InterestPayment outside; protected SwapAgreement agreement; private double balance;

public Party(InterestPayment i, SwapAgreement s) {

outside = i; agreement = s; }

public abstract void adjust();

public String toString() {

return "Balance = " + balance;

} void decreaseBalance(double x) { balance = balance - x; } void increaseBalance(double x) { balance = balance + x; }

}

FixedPayerPartypublic class FixedPayerParty extends Party {

public FixedPayerParty(InterestPayment i, SwapAgreement s) { super(i,s); }

public void adjust() {

// pay outside lender double pay = outside.computeAmount(); decreaseBalance(pay); // Pay counterParty LIBOR by decreasing balance // by the correct amount pay = agreement.floatCashFlow(); decreaseBalance(pay);

// Receive fixedRate amount agreed upon double get = agreement.fixedCashFlow(); }}

FloatPayerParty

public class FloatPayerParty extends Party {

public FloatPayerParty(InterestPayment i, SwapAgreement s) { super(i,s); }

public void adjust() {

// pay outside lender LIBOR + Points double pay = outside.computeAmount(); decreaseBalance(pay); // Receive counterParty LIBOR by adding to balance double get = agreement.floatCashFlow(); increaseBalance(get); // Pay fixedRate amount agreed upon pay = agreement.fixedCashFlow(); decreaseBalance(pay); }}

Simulatorpublic class Simulator {

public static void main(String a[]) {

SwapAgreement agree = new SwapAgreement(100, 5 , 3, 6 );

FloatInterestPayment floatpmt = new FloatInterestPayment(100,3,6,0);

FixedInterestPayment fixedpmt = new FixedInterestPayment(100,3,6,5);

FixedPayerParty fixedParty = new FixedPayerParty(fixedpmt,agree);

FloatPayerParty floatParty = new FloatPayerParty(floatpmt, agree);

for(int period = 1; period <= 6; period++) {

fixedParty.adjust(); floatParty.adjust(); System.out.println(floatParty); Libor.next(); } }}

OutputC:\McCarthy\Financial Engineering\FixedFloatSwap>java SimulatorBalance = -2.5Balance = -5.0Balance = -7.5Balance = -10.0Balance = -12.5Balance = -15.0

Role of Financial Intermediary

Company A Company B

5.2% LIBOR + 0.8%

LIBOR 5.015%

LIBOR4.985%

FinancialInstitution

Source : John Hull

Role of Financial Intermediary

Company A Company B

5.2% LIBOR + 0.8%

LIBOR 5.015%

LIBOR4.985%

FinancialInstitution

Source : John Hull

The Bank has twoagreements.

XML For the Agreement

<?xml version="1.0" encoding="UTF-8"?><!DOCTYPE FixedFloatSwap SYSTEM "FixedFloatSwap.dtd"><FixedFloatSwap> <Notional>100</Notional> <Fixed_Rate>5</Fixed_Rate> <NumYears>3</NumYears> <NumPayments>6</NumPayments></FixedFloatSwap>

A DTD For The Agreement

<?xml version="1.0" encoding="utf-8"?><!ELEMENT FixedFloatSwap (Notional, Fixed_Rate, NumYears, NumPayments) ><!ELEMENT Notional (#PCDATA) ><!ELEMENT Fixed_Rate (#PCDATA) ><!ELEMENT NumYears (#PCDATA) ><!ELEMENT NumPayments (#PCDATA) >

Reading the SwapAgreement with JAXP

import java.io.File;import org.w3c.dom.Document;import org.w3c.dom.NodeList;import org.w3c.dom.Node;import javax.xml.parsers.DocumentBuilderFactory;import javax.xml.parsers.DocumentBuilder;import org.xml.sax.SAXException;import org.xml.sax.SAXParseException;

public class Simulator2 { public static void main(String argv[]) { Document doc; if(argv.length != 1 ) {

System.err.println("usage: Simulator2 documentname"); System.exit(1);

} try { DocumentBuilderFactory docBuilderFactory = DocumentBuilderFactory.newInstance(); DocumentBuilder docBuilder = docBuilderFactory.newDocumentBuilder(); doc = docBuilder.parse(new File(argv[0])); Node top = doc.getDocumentElement();

if(top.hasChildNodes()) {

NodeList list = top.getChildNodes(); for(int i = 0; i < list.getLength();i++) { Node n = list.item(i); if(n.getNodeType() == Node.ELEMENT_NODE){ Node content = n.getFirstChild();

String s = content.getNodeValue();

System.out.println(s); } } } }

catch(SAXParseException err) { System.out.println("Parsing error" + ", line " + err.getLineNumber() + ", URI " + err.getSystemId()); System.out.println(" " + err.getMessage()); } catch(SAXException e) { Exception x = e.getException(); ((x == null) ? e : x).printStackTrace(); } catch (Throwable t) { t.printStackTrace(); } System.exit(0); }}

Lab Problem:

Execute the Simulator2 class on the SwapAgreement.xml file.