Dodd-Frank Legislation
• Favors the use of Future-ized Swaps over OTC and Cleared Swaps.
• Mandates centralized clearing for standardized swap contracts,
including plain vanilla IRS instruments.
• Initial margin for futures is designed to cover a minimum one-day (2-
day HVaR) liquidation timetable, minimum five-day (5-day HVaR) for
cleared IRS, and 10-day for non-cleared IRS.
– Thus, Future-ized Swap contracts may be traded with an advantageous
capital requirement compared to alternatives.
• Strict margining and execution procedures for swaps have opened
the door to competing swap products on futures exchanges, directly
benefiting liquidity, capital efficiency, and compliance.
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2
Swap Future Contract Advantages
• Future-ized Swap contracts are intended to provide a liquid means
of managing rate exposure, offering the opportunity to trade actual
interest rate swaps on a forward basis with the financial protections
attendant to a standard futures contract.
• IMM expiration dates correspond with the normal expiration cycle of
CME Eurodollar futures contracts to provide a more precise hedge.
• The existence of a central limit order book on the exchange allows
end-users to access all sources of liquidity in one location; rather
than dealing with different dealers on different SEFs.
• Many investors and hedgers will get involved in the Future-ized
Swap market due primarily to margining advantages, but also strong
dealer support, a standardized contract, and lower block size limits.
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Dodd-Frank Mandated Exchange-Clearing:
Interest Rate Swaps vs. LIBOR-Based Futures
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Exchange Traded LIBOR Futures • Offering:
A. Inherent Dodd-0Frank-compliance- CCP-clearing & competitive execution
B. Total market transparency— bid/ask, size, actionable markets
C. Best-in-capital-markets Liquidity— universal access to all users
D. Maximum capital efficiency— D/F min 2-day HVaR margining
For interest rate hedging: use exchange-cleared LIBOR-based futures.
• Eligible risk transfer vehicles for interest rate hedging; cleared through best-in-class CME:
– 3-month LIBOR futures (“Eurodollar” futures)
– 2, 5, 7, 10 & 30-year flex-tenor LIBOR Swap futures (Eris Swap Futures)
– 2, 5, 10 & 30-year LIBOR Deliverable Swap Futures
• For fixed-rate amortizing loans, a combination of futures contracts required for best hedge accuracy.
• ***Cleared OTC Swaps—not futures—exist at substantially higher (~2x collateral) margins, require SEF execution, additional Dodd-
Frank compliance mandates, designed as non-dynamic, portfolio hedge vehicle PRIOR TO development of swap futures.
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Margin Savings
• Futures-style margining- approx. 65% lower than CME Cleared IRS – (Dodd-Frank compliant at 2-day HVaR margins vs. 5- or 10-day HVaR for non futures)
• Risk offsets (spread credits) against Eurodollar and Treasury
Futures – Margin offsets for options
• Eris and DSF swap futures clear CME- garnering risk offsets
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Eurodollar Futures
Packs and Bundles
• The simultaneous purchase or sale of a consecutive series of Eurodollar
contracts in equal proportions
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Underlying Eurodollar Time Deposit having a principal value of USD $1,000,000 with a three-month maturity. 3-month LIBOR Rate
Contract Size Notional Amount: $1,000,000. $25 per tick ($1,000,000 x (90/360) = $25).
Minimum Price Quoted in IMM Index Points. One-quarter of one basis point.
Price Fluctuation (Tick) (0.0025 = $6.25 per contract) in the nearest expiring contract month. One-half of one basis point (0.005 = $12.50 per contract) in all other contract months.
Contract Months March, June, September and December extending out 10 years (total of 40 contracts). Plus the four nearest serial expirations (months that are not in the March quarterly cycle).
Bloomberg Symbols EDA CMDTY CT <GO> EDSF <GO> MPAK <GO>
Last Trading Day IMM Dated. Second London bank business day prior to the third Wednesday of the contract month.
Final Settlement Cash settlement to 100 minus the British Bankers’ Association survey of 3-month LIBOR. Final settlement price will be rounded to four decimal places, equal to 1/10,000 of a percent, or $0.25 per contract.
Trading Hours CME Globex Electronic Markets: 6:00 p.m. to 5:00 p.m. ET Sunday – Friday
Eris Standard Swap Futures
Eris Standards: Quarterly Swap Futures
• Benchmark Contracts
– 2, 5, 7, 10, & 30 year contracts with quarterly effective dates that
coincide with IMM dates
– Liquidity, transparency, and efficiently of futures, but performance and
economics or an OTC IR swap
– Can be rolled or held to maturity as futures (no physical delivery)
– Large pool of dealers streaming markets
– Streaming quotes past the contract’s effective date
– 2-day Var margin through the maturity date
– Positions automatically net
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Eris Standard Swap Futures Specs
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Reference Tenors 2Y Stnd, 5Y Stnd, 7Y Stnd, 10Y Stnd, 30Y Stnd
Effective Dates Quarterly IMM Dates (3rd Wednesday of each March, June, September, December) for Expiration and Maturity
Contract Fixed Rate Predetermined rate set by Eris Exchange which will remain static throughout the life of the Contract. Determined just prior to quarterly listing. Multiple fixed rates may be predetermined and listed for IMM Date.
Pricing Convention Price = Swap NPV + Historical Fixed & Floating Payments + Synthetic Interest on Margins + Index Price of $100 Priced on a basis of 100, similar to market practice for bonds and other futures contracts. Unique pricing convention replicates OTC swap economics.
Contract Size 1 contract = 1 lot = $100,000 notional
Contract Specifics Tenor Minimum Per Contract Hedge Margin Block Size
30Y Stnd 1/50th point ($20.00) $5,200 100
10Y Stnd 1/100th point ($10.00) $1,750 100
7Y Stnd 1/100th point ($10.00) $1,400 100
5Y Stnd 1/200th point ($5.00) $1,150 100
2Y Stnd 1/500th point ($2.00) $400 100
Last Trading Day The last day on which the contract can be traded is the NY business day preceding the Maturity Date
Trading Hours Eris Exchange standard trading hours are currently 8:20 AM to 4:30 PM EST
Bloomberg Tickers Tenor Generic Current Contract
30 Y Stnd LIEA LIEZ5
10Y Stnd LIYA LIYZ5
7Y Stnd LIBA LIBZ5
5Y Stnd LIWA LIWZ5
2Y Stnd LITA LITZ5
Matching Algorithms FIFO © 2015 CME Group
Eris Flexible Swap Future
Eris Flexes: Date Flexible Swap Futures
• Customizable Contracts
– Effective date can be any business day up to 10 years out
– Maturity date can be any business day u to 30 years following the
effective date
– Yield curve granularity with accounting treatment of OTC swaps
– 5-day Var margin vs. 10=day Var for most OTC IR swaps
– Easy request for quote for contracts if not streaming
– Notional value = $100k per contract
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Deliverable Swap Future Specs
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Reference Tenors • 2, 5, 10, 30 Year
Delivery Months • Quarterly Cycle (March, June, Sept, Dec)
Contract Fixed Rate • Set by the CME before contract is listed for trading, as a rate per annum with 30/360 day count
fraction, at an integer multiple of 25bps (Current: 2yr 1.50%, 5yr 2.25%, 10yr 2.75%, 30yr 3.25%)
Price Basis • 100 points plus NPV of deliverable grade IRS
Contract Size • $1,000 per point ($100,000 Notional per contract)
Minimum Price Increment Reference Tenor Minimum Price Increment Approx DV01 Hedge
Per Contract Equivalent Margin
30-Year 1/32nd point ($31.25) 1/8 $5,200
10-Year ½ 1/32nd point ($15.625) 1/6 $1,750
5-Year ½ 1/32nd point ($15.625) 1/3 $1,150
2-Year ¼ 1/32nd point ($7.8125) 3/8 $400
Last Trading Day • Second London business day before 3rd Wed. of futures Delivery Month
Trading Hours • CME Globex 6:00 PM to 5:00 PM EST, Sun-Fri
• Trading in expiring futures terminates at 3:00 PM EST on Last Trading Day
Bloomberg Tickers Tenor Generic Current Contract
30-Year CBPA CBPZ5
10-Year CNPA CNPZ5
5-Year CFPA CFPZ5
2-Year CTPA CTPZ5
Matching Algorithms Outrights Calendar Spreads
FIFO (F) Pro Rata (K) © 2015 CME Group
Bullet & Synthetic Amortizing Swaps
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Fixed Income Group Models
HedgeBuilder
SwapBuilder
SwapMon
Monitors Best Bid/Ask by Yield
Defines Largest Actionable Size
Describes DV’01 & Convexity
HedgeBuilder: ED$-Based Swap Replication Software
Cash Flow and
Balance-Based
Eurodollar Strip
Construction
Liability-Side
Accounting
Description
Live Feed
Excel Platform
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SwapBuilder: “A Hedged Asset is a Match-Funded Asset”
Q: “Can we hedge the price of a less-liquid asset?”
A: No. Price is stochastic— a function of many demand inputs
Q: “Can we effectively hedge a less-liquid asset at all?”
A: Yes. Carry value is absolute. We can hedge the Net Interest Margin (NIM) to
the degree of accuracy that prepayment and default expectations may be
projected.
Q: “Why would we underwrite a less-liquid asset at all?”
A: Not all assets are created to be sold. Assets created with a market demand
price greater than internal value are generally sold. Assets that do not receive a
market price greater than value are retained— or, not made at all.
Asset originators are the arbiters of credit worthiness and credit valuation. Market acceptance of
“credit risk” is historically inconsistent in liquidity and price– “If you make it, be prepared to take it.”
Interest Rate Risk is readily priced and transferrable in most all market conditions.
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Input Proprietary Factor Ramp/UPBs or
Generate Cash Flows from Static Prepay Assumptions
(up to 30 separately defined pools simultaneously)
• Load Principal Mortality
Factors, Prepayment
Ramp or Static CPR
• Add WAC
• Add Pool Balance
• Add WAM & AM
• Calculate
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The Fixed Income Group maintains a vital “best-ex” presence on the trading floor to complement electronic execution for amortizing Eurodollar strips.
“Value” attributes of the pool are calculated:
Max Value at Market
Max Net Interest Margin (NIM) Present Value
Risk attributes of the loan pool are calculated and analyzed monthly
Partial/Monthly interest rate sensitivities for both liability and asset generated
Other hedge performance (Convexity, PAI, etc) attributes are imparted
Input Proprietary Factor Ramp/UPBs or Generate Cash Flows from Static Prepay Assumptions
(up to 30 separately defined pools simultaneously)
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Behind The Scenes- Risk Reversal
Hedge alternatives are cascaded through multiple optimization
routines
Best-Fit interest rate neutralization and synthetic match funding are
generated
Last Trade, Mid, Bid or Ask market levels (user defined) are
rechecked and final hedge amortization is defined
Real-time data and yield curve levels pulled through Bloomberg™ API
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Risk & Required Hedge Output
Existing Risk Defined
Existing Hedge Defined
Best Fit Hedge/Adjusted Defined
Required Transaction to
Neutralize to Best Fit Defined
Graphic Presentation to Illustrate
Excess Yield Curve Exposure
Numerical Risk Figures For
Loan Pool
DV’01 Hedge Contribution for
Each LIBOR Futures Position
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Initial Margin & Rate Shock
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Transaction Advice Email
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About R.J. O’Brien
• RJO has the size, resources and experience that you need in a global FCM.
– We are the 11th largest FCM in the United States as measured by Segregated Assets
• RJO has vast expertise across many markets.
– Agricultural Products
– Fixed Income
– Energies
– Metals
• Client Service is at the core of who we are.
– Unparalleled willingness and ability to provide customized solutions to our clients.
– High tech support throughout the life of the relationship for vetting new opportunities, strategic planning, and conflict resolution.
• Collaborative approach to risk management
– Working with RJO provided systems and staff to understand the entire picture, not just what the numbers present on the surface.
• RJO does not have a proprietary trading unit, eliminating the potential for conflicts.
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FIG – The Fixed Income Group
• The Fixed Income Group unified in 1997 at R.J. O’Brien.
• Our service is solely directed to institutional clients.
• Using exchange-traded futures and options, we design, execute, and clear hedge and derivative solutions at the request of our clients and the perceived needs of the industry.
• Current focus is motivated by Dodd-Frank mandates that necessitate traditional effectiveness but emphasize margin and compliance efficiency.
• FIG’s proprietary swap futures software optimizes for margin minimization, convexity maximizations, as well as arbitrage opportunities between the new Deliverable Swap Futures, Eris Swap Futures, and Eurodollar-based synthetic interest rate swap positions.
• Historically we focus on assets, portfolios, and businesses with significant non-linear risk profiles/asymmetric behavior and leverage: mortgage derivatives, adjustable rate mortgages, Jumbo, Alt-A & non-conforming credit, MSRs, IO, ABS, equipment leasing, structured financing/repo, vega immunization, synthetic swap/cap/floor/swaptions, rate lock…
• The FIG maintains a vital best-execution presence on the trading floor to handle option arbitrage, inter-market spreads and weighted “tailing” strategies –transactions that routinely result in less-efficient execution on electronic platforms.
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The Company Segregation of Customer Funds
• RJO does not engage in proprietary trading. The firm operates as an agency model
brokerage company which focuses all resources squarely on customers.
• Through our entire history, RJO has maintained proper segregation of all client
assets. In fact, we currently carry approximately $190 million in excess of what is
required by the Commodity Exchange Act.
• RJO invests customer assets within the guidelines of CFTC Rule 1.25 and in many
cases are even more conservative than the rule states.
• When customer segregated funds are deposited with a banking institution, the bank
signs a written acknowledgment stating it will not use the funds for anyone other than
the customer. RJO’s segregated customer funds are deposited principally at Harris
Bank, Wells Fargo, Fifth Third Bank, JPMorgan, and the various exchanges on which
RJO transacts business.
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Contact Information
Chicago Office 800.367.3349
Corrine Abele [email protected]
John Coleman [email protected]
Rob Powell [email protected]
Brian Rachwalski [email protected]
Dan Sobolewski [email protected]
Evan Vollman [email protected]
Sacramento Office 312.286.0491
Jeff Bauman [email protected]
Chicago Floor 800.367.3650
Rocco Chierici [email protected]
Rich Goldblatt [email protected]
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This material has been prepared by a sales or trading employee or agent of R.J. O’Brien and is, or is in the nature of, a solicitation.
This material is not a research report prepared by R.J. O’Brien’s Research Department. By accepting this communication, you agree that you
are an experienced user of the futures markets, capable of making independent trading decisions, and agree that you are not, and will not, rely
solely on this communication in making trading decisions.
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COMMUNICATION INDIRECTLY SHOULD INFORM THEMSELVES ABOUT AND OBSERVE ANY SUCH PROHIBITION OR
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NOT BE CONSIDERED A SOLICITATION.
The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable
investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results. Trading
advice is based on information taken from trades and statistical services and other sources that R.J. O’Brien believes are reliable. We do not
guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith
judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades.
Disclaimer
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