FAS 133 “Show-Me” Survey

Background

FinancialCAD®, which provides financial instrument management software and online application services to some 2400 companies, began its FAS 133 development efforts in 1998 when one of its clients, Ernst & Young, approached the vendor (as well as several others) for help in developing a system that could test the reasonableness of their client derivative valuations as required by FAS 133. Eventually, E&Y became FinancialCAD's first corporate user of their FAS 133 technology.

Joining the FAS133.com survey universe in May of 2000, FinancialCAD® provides FAS 133 functionality via The Perfect Hedge®, a secure online FAS 133 Audit Support business application. Delivered as an application service, users can access the company's product without actual software deployment. The ASP (application service provider) model allows for easy updating and quick distribution of new functionalities - a quality deemed critical in the ever-changing FAS 133 arena (with DIG issues as well as amendments). For more about The Perfect Hedge, visit http://www.fincad.com/.

“Show-Me” Survey

The first vendor to send in its response, FinancialCAD® has provided a nearly complete set of responses. The only missing component in the output table is fair value data for the FX option. At the time of the survey (December 2000), The Perfect Hedge was still missing some data related to option valuation. Indeed, its original "data" relationship was also the reason it could not price the four transactions based on the historical time series in the original input tables. (Nearly all vendors, with the exception of Open Link, reported the same hurdles; see main analysis).

However, by January 2001, according to Fred Balcom, product manager at FinancialCAD® the vendor has forged a new relationship with a different data provider, and now has historical as well as option data. Swap rates, for instance, go back 10-12 years. A January 31 release of The Perfect Hedge will therefore include FX options, interest rate caps and floors as well as amortizing bonds and other new instruments. "That's why we like the ASP model so much," Mr. Balcom noted, "since it allows us to deliver upgrades instantaneously, as FAS 133 gets amended and things change."

Another missing output is the pricing information for the end-dates for the transaction set. According to Mr. Balcom, the system priced the deals with actual data from the time periods chosen, "because this is what you would need to do in a "real hedge." This approach, Mr. Balcom says, appears to make the most sense and produce more consistent numbers. "Because my termination date is in the future, no values are available for that date."

(Obviously, the system can price both on a current and historical basis. Hence the fair values are acceptable, and illustrate the system's FAS 133's readiness. Note, however, that other vendors chose a different approach; some decided to "turn the clock" forward providing fair value for each accounting period, including termination with OCI and GL entries - for example, see INSSINC - and others used the forward rate to provide pricing input for the future periods. While FinancialCAD® approach is valid, we consider the fuller responses more complete.)

FinancialCAD's response is based on the following set of assumptions (all of which are straightforward and based on market practice).

1. While the infrastructure is in place, the system did not have market data prior to December 31, 1999.  In an effort to support "real" calculations, the following pricing dates were used: 
   1. Date 1 (Inception): February 1, 2000
   2. Date 2 (Intermediate): May 1, 2000
   3. Date 3 (First repricing date): August 1, 2000
   4. Date 4 (Second repricing date): November 1, 2000
2. Consistent with the pricing dates asked for, the maturity dates (end date) of the transactions have been adjusted appropriately as a function of the inception date.  For example, the interest rate swaps have a tenure of four years (meaning they will mature on February 1, 2004), while the forward and option contracts have a tenure of one year each, and will mature on February 1, 2001.  In being consistent with these durations, this also means that there will be no ending values generated for these derivatives
3. Analytical assumptions related to swaps:
   1. All unknown reset rates are assumed to be 6%
   2. All day count fractions are assumed to be actual/360
   3. All business day conventions are assumed to be modified following business day
   4. All pricing is done at using end-of-day mid-market rates
   5. Curves are constructed using the 1, 3, 6, and 9 month deposit rates (which are compounded on a simple interest basis and accruing on an actual/360 basis) and the 1 to 10 year par swap rates (which are compounded on a semi-annual basis with 30/360 compounding)
   6. The bootstrapping methodology employed is to interpolate from rates and bootstrap assuming a linear par yield rate profile
4. Analytical assumptions related to forwards:
   1. It was assumed that the contract rate that was locked in was the current spot rate at the time the contract was entered into (February 1, 2000)
   2. It was assumed that the full contract amount ($100,000,000) was denominated in Euros

General Output Table

Documentation

1. Historical Interest Rate Curve for February 1, 2000
2. Historical Interest Rate Curve for May 1, 2000 (the actual repricing date of May 1. 2000 falls on a day where no curve was available)
3. Historical Interest Rate Curve for August 1, 2000
4. Historical Interest Rate Curve for November 1, 2000
5. Detailed Historical Report for a Swap
6. Drill-down into a Swap Leg
7. Detailed Report for an Underlying
8. FX Forward Report
9. Fair Value Hedge Details | Continued
10. Hedge Effectiveness Details
11. Supporting Documentation (Effectiveness Methodology)
12. Portfolio Mark-to-Market
13. Portfolio Value-at-Risk | VaRb

DISCLAIMERS: The questions and qualitative narratives contained in this survey do not constitute accounting advice nor the determination of the ability to successfully complete an audit. Those requiring a professional assessment of suitability for accounting and/or audit purposes must rely on professionally qualified auditors and accountants. The questions and answers incorporated in this survey are not intended to reflect transactions that necessarily qualify for FAS 133 treatment. However, the questions were prepared with the assumption that the selected transesentative of common corporate risk management practices and suitable for some degree of systems processing in a manner meant to be consistent with FAS 133. The respondent alone retains the responsibility for determining what transactions are contained within his or her system or software solution and the degree of systems automation provided for any one transaction. WITH REGARD TO INFORMATION RELATED TO THIS SURVEY, WE DISCLAIM ALL EXPRESS WARRANTIES AND ALL DUTIES, OBLIGATIONS, AND WARRANTIES IMPLIED BY LAW, INCLUDING, BUT NOT LIMITED TO, IMPLIED WARRANTIES OF MERCHANTABLITY AND FITNESS FOR A PARTICULAR PURPOSE.

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