Bucketing Floating-Rate Bond Cash Flows for Banking-Book Interest Rate Risk
Summary
The document examines how floating-rate bonds should be represented in banking-book interest-rate risk calculations under a regulatory approach that treats cash flows through the next reset and places a par notional at a bucket near that reset. It asks how this rule applies to bonds with nonstandard coupons, including coupons based on averaged overnight rates or LIBOR plus a spread, where reset value may not equal par under the stated discounting assumptions.
It also asks how to assign cash flows to regulatory time buckets when coupon dates and maturity fall within or near bucket boundaries. A six-month coupon bond maturing in one year is used to raise whether the first payment should be assigned using its actual date or a bucket midpoint. The text provides questions rather than answers, calculations, or evidence; application depends on the relevant regulation and valuation conventions.
Key ideas
- The described regulatory treatment models floating-rate cash flows through the next repricing date and a notional reset near that date.
- The document questions whether nonstandard coupons justify assuming the bond resets to par.
- It asks how coupon and maturity cash flows should be assigned to regulatory time buckets.
- No calculation method or regulatory interpretation is provided to settle the questions.
Tags
Full text
# Interest rate risk calculation for Banking book # Interest rate risk calculation for Banking book There is a detailed discussions on the Interest rate risk for Banking book. For Floating rate bond, this states like below - > such positions generate cash flows that are not predictable past the next repricing date other than that the present value would be reset to par. Accordingly, such instruments can be treated as a series of coupon payments until the next repricing and a par notional cash flow at the time bucket midpoint closest to the next reset date bucket. Assume that, the regulator also defines the time buckets as `O/N, O/N-4m, 4m-9M, 9M-2Y, 2Y-10Y` etc. My questions are as below - - Let consider a non-standard floating rate bond with coupon payment frequency as `6-months`, which pays rate as average of `O/N` rates during the relevant period. Or, a bond which pays coupon based on `Libor` plus some spread. Typically, such bonds will be priced at Par only if coupon rate is same as discount rate. Therefore, for above bonds, how the statement "present value would be reset to par" will be valid? - How exactly the slotting onto time-bucket would happen in practice? Let say, the bond's coupon frequency is `6M` and matured at `1Y` from today. So the 1st coupon payment will fall on the slot of `4m-9M`. So to calculate the risk, should I assume, it's effective maturity is `4M` (as it is closer to the actual maturity of 6M)? Or the mid-point as 6.5m for all PV and other calculations? Any insight will be highly appreciated.
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