Integration

The system is currently only able to valuate basket options with the following properties:

European exercise type

Foreign exchange transactions as underlyings

The system can also valuate average spot basket options. The value of these options is not calculated on the basis of a spot at any one particular point in time, but rather by calculating average values over a time series. To create an average spot basket option, follow the procedure as defined below, but use the average spot basket option category of option. For more information about setting up a time series, see the Creating Average Spot Options document.

For more information about valuating basket options, see the Basket Options and Average Spot Options document in the Price Calculator documentation.

Procedure

Create the following hierarchy to display a basket option as a generic transaction: In the figure below you can see a basket option with three foreign exchange transactions used as underlyings.

Create the hierarchy as follows:

Create a new generic transaction. See Edit Generic Transaction for the procedure.

In the dialog structure, select the first elementary transaction and assign to it transaction form 061 (OTC option).

The system displays three tab pages.

Enter the following information on the Header Information tab page:

Start of term field.

Enter the start date for the term of the option.

End of term field.

Enter the due date for the option.

Purchase/Sale field

Enter whether the OTC option is a purchase or a sale.

The system interprets the OTC option as a purchase or a sale depending on the entries you make for the elementary transaction on the highest level of the hierarchy.

Enter the following information on the Cash Flow tab page:

Cash Flow Type field

Specify the type of the cash flow (for example, sale or purchase cash flow).

Due Date field

Specify when the premium payment for the option is due.

CF Amount field

Currency field

Currency of cash flow

Plus/Minus Sign field

Specify if the cash flow represents an in- or an outflow.

Enter the following information on the Option Information tab page:

Option Category field

Assign the option to the basket option category.

Exercise Type field

The system can currently only process basket options with a European exercise type.

Put/Call Indicator field

Select the Bermuda option as either a put option or a call option.

You must enter a term start date for the option, although it is not used by the price calculator for evaluation purposes.

Create a transaction with the transaction form 41 (foreign exchange) under the OTC option elementary transaction for the first elementary transaction at the second level. To do this, select the OTC Option elementary transaction in the dialog structure and choose Create Elementary Trans.: Next Level . Select the new elementary transaction and assign to it transaction form 41.

The system displays three tab pages. Specify two cash flows on the Cash Flow tab page that have different plus/minus signs. The ratio of the first cash flow to the second is equal to the strike rate.

Create another transaction with transaction form 41 (foreign exchange) under the second Foreign Exchange elementary transaction. Proceed as for step 3.

Create another transaction with transaction form 41 (foreign exchange) under the second Foreign Exchange elementary transaction. Proceed as for step 3.

Select Back and then Save

Result

You have created a basket option with an OTC option as an elementary transaction on the first level of the hierarchy, and three elementary transactions of the Foreign Exchange transaction form on the second level.

Example

A French firm carries out business in America, Australia, and Switzerland and wants to protect itself from a possible decline in foreign currencies. The amounts to be hedged are 24,600,000 USD, 12,300,000 AUD and 23,400,000 CHF. The company buys an basket put option at 50 billion euro that runs for over a year, and is due on 23.03.2005. The exchange rates in force at the time the option was concluded are agreed upon as the option’s strike price.

1.23 euro per US dollar

1.64 euro per Australian dollar

1.56 euro per Swiss Franc

Note that when creating a basket option as a generic transaction, the strike prices must be represented by two cash flows (one in euro, and one in the other respective foreign currency).