The Federal Farm Credit Bureau (FFCB), based in Jersey City, NJ, is a major user of derivatives-no surprise, considering it serves a business in which the principal actors-farmers-routinely take long, hedged commodities positions on margin in a business with large fixed costs. FFCB, a government-sponsored enterprise not dissimilar to federally-chartered Fannie Mae, manages a portfolio with notational amounts of $23.6 billion at year-end 1996-$21 billion in interest rate swaps.

With such extensive, and often complex holdings, FFCB has been challenged to value options derived from its products. "We issue a lot of callable debt, and one of the things we need to do for our banks is value the option in the callable bond," says Bill Whitehead, FFCB's director of research. "They use that for their pricing, because if, say, they have a three-year loan with a pre-payment feature in it, they need to match off their assets and liabilities. This way they can call their debts if interest rates fall, and keep their balance sheet matched off."

To price and monitor the risks in these exposures, FFCB uses FinancialCAD's library of algorithms and other underlying derivatives mathematics. FFCB took on this service when several of its lending institutions requested a weekly report on the embedded call options in their loans to produce an estimate on their call costs. "We were running the analysis on determining the actual options costs and implied volatilities using the Bloomberg OAM-1 model, which is an on-screen model where you plug in all the bond (characteristics), which is time-consuming, and you get an answer back which is your spread over Treasuries," he says.

This turned into an enormous task for Whitehead and his staff, because it meant taking six steps for each of its 20 instruments. So when he saw an ad for FinancialCAD about a year ago and noticed the price had fallen from $1,500 to $395 for the whole package. "We said, 'What do we have to lose? We'll give it a shot.'"

"There's a bit of learning curve, because it's Excel-based, but it took me about a weekend to figure it out," Whitehead says. "It has a number of add-in models and you need to understand derivatives to understand which one to use to be able to design your spreadsheet and your solution. But they have some great utilities, like adding dates and interpolations."

This was quite valuable for Whitehead, because some call options have 367 days in them for arcane reasons connected to the call dates. Previously, he says, his Excel spreadsheets didn't handle the odd coupon- but FinancialCAD does-saving him time and effort. "I only had to plug in the dates, and it goes," he says.

Whitehead needed a system that would speed a time-consuming calculation process that had his people manually inserting dates and data to price new instruments. "We had to do this (weekly report) every Wednesday, and we just hated it."

But there were other spurs to his adopting FinancialCAD: His St. Paul, MN, bank had been using the system, and Whitehead had a live feed installed in his department at the recommendation of one of the futures brokers he uses. The resulting daily demonstrations, he says, helped convince him to give FinancialCAD a trial run. That experience, he says, sold him on the system.

The advantages for Whitehead: "Cost and productivity," he says. "Doing this on a spreadsheet solved my problem of rolling my dates forward each week, so that as a result, where we were only pricing about 20 instruments per week before, we're now pricing about 40 or 45."

Whitehead says he began using FinancialCAD this past summer, and he's found it spreading through his department like ivy on an old farmhouse. "We're using it all over the place now," he says. "I have a whole list of things that I'm developing" for FinancialCAD applications. "We use it in our group here, and (with his member banks.)"

One example of how he uses it: FFCB had a set of 15-year bonds, three of them non-callable for ten years, that have call options due in about 12 to 18 months. FinancialCAD's interest rate swaptions calculators allowed Whitehead to design a synthetic call on the bond considerably ahead of the exercise date, so that if rates fell, he could lock in the value of the option, and price the value of the hedge. Whitehead also uses it to calculate forward rates for his member banks. Even Whitehead thinks that's smooth operating.

-reinbach tfn.com

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