Mark-to-market: High-quality calculators and data generate successful valuation strategies

For treasurers of both large and small corporations, a key part of their workflow revolves around derivatives trading such as NDF swaps and foreign currency options. The prices of such instruments, however, fluctuate several times during the same day, making it difficult to calculate the company’s total exposure.

As the use of derivatives for hedging against FX and interest rate risks has increased , the nature of companies’ pricing practices has changed drastically and become quite complex. As a consequence, a major change was made in the traditional standards used to prepare financial statements — because of the increased need for fair value accounting models to make accurate valuation in companies.

The “fair value” model, also known as “mark-to-market (MtM),” is an accounting method that represents the fair value price for the financial instruments traded by treasurers. It is designed to show the current market value of such assets: how much would be obtained if the transaction were closed on a given day. Therefore, it seeks to present a realistic picture of the company’s financial situation at that specific time. Since it is more transparent, this information is highly valued in matters of compliance and regulation as it can be ascertained when an audit is done.

One of the biggest features of the futures market is the daily MtM price on all contracts. For exchange-traded assets, such as dollar futures, the closing price can be easily reported and retrieved every day on the stock exchange website. However, the exchange only offers contracts with predetermined default maturities, and a company certainly needs instruments with different dates tailored for its own trades. In this case, the company would have to adapt to the terms of the stock exchange, which would considerably hurt operations in general.

Automated tools prevent valuation risks

Performing simple derivative calculations to reach fair price via Excel may eventually involve complex formulas, and Excel is not the safest and most efficient tool for this function. The use of such software may lead to operational errors due to manual input, use of incorrect data and manipulation of information by third parties. All such risks may result in substantial differences in the pricing of derivatives and have a massively negative impact on the company’s audit process.

Furthermore, another aggravating factor in the use of Excel is in the pricing of more complex derivatives, such as swaps. In this case, the treasurer must add the prices of various curve inputs (e.g., interest in dollars, interest in real, etc.) to reach the fair price. In addition to involving the aforementioned risks, performing this type of calculation in Excel is extremely complicated and difficult to complete successfully. Consequently, the treasury department benefits much more by having the support of a tool that automatically calculates fair prices.

The importance of using high-quality data and calculators

Periods of intense market movement highlight the importance of getting constant market data updates — especially during times of significant price fluctuations. As companies become more aware of the hidden complexities inherent in traded financial instruments, access to and use of high-quality data will play an increasingly crucial role.

Using a solution that offers reliable data from the derivatives market, which then feeds high-quality calculators, generates a valuation output, which is MtM. Regulators and auditors, who always aim to increase transparency in the derivatives market, are adopting the best pricing practices for their financial instruments and avoiding negative points.

By having all the details of trades and calculators that generate MtM prices, the auditor has all the information from all steps used to construct and determine the price of a derivative. As a result, the process of challenging prices declines in difficulty and becomes more automated, generating greater efficiency for both involved parties.

How the Bloomberg Terminal can help you:

• Access a comprehensive library that provides pricing and risk assessments for derivatives and several other asset classes.
• Use pricing calculators with modeling techniques that take market dynamics into account.
• Access high-quality data that fuels reliable and powerful valuations.
• Get flexibility and transparency for market data and pricing and calculation models.
• Integrate with legacy systems.
• Generate custom reports.