U.S. patent application number 13/685578 was filed with the patent office on 2013-08-29 for market-based view of probability of default.
This patent application is currently assigned to EXCHANGE HOLDINGS INC.. The applicant listed for this patent is EXCHANGE HOLDINGS INC.. Invention is credited to David G. Patterson, John T. Rickard, Annie Theriault.
Application Number | 20130226761 13/685578 |
Document ID | / |
Family ID | 44735779 |
Filed Date | 2013-08-29 |
United States Patent
Application |
20130226761 |
Kind Code |
A1 |
Patterson; David G. ; et
al. |
August 29, 2013 |
MARKET-BASED VIEW OF PROBABILITY OF DEFAULT
Abstract
Systems and methods are provided for providing a credit default
futures market. A system providing the credit default futures
market includes a processor, memory and an interface. The interface
is configured to display credit default futures contracts that
subscribe to a set of standard terms and conditions. The processor
is configured to settle certain credit futures contracts in kind
and other in cash, depending on, at least in part, the maturity
date of the futures contract. A method is presented for
electronically clearing and settling probability of default futures
contracts.
Inventors: |
Patterson; David G.;
(Toronto, CA) ; Theriault; Annie; (Oakville,
CA) ; Rickard; John T.; (Larkspur, CO) |
|
Applicant: |
Name |
City |
State |
Country |
Type |
EXCHANGE HOLDINGS INC.; |
|
|
US |
|
|
Assignee: |
EXCHANGE HOLDINGS INC.
Toronto
CA
|
Family ID: |
44735779 |
Appl. No.: |
13/685578 |
Filed: |
November 26, 2012 |
Related U.S. Patent Documents
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Application
Number |
Filing Date |
Patent Number |
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12783485 |
May 19, 2010 |
8321328 |
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13685578 |
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12186321 |
Aug 5, 2008 |
7970670 |
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12783485 |
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Current U.S.
Class: |
705/37 |
Current CPC
Class: |
G06Q 40/04 20130101 |
Class at
Publication: |
705/37 |
International
Class: |
G06Q 40/04 20060101
G06Q040/04 |
Claims
1-10. (canceled)
11. A method comprising: maintaining, by a computer, indications of
current trading prices of probability of default futures contracts
(PODs) relating to a reference entity, the PODs each having a
maturity date, the PODs each having first and second potential
settlement prices at the maturity date that are predetermined prior
to a beginning of a term of the POD, wherein at maturity one of the
first and second potential settlement prices is selected to be a
final settlement price of the POD based at least in part on
solvency of the reference entity, and wherein at maturity a final
settlement payment between a first party having a long position on
the POD and a second party having a short position on the POD is
determined based on the final settlement price, the first party and
the second party both being obligated to settle the POD at the
final settlement price via a payment of the final settlement
payment, the final settlement payment being paid by the first party
to the second party if the reference entity is insolvent at the
maturity date and the final settlement payment being paid by the
second party to the first party if the reference entity is solvent
at the maturity date; providing a market-based view of a
probability of default of the reference entity to participants in a
credit market, including communicating the current trading price of
the PODs for the reference entity to the market participants on at
least a daily basis, wherein the current trading price of the PODs
for the reference entity is indicative of the market-based view of
the probability of default for the reference entity.
12. The method according to claim 11, wherein the final settlement
price is determined to be 0 if the reference entity is insolvent at
the maturity date.
13. The method according to claim 11, wherein the final settlement
price is determined to be a face value of the POD if the reference
entity is solvent at the maturity date.
14. The method according to claim 11, wherein the traded price is
(1-(probability of default of the reference entity)) multiplied by
a face value of the contract.
15. The method according to claim 11, further comprising charging a
fee to the participants in the credit market for the market-based
view of the probability of default of the reference entity.
16. A method comprising: maintaining, by a computer, indications of
current trading prices of probability of default futures contracts
(PODs) relating to a reference entity, including, for each
probability of default futures contract (POD) receiving, by the
computer, a first trade order from a first party requesting a long
position on the POD, the POD having a maturity date, and the POD
having first and second potential settlement prices at the maturity
date that are predetermined prior to a beginning of a term of the
POD, receiving, by the computer, a second trade order from a second
party requesting a short position on the POD, matching, by the
computer, the first trade order with the second trade order,
recording on a computer readable storage medium, a completed
transaction, the completed transaction indicating the first trade
order, the second trade order, and a traded price, determining, by
the computer, a daily settlement price for the POD for each day of
trading of the POD, determining, by the computer, a daily
settlement payment between the first party and the second party
based on the daily settlement price, selecting one of the first and
second potential settlement prices to be a final settlement price
of the POD, the selecting being performed based at least in part on
solvency of the reference entity, determining, by the computer, a
final settlement payment between the first party and the second
party based on the final settlement price, the first party and the
second party both being obligated to settle the POD at the final
settlement price via a payment of the final settlement payment, the
final settlement payment being paid by the first party to the
second party if the reference entity is insolvent at the maturity
date and the final settlement payment being paid by the second
party to the first party if the reference entity is solvent at the
maturity date, and recording on a computer readable storage medium,
settlement of the POD at the final settlement price; and providing
a market-based view of a probability of default of the reference
entity to participants in a credit market, including communicating
the current trading price of the PODs for the reference entity to
the market participants on at least a daily basis, wherein the
current trading price of the PODs of the reference entity is
indicative of the market-based view of the probability of default
for the reference entity.
17. The method according to claim 16, wherein the final settlement
price is determined to be 0 if the reference entity is insolvent at
the maturity date.
18. The method according to claim 16, wherein the final settlement
price is determined to be a face value of the POD if the reference
entity is solvent at the maturity date.
19. The method according to claim 16, wherein the traded price is
(1-(probability of default of the reference entity)) multiplied by
a face value of the contract.
20. The method according to claim 16, further comprising charging a
fee to the participants in the credit market for the market-based
view of the probability of default of the reference entity.
21. The method according to claim 16, the method further comprises
recording a clearing house as a counterparty to both the first
party and the second party.
22. The method according to claim 16, further comprising settling
the POD in kind at a time prior to the maturity date.
23. The method according to claim 22, wherein settling the POD in
kind comprises settling the POD in kind based at least in part on a
comparison between the maturity date and an identified date.
24. The method according to claim 23, wherein settling the POD in
kind comprises settling the POD in kind when a difference between
the maturity date and the identified date is 3 years.
25. The method according to claim 22, wherein settling the POD in
kind comprises settling the POD into a series of PODs, each of the
series of PODs having a reference entity, a maturity date and a
final settlement price at the maturity date based at least in part
on solvency of the reference entity, none of the series of PODs
sharing a common maturity date.
26. The method according to claim 25, wherein settling the POD into
the series of PODs comprises settling the POD into a series of
PODs, each of the series of PODs having a quarterly maturity
date.
27. The method according to claim 25, further compromising settling
each of the series of PODs subsequent to one of the series of PODs
when the one of the series of PODs settles to 0.
28. A computer readable medium comprising computer readable
instructions that, as a result of being executed by a processor,
instruct the processor to perform a method, the method comprising:
maintaining, by a computer, indications of current trading prices
of probability of default futures contracts (PODs) relating to a
reference entity, including, for each probability of default
futures contract (POD) receiving, by a computer, a first trade
order requesting a long position on a probability of default
futures contract (POD), the POD having a reference entity and a
maturity date, the POD having first and second potential settlement
prices at the maturity date that are predetermined prior to a
beginning of a term of the POD; receiving, by the computer, a
second trade order from a second party requesting a short position
on the POD; matching, by the computer, the first trade order with
the second trade order; recording, on a computer readable storage
medium, a completed transaction, the completed transaction
indicating the first trade order, the second trade order, and a
traded price; determining, by the computer, a daily settlement
price for the POD for each day of trading of the POD; determining,
by the computer, a daily settlement payment between the first party
and the second party based on the daily settlement price; selecting
one of the first and second potential settlement prices to be a
final settlement price of the POD, the selecting being performed
based at least in part on solvency of the reference entity;
determining, by the computer, a final settlement payment between
the first party and the second party based on the final settlement
price, the first party and the second party both being obligated to
settle the POD at the final settlement price via a payment of the
final settlement payment, the final settlement payment being paid
by the first party to the second party if the reference entity is
insolvent at the maturity date and the final settlement payment
being paid by the second party to the first party if the reference
entity is solvent at the maturity date; and recording on a computer
readable storage medium, settlement of the POD at the final
settlement price. providing a market-based view of a probability of
default of the reference entity to participants in a credit market,
including communicating the current trading price of the PODs for
the reference entity to the market participants on at least a daily
basis, wherein the current trading price of the PODs of the
reference entity is indicative of the market-based view of the
probability of default for the reference entity.
29. The method according to claim 28, wherein the final settlement
price is determined to be 0 if the reference entity is insolvent at
the maturity date.
30. The method according to claim 28, wherein the final settlement
price is determined to be a face value of the POD if the reference
entity is solvent at the maturity date.
31. The method according to claim 28, wherein the traded price is
(1-(probability of default of the reference entity)) multiplied by
a face value of the contract.
32. The method according to claim 28, further comprising charging a
fee to the participants in the credit market for the market-based
view of the probability of default of the reference entity.
33. The method according to claim 28, the method further comprises
recording a clearing house as a counterparty to both the first
party and the second party.
34. The method according to claim 28, further comprising settling
the POD in kind at a time prior to the maturity date.
35. The method according to claim 34, wherein settling the POD in
kind comprises settling the POD in kind based at least in part on a
comparison between the maturity date and an identified date.
36. The method according to claim 35, wherein settling the POD in
kind comprises settling the POD in kind when a difference between
the maturity date and the identified date is 3 years.
37. The method according to claim 34, wherein settling the POD in
kind comprises settling the POD into a series of PODs, each of the
series of PODs having a reference entity, a maturity date and a
final settlement price at the maturity date based at least in part
on solvency of the reference entity, none of the series of PODs
sharing a common maturity date.
38. The method according to claim 37, wherein settling the POD into
the series of PODs comprises settling the POD into a series of
PODs, each of the series of PODs having a quarterly maturity
date.
39. The method according to claim 37, further compromising settling
each of the series of PODs subsequent to one of the series of PODs
when the one of the series of PODs settles to 0.
Description
CROSS REFERENCE TO RELATED APPLICATION
[0001] The present application is a continuation of U.S. Ser. No.
12/783,485 entitled ELECTRONIC BOND RECOVERY RATE FUTURES MARKET,
filed May 19, 2010, now U.S. Pat. No. 8,321,328, which is a
continuation in part of U.S. Ser. No. 12/186,321 entitled
ELECTRONIC CREDIT DEFAULT FUTURES MARKET, filed Aug. 5, 2008, now
U.S. Pat. No. 7,970,670, the entire contents of both of which are
hereby incorporated by reference in their entirety.
BACKGROUND
[0002] Aspects of the present inventions relate to methods and
systems useful for electronic brokerage services and, more
particularly, to methods and systems for providing an electronic
market for futures contracts and associated instruments.
[0003] Buyers and sellers of various financial instruments
currently transact business within a variety of established
markets. Some of these established markets are over the counter
markets that operate using voice or electronic communication among
trading desks, some are traditional, brick and mortar exchanges
with a trading floor, and others are virtual, electronic
exchanges.
[0004] A particular example of an over the counter market is the
current market for credit default swaps (CDSs) and other related
instruments such as fixed recovery CDS and recovery locks (also
referred to as recovery default swaps (RDS)). A credit default swap
is a contract between a buyer and a seller which shifts the
financial risk that a reference entity may experience a credit
default event from the buyer to the seller. In exchange for
assuming this risk, the seller receives some form of consideration
from the buyer, such as periodic cash payments or the combination
of an upfront cash payment and standardized periodic cash payments.
In addition to the default risk, the seller of CDS also has
exposure to the recovery rate of the underlying bond since the loss
on default will depend on the amount recovered for the bond. Fixed
recovery CDS shift some of this risk back to the buyer of the CDS
as they function exactly like ordinary CDS with the exception of
having a fixed recovery rate that is a pre-specified percent of
notional negotiated by the counterparties at inception. The
seller's obligation in a CDS, whether it is a regular CDS or a
fixed recovery CDS, is triggered if the reference entity defaults
on a credit obligation, such as by entering bankruptcy.
[0005] A recovery lock is an over-the-counter instrument that
allows traders to lock-in or speculate on the recovery rate on the
obligations of a corporation or government entity upon the
occurrence of a credit event. Upon the occurrence of a credit
event, either the buyer or the seller will have an obligation to
pay its counterparty, depending on the difference between the
realized and fixed recovery rate. Typically, recovery locks are
structured such that no consideration is paid by either party at
any point during the term of the contract if the reference entity
does not experience a credit event.
[0006] Along with the three above mentioned over the counter credit
derivatives that consist the foundation of the over the counter
credit derivatives market, this market includes many other
financial instruments. Thus, the current over the counter credit
derivatives market provides sundry instruments for executing
financial tactics such as hedging and speculation.
[0007] Public markets also offer similar instruments or have
attempted to do so in the past. In particular, these products
include the CME credit event futures, the CBOE credit event binary
option and the Eurex credit futures. The CME credit event futures
are not currently offered for trading. They were futures contracts
that allowed the transfer of credit risk from buyer to seller on a
futures exchange without any consideration transferred from buyer
to seller at the outset of the trade. The gain or loss was made
based on the starting and final settlement price of the futures
contract, which was a function of both the state of the reference
entity and the recovery rate on the debt of the underlying
reference entity. The CBOE credit event binary options are option
contracts that allow buyers to obtain protection in the event of a
default by the reference entity or defaults by a basket of
reference entities in exchange for the upfront payment of a
premium. Upon the occurrence of one or more defaults, the contracts
are automatically exercised and provide a pre-determined cash
payoff to the buyer. Similar options are also offered on a basket
of reference entities, with payoffs occurring either upon each
occurrence or at expiration based on the default history of the
basket of reference entities. Lastly, the credit futures traded on
the Eurex are index futures linked to iTraxx.RTM.. The final
settlement value of these contracts are determined by the number of
names contained in the index, the default status of the reference
entities are determined by the ISDA.RTM. rules and the ISDA.RTM.
committee.
[0008] Together, these contracts provide some publically traded
instruments to move credit risk among participants on an exchange
facility.
[0009] There are related markets for the transfer of natural
catastrophe risk, where the final value of the instrument or the
payoff in the case of an option structure depend on the occurrence
of natural catastrophes such as hurricanes, earth quakes and
floods. Examples of such markets include the over the counter
markets for insurance or reinsurance swaps, catastrophe bonds (CAT
bonds) and industry loss warrants (ILWs) and the traditional
electronic market for insurance futures.
[0010] The over the counter markets for insurance or reinsurance
swaps, CAT bonds and ILWs function like the market for CDS and
related products. Insurance or reinsurance swaps are contracts
between a buyer and a seller that shift the financial risk from the
buyer to the seller in the event of the occurrence of a natural
catastrophe, as defined in the contract. In some cases, the mere
occurrence of the event is not the trigger, but rather payment from
the seller to the buyer may depend on the losses incurred as a
result of the event breaching a certain threshold. In exchange for
assuming this risk, the seller receives some form of consideration
from the buyer, such as periodic cash payments. Catastrophe bonds
are financial instruments where a buyer of the bond, an investor,
lends funds to the seller, typically an insurance company, in
exchange for periodic interest payments. In the event of a default
and, in some cases in the event that the losses realized by the
seller meets certain criteria such as exceeding a threshold, the
seller only returns a portion of the principal, if any remains
after the amount defined in the debenture is retained. CAT bonds
are also traded in the secondary market after they are issued. ILWs
are options on natural disasters. In exchange for a premium, a
buyer receives the right to a pre-defined payoff in the event that
a natural disaster causes a pre-specified amount of industry loss.
There are many variations on the exact terms and triggers of these
over the counter insurance products that allow market participant
to receive tailored or generic hedges and to speculate on
events.
[0011] Insurance futures are traded on exchanges such as the
Insurance Futures Exchange, and have a binary settlement value
determined by the occurrence of a natural catastrophe. The final
settlement value may also depend on the level of industry losses
caused by the natural catastrophe. For example, the Florida
Hurricane contracts traded on the Insurance Futures Exchange settle
at 100, in the event of a Florida hurricane causing more than $US
20 Billion in industry losses. Otherwise, if either no events occur
or if the event does not cause more than $US 20 Billion in industry
losses, the contract settles at 0.
SUMMARY
[0012] According to one embodiment, a method for exchanging credit
futures and bond recovery rate contracts is provided. The method
includes acts of receiving a first trade order requesting a long
position on a probability of default (POD.TM.) futures contract or
bond recovery rate (REC) futures contract, the POD.TM. futures or
the REC futures having a reference entity, a maturity date and a
settlement value at the maturity date based at least in part on the
solvency of the reference entity for both types of futures and also
on the realized recovery rate for the REC futures in the event of a
default for the reference entity, receiving a second trade order
requesting a short position on the POD.TM. futures or REC, futures
matching the first trade order with the second trade order and
recording, on a computer readable storage medium, a completed
transaction, the completed transaction indicating the first trade
order and the second trade order.
[0013] In the method, the act of receiving the first trade order
may include an act of receiving the first trade order from a first
party, and the method may further include an act of determining
whether the first party has sufficient resources to meet a margin
requirement for the position requested in the first trade order.
Moreover, the act of receiving the first trade order may include an
act of receiving the first trade order from a first party and the
act of receiving the second trade order may include an act of
receiving the second trade order from a second party. The method
may further include an act of recording a clearing house as a
counterparty to both the first party and the second party.
[0014] The method may further include an act of settling the
POD.TM. futures to zero or any other fixed amount, including a
value near zero, when the reference entity is insolvent at the
maturity date. Additionally, the method may include an act of
settling the POD.TM. futures to face value when the reference
entity is solvent at the maturity date. Similarly, the method may
include an act of settling the REC futures to zero, or any other
fixed amount, including a value near zero, when the reference
entity is solvent at the maturity date and an act of settling the
REC futures to the realized bond recovery rate value when the
reference entity is insolvent at the maturity date, the realized
recovery rate being determined either from public sources such as a
public auction or by a survey of market participants. Moreover, the
method may include an act of settling the POD.TM. futures or the
REC futures in kind at a time prior to the maturity date. The act
of settling the POD.TM. futures or the REC futures in kind may
include an act of settling the POD.TM. futures or REC futures in
kind based at least in part on a comparison between the maturity
date and an identified date. More particularly, the act of settling
the POD.TM. futures or REC futures in kind may include an act of
settling the POD.TM. futures or REC futures in kind when a
difference between the maturity date and the identified date is 3
years, or some other arbitrary time period.
[0015] In the method, the act of settling the POD.TM. futures or
REC futures in kind may also include settling the POD.TM. futures
or REC futures into a series of POD.TM. futures or REC futures
contracts, each of the series of POD.TM. futures or REC futures
contracts having a reference entity, a maturity date and a
settlement value at the maturity date based at least in part on
solvency of the reference entity for both types of futures and also
on the realized recovery rate for the REC futures in the event of a
default for the reference entity, none of the series of POD.TM.
futures or REC futures contracts sharing a common maturity date.
The act of settling the POD.TM. futures or REC futures into the
series of POD.TM. futures or REC futures contracts may include an
act of settling the POD.TM. futures or REC futures into a series of
POD.TM. futures or REC futures contracts with each of the series of
POD.TM. futures or REC futures contracts having a shorter time to
maturity than the contract exchanged, for example settling an
annual maturity contract into a series of quarterly maturity date
contracts. Further, the method may include an act of settling each
of the series of POD.TM. futures subsequent to one of the series of
POD.TM. futures when the one of the series of POD.TM. futures
settles to zero or any other fixed value, including a value near
zero. Similarly for REC futures, the method may include an act of
settling each of the series of REC futures subsequent to one of the
series of REC futures when one of the series of REC futures settles
to the realized recovery rate.
[0016] According to another embodiment, another method for
exchanging futures contracts is provided. The method includes acts
of recording, on a computer readable storage medium, a completed
transaction including at least one first trade order, at least one
second trade order and clearing the completed transaction using a
clearing house. In the method, the act of recording may include an
act of recording at least one first trade order that requests a
long position on a series of futures contracts, each of the series
of futures contact having at least one of reference entity and a
settlement value at a maturity date, the settlement value at the
maturity date being based at least in part on solvency of at least
one reference entity and also on the realized bond recovery rate
for the REC futures in the event of a default for the reference
entity, none of the series of futures contracts sharing a common
maturity date. Furthermore, the act of recording may include an act
of recording at least one second trade order that requests a short
position on the series of futures contracts.
[0017] In the method, the act of recording, on a computer readable
storage medium, a completed transaction may include an act of
recording at least one first trade order requesting a long position
on a series of POD.TM. futures or REC futures contracts.
Furthermore, the act of recording, on a computer readable storage
medium, a completed transaction may include an act of recording a
long position on a series of probability of default index futures
contracts or recovery index futures contracts. In addition, the act
of recording, on a computer readable storage medium, a completed
transaction may include an act of recording a long position on a
series of probability of default index tranche futures contracts or
on a series of recovery index tranche futures.
[0018] According to another embodiment, another method for
exchanging futures contracts is provided. The method includes acts
of receiving at least one first trade order requesting a long
position on a futures contract, the futures contract having a
binary reference event, a maturity date and a settlement value at
the maturity date, the binary reference event having two possible
outcomes and the settlement value at the maturity date being based
at least in part on which of the two possible outcomes occurs with
a time period ending at the maturity date and also potentially
being based on the value of a random variable contingent on the
occurrence of one of states of the reference event, receiving at
least one second trade order requesting a short position on the
series of futures contracts, matching at least one first trade
order with at least one second trade order and recording, on a
computer readable storage medium, a completed transaction
indicating at least one first trade order and indicating at least
one second trade order. The method may further include an act of
settling subsequent futures contracts of the series after one of
the two possible outcomes occurs.
[0019] According to another embodiment, a computer readable medium
comprising computer readable instructions that, as a result of
being executed by a processor, instruct the processor to perform a
method is provided. The method executed by the processor includes
acts of receiving a first trade order requesting a long position on
a POD.TM. futures contract or REC futures, the POD.TM. futures and
the REC futures having a reference entity, a maturity date and a
settlement value at the maturity date based at least in part on
solvency of the reference entity and the REC futures having a
settlement value also being based at least in part on the realized
bond recovery rate for the REC futures in the event of a default
for the reference entity, receiving a second trade order requesting
a short position on the POD.TM. futures, matching the first trade
order with the second trade order and recording, on a computer
readable storage medium, a completed transaction, the completed
transaction indicating the first trade order and the second trade
order.
[0020] According to another embodiment, a system providing a credit
futures contract and REC futures exchange is provided. The system
includes an order interface configured to receive trade requests
for positions on a futures contract, the POD.TM. futures and the
REC futures having at least one reference entity, a maturity date
and a settlement value at the maturity date based at least in part
on solvency of at least one reference entity and the REC futures
having a settlement value also being based at least in part on the
realized bond recovery rate for the REC futures in the event of a
default for the reference entity, a portion of the trade requests
being offsetting trade requests, an auction engine configured to
match the offsetting trade requests and store the offsetting trade
requests as completed transactions and a settlement engine
configured to settle at least a portion of the completed
transactions. In the system, the futures contract may include at
least one of a POD.TM. futures, a REC futures, a probability of
default index futures contract and a probability of default index
tranche futures contract.
[0021] According to another embodiment, a method for exchanging an
index of credit futures contracts or an index of bond recovery rate
contracts or an index of a combination of credit futures contracts
and bond recovery rate futures contracts is provided. The method
includes acts of receiving a first trade order requesting a long
position on one of the index contracts, the index having a
settlement value based at least in part on a plurality of POD.TM.
futures or REC futures contracts or a combination of POD.TM.
futures and REC futures contracts, receiving a second trade order
requesting a short position on the index, matching the first trade
order with the second trade order and recording, on a computer
readable storage medium, a completed transaction, the completed
transaction indicating the first trade order and the second trade
order.
[0022] The method may further include an act of settling the index
in kind at a time prior to a maturity date of the index. In the
method, the act of the index in kind comprises settling the index
in kind based at least in part on a comparison between the maturity
date and an identified date. Moreover, the act of settling the
index in kind may include an act of settling the index in kind when
a difference between the maturity date and the identified date is 3
years, or some other arbitrary time period. Additionally, the act
of settling the index in kind may include an act of settling the
index into a series of index contracts, each of the series of index
contracts having a settlement value based at least in part on a
plurality of POD.TM. futures or REC futures contracts or a
combination of POD.TM. futures and REC futures contracts, none of
the series of index contracts sharing a common maturity date.
[0023] Furthermore, the act of settling the index into the series
of index contracts may include an act of settling the index into a
series of index contracts, each of the series of index contracts
having a quarterly maturity date. The method may also include an
act of settling each of the series of index contracts subsequent to
one of the series of index contracts when one of the series of
index contracts settles to zero for an index of POD.TM. futures or
when one of the series of index contracts experiences sufficient
defaults to cause all of its members to be settled early for an
index of REC futures.
[0024] According to another embodiment, a method for exchanging a
tranche in an index of credit futures contracts or an index of bond
recovery rate futures contracts or an index of a combination of
credit futures contracts and bond recovery rate futures contracts
is provided. The method includes acts of receiving a first trade
order requesting a long position on the tranche, the tranche having
a settlement value based at least in part on a settlement value of
the index, receiving a second trade order requesting a short
position on the tranche, matching the first trade order with the
second trade order and recording, on a computer readable storage
medium, a completed transaction, the completed transaction
indicating the first trade order and the second trade order.
[0025] The method may further include an act of settling the
tranche in kind at a time prior to a maturity date of the tranche.
In the method, the act of settling the tranche in kind may include
an act of settling the tranche in kind based at least in part on a
comparison between the maturity date and an identified date.
Further, the act of settling the tranche in kind may include an act
of settling the tranche in kind when a difference between the
maturity date and the identified date is 3 years, or some other
arbitrary time period. Additionally, the act of settling the
tranche in kind may include an act of settling the tranche into a
series of tranche contracts, each of the series of tranche
contracts having a settlement value based at least in part on the
settlement value of the index, none of the series of tranche
contracts sharing a common maturity date. Moreover, the act of
settling the tranche into the series of tranche contracts may
include an act of settling the tranche into a series of tranche
contracts, each of the series of tranche contracts having a
quarterly maturity date. The method may also include an act of
settling each of the series of tranche contracts subsequent to one
of the series of tranche contracts when the one of the series of
tranche contracts settles to zero or to another fixed value, which
may be close to zero, for an index of POD.TM. futures or when one
of the series of index contracts experiences sufficient defaults to
cause all of its members to be settled early for an index of REC
futures or an index of a combination of POD.TM. futures and REC
futures contracts.
[0026] According to another embodiment, another method for
exchanging a series of futures contracts is provided. The method
includes acts of receiving a first trade order requesting a long
position on at least one of the series of futures contracts, the
series of futures contracts having a risk period substantially
equivalent to a risk period of a previously traded futures
contract, each of the series of futures contracts having a maturity
date, none of the series of futures contracts sharing a common
maturity date, receiving a second trade order requesting a short
position on at least one of the series of futures contracts,
matching the first trade order with the second trade order and
recording, on a computer readable storage medium, a completed
transaction, the completed transaction indicating the first trade
order and the second trade order. In the method, the act of
receiving a first trade order may include an act of receiving a
first trade order requesting a long position on at least one of the
series of futures contracts, each of the series of futures
contracts having a quarterly maturity date.
[0027] According to another embodiment, another method for
exchanging a series of futures contracts is provided. The method
includes acts of receiving a first trade order requesting a long
position on one of the series of POD.TM. futures contract,
receiving a second trade order requesting a long position on at
least one of the series of REC futures, both futures having
substantially the same risk period and the same underlying name,
matching the first trade order with the second trade order and
recording, on a computer readable storage medium, a completed
transaction, the completed transaction indicating the first trade
order and the second trade order. In the method, the act of
receiving a first trade order may include an act of receiving a
first trade order requesting a long position on at least one of the
series of futures contracts, each of the series of futures
contracts having a quarterly maturity date. Similarly, the method
may be applied to the case where short positions are taken for both
the REC futures and the POD.TM. futures.
[0028] According to another embodiment, another method for
exchanging a series of futures contracts is provided. The method
includes acts of receiving a first trade order requesting a long
position on one index of credit futures contract, receiving a
second trade order requesting a long position on at least one index
of bond recovery rate futures contracts, both futures having
substantially the same risk period and the same reference entities,
matching the first trade order with the second trade order and
recording, on a computer readable storage medium, a completed
transaction, the completed transaction indicating the first trade
order and the second trade order. In the method, the act of
receiving a first trade order may include an act of receiving a
first trade order requesting a long position on at least one of the
series of futures contracts, each of the series of futures
contracts having a quarterly maturity date. Similarly, the method
may be applied to the case where short positions are taken for both
the index of credit futures and the index of REC futures.
[0029] Still other aspects, embodiments, and advantages of these
exemplary aspects and embodiments, are discussed in detail below.
Moreover, it is to be understood that both the foregoing
information and the following detailed description are merely
illustrative examples of various aspects and embodiments, and are
intended to provide an overview or framework for understanding the
nature and character of the claimed aspects and embodiments. The
accompanying drawings are included to provide illustration and a
further understanding of the various aspects and embodiments, and
are incorporated in and constitute a part of this specification.
The drawings, together with the remainder of the specification,
serve to explain principles and operations of the described and
claimed aspects and embodiments.
BRIEF DESCRIPTION OF DRAWINGS
[0030] The accompanying drawings are not intended to be drawn to
scale. In the drawings, each identical or nearly identical
component that is illustrated in various FIG. s is represented by a
like numeral. For purposes of clarity, not every component may be
labeled in every drawing. In the drawings:
[0031] FIG. 1A is a block diagram of one example of a network
environment that includes a POD.TM. futures contract market
system;
[0032] FIG. 1B is a block diagram of another example of a network
environment that includes a POD.TM. futures contract market
system;
[0033] FIG. 2 is a visual representation of a logical architecture
of a PODM system according to one embodiment;
[0034] FIG. 3 is a flow chart of a process for settling POD.TM.
futures and REC futures contracts according to one embodiment;
[0035] FIG. 4 is a flow chart of a process for settling POD.TM.
index futures contracts and bond recovery rate index futures
contracts according to another embodiment;
[0036] FIG. 5 is a flow chart of a process for settling POD.TM.
index tranche futures contracts and bond recovery rate index
tranche futures contracts according to another embodiment;
[0037] FIG. 6 is flow chart of a process for forming a credit
default or bond recovery rate contract according to another
embodiment;
[0038] FIG. 7 is a flow chart of a process for receiving trade
orders of credit futures contracts or bond recovery rate contracts
according to an embodiment;
[0039] FIG. 8 is a flow chart of a process for matching trade
orders of credit futures contacts or bond recovery rate contracts
according to an embodiment;
[0040] FIG. 9 is flow chart of a process for clearing credit future
contract or bond recovery rate contract transactions according to
an embodiment;
[0041] FIG. 10 shows a general-purpose computer system upon which
various embodiments may be practiced;
[0042] FIG. 11 illustrates a storage device of a general-purpose
computer system suitable for implementing various embodiments;
and
[0043] FIG. 12 depicts a network of general-purpose computer
systems in which various embodiments may be practiced.
[0044] It will be recognized that some or all of the FIG.s are
schematic representations for purposes of illustration and do not
necessarily depict the actual relative sizes or locations of the
elements shown. The FIG.s are provided for the purpose of
illustrating one or more embodiments with the explicit
understanding that they will not be used to limit the scope or the
meaning of the claims.
DETAILED DESCRIPTION
[0045] As discussed below, aspects and embodiments disclosed herein
provide for a probability of default futures contract market (PODM)
system and methods that allow investors to trade credit and bond
recovery rate based futures contracts. The formulation of useful
systems and methods for managing these transactions is impacted by
the unique manner in which a PODM system may be structured and
organized. The credit based futures contracts may include
probability of default (POD.TM.) futures contracts, which may be
standardized in order to ease usage in a PODM system, and futures
contracts derived from POD.TM. futures, such as POD.TM. indexes
futures and POD.TM. index tranche futures. The bond recovery rate
based futures contracts may include the recovery rate (REC) futures
contracts, which may be standardized in order to ease usage in a
PODM system, futures contracts derived from REC futures, such as
REC index futures and REC index tranche futures, and futures
derived from combinations of POD.TM. futures and REC futures
contracts. Each of these credit futures contracts may have
specialized attributes that may make each suited for one or more
particular investment tactics, such as speculation or hedging, in
the context of a system built for PODM.
[0046] According to certain aspects of the present invention, a
facility is provided for trading of futures contracts with a
settlement value based at least in part on a binary reference event
or on the combination of a binary reference event and the value of
a random variable when one of the two potential outcomes occurs. A
binary reference event may be an event that is defined such that
the event has only two potential outcomes. As one example, a binary
reference event may be an event that occurs or does not occur
within a specified time frame. In some embodiments, a random
variable may be defined as any variable that determines the final
price of the futures contract and that is not pre-determined prior
to the occurrence or non-occurrence of the binary event. More
particularly, according to certain aspects, a facility allowing for
the trading of credit default futures and bond recovery rate
futures is provided. Various embodiments related to the provision
of these services can address or permit a variety of advantages to
allow trading these interests. For example, one embodiment provides
for the trading of standardized POD.TM. futures and other futures
contracts based thereon and for the trading of standardized REC
futures and other futures contracts based thereon. As is discussed
further below, POD.TM. futures and REC futures contracts allow
market participants to financially express their views on the
likelihood of default of a given reference entity over a specified
period of time and the REC futures also allow market participants
to financially express their views on the bond recovery rate in the
event of a default of a given reference entity over a specific
period of time. Certain other embodiments are directed toward
systems and methods for providing an electronic PODM system. A PODM
system may use software and hardware to provide buyers and sellers
of credit futures contracts and bond recovery rate futures
contracts a virtual exchange in which to transact trades. The PODM
system may include methods and facilities to match trade requests,
monitor investor positions and report information related to those
positions to interested entities. The PODM may also include a
clearing house function that provides a well established
counterparty to market participants.
[0047] For instance, the PODM system may provide an order request
interface to both buyers and sellers. This order interface may be
used by the buyers and sellers to post trade requests on the PODM
system. The PODM system may match offsetting order requests and
consummate transactions based on the matched orders. Additionally,
the PODM system may provide a facility for a market maker to
provide bids and offers in the market, thereby enhancing liquidity
for other market participants. Also, a clearing house function may
insert a clearing house as the buyer to every seller and as the
seller to every buyer. Consequently, in regards to clearing and
settlement, both of the original parties to the contract may be, in
fact, dealing with the central counterparty, with consideration and
performance flowing appropriately between all three parties
according to the rights and obligations of the contract.
[0048] Furthermore, the PODM system may maintain near real-time
indications of the current trading prices, such as bid prices and
ask prices, of various instruments, such as POD.TM. futures,
options and indexes. The PODM system may also maintain an
accounting of investor positions and may report this accounting
through various interfaces to external entities, such as users or
other systems, or may take other actions depending upon the PODM
system configuration. For instance, the PODM system may expose user
and system interfaces to summarized market data. This market data
may include trading volumes, futures contract prices and the
market's view on the probability of default of various reference
entities. This information may be provided to external entities, by
the administrator of the PODM system, in exchange for a fee.
[0049] The aspects disclosed herein, which are in accord with the
present invention, are not limited in their application to the
details of construction and the arrangement of components set forth
in the following description or illustrated in the drawings. These
aspects are capable of assuming other embodiments and of being
practiced or of being carried out in various ways. Examples of
specific implementations are provided herein for illustrative
purposes only and are not intended to be limiting. In particular,
acts, elements and features discussed in connection with any one or
more embodiments are not intended to be excluded from a similar
role in any other embodiments. Also, the phraseology and
terminology used herein is for the purpose of description and
should not be regarded as limiting. The use herein of "including,"
"comprising," "having," "containing," "involving," and variations
thereof is meant to encompass the items listed thereafter and
equivalents thereof as well as additional items.
[0050] According to one embodiment, a standard form of contract may
be provided for specification of a credit default futures contract.
One example of certain terms for a credit default futures contract
is explained with reference to Table 1a.
TABLE-US-00001 TABLE 1a Contract Description $1,000,000 in face
value of default exposure on a specific corporate, government,
institutional or financial entity (reference entity) for a specific
Risk Period, ending at 11:59 p.m. Greenwich Mean Time (GMT) on the
20th calendar day of the Settlement Month. A Reference Entity will
be declared to be in default if a Credit Event has occurred as
defined in section 4.1. of the 2003 Credit Derivatives Definitions
where section 4.2. (Bankruptcy) and section 4.5. (Failure to Pay)
shall only apply. Contract Name "[Entity name] probability of
default (POD .TM.) futures" Final Settlement Price Contracts will
settle with a final settlement price of zero (0) if there has been
a Credit Event or at one hundred (100) if there has been no Credit
Events. Since the contract size is $1,000,000 the price will be
multiplied by $10,000 to obtain the value of the contract. Tick
Size Minimum price fluctuations will be .01. A tick of .01 will
represent $100 of value. Multiplier $10,000 Contracts Listed
Contracts expiring quarterly for three years: March, June,
September, December; and contracts expiring annually for 7
additional years: December ("Settlement Month") Risk Period 1.
Quarterly Contracts A period of one quarter beginning at 12:00 am
(GMT) on the 21st calendar day of the month that is 3 months before
the Settlement Month and ending at 11:59 pm (GMT) on the 20th
calendar day of the Settlement Month. Annual Contracts A period of
one year beginning at 12:00 am (GMT) on the 21st calendar day of
the month that is 12 months before the Settlement Month and ending
at 11:59 pm (GMT) on the 20th calendar day of the Settlement Month.
Last Trading Day Trading terminates upon the earlier of the Credit
Event Determination Date or the close of business on the 20.sup.th
calendar day of the Settlement Month. If the 20.sup.th calendar day
of the Settlement Month is a non-business day, trading shall cease
on the last business day preceding the 20.sup.th calendar day of
the settlement month. Credit Event Determination Date The Credit
Event Determination Date will be the third business day following
the earlier of (a) the announcement of the occurrence of a Credit
Event on the exchange's website or (b) the 20th calendar day of the
Settlement Month. The Credit Event Determination Date may be
postponed ("Postponement") by up to four additional business days
if the exchange is not satisfied of the state of the Reference
Entity by 9:15 p.m. (GMT). In the event of a Postponement, the
Credit Event Determination Date will be the Date on which a final
determination is announced by the exchange. Under special
circumstances ("Special Circumstances"), the exchange may delay the
Credit Event Determination Date until a conclusive determination
can be made. Settlement Day The next business day following the
Credit Event Determination Date. Trading Hours Electronic Trading
from 6:30 pm to 4:00 pm (New York time) time Sunday to Friday. For
expiring contracts last trade on the last trading day will be at
12:00 noon (New York time). Settlement Procedure 1. Credit Event
Upon the declaration of a Credit Event for the Reference Entity,
the exchange will post an announcement on its website. This
determination is considered preliminary. Any evidence to the
contrary must be presented to the exchange by 5:00 p.m. (GMT) on
the Credit Event Determination Date. Under normal circumstances,
the final determination of the exchange shall be made by 9:15 p.m.
(GMT) and a cash settlement shall occur on the following business
day if it is determined that a Credit Event did occur or if the
contract has expired. In the event of a Postponement, the final
determination shall be announced by the exchange as soon as a
decision is reached and a cash settlement shall occur on the
following business day if it is determined that a Credit Event did
occur or if the contract has expired. 2. No Credit Event If no
Credit Event is declared by the exchange by the 20.sup.th calendar
day of the Settlement Month at 11:59 p.m. (GMT), the exchange will
post on its website the determined final settlement price of the
expiring contract to be one hundred (100). This determination is
considered preliminary. Any evidence to the contrary must be
presented to the exchange by 5:00 p.m. (GMT) on the Credit Event
Determination Date. Under normal circumstances, the final
determination of the exchange shall be made by 9:15 p.m. (GMT) and
a cash settlement shall occur on the following business day. In the
event of a Postponement, the final determination shall be announced
by the exchange as soon as a decision is reached and a cash
settlement shall occur on the following business day. 3. Special
Circumstances A ruling may be delayed if a conclusive determination
cannot be made by the seventh business day at 9:15 p.m. (GMT)
following the announcement of a Credit Event. If the contract has
expired, a new contract would be issued for the purpose of position
transfer. The final determination shall be announced by the
exchange as soon as a decision is reached and a cash settlement
shall occur on the close of business on the day following the
Credit Event Determination Date. Early Settlement: All later
contracts in any series of contracts will immediately settle at 100
if any early contract in the series settles at zero. Settlement
Procedure for Annual Contracts: Annual contracts will settle on the
delivery date with three years to final maturity. They will settle
in kind, with both long and short positions delivering four
quarterly equivalent contracts each at the following function of
the last traded price of the annual contract in question. Each
quarterly contract will initially be priced at P = (price of annual
contract - 100) / 4) + 100.
[0051] In this example, the contract is for a credit default future
in an individual credit contract, denoted as "[Entity name]" which
corresponds to the entity for which a default contract is
purchased. In this example, the face value is the monetary value of
the settlement in the event that the entity referred in the
contract does not suffer a default event (bankruptcy or insolvency)
in the specified time period. In this example, the face value of
the contract is $1,000,000, and in this particular example, the
face value of each contract monitored for exchange by a PODM
system, is the same.
[0052] In alternative embodiments, the face values may be
constrained to a limited number of potential face values, e.g., two
or three (although other embodiments may have more or unlimited
possibilities). By constraining the face value of the contract (or
other terms of the contract) to a fixed number of possibilities,
the ability to establish a uniform, automated exchange facility is
promoted. In other embodiments, the exchange may be structured by
fixing aspects of the contract other than the face value.
[0053] In this example, another contract term that is constrained
is the period for which a futures contract is made. In this
example, the face value is fixed at $1,000,000 for specific periods
of time (which are constrained in this example to quarterly
contracts for the first three years and annual contracts for an
additional seven years). If at the end of the specified period no
default has occurred, the long receives and the short position pays
a final settlement based on a final settlement price equal to the
face value of the futures contract. On the other hand, if a default
does occur in the specified time period, then the long pays and the
short receives a final settlement based on a final settlement price
equal to a value of zero or any other fixed value, including a
value near zero. In this example, as indicated in "early
settlement," if a default occurs in advance of the specified time
period for a particular contract on a particular reference entity,
an early settlement is triggered on these later contracts where the
long position receives and the short pays a final settlement based
on a final settlement price equal to the face value of those later
contracts. In this embodiment, the risk associated with short term
default is separated from the risk associated with a default in the
longer term (assuming there is no short-term default). Thus, with
this embodiment, tightness in the short term credit market may not
spill over to the same degree to the long term credit market.
[0054] In other embodiments, an earlier default could result in the
contract taking a final settlement value of zero or a fixed number
close to zero. Also, other embodiments may manifest different
relationships between defaults and obligations to pay. For example,
in one embodiment, final settlement at the face value of the
contract may be obliged when a reference entity defaults within a
specified time period. In another embodiment, final settlement at
the face value of the contract may be obliged when a reference
entity defaults in a particular manner (for example, filing for
bankruptcy) within a specified time period.
[0055] In other embodiments, payments may be based on events other
than default and, depending on the nature of the possibility of
multiple occurrences of these events, may or may not have a similar
"early settlement" provision for later contracts. More
specifically, embodiments in accord with the present invention may
provide for contracts valued by occurrence or non-occurrence of a
single occurrence event, i.e. a binary reference event, and may
provide for similar "early settlement" of particular single
occurrence futures contracts.
[0056] Other time periods for the futures contracts may be fixed
and the face value could either be the same, or different, for
different time periods. For example, a POD.TM. futures could be
limited only to quarterly, to quarterly for some time frames and
annual for others (as in the example illustrated in Table 1a), or
may permit quarterly and annual (or other time frame) contracts to
be placed at any particular time through the PODM.
[0057] In one embodiment, the probability of default associated
with these contracts is determined by the market based on the
trading price for the particular POD.TM. futures, and the price of
the contracts is set accordingly. In this example, the pricing
mechanism used by the market for these contracts may be
(100-(P.times.100)) to two decimal places, where P is the
probability of default as determined by the market for the period
specified. In this example, the multiplier is $10,000 and the tick
size is 0.01. Changes in contract prices may be cleared and settled
daily. Thus, the profit or loss that a trader incurs on a given day
of trading is based upon the change in the market's perception of
the value of P at the end of that day. For example, if the P.sub.p
at the end of the previous trading day was 8% and the P.sub.c at
the end of the current trading day is 10% the amount of money lost
by the long position (and the amount of money gained by the short
position) on a $1,000,000 face value contract would be $20,000 as
shown by the following calculations:
$10 , 000 .times. ( 100 - ( P c .times. 100 ) ) = $10 , 000 .times.
( 100 - ( .10 .times. 100 ) ) = $900 , 000 ##EQU00001## $10 , 000
.times. ( 100 - ( P p .times. 100 ) ) = $10 , 000 .times. ( 100 - (
.08 .times. 100 ) ) = $920 , 000 _ ##EQU00001.2## ( $20 , 000 )
##EQU00001.3##
[0058] In this embodiment, price at contract maturity may be
determined in the same manner. For example, at maturity the P is
either 1 or 0. Thus, where P=0 the settlement price of the contract
would be:
$10,000.times.(100-(0.times.100))=$1,000,000
[0059] Similarly, were the P=1, the settlement price of the
contract would be 0. Thus, the amount of money gained or lost by
the long on the maturity date would be the difference between
either the face value of the contract or zero and the contract
price at the end of the previous day multiplied by $10,000, and the
amount gained or lost by the short on the maturity date would be
the difference between the contract price at the end of the
previous day multiplied by $10,000 and either the face value of the
contract or zero.
[0060] Since the value of P is determined by the market, in this
example, in establishing the price of a contract with a face value
of $1,000,000, rather than expressly agreed upon as such or set by
an external entity, different entities in the market may arrive at
different estimates of the value of P and, therefore, wish to enter
into or exchange a credit default contract for this reason (of
course, other reasons may exist for motivating a sale or purchase).
Additionally, other models may be applied for determining price,
e.g., the model above was linear and nonlinear models may be
applied. Moreover, other factors (such as time value of money,
tolerance to risk or currently held assets/positions) may be
reflected in a trader determining a price point at which they are
willing to enter the market.
[0061] The tick size, or smallest unit of increasing or decreasing
the change of the price of a particular contract, in this example,
is 0.01 and therefore corresponds to $100. Establishing a tick size
can assist in facilitating the setting of prices and trading of
interests.
[0062] In this example, there is a fixed time for permitting
trading of futures contracts and a fixed time and mechanism
identified for establishing whether a default has occurred, as
illustrated in Table 1a. This permits orderly trading and
administration of futures contracts and settlement of futures
contracts.
[0063] As described above, in this example and for quarterly
contracts, if there is no default in the time period specified in a
futures contract, the settlement is in cash at a final settlement
value equal to the face amount of the contract (e.g., 100 times the
multiplier of $10,000 which is $1,000,000). If there is a default,
the final settlement value is zero.
[0064] In this example, annual contracts may also be purchased for
time periods more than three years out. These contracts could also
be settled in cash at the end of the specified period, with a final
settlement value equal to a face amount when there is no default
occurring in the specified period as for quarterly contracts.
[0065] In an alternative embodiment, and in particular the one
illustrated in Table 1a, the annual contract may instead be settled
in kind (e.g., in exchange for other futures contracts) when its
final maturity is within an identified period of time from the
present which may be any period of time greater than the shortest
risk period available. For example, when the final maturity is
three years out, an annual futures contract could be converted into
four quarterly futures contracts, one for each of the four quarters
leading up to the final maturity date. Thus, the entire series,
taken as a whole, may have the same risk period as the previously
traded futures contract, e.g. one year. In this example, the face
amount of the quarterly contract would be equal to the face value
of the annual contract.
[0066] In an alternative embodiment, the futures contracts for time
periods farther than three years out may also be maintained as
separate quarterly contracts. For those periods, the PODM may
require trading of contracts in blocks of four, one for each
quarter of the applicable calendar year. This would achieve a
similar effect, without a formal in-kind settlement of annual
futures contracts into quarterly ones. In other embodiments as
described above, such a restriction could be omitted and only
quarterly (or some other time unit) time periods employed for all
periods of time for which a futures contract may be specified.
[0067] By allowing sale of credit default futures contracts in
specified time periods, an institution may hedge when considering
entering into a loan transaction with a company. For example, if an
institution is considering making a large loan but is concerned
about a short-term default event, the institution may make the loan
and sell default futures contracts to cover the risk of a short
term default. Any increase from the sale price of the contracts
would be the net cost of the hedging in the event no default
occurs, but in the event of a default, the institution will net the
decrease from sale price of the contract, which could provide a
hedge in addition to covering the margin between sale price and the
face values of any other futures contracts that were sold (i.e.,
cover the payout for those time periods where no default occurred,
either before or after the actual default). Thus, this type of
facility can permit institutions to continue to make long-term
loans even in the face of fear of short-term default by providing a
vehicle for an institution to hedge against short-term default
risk.
[0068] An example of an alternative set of standard terms for a
credit futures contract is given in Table 1b.
TABLE-US-00002 TABLE 1b Contract Description $100,000 in face value
of default exposure on a specific corporate, government,
institutional or financial entity (reference entity), for a
Specific Risk Period beginning from the listing date and ending at
11:59 p.m. Greenwich Mean Time (GMT) on the 20th calendar day of
the Settlement Month. A Reference Entity will be declared to be in
default if a Credit Event has occurred as defined in section 4.1.
of the 2003 Credit Derivatives Definitions where section 4.2.
(Bankruptcy) and section 4.5. (Failure to Pay) shall only apply.
Contract Name "[Entity name] probability of default (POD .TM.)
futures" Final Settlement Price Contracts will settle with a final
settlement price of zero (0) if there has been a Credit Event or at
one hundred (100) if there has been no credit events. Since the
contract size is $100,000 the price will be multiplied by $1,000 to
obtain the value of the contract. Tick Size Minimum price
fluctuations will be .01. A tick of .01 will represent $10 of
value. Multiplier $1,000 Contracts Listed Contracts expiring
quarterly for five years: March, June, September, December Risk
Period A period beginning from the initial date of listing of the
contract and ending at 11:59 pm (GMT) on the 20.sup.th calendar day
of the Settlement Month. Last Trading Day Trading terminates upon
the earlier of the Credit Event Determination Date or the close of
business on the 20.sup.th calendar day of the Settlement Month. If
the 20.sup.th calendar day of the Settlement Month is a
non-business day, trading shall cease on the last business day
preceding the 20.sup.th calendar day of the settlement month.
Credit Event Determination Date The Credit Event Determination Date
will be the third business day following the earlier of (a) the
announcement of the occurrence of a Credit Event on the exchange's
website or (b) the 20th calendar day of the Settlement Month. The
Credit Event Determination Date may be postponed ("Postponement")
by up to four additional business days if the exchange is not
satisfied of the state of the Reference Entity by 9:15 p.m. (GMT).
In the event of a Postponement, the Credit Event Determination Date
will be the Date on which a final determination is announced by the
exchange. Under special circumstances ("Special Circumstances"),
the exchange may delay the Credit Event Determination Date until a
conclusive determination can be made. Settlement Day The next
business day following the Credit Event Determination Date. Trading
Hours Electronic Trading from 6:30 pm to 4:00 pm (New York time)
time Sunday to Friday. For expiring contracts last trade on the
last trading day will be at 12:00 noon (New York time). Settlement
Procedure 1. Credit Event Upon the declaration of a Credit Event
for the Reference Entity, the exchange will post an announcement on
its website. This determination is considered preliminary. Any
evidence to the contrary must be presented to the exchange by 5:00
p.m. (GMT) on the Credit Event Determination Date. Under normal
circumstances, the final determination of the exchange shall be
made by 9:15 p.m. (GMT) and a cash settlement shall occur on the
following business day if it is determined that a Credit Event did
occur or if the contract has expired. In the event of a
Postponement, the final determination shall be announced by the
exchange as soon as a decision is reached and a cash settlement
shall occur on the following business day if it is determined that
a Credit Event did occur or if the contract has expired. 2. No
Credit Event If no Credit Event is declared by the exchange by the
20.sup.th calendar day of the Settlement Month at 11:59 p.m. (GMT),
the exchange will post on its website the determined final
settlement price of the expiring contract to be one hundred (100).
This determination is considered preliminary. Any evidence to the
contrary must be presented to the exchange by 5:00 p.m. (GMT) on
the Credit Event Determination Date. Under normal circumstances,
the final determination of the exchange shall be made by 9:15 p.m.
(GMT) and a cash settlement shall occur on the following business
day. In the event of a Postponement, the final determination shall
be announced by the exchange as soon as a decision is reached and a
cash settlement shall occur on the following business day. 3.
Special Circumstances A ruling may be delayed if a conclusive
determination cannot be made by the seventh business day at 9:15
p.m. (GMT) following the announcement of a Credit Event. If the
contract has expired, a new contract would be issued for the
purpose of position transfer. The final determination shall be
announced by the exchange as soon as a decision is reached and a
cash settlement shall occur on the close of business on the day
following the Credit Event Determination Date. Early Settlement:
All later contracts in any series of contracts will immediately
settle at 0 if the exchange determines that a Credit Event has
occurred for the Reference Entity.
[0069] In this example, all contracts on a reference entity have
exposure to the default of the reference entity from the first date
that they are listed until the 20.sup.th calendar day of the
settlement month of the contract. Contracts also have a smaller
notional outstanding of $100,000.
[0070] According to one embodiment of the present inventions, a
standard form of contract may be provided for specification of a
bond recovery rate futures contract. One example of certain terms
for a bond recovery rate futures contract is explained with
reference to Table 2. In this example, Credit Event shall have the
meaning ascribed in the contract specification of the POD.TM.
Futures (Table 1a); Special Circumstances shall have the meaning
ascribed in the contract specification of the POD.TM. Futures
(Table 1a); and Credit Event Determination Date shall have the
meaning ascribed in the contract specification of the POD.TM.
Futures (Table 1a).
TABLE-US-00003 TABLE 2a Contract Description $1,000,000 in face
value linked to the recovery rate of a specific corporate,
government, institutional or financial entity (reference entity)
for a specific period in the event that a Credit Event occurs for
the Reference Entity causing the POD .TM. Futures for the Reference
Entity to settle at zero(0). Contract Name "[Entity name] bond
recovery rate (REC) futures" Final Settlement Price Contracts will
settle at 100 .times. R to two decimal places, where R is the
recovery rate of the Reference Entity ("Settlement Recovery Rate")
and is a number from 0 to 1 inclusive. Tick Size Minimum price
fluctuations will be .01. A tick of .01 will represent $100 of
value. Multiplier $10,000 Contracts Listed Contracts expiring
quarterly contracts for three years: March, June, September,
December; and contracts expiring annually for 7 additional years:
December ("Settlement Month") Risk Period Quarterly Contracts A
period of one quarter beginning at 12:00 am (GMT) on the 21st
calendar day of the month that is 3 months before the settlement
month and ending at 11:59 pm (GMT) on the 20th calendar day of the
Settlement Month. Annual Contracts A period of one year beginning
at 12:00 am (GMT) on the 21st calendar day of the month that is 12
months before the settlement month and ending at 11:59 pm (GMT) on
the 20th calendar day of the Settlement Month. Recovery Rate
Determination Date The Recovery Rate Determination Date shall not
occur any later than 45 calendar days after the 20th calendar day
of the Settlement Month unless Special Circumstances ("Special
Circumstances") apply. 1. Credit Event If ISDA .RTM. also
recognizes the Credit Event for a specific Reference Entity and
determines that it will have an auction, the Recovery Rate
Determination Date ("Recovery Rate Determination Date") will be the
date of the ISDA .RTM. auction. If ISDA .RTM. does not hold an
auction either because it determines that it will not hold an
auction, because it cancels an auction, or because it does not
recognize the Credit Event, the Recovery Rate Determination Date
will be the later of a) third business day following a decision by
ISDA .RTM. not to hold an auction or to cancel an auction or b) the
third business day following the Credit Event Determination Date.
2. No Credit Event If the exchange determines that no Credit Event
has occurred prior to the expiration of the POD .TM. Futures on the
Reference Entity, the Recovery Rate Determination Date shall be the
Credit Event Determination Date. Last Trading Day Trading
terminates on the Recovery Rate Determination Date. Settlement Day
The next business day following the Recovery Rate Determination
Date. Trading Hours Electronic Trading from 6:30 pm to 4:00 pm (New
York time) time Sunday to Friday. For expiring contracts last trade
on the last trading day will be at 12:00 noon (New York time).
Settlement Procedure The settlement of the REC Futures is dependent
upon the settlement of the POD .TM. Futures for the Reference
Entity, whose settlement price shall be determined as described in
the contract specification of the POD .TM. Futures. 1. Credit Event
If it is determined that a Credit Event did occur, the exchange
will post an announcement on its website detailing the anticipated
settlement process. This procedure is considered preliminary. If
there is an ISDA .RTM. auction, the Settlement Recovery Rate shall
be the result of the ISDA .RTM. auction. A cash settlement shall
occur on the business day following the Recovery Rate Determination
Date, which shall be the date of the ISDA .RTM. auction. If there
is no ISDA .RTM. auction, either because ISDA .RTM. determines that
it will not hold an auction or cancels an auction, or because ISDA
.RTM. does not recognize the default, the Recovery Rate shall be
the average bid price for $US 50 million of bonds on the third
business day following the Credit Event Determination Date, as
determined by the average of five dealer quotes, excluding the
highest and lowest. The result will be announced by 9:15 p.m. (GMT)
on the Recovery Rate Determination Date. A cash settlement shall
occur on the business day following the Recovery Rate Determination
Date. 2. No Credit Event If it is determined that no Default Credit
Event did occur prior to the expiration of the POD .TM. Futures,
the Settlement Recovery Rate, and consequently the settlement price
will be zero (0). A cash settlement shall occur on the business day
following the Recovery Rate Determination Date. 3. Special
Circumstance A ruling may be delayed if a conclusive determination
cannot be made by the seventh business day at 9:15 p.m. (GMT)
following the announcement of a Credit Event. If the contract has
expired, a new contract would be issued for the purpose of position
transfer. The final determination shall be announced by the
exchange as soon as a decision is reached and a cash settlement
shall occur on the close of business on the day following the
Credit Event Determination Date. Early Settlement: All later
contracts in any series of contracts will immediately settle at 0
if any early contract in the series settles at a realized recovery
rate following a default by the reference entity. Settlement
Procedure for Annual Contracts: Annual contracts will settle on the
delivery date with three years to final maturity. They will settle
in kind, with both long and short positions delivering four
quarterly equivalent contracts each at the following function of
the last traded price of the annual contract in question. Each
quarterly contract will initially be priced at P = (price of annual
contract - 100) / 4) + 100.
[0071] In this example, the contract is for a bond recovery rate
future in an individual credit contract, denoted as "[Entity name]"
which corresponds to the entity for which a bond recovery rate
contract is purchased. In this example, the face value is the value
on which the realized recovery rate is applied to determine the
settlement value in the event of a default (bankruptcy or
insolvency) by the entity referred in the contract in the specified
time period. In this example, the face value of the contract is
$1,000,000, and in this particular example, the face value of each
contract monitored for exchange by a PODM system, is the same.
[0072] In alternative embodiments, the face values may be
constrained to a limited number of potential face values, e.g., two
or three (although other embodiments may have more or unlimited
possibilities), generally (although not necessarily) face values
that are easily divisible in the face value of the POD.TM. futures.
By constraining the face value of the contract (or other terms of
the contract) to a fixed number of possibilities that may be
divisible in the face value of the POD.TM. futures, the ability to
establish a uniform, automated exchange facility for the bond
recovery rate contract and for combinations of one or more bond
recovery rate contract and one or more POD.TM. futures is promoted.
In other embodiments, the exchange may be structured by fixing
aspects of the contract other than the face value of the
contract.
[0073] In this example, another contract term that is constrained
is the period for which a futures contract is made. In this
example, the face value is fixed at $1,000,000 for specific periods
of time (which are constrained in this example to quarterly
contracts for the first three years and annual contracts for an
additional seven years). If at the end of the specified period no
default has occurred, the long pays and the short receives a
settlement based on a settlement value of zero. On the other hand,
if a default does occur in the specified time period, the exchange
determines the realized recovery rate based on publically available
information or based on a survey of market participants. The
settlement value is the product of the face value of the futures
contract and the realized recovery rate determined by the exchange.
At a later date, the long receives and the short pays a settlement
based on the final settlement value. In this example, as indicated
in "early settlement," if a default occurs in advance of the
specified time period for a particular contract belonging to a
particular series, an early settlement is triggered on these later
contracts where the long position pays and the short receives a
settlement based on the face value of those later contracts. In
this embodiment, the risk associated with short term default is
separated from the risk associated with a default in the longer
term (assuming there is no short-term default). Thus, with this
embodiment, tightness in the short term credit market may not spill
over to the same degree to the long term credit market.
[0074] In other embodiments, an earlier default could result in all
contracts on the reference entity being settled early at the
realized recovery rate. Also, other embodiments may manifest
different relationships between defaults and obligations to pay.
For example, in one embodiment, payment of the realized recovery
rate may be obliged when a reference entity defaults within a
specified time period. In another embodiment, payment of the
realized recovery rate may be obliged when a reference entity
defaults in a particular manner (for example, filing for
bankruptcy) within a specified time period.
[0075] In other embodiments, payments may be based on events other
than default or based on other variables than the recovery rate
upon default and, depending on the nature of the possibility of
multiple occurrences of these events, may or may not have a similar
"early settlement" provision for later contracts. More
specifically, embodiments in accord with the present invention may
provide for contracts valued by occurrence or non-occurrence of a
single occurrence event, i.e. a binary reference event, and may
provide for similar "early settlement" of particular single
occurrence futures contracts.
[0076] Other time periods for the futures contracts may be fixed
and the face value could either be the same, or different, for
different time periods. For example, a Recovery Rate Futures could
be limited only to quarterly, to quarterly for some time frames and
annual for others (as in the example illustrated in Table 1a), or
may permit quarterly and annual (or other time frame) contracts to
be placed at any particular time through the PODM.
[0077] In one embodiment, the probability of default and expected
recovery rate associated with these contracts are determined by the
market based on the trading price for the particular REC futures,
and the price of the contracts is set accordingly. In this example,
the pricing mechanism used by the market for these contracts may be
(100.times.P.times.R) to two decimal places, where P is the
probability of default as determined by the market for the period
specified and R is the recovery rate expected by the market for the
senior unsecured funded debt of the reference entity. In this
example, the multiplier is $10,000 and the tick size is 0.01.
Changes in contract prices may be cleared and settled daily. Thus,
the profit or loss that a trader incurs on a given day of trading
is based upon the change in the market's perception of the P and R
at the end of that day. For example, if P.sub.p at the end of the
previous trading day was 8%, R.sub.p at the end of the previous
trading day was 40%, the P.sub.c at the end of the current trading
day is 10%, and R.sub.c at the end of the current trading day is
42%, the amount of money gained by the long position (and the
amount of money lost by the short position) on a $1,000,000 face
value contract would be $10,000 as shown by the following
calculations:
$10 , 000 .times. ( 100 .times. P c .times. R c ) = $10 , 000
.times. ( 100 .times. .10 .times. 0.42 ) = $42 , 000 $10 , 000
.times. ( 100 .times. P p .times. R p ) = $10 , 000 .times. ( 100
.times. .08 .times. 0.40 ) = $32 , 000 _ ##EQU00002## $10 , 000
##EQU00002.2##
[0078] In this embodiment, price at contract maturity may be
determined in the same manner. For example, at maturity the P is
either 1 or 0 and the expected recovery rate is indeterminate as
the bond neither defaulted nor matured (except under unusual
circumstances, in which case the recovery would be 100%). Thus,
where the value of P=0 the settlement price of the contract would
be:
$10,000.times.(100.times.0.times.R.sub.m)=$0.
[0079] Where the value of P=1, the settlement price of the contract
would be determined once a realized recovery rate can be
established. In this embodiment, the realized recovery rate will be
either the ISDA.RTM. determined recovery rate if ISDA.RTM. holds a
public auction for the bonds or the average of 3 of 5 bids for $50
million face value of senior unsecured bonds, where the greatest
and lowest bids are excluded. Thus, the amount of money gained or
lost by the long would be the difference between either the
realized recovery rate times 100 multiplied by $10,000 in the event
of a default or zero otherwise and the contract price at the end of
the previous day multiplied by $10,000, and the amount of money
gained or lost by the short would be the difference between either
the realized recovery rate times 100 multiplied by $10,000 in the
event of a default or zero otherwise and the contract price at the
end of the previous day multiplied by $10,000.
[0080] Since P and R are determined by the market, in this example,
in establishing the price of a contract with a face value of
$1,000,000, rather than expressly agreed upon as such or set by an
external entity, different entities in the market may arrive at
different estimates of P and R and, therefore, wish to enter into
or exchange a bond recovery rate contract for this reason (of
course, other reasons may exist for motivating a sale or purchase).
Additionally, other models may be applied for determining price,
e.g. the model above was a function of the product of the
probability of default and the expected recovery rate, other
functions could be used. Moreover, other factors (such as time
value of money, tolerance to risk or currently held
assets/positions, cash bond prices, phase of the economic cycle)
may be reflected in a trader determining a price point at which
they are willing to enter the market.
[0081] The tick size, or smallest unit of increasing or decreasing
the change of the price of a particular contract, in this example,
is 0.01 and therefore corresponds to $100. Establishing a tick size
can assist in facilitating the setting of prices and trading of
interests.
[0082] In this example, there is a fixed time for permitting
trading of futures contracts and a fixed time and mechanism
identified for establishing whether a default has occurred, as
illustrated in Table 1a. This permits orderly trading and
administration of futures contracts and settlement of futures
contracts.
[0083] As described above, in this example and for quarterly
contracts, if there is no default in the time period specified in a
futures contract, the settlement is in cash and the final
settlement value is zero. If there is a default, the final
settlement value is the realized recovery rate multiplied by 100
and by the multiplier of $10,000.
[0084] In this example, annual contracts may also be purchased for
time periods more than three years out. These contracts could also
be settled in cash at the end of the specified period, with a final
settlement value equal to zero when there is no default occurring
in the specified period as for quarterly contracts.
[0085] In an alternative embodiment, and in particular the one
illustrated in Table 2, the annual contract may instead be settled
in kind (e.g., in exchange for other futures contracts) when its
final maturity is within an identified period of time from the
present which may be any period of time grater than the shortest
risk period available. For example, when the final maturity is
three years out, an annual futures contract could be converted into
four quarterly futures contracts, one for each of the four quarters
leading up to the final maturity date. Thus, the entire series,
taken as a whole, may have the same risk period as the previously
traded futures contract, e.g. one year. In this example, the face
amount of the quarterly contract would be equal to the face value
of the annual contract.
[0086] In an alternative embodiment, the futures contracts for time
periods farther than three years out may also be maintained as
separate quarterly contracts. For those periods, the PODM may
require trading of contracts in blocks of four, one for each
quarter of the applicable calendar year. This would achieve a
similar effect, without a formal in-kind settlement of annual
futures contracts into quarterly ones. In other embodiments as
described above, such a restriction could be omitted and only
quarterly (or some other time unit) time periods employed for all
periods of time for which a futures contract may be specified.
[0087] By allowing sale of bond recovery rate futures contracts in
specified time periods, an institution may hedge recovery risk when
considering using POD.TM. futures to hedge a bond. For example, if
an institution is considering hedging the default risk and the risk
of a lower than expected realized bond recovery rate on a bond with
a POD.TM. futures and a REC futures by selling default futures and
bond recovery rate futures contracts to cover the risk of a short
term default and bond recovery rate risk. Any increase from the
sale price of the POD.TM. futures less the decrease in the price of
the REC futures would be the net cost of the hedging in the event
no default occurs, but in the event of a default, the institution
will net the decrease from sale price of the POD.TM. futures less
the increase from sale price of the REC futures, which could
provide a precise hedge for the bond in addition to covering the
margin between sale price and the face values of any other futures
contracts that were sold (i.e., cover the payout for those time
periods where no default occurred, either before or after the
actual default). Adding a REC futures to the trade will allow the
institution to ensure that the gain on the trade in an event of
default matches the loss on the bonds of the reference entity and
to cheapen the cost of the hedge by avoiding over hedging. Thus,
this type of facility can permit institutions to continue to hold
bonds, while hedging the short-term default and recovery risk.
[0088] An example of an alternative set of standard terms for a
bond recovery rate futures contract is given in Table 2b. In this
example, the terms Credit Event shall have the meaning ascribed in
the contract specification of the POD.TM. Futures (Table 1b);
Special Circumstances shall have the meaning ascribed in the
contract specification of the POD.TM. Futures(Table 1b); and Credit
Event Determination Date shall have the meaning ascribed in the
contract specification of the POD.TM. Futures(Table 1b).
TABLE-US-00004 TABLE 2b Contract Description $100,000 in face value
linked to the recovery rate of a specific corporate, government,
institutional or financial entity (reference entity) in the event
that a Credit Event occurs for the Reference Entity causing the POD
.TM. Futures for the Reference Entity with the same Risk Period to
settle at zero(0). Contract Name "[Entity name] bond recovery rate
(REC) futures" Final Settlement Price Contracts will settle at 100
.times. R to two decimal places, where R is the recovery rate of
the Reference Entity ("Settlement Recovery Rate") and is a number
from 0 to 1 inclusive. Tick Size Minimum price fluctuations will be
.01. A tick of .01 will represent $10 of value. Multiplier $1,000
Contracts Listed Contracts expiring quarterly contracts for three
years: March, June, September, December; and contracts expiring
annually for 7 additional years: December ("Settlement Month") Risk
Period A period starting from the date of the listing of the
contract and ending at 11:59 pm (GMT) on the 20.sup.th calendar day
of the Settlement Month. Recovery Rate Determination Date The
Recovery Rate Determination Date shall not occur any later than 45
calendar days after the 20th calendar day of the Settlement Month
unless Special Circumstances ("Special Circumstances") apply. 1.
Credit Event If ISDA .RTM. also recognizes the Credit Event for a
specific Reference Entity and determines that it will have an
auction, the Recovery Rate Determination Date ("Recovery Rate
Determination Date") will be the date of the ISDA .RTM. auction. If
ISDA .RTM. does not hold an auction either because it determines
that it will not hold an auction, because it cancels an auction, or
because it does not recognize the Credit Event, the Recovery Rate
Determination Date will be the later of a) third business day
following a decision by ISDA .RTM. not to hold an auction or to
cancel an auction or b) the third business day following the Credit
Event Determination Date. 2. No Credit Event If the exchange
determines that no Credit Event has occurred prior to the
expiration of the POD .TM. Futures on the Reference Entity, the
Recovery Rate Determination Date shall be the Credit Event
Determination Date. Last Trading Day Trading terminates on the
Recovery Rate Determination Date. Settlement Day The next business
day following the Last Trading Day. Trading Hours Electronic
Trading from 6:30 pm to 4:00 pm (New York time) time Sunday to
Friday. For expiring contracts last trade on the last trading day
will be at 12:00 noon (New York time). Settlement Procedure The
settlement of the REC is dependent upon the settlement price of the
POD .TM. Futures for the Reference Entity, whose settlement shall
be determined as described in the contract specification of the POD
.TM. Futures. 1. Credit Event If it is determined that a Credit
Event did occur, the exchange will post an announcement on its
website detailing the anticipated settlement process. This
procedure is considered preliminary. If there is an ISDA .RTM.
auction, the Settlement Recovery Rate shall be the result of the
ISDA .RTM. auction. A cash settlement shall occur on the business
day following the Recovery Rate Determination Date, which shall be
the date of the ISDA .RTM. auction. If there is no ISDA .RTM.
auction, either because it determines that it will not hold an
auction or cancels an auction after recognizing the default or
because it does not recognize the default, the Recovery Rate shall
be the average bid price for $US 50 million of bonds on the third
business days following the Credit Event Determination Date, as
determined by the average of five dealer quotes, excluding the
highest and lowest. The result will be announced by 9:15 p.m. (GMT)
on the Recovery Rate Determination Date. A cash settlement shall
occur on the business day following the Recovery Rate Determination
Date. 2. No Credit Event If it is determined that no Default Credit
Event did occur, the Settlement Recovery Rate, and consequently the
settlement price will be zero (0). A cash settlement shall occur on
the business day following the Recovery Rate Determination Date. 3.
Special Circumstance A ruling may be delayed if a conclusive
determination cannot be made by the seventh business day at 9:15
p.m. (GMT) following the announcement of a Credit Event. If the
contract has expired, a new contract would be issued for the
purpose of position transfer. The final determination shall be
announced by the exchange as soon as a decision is reached and a
cash settlement shall occur on the close of business on the day
following the Credit Event Determination Date. Early Settlement:
All later contracts in any series of contracts will settle early at
100 .times. R if the exchange determines that a Credit Event has
occurred for the Reference Entity.
[0089] In this example, all contracts on a reference entity have
exposure to the default of the reference entity from the first date
that they are listed until the 20.sup.th calendar day of the
settlement month of the contract. The notional value of the futures
contract also differs.
[0090] In addition (or instead) to permitting individual credit
default futures contracts or bond recovery rate futures contracts,
a PODM may permit exchange of futures contracts for an index of
possible entity default events and/or an index of possible entity
bond recovery rate following entity default events. An index may,
for example, be established to track the default risk of a group of
financial institutions. Similarly, an index may be formed from a
variety of individual POD.TM. futures contracts to correspond to an
index on the general probability of default in the market. Indices
may also be formed using the corresponding REC futures contracts.
Such recovery indices may be, for example, established to track the
bond recovery rates of a group of industrial names or for an index
on the general recovery rate in the market. Indices may be included
as part of a PODM, and traded in a fashion similar to the
individual contracts described above with reference to Tables 1 and
2. An example of a set of contract terms and system constraints for
an index called High Grade POD.TM. Futures Index are included Table
3. Like other provided examples, Special Circumstance shall have
the meaning ascribed in the contract specification of the POD.TM.
Futures (Table 1a or Table 1b).
TABLE-US-00005 TABLE 3 Contract Description $1,000,000 in face
value linked to the final settlement price of a specific basket of
POD .TM. Futures with High Grade Reference Entities. Contract Name
"High Grade POD .TM. index futures" Final Settlement Price
Contracts will settle at the sum of the POD .TM. Futures settlement
prices contained in the index divided by the original number of POD
.TM. Futures in the index. Tick Size Minimum price fluctuations
will be .01. A tick of .01 will represent $100 of settlement value.
Multiplier $10,000 Contracts Listed Contracts expiring quarterly
for three years: March, June, September, December; and contracts
expiring annually for 7 additional years: December Risk Period
Quarterly Contracts A period of one quarter beginning at 12:00 am
(GMT) on the 21st calendar day of the month that is 3 months before
the settlement month and ending at 11:59 pm (GMT) on the 20th
calendar day of the Settlement Month. Annual Contracts A period of
one year beginning at 12:00 am (GMT) on the 21st calendar day of
the month that is 12 months before the settlement month and ending
at 11:59 pm (GMT) on the 20th calendar day of the Settlement Month.
Last Trading Day The next business day following the determination
of the final settlement price. Trading Hours Electronic Trading
from 6:30 pm to 4:00 pm (New York time) time Sunday to Friday. For
expiring contracts last trade on the last trading day will be at
12:00 noon (New York time). Settlement Procedure for Quarterly
Contracts The settlement of the POD .TM. Index Futures is dependent
upon the settlement of each individual POD .TM. Futures contained
in the index, whose settlement prices shall be determined as
described in the contract specification of the POD .TM. Futures.
The exchange will post on its website a preliminary settlement
price of the POD .TM. Index Futures by 4:30 p.m. (GMT) on the Last
Trading Day. This settlement price is based on the preliminary
settlement prices of the POD .TM. Futures and considered
preliminary. Contracts that have been settled early due to Credit
Events will be assigned a settlement price of zero (0). The normal
final determination of the exchange is made by 9:30 p.m. (GMT) on
the third business day following the 20th calendar day of the
Settlement Month. A cash settlement shall occur on the close of
business on the following business day. If the final settlement
price of any of the POD .TM. Futures contained in the index is not
available, the exchange may postpone ("Postponement") the
announcement of the final settlement price of the POD .TM. Index
Futures by up to four additional business days. The final
settlement price of the POD .TM. Index Futures will be announced by
the exchange as soon as the final settlement prices for all the POD
.TM. Futures contained in the index have been determined. A cash
settlement shall occur on the close of business on the following
business day. Special Circumstance The determination of the final
settlement price of the POD .TM. Index Futures may be delayed
beyond the seventh business day following the announcement of a
Credit Event if Special Circumstances apply to the settlement of
any of the POD .TM. Futures contained in the index. If the contract
has expired, a new contract would be issued for the purpose of
position transfer. The final settlement price shall be announced by
the exchange as soon as the final settlement prices of all POD .TM.
Futures contained in the index are available and a cash settlement
shall occur on the close of business on the following business day.
Settlement Procedure for Annual Contracts Annual contracts will
settle on the delivery date with three years to final maturity.
They will settle in kind, with both long and short positions
delivering four quarterly equivalent contracts each at the
following function of the last traded price of the annual contract
in question. Each quarterly contract will be priced at P = (price
of annual contract - 100) / 4) + 100.
[0091] In this example, the index corresponds to n different
institutions/set of default contracts, each being weighted equally
in the index. Thus, the pricing mechanism corresponds to an average
price of a futures contract for the applicable time period of each
of the n entities in the index. As with POD.TM. futures contracts,
changes in index contract prices may be cleared and settled daily.
Thus, the profit or loss that a trader incurs on a given day of
trading is based upon the change in price of the individual POD.TM.
futures contained in the index at the end of that day. For
settlement at maturity, at the end of the quarterly (in this
example) period for a quarterly contract, the index is priced and
settled as though it were composed of n contracts in the n
individual entities--each having a face value in the amount of the
face value of the index (here, $1,000,000) divided by the number of
entities (here, n).
[0092] In this example annual contracts are converted in-kind to
quarterly contracts in a manner similar to that described
above.
[0093] Since an index futures contract is itself a futures
contract, the index contract may correspond to various listed
individual contracts but it may also be established in the
abstract. That is, for example, an index can be created including
entities that do not have individual contracts being traded since
it is possible for the market to determine a price for the index as
a whole and it is possible to settle a contract by ascertaining the
default status of an individual entity whether or not the entity
happens to also have individual futures contracts listed on the
PODM.
[0094] In the example of Table 3, the index is linearly weighted;
that is, each listed entity contributes the same weight to the
index as a whole. In alternative embodiments, the fund could be
weighted in some other fashion, e.g., with the weight of one entity
included in the index participating in the value (for price and
return) more than another.
[0095] In the example of Table 3, the index is linked to the
POD.TM. futures contracts with contract specifications given in
Table 1a. In alternative embodiments, the POD.TM. index futures may
be linked to POD.TM. futures contracts with contract specifications
given in Table 1b or with other specifications.
[0096] In the example of Table 3, the face amount, trading times,
settlement dates are the same as in Table 1a. Some aspects may
facilitate trading, such as permitting trading at the same times
for a system that includes both indexes and individual entity
futures contracts (some systems may include only one or the other).
This is not a requirement, however. Similarly, indexes could have
different face amounts from each other or from individual futures
contracts.
[0097] An example of a set of contract terms and system constraints
for an index called High Grade recovery index futures are included
Table 4. As with other examples, Special Circumstance shall have
the meaning ascribed in the contract specification of the POD.TM.
Futures (Table 1a or Table 1b).
TABLE-US-00006 TABLE 4 Contract Description $1,000,000 in face
value linked to the final settlement price of a specific basket of
REC Futures with High Grade Reference Entities Contract Name "High
Grade recovery (REC) index futures" Final Settlement Price
Contracts will settle at the sum of the REC Futures settlement
prices contained in the index divided by the original number of REC
Futures in the index. Tick Size Minimum price fluctuations will be
.01. A tick of .01 will represent $100 of settlement value.
Multiplier $10,000 Contracts Listed Contracts expiring quarterly
for three years: March, June, September, December; and contracts
expiring annually for 7 additional years: December Risk Period
Quarterly Contracts A period of one quarter beginning at 12:00 am
(GMT) on the 21st calendar day of the month that is 3 months before
the settlement month and ending at 11:59 pm (GMT) on the 20th
calendar day of the Settlement Month. Annual Contracts A period of
one year beginning at 12:00 am (GMT) on the 21st calendar day of
the month that is 12 months before the settlement month and ending
at 11:59 pm (GMT) on the 20th calendar day of the Settlement Month.
Last Trading Day Trading ceases on the earlier of the day that the
Settlement Recovery Rate is determined for all REC Futures
contained index and 45 calendar days following the end of the Risk
Period Settlement Day The next business day following the
determination of the final settlement price. Trading Hours The
settlement of the REC Index Futures is dependent upon the
settlement of each individual REC Futures contained in the index,
whose settlement prices shall be determined as described in the
contract specification of the REC Futures. The exchange will post
on its website a preliminary settlement price of the REC Index
Futures by 4:30 p.m. (GMT) on the Last Trading Day. This settlement
price is based on the preliminary settlement prices of the REC
Futures and considered preliminary. Contracts that have been
settled early due to Credit Events will be assigned a settlement
price of zero (0). The normal final determination of the exchange
is made by 9:30 p.m. (GMT) on the third business day following the
20th calendar day of the Settlement Month. A cash settlement shall
occur on the close of business on the following business day. If
the final settlement price of any of the REC Futures contained in
the index is not available, the exchange may postpone
("Postponement") the announcement of the final settlement price of
the REC Index Futures by up to four additional business days. The
final settlement price of the REC Index Futures will be announced
by the exchange as soon as the final settlement prices for all the
REC Futures contained in the index have been determined. A cash
settlement shall occur on the close of business on the following
business day. Special Circumstance The determination of the final
settlement price of the REC Index Futures may be delayed beyond the
seventh business day following the announcement of a Credit Event
if Special Circumstances apply to the settlement of any of the REC
Futures contained in the index. If the contract has expired, a new
contract would be issued for the purpose of position transfer. The
final settlement price shall be announced by the exchange as soon
as the final settlement prices of all REC Futures contained in the
index are available and a cash settlement shall occur on the close
of business on the following business day. Settlement Procedure for
Annual Contracts Annual contracts will settle on the delivery date
with three years to final maturity. They will settle in kind, with
both long and short positions delivering four quarterly equivalent
contracts each at the following function of the last traded price
of the annual contract in question. Each quarterly contract will be
priced at P = (price of annual contract - 100) / 4) + 100.
[0098] In this example, the index corresponds to n different
institutions/set of bond recovery rate contracts, each being
weighted equally in the index. Thus, the pricing mechanism
corresponds to an average price of a futures contract for the
applicable time period of each of the n entities in the index. As
with POD.TM. futures, REC futures and POD.TM. index futures,
changes in bond recovery rate index contract prices may be cleared
and settled daily. Thus, the profit or loss that a trader incurs on
a given day of trading is based upon the change in the recovery
rate index the end of that day. For settlement at maturity, at the
end of the quarterly (in this example) period for a quarterly
contract, the index is priced and settled as though it were
composed of n contracts in the n individual entities--each having a
face value in the amount of the face value of the index (here,
$1,000,000) divided by the number of entities (here, n).
[0099] In this example annual contracts are converted in-kind to
quarterly contracts in a manner similar to that described
above.
[0100] Since a recovery index futures contract is itself a futures
contract, the index contract may correspond to various listed
individual contracts but it may also be established in the
abstract. That is, for example, an index can be created including
entities that do not have individual contracts being traded since
it is possible for the market to determine a price for the index as
a whole and it is possible to settle a contract by ascertaining the
default status and realized bond recovery rate of an individual
entity whether or not the entity happens to also have individual
futures contracts listed on the PODM.
[0101] In the example of Table 4, the index is linearly weighted;
that is, each listed entity contributes the same weight to the
index as a whole. In alternative embodiments, the fund could be
weighted in some other fashion, e.g., with the weight of one entity
included in the index participating in the value (for price and
return) more than another.
[0102] In the example of Table 4, the face amount, trading times,
settlement dates are the same as in Table 1a, 1b, 2a, 2b and 3.
Some aspects may facilitate trading, such as permitting trading at
the same times for a system that includes both indexes and
individual entity futures contracts (some systems may include only
one or the other). This is not a requirement, however. Similarly,
indexes could have different face amounts from each other or from
individual futures contracts.
[0103] A PODM may also permit trading of indexes of POD.TM. futures
and/or REC futures in tranches. In one example of an index of
POD.TM. futures, a tranche is a slice of the index corresponding to
an order of defaults. For example, the first 0-3% of defaults in an
index for the specified time period could be assigned to one
(highest risk) tranche. The next 3-10% of the defaults could
correspond to the next tranche, etc. Similarly, in one example, a
tranche is a slice of the index corresponding to an order of
defaults on the reference entities of the REC futures contained in
the index and the settlement values of the futures are linked to
the bond recovery rates realized on the bonds of the entities
contained in an index tranche. For example, the first 0-3% of
defaults in an index for the specified time period could be
assigned to one (highest risk) tranche and the settlement value of
the tranche would be linked to the recovery rates of the bonds of
the names in the tranche once defaults are realized. The next 3-10%
of the defaults could correspond to the next tranche, etc.
[0104] In these examples, the credit futures contract and the bond
recovery rate futures contract are divided not just based on number
of defaults but also temporally, e.g., a tranche may be sold
covering a tranche of risk (e.g., the first 0-3% of defaults in the
index and their corresponding recovery rates) that occur in a
specified time period such as a particular quarter. These tranches
may also be formed and traded as default futures contracts or bond
recovery rate contracts on a PODM.
[0105] Table 5 provides one example of set of contract and system
specifications for one example of a credit tranche futures
contract. In this example, Credit Event Determination Date shall
have the meaning ascribed in the contract specification of the
POD.TM. Futures (Table 1a or Table 1b); Special Circumstance shall
have the meaning ascribed in the contract specification of the
POD.TM. Futures.
TABLE-US-00007 TABLE 5 Contract Description $1,000,000 in face
value of default exposure linked to the final settlement price of a
specific tranche of a named index of probability of default
futures. Contract Name "[Tranche name] on [index name] probability
of default futures" Series: 0%-3%, 3%-10%, 10%-20%, 20%-30%,
30%-100% Final Settlement Price Contracts will settle at 100[1 -
min(max((D - LB), 0), (UB - LB))/(UB - LB)] to two decimal places
where D is the realized percentage of POD .TM. Futures contained in
the index with a final settlement price of zero (0) from the start
of the series and UB and LB are the upper and lower bounds of the
tranches, expressed in percentage, respectively. In other words,
the percentage loss on the index is first allocated to the lowest
tranche (the 0-3% tranche) to the degree the loss does not exceed
the detachment point. Then the next lowest tranche is attached and
so on until the loss is fully assigned. Once the loss assigned to a
tranche is known, its settlement price equals 100 less the percent
of the tranche represented by its assigned loss. Since the contract
size is $1,000,000 the price will be multiplied by $10,000 to
obtain the settlement value. Tick Size Minimum price fluctuations
will be .01. A tick of .01 will represent $100 of settlement value.
Multiplier $10,000 Contract Listed Contracts expiring quarterly
contracts for three years: March, June, September, December; and
contracts expiring annually for 7 additional years: December Risk
Period Quarterly Contracts A period of one quarter beginning at
12:00 am (GMT) on the 21st calendar day of the month that is 3
months before the settlement month and ending at 11:59 pm (GMT) on
the 20th calendar day of the Settlement Month. Annual Contracts A
period of one year beginning at 12:00 am (GMT) on the 21st calendar
day of the month that is 12 months before the settlement month and
ending at 11:59 pm (GMT) on the 20th calendar day of the Settlement
Month. Last Trading Day For each tranche, trading shall terminate
on the earlier of the Credit Event Determination Date of the POD
.TM. Futures that has (have) caused the percentage loss to equal or
exceed the upper bound of the tranche, or the close of business on
the 20.sup.th calendar day of the Settlement Month. If the
20.sup.th calendar day of the Settlement Month is a non-business
day, trading shall cease on the last business day preceding the
20.sup.th calendar day of the Settlement Month. Settlement Day The
next business day following the determination of the final
settlement price.. Trading Hours Electronic Trading from 6:30 pm to
4:00 pm (New York time) time Sunday to Friday. For expiring
contracts last trade on the last trading day will be at 12:00 noon
(New York time). Settlement Procedure The settlement of the POD
.TM. Index Tranche Futures is dependent upon the settlement of each
individual POD .TM. Futures contained in the index, whose
settlement prices shall be determined as described in the contract
specification of the POD .TM. Futures. 1. Sufficient number of
Credit Events to cause the loss to equal or exceed the upper bound
Upon the declaration of a Credit Event or Credit Events that may
cause the percentage of POD .TM. Futures contained in the index
with a final settlement price of zero (0) to equal or exceed the
upper bound of a POD .TM. Index Tranche Futures, thereby causing an
Early Settlement on the POD .TM. Index Tranche Futures ("Early
Settlement"), the exchange shall post an announcement on its
website. This determination is considered preliminary. Under normal
circumstances, the final determination on the Early Settlement
shall be announced by 9:30 p.m. (GMT) on the third business day
following the announcement and a cash settlement shall occur on the
following business day if it is determined that the Credit Event(s)
did occur and cause the percentage of POD .TM. Futures contained in
the index with a final settlement price of zero (0) to equal or
exceed the upper bound or if the contract has expired. In the event
of a Postponement or Postponement(s) for the POD .TM. Futures, the
POD .TM. Index Tranche Futures shall also be postponed by up to
four additional business days. In the event of a Postponement, the
final determination shall be announced by the exchange as soon as a
decision is reached and a cash settlement shall occur on the
following business day if it is determined that a Credit Event(s)
did occur and cause the percentage of POD .TM. Futures contained in
the index with a final settlement price of zero (0) to equal or
exceed the upper bound or if the contract has expired. 2.
Insufficient number of Credit Events to cause the loss to equal or
exceed the upper bound The exchange will post on its website a
preliminary settlement price by 4:30 p.m. (GMT) on the 20th
calendar day of the Settlement Month. This settlement price is
considered preliminary and based on the preliminary settlement
prices of the POD .TM. Futures. The normal final determination of
the exchange is made by 9:30 p.m. (GMT) on the third business day
following the 20th calendar day of the Settlement Month. In the
event of a Postponement, the final settlement price will be
announced by the exchange as soon as it is available and a cash
settlement shall occur on the close of business on the day
following the final determination of the settlement price. 3.
Special Circumstances The determination on an Early Settlement or
of the final settlement price of a POD .TM. Index Tranche Futures
may be delayed beyond the seventh business day following the
announcement of a Credit Event if Special Circumstances apply to a
POD .TM. Futures contained in the index. If the contract has
expired, a new contract would be issued for the purpose of position
transfer. The final determination or final settlement price shall
be announced by the exchange as soon as a decision is reached and a
cash settlement shall occur on the close of business on the
following business day. Early Settlement: In any quarter when a
tranche reaches its detachment point all contracts of that same
tranche for later quarters will immediately settle at 100.
Settlement Procedure for Annual Contracts: Annual contracts will
settle on the delivery date with three years to final maturity.
They will settle in kind, with both long and short positions
delivering four quarterly equivalent contracts each at the
following function of the last traded price of the annual contract
in question. Each quarterly contract will be priced at P = (price
of annual contract - 100) / 4) + 100.
[0106] As for the other contract examples, the tranche is set up
with the same face value, operating times, etc., although this is
not intended to be limiting.
[0107] While in the embodiments disclosed above, the face value and
accompanying multiplier are $1,000,000 and $10,000 respectively,
other embodiments may use other face values and multipliers. For
example, in one embodiment the face value and multiplier of futures
contracts are $100,000 and $1,000 respectively. Further, different
futures contracts may use different face values or multipliers and
the invention is not limited to any specific face value or
multiplier.
[0108] In one embodiment, tranche prices may be modeled as follows.
The tranche boundaries represent a percent of losses and may be
denoted by a.sub.m, m=0, . . . , M, where a.sub.0=0% and
a.sub.M=100%, such that there are M tranches in the structure and
the n.sup.th tranche accounts for the losses between a.sub.n-1 and
a.sub.n, n=1, . . . , M. The realized incremental loss percentage
to be allocated among the tranches at each expiration time s may be
denoted as x.sub.s, s=1, . . . , S so that the cumulative loss
percentage of the index at expiration time t may be expressed
as
s = 1 t x s . ##EQU00003##
[0109] The settlement price of the contract corresponding to the
n.sup.th tranche that expires at expiration time t is denoted by
P.sub.n,t and corresponds to the percentage of the tranche interval
that was not invaded by the incremental loss between expiration
times t-1 and t. It is described by a function P.sub.n,t=f(x.sub.1,
. . . , x.sub.t; a.sub.0, . . . , a.sub.M). This function may be
iteratively specified by considering five cases enumerated
below.
[0110] For each case, assume the cumulative loss percentage at the
t.sup.th expiration time lies between the tranche boundaries of the
q.sup.th-tranche, such that
a q - 1 .ltoreq. s = 1 t x s < a q , ##EQU00004##
and the cumulative loss percentage up to the (t-1).sup.th
expiration period lies between the boundaries of the p.sup.th
tranche such that
a p - 1 .ltoreq. s = 1 t - 1 x s < a p , ##EQU00005##
where p.ltoreq.q. Then, the expiration price of the futures
contract on the n.sup.th index tranche expiring at time t is
determined by:
[0111] If n>q, P.sub.n,t=100. In other words, at expiration time
t, all tranches higher than the q.sup.th tranche that expire at
time t settle at 100 since the cumulative loss does not invade
their range.
if n = q , P n , t = { 100 a n - a n - 1 - x t a n - a n - 1 , if s
= 1 t - 1 x s > a n - 1 100 a n - s = 1 t x s a n - a n - 1 , if
s = 1 t - 1 x s .ltoreq. a n - 1 . ##EQU00006##
[0112] The equation used to calculate the percentage of the
n.sup.th tranche that has not been invaded between the (t-1).sup.th
and t.sup.th expiration dates depends upon whether the cumulative
loss in the previous period had invaded the tranche. If the
n.sup.th tranche was assigned a loss in the (t-1).sup.th period
(top equation), the numerator corresponds to the maximum total loss
percentage range of the tranche minus the incremental loss
occurring in period t; otherwise if the first time the n.sup.th
tranche is assigned a loss is in the t.sup.th expiration period
(lower equation), the numerator can be calculated as the difference
between the upper bound of the tranche and the cumulative loss.
if n < q , P n , t = { 0 , if n > p 100 s = 1 t - 1 x s - a n
- 1 a n - a n - 1 , if n = p . ##EQU00007##
[0113] For contracts below tranche q, the expiration price depends
on whether the tranche is above or below tranche p, which was the
highest tranche to be assigned a loss in period t-1. If the tranche
lies between tranches p and q, the expiration value is 0 since its
entire range is subsumed by the current period's incremental loss.
For contracts on tranche p, the settlement price is 100 times the
fraction of the tranche losses previously allocated as of the last
period, which therefore cannot be re-allocated this period. (Note
that contracts on tranches below the p.sup.th tranche that were
initially to expire at the end of period t already will have
settled, since all future-expiring contracts on a tranche are
settled in the period in which the cumulative loss first exceeds
the maximum total loss percentage of its upper bound.)
[0114] The expiration price of the futures contract on the n.sup.th
index tranche expiring in future periods (i.e., s>t) is
determined by:
[0115] If q>n.gtoreq.p, P.sub.n,s=P.sub.p,s=100. In other words,
contracts expiring in future periods on tranches for which the
maximum total percentage loss is exceeded during period t have
settlement values of 100, since no further losses can be assigned
to contracts on these tranches. In this embodiment, these contracts
are also settled at time t since their value is known with
certainty at that time.
[0116] All other contracts expiring in future periods that have not
been settled early due to excess cumulative losses will have values
that are market determined (i.e. for example, a function of the
last daily traded price and/or bid-ask prices as per the rules of
the exchange). Market prices will depend upon, among other factors,
the expected future incremental losses x.sub.s, s>t.
[0117] Table 6 provides one example of set of contract and system
specifications for one example of a bond recovery rate tranche
futures contract. In this example, Special Circumstance shall have
the meaning ascribed in the contract specification of the POD.TM.
Futures (Table 1a or Table 1b).
TABLE-US-00008 TABLE 6 Contract Description $1,000,000 in face
value linked to the recovery rates of a tranche of a named index of
probability of default futures. Contract Name "[Tranche name] on
[index name] bond index recovery rate futures" Series: 0%-3%,
3%-10%, 10%-20%, 20%-30%, 30%-100% Final Settlement Price Prices
will be quoted will have a range of 0 to 100 inclusive. Once the
individual REC Futures settlement prices have been determined the
individual REC Futures will be assigned to a tranche based on the
order of date and time of default starting with the lowest tranche
(for example the 0-3% tranche) to the degree that it has not been
assigned a REC Futures in a previous quarter in the same series and
to the degree the loss does not exceed the detachment point. Once
the detachment point is reached, that is once the number of
defaults reaches the maximum number allowable for the tranche, the
next lowest tranche is then attached and so on until all the REC
Futures with defaults are allocated. The other REC Futures are all
settled at 0, and therefore are not assigned in any particular
order. For each tranche, the settlement price is 100 times the
average settlement price of the REC Futures assigned to the
tranche. Since the contract size is $1,000,000 the price will be
multiplied by $10,000 to obtain the settlement value. Tick Size
Minimum price fluctuations will be .01. A tick of .01 will
represent $100 of settlement value. Multiplier $10,000 Contract
Listed Contracts expiring quarterly contracts for three years:
March, June, September, December; and contracts expiring annually
for 7 additional years: December Risk Period Quarterly Contracts A
period of one quarter beginning at 12:00 am (GMT) on the 21st
calendar day of the month that is 3 months before the settlement
month and ending at 11:59 pm (GMT) on the 20th calendar day of the
Settlement Month. Annual Contracts A period of one year beginning
at 12:00 am (GMT) on the 21st calendar day of the month that is 12
months before the settlement month and ending at 11:59 pm (GMT) on
the 20th calendar day of the Settlement Month. Last Trading Day
Trading ceases on the earlier of the day that the Settlement
Recovery Rate is determined for all REC Futures contained index and
45 calendar days following the end of the Risk Period. Settlement
Day The next business day following the determination of the final
settlement price. Trading Hours Electronic Trading from 6:30 pm to
4:00 pm (New York time) time Sunday to Friday. For expiring
contracts last trade on the last trading day will be at 12:00 noon
(New York time). Settlement Procedure The settlement of the POD
.TM. Index Recovery Tranche Futures is dependent upon the
settlement of each individual REC Futures contained in the index,
whose settlement prices shall be determined as described in the
contract specification of the REC Futures. 1. Sufficient number of
Credit Events to cause the loss to equal or exceed the upper bound
Upon the declaration of a Credit Event or Credit Events that may
cause the percentage of REC Futures contained in the index with a
final settlement price of zero (0) to equal or exceed the upper
bound of a POD .TM. Index Recovery Tranche Futures, thereby causing
an Early Settlement on the POD .TM. Index Recovery Tranche Futures
("Early Settlement"), the exchange shall post an announcement on
its website. This determination is considered preliminary. Under
normal circumstances, the final determination on the Early
Settlement shall be announced by 9:30 p.m. (GMT) on the third
business day following the announcement and a cash settlement shall
occur on the following business day if it is determined that the
Credit Event(s) did occur and cause the percentage of REC Futures
contained in the index with a final settlement price of zero (0) to
equal or exceed the upper bound or if the contract has expired. In
the event of a Postponement or Postponement(s) for the REC Futures,
the POD .TM. Index Recovery Tranche Futures shall also be postponed
by up to four additional business days. In the event of a
Postponement, the final determination shall be announced by the
exchange as soon as a decision is reached and a cash settlement
shall occur on the following business day if it is determined that
a Credit Event(s) did occur and cause the percentage of REC Futures
contained in the index with a final settlement price of zero (0) to
equal or exceed the upper bound or if the contract has expired. 2.
Insufficient number of Credit Events to cause the loss to equal or
exceed the upper bound The exchange will post on its website a
preliminary settlement price by 4:30 p.m. (GMT) on the 20th
calendar day of the Settlement Month. This settlement price is
considered preliminary and based on the preliminary settlement
prices of the REC Futures. The normal final determination of the
exchange is made by 9:30 p.m. (GMT) on the third business day
following the 20th calendar day of the Settlement Month. In the
event of a Postponement, the final settlement price will be
announced by the exchange as soon as it is available and a cash
settlement shall occur on the close of business on the day
following the final determination of the settlement price. 3.
Special Circumstances The determination on an Early Settlement or
of the final settlement price of a POD .TM. Index Recovery Tranche
Futures may be delayed beyond the seventh business day following
the announcement of a Credit Event if Special Circumstances apply
to a POD .TM. Futures contained in the index. If the contract has
expired, a new contract would be issued for the purpose of position
transfer. The final determination or final settlement price shall
be announced by the exchange as soon as a decision is reached and a
cash settlement shall occur on the close of business on the
following business day. Early Settlement: In any quarter when a
tranche reaches its detachment point all contracts of that same
tranche for later quarters will immediately settle at 0. Settlement
Procedure for Annual Contracts: Annual contracts will settle on the
delivery date with three years to final maturity. They will settle
in kind, with both long and short positions delivering four
quarterly equivalent contracts each at the following function of
the last traded price of the annual contract in question. Each
quarterly contract will be priced at P = (price of annual contract
- 100) / 4) + 100.
[0118] As for the other contract examples, the REC futures tranche
is set up with the same face value, operating times, etc., although
this is not intended to be limiting.
[0119] While in the embodiments disclosed above, the face value and
accompanying multiplier are $1,000,000 and $10,000 respectively,
other embodiments may use other face values and multipliers. For
example, in one embodiment the face value and multiplier of futures
contracts are $100,000 and $1,000 respectively. Further, different
futures contracts may use different face values or multipliers and
the invention is not limited to any specific face value or
multiplier.
[0120] In one embodiment, tranche prices may be modeled as follows.
The tranche boundaries represent a number of defaulted names and
may be denoted by b.sub.m, m=0, . . . , M, where b.sub.0=1 and
b.sub.M=100, such that there are M tranches in the structure and
the n.sup.th tranche accounts for the default numbers between
b.sub.n-1 and b.sub.n, n=1, . . . , M.
[0121] The settlement price of the contract corresponding to the
n.sup.th tranche that expires at expiration time t is denoted by
P.sub.n,t and corresponds to the average bond recovery rate of the
REC futures assigned to the tranche, all of which have exposure to
defaults occurring between t-1 and t. It is described by a function
P.sub.n,t=f(R.sub.1, . . . , R.sub.100; b.sub.0, . . . , b.sub.M),
where R.sub.i, denotes the realized recovery rate of the i.sup.th
contract contained in the index and i=1, . . . , 100 for an index
of 100 names. The settlement values of R.sub.i are assigned up to
the maturity date of the tranche as defaults occur. If a default on
a name in index occurs prior to t-1, then for the purpose of
pricing the n.sup.th tranche that expires at expiration time t, the
name will take on the index i, starting from i=1 for the first
default and taking on the next largest value of i for each
subsequent default and its recovery rate, R.sub.i, will be set at
zero. Between t-1 and t, the settlement values of R.sub.i assigned
begin with the next value of i as at t-1. The settlement value of
the recovery rate for the i.sup.th name is the realized recovery
rate on the name, as determined to price the single name REC
futures contained in the index that default within the period. At
the end of the period, all other names in the index that have not
defaulted during the risk period specified for the contract are
assigned a realized recovery rate of 0. In other words, once a name
in the index has been assigned to a tranche, it continues to be
assigned to the tranche with that index i and takes on a settlement
recovery rate of 0 to price all futures on the tranche expiring in
subsequent periods.
[0122] For each tranche, the final settlement price is given
by:
P n , t = 100 j = b n - 1 b j R j b n - b n - 1 . ##EQU00008##
[0123] The three following examples are provided to illustrate the
method. Although not limiting, embodiments of the present
inventions shown in these examples include five tranches (n=1, 2,
3, 4, 5) expiring at the end of five periods (s=1, 2, 3, 4, 5). In
all three examples, settlement prices are given at each maturity
date, (t=1, 2, 3, 4, 5) and the vector of tranche boundaries for
the credit futures may be expressed as:
a=[0 3 10 20 30 100],
[0124] such that tranche n=1 corresponds to the 0-3% cumulative
loss level or equivalently of defaults since the there are 100
names in the index according to this embodiment, n=2 to the 3-10%
cumulative loss, etc.
Example 1
[0125] In this first example, small numbers of defaults take out
the first tranche and portions of the second tranche over the five
periods. Assume the vector of numbers of defaults, or equivalently
of incremental percentage loss (since the index in this example
contains 100 names) is:
[0126] x=[1 2 1 1 2], and also assume that the recovery rates
achieved for these names are given by:
[0127] Recoveries=(40%, 35%, 25%, 55%, 65%, 30%, 45%)
[0128] in chronological order of default occurrence, with the first
default occurring in period 1, the next two defaults occurring in
period 2, etc. as illustrated in the vector x.
[0129] In this example, the matrices of settlement prices for the
credit futures and recovery rate futures at the end of each period
are given in Tables 7 through 16 and may be found using the above
pricing algorithms. All tables show the settlement prices ordered
by seniority from top to bottom, with the most senior
(30-100%/30-100 defaults) at the top and the most junior (0-3%/1-3
defaults) at the bottom, and by expiration date from left to right,
with contracts expiring in period 1 in the leftmost column and
contracts expiring at the end of period 5 in the rightmost column.
As such, the number of columns decreases by one each hypothetical
period. In all cases, MDDS represents a market determined daily
settlement price as explained in the above algorithm.
TABLE-US-00009 TABLE 7 100 MDDS MDDS MDDS MDDS 100 MDDS MDDS MDDS
MDDS 100 MDDS MDDS MDDS MDDS 100 MDDS MDDS MDDS MDDS 66.67 MDDS
MDDS MDDS MDDS
[0130] Table 7 shows the settlement prices of the credit futures
contracts expiring in all periods at the end of period 1. In this
example, the first tranche absorbs 1% of loss assigned to the
structure, leaving 2%/3% of the tranche unassigned and none of the
other tranches maturing at the end of period 1 absorb any losses.
All other settlement prices are market determined as per the usual
daily settlement procedure of the exchange.
TABLE-US-00010 TABLE 8 0 MDDS MDDS MDDS MDDS 0 MDDS MDDS MDDS MDDS
0 MDDS MDDS MDDS MDDS 0 MDDS MDDS MDDS MDDS 13.33 MDDS MDDS MDDS
MDDS
[0131] Table 8 shows the settlement prices of the bond recovery
rate contracts expiring in all periods at the end of period 1. In
this example, for the contracts expiring in period 1, R.sub.1=40%,
while R.sub.2 to R.sub.100 take on the value of 0. The settlement
prices of the 0-3% tranche will be, 100*0.4/3=13.33, while all
other tranches will have final settlement prices of 0. All other
settlement prices are market determined as per the usual daily
settlement procedure of the exchange.
TABLE-US-00011 TABLE 9 100 MDDS MDDS MDDS 100 MDDS MDDS MDDS 100
MDDS MDDS MDDS 100 MDDS MDDS MDDS 33.33 100 100 100
[0132] Table 9 shows the settlement prices of the credit default
contracts that expire in periods 2 to 5 at the end of period 2. As
shown, in this example, the first tranche continues to absorb all
of the losses in period 2; however this exhausts the tranche as the
total loss now equals 3%. In this embodiment, the futures on the
same tranche with later maturity dates are settled early at the end
of period 2 at a settlement price of 100. After the 2% loss is
assigned to the lowest tranche, 1%/3% of the tranche is unassigned
during the period. All other futures maturing in period 1 settle at
100. All other settlement prices are market determined as per the
usual daily settlement procedure of the exchange.
TABLE-US-00012 TABLE 10 0 MDDS MDDS MDDS 0 MDDS MDDS MDDS 0 MDDS
MDDS MDDS 0 MDDS MDDS MDDS 20 0 0 0
[0133] Table 10 shows the settlement prices of the bond recovery
rate contracts that expire in periods 2 to 5 at the end of period
2. In this example, for the contracts expiring in period 2,
R.sub.1=0%, R.sub.2=35%, R.sub.3=25% while R.sub.4 to R.sub.100
take on the value of 0. The settlement prices of the 0-3% tranche
will be, 100*(0+0.35+0.25)/3=20, while all other tranches maturing
at the end of period 2 will have final settlement prices of 0. In
this embodiment, the futures on the same tranche with later
maturity dates are settled early at the end of period 2 since the
maximum number of defaults of the tranche has been reached. All
other settlement prices are market determined as per the usual
daily settlement procedure of the exchange.
TABLE-US-00013 TABLE 11 100 MDDS MDDS 100 MDDS MDDS 100 MDDS MDDS
85.71 MDDS MDDS Settled Settled Settled
[0134] Table 11 shows the settlement prices of the credit default
contracts that expire in periods 3 to 5 at the end of period 3. As
shown, in this example, the second tranche begins to attach as the
first tranche was exhausted by previous defaults. The unused
portion of the tranche at the end of the period is 6%/7%. Contracts
on the other tranches maturing at the end of period 2 have a
settlement value of 100. All other settlement prices are market
determined as per the usual daily settlement procedure of the
exchange. Note that the 0-3% tranche futures were settled early.
For clarity, the table shows these contracts as Settled.
TABLE-US-00014 TABLE 12 0 MDDS MDDS 0 MDDS MDDS 0 MDDS MDDS 7.86
MDDS MDDS Settled Settled Settled
[0135] Table 12 shows the settlement prices of the bond recovery
rate contracts that expire in periods 3 to 5 at the end of period
3. In this example, for the contracts expiring in period 3,
R.sub.4=55% while R.sub.1 to R.sub.3 and R.sub.5 to R.sub.100 take
on the value of 0. The settlement prices of the 3-10% tranche will
be, 100*0.55/7=7.86, while all other tranches expiring at the end
of period 3 will have final settlement prices of 0. All other
settlement prices are market determined as per the usual daily
settlement procedure of the exchange. Note that the 0-3% tranche
was settled early.
TABLE-US-00015 TABLE 13 100 MDDS 100 MDDS 100 MDDS 85.71 MDDS
Settled Settled
[0136] Table 13 shows the settlement prices of the credit default
contracts that expire in periods 4 and 5 at the end of period 4. As
shown, in this example, the losses continue to be assigned to the
3-10% tranche. The unassigned loss remaining at the end of period 4
is 6%/7%. The other contracts maturing at the end of period 4 have
settlement values of 100. All other settlement prices are market
determined as per the usual daily settlement procedure of the
exchange.
TABLE-US-00016 TABLE 14 0 MDDS 0 MDDS 0 MDDS 9.29 MDDS Settled
Settled
[0137] Table 14 shows the settlement prices of the bond recovery
rate contracts that expire in periods 4 and 5 at the end of period
4. In this example, for the contracts expiring in period 4,
R.sub.5=65% while R.sub.1 to R.sub.4 and R.sub.6 to R.sub.100 take
on the value of 0. The settlement prices of the 3-10% tranche will
be, 100*0.65/7=9.29, while all other tranches will have final
settlement prices of 0. All other settlement prices are market
determined as per the usual daily settlement procedure of the
exchange.
TABLE-US-00017 TABLE 15 100 100 100 71.45 Settled
[0138] Table 15 shows the settlement prices of the credit default
contracts that expire in period 5 at the end of period 5. As shown,
the second tranche absorbs all of the losses in this period and
5%/7% of the loss in this contract is unassigned at the end of
period 5. At that time, in this example, all contracts on the index
mature.
TABLE-US-00018 TABLE 16 0 0 0 10.71 Settled
[0139] Table 16 shows the settlement prices of the bond recovery
rate contracts that expire in period 5 at the end of period 5. In
this example, for the contracts expiring in period 3, R.sub.6=30%,
R.sub.7=45% while R.sub.1 to R.sub.5 and R.sub.8 to R.sub.100 take
on the value of 0. The settlement prices of the 3-10% tranche will
be, 100*(0.30+0.45)/7=10.71, while all other tranches will have
final settlement prices of 0. All other settlement prices are
market determined as per the usual daily settlement procedure of
the exchange.
Example 2
[0140] This example illustrates the case where the loss in the
first period exhausts the maximum potential loss of the lowest
tranche as well as some boundary cases where the cumulative loss in
some intermediate periods corresponds to the lower boundary of
tranche q. Assume the numbers of defaults, or equivalently of
incremental default percentages (since the index in this example
contains 100 names) is given by:
x=[5 5 5 5 5].
[0141] and the recovery rates achieved for these names are given
by:
[0142] Recoveries=(40%, 35%, 25%, 55%, 65%, 40%, 35%, 25%, 55%,
65%, 40%, 35%, 25%, 55%, 65%, 40%, 35%, 25%, 55%, 65%, 40%, 35%,
25%, 55%, 65%) in chronological order of default occurrence.
[0143] Tables 17 through 26 illustrate the settlement prices of the
credit default and bond recovery rate contracts at the end of
periods 1 through 5 with the same ordering as in example 1.
TABLE-US-00019 TABLE 17 100 MDDS MDDS MDDS MDDS 100 MDDS MDDS MDDS
MDDS 100 MDDS MDDS MDDS MDDS 71.43 MDDS MDDS MDDS MDDS 0 100 100
100 100
[0144] Table 17 shows the settlement prices of the credit default
contracts at the end of period 1. As shown, the incremental loss of
5% exhausts the maximum potential loss of 3% of the 0-3% tranche.
As a result, the contract on this tranche expiring in period 1
settles with a value of 0 and contracts on this tranche expiring in
future periods settle at 100 and are settled early at the end of
period 1. The remaining 2% of incremental loss is assigned to the
next lowest tranche, leaving 5%/7% of the loss for the 3-10%
tranche unassigned. All other settlement prices are market
determined as per the usual daily settlement procedure of the
exchange.
TABLE-US-00020 TABLE 18 0 MDDS MDDS MDDS MDDS 0 MDDS MDDS MDDS MDDS
0 MDDS MDDS MDDS MDDS 17.14 MDDS MDDS MDDS MDDS 33.33 0 0 0 0
[0145] Table 18 shows the settlement prices of the bond recovery
rate contracts at the end of period 1. For the purpose of
determining the final settlement prices of these contracts the
realized recovery rates are as follows: R.sub.1=40%, R.sub.2=35%,
R.sub.3=25%, R.sub.4=55%, R.sub.5=65% while R.sub.6 to R.sub.100
take on the value of 0. As shown, the occurrence of 5 defaults in
period 1 exhausts the 0-3% default tranche. This contract settles
at 100.times.(0.40+0.35+0.25)/3=33.33. Since the maximum allowable
number of default is exceeded, all other futures contracts of this
tranche are settled early with a value of 0. The 3-10% tranche
settles at 100.times.(0.55+0.65)/7=17.14 and all other recovery
contracts expiring at the end of period 1 settle at 0. All other
settlement prices are market determined as per the usual daily
settlement procedure of the exchange.
TABLE-US-00021 TABLE 19 100 MDDS MDDS MDDS 100 MDDS MDDS MDDS 100
MDDS MDDS MDDS 28.57 100 100 100 Settled Settled Settled
Settled
[0146] Table 19 shows the settlement prices of the credit default
contracts that expire in periods 2 to 5 at the end of period 2. For
clarity, the expired contracts of the 0-3% tranche are also
included in the table. As shown, the second tranche absorbs all of
its remaining incremental losses, leaving 2%/7% of the tranche
unassigned in period 2. Since this loss exhausts the tranche all
contracts of the second tranche expiring in future periods are
settled at a value of 100 at the end of this period. For
calculation purposes, note that at expiration period t=2 the middle
tranche is tranche q in the notation of our previous equations, and
that its lower boundary is just touched by the cumulative loss.
Thus condition 2 of the algorithm correctly gives a settlement
price of 100 for this tranche. All other settlement prices are
market determined as per the usual daily settlement procedure of
the exchange.
TABLE-US-00022 TABLE 20 0 MDDS MDDS MDDS 0 MDDS MDDS MDDS 0 MDDS
MDDS MDDS 31.43 0 0 0 Settled Settled Settled Settled
[0147] Table 20 shows the settlement prices of the bond recovery
rate contracts at the end of period 2. For the purpose of
determining the final settlement prices of these contracts the
realized recovery rates are as follows: R.sub.6=40%, R.sub.7=35%,
R.sub.8=25%, R.sub.9=55%, R.sub.10=65% while R.sub.1 to R.sub.5 and
R.sub.11 to R.sub.100 take on the value of 0. As shown, the
occurrence of 5 defaults in period 2 exhausts the 3-10% default
tranche. This contract settles at
100.times.(0.40+0.35+0.25+0.55+0.65)/7=31.43. Since the maximum
allowable number of default is exceeded, all other futures
contracts of this tranche are settled early with a value of 0. All
other recovery contracts expiring at the end of period 2 settle at
0. All other settlement prices are market determined as per the
usual daily settlement procedure of the exchange.
TABLE-US-00023 TABLE 21 100 MDDS MDDS 100 MDDS MDDS 50 MDDS MDDS
Settled Settled Settled Settled Settled Settled
[0148] Table 2 shows the settlement prices of the credit default
contracts that expire in periods 3 to 5 at the end of period 3 as
well as the settled contracts of the lowest two tranches. As shown,
the middle tranche absorbs all of the 5% incremental losses in this
period, leaving 5%/10% of the tranche unused. All other futures
expiring at the end of period 3 settle at 100. All other settlement
prices are market determined as per the usual daily settlement
procedure of the exchange.
TABLE-US-00024 TABLE 22 0 MDDS MDDS 0 MDDS MDDS 22 MDDS MDDS
Settled Settled Settled Settled Settled Settled
[0149] Table 22 shows the settlement prices of the bond recovery
rate contracts at the end of period 3. For the purpose of
determining the final settlement prices of these contracts the
realized recovery rates are as follows: R.sub.11=40%, R.sub.12=35%,
R.sub.13=25%, R.sub.14=55%, R.sub.15=65% while R.sub.1 to R.sub.10
and R.sub.16 to R.sub.100 take on the value of 0. This contract
settles at 100.times.(0.40+0.35+0.25+0.55+0.65)/10=22. All other
recovery contracts expiring at the end of period 3 settle at 0. All
other settlement prices are market determined as per the usual
daily settlement procedure of the exchange.
TABLE-US-00025 TABLE 23 100 MDDS 100 MDDS 50 100 Settled Settled
Settled Settled
[0150] Table 23 shows the settlement prices of the credit default
contracts that expire in periods 4 and 5 at the end of period 4 as
well as the previously settled contracts of the lowest two
tranches. As shown, the middle tranche absorbs all of the remaining
loss, and all other middle tranche contracts expire this period
with a settlement price of 100. As in Table 19, tranche q (i.e.,
the fourth tranche) is not assigned a loss, as calculated using
condition 2 of the algorithm. All other settlement prices are
market determined as per the usual daily settlement procedure of
the exchange.
TABLE-US-00026 TABLE 24 0 MDDS 0 MDDS 22 0 Settled Settled Settled
Settled
[0151] Table 24 shows the settlement prices of the bond recovery
rate contracts at the end of period 4. For the purpose of
determining the final settlement prices of these contracts the
realized recovery rates are as follows: R.sub.16=40%, R.sub.17=35%,
R.sub.18=25%, R.sub.19=55%, R.sub.20=65% while R.sub.21 to
R.sub.100 take on the value of 0. The defaults occurring in period
This contract settles at
100.times.(0.40+0.35+0.25+0.55+0.65)/10=22. This exhausts the
10-20% tranche, such that all other bond recovery rate contracts on
this tranche are settled early at a settlement value of 0. All
other recovery contracts expiring at the end of period 4 settle at
0. All other settlement prices are market determined as per the
usual daily settlement procedure of the exchange.
TABLE-US-00027 TABLE 25 100 50 Settled Settled Settled
[0152] Table 25 shows the settlement prices of the credit default
contracts that expire in period 5 at the end of period 5. As shown,
the fourth tranche absorbs all of the incremental loss of the fifth
period and thus settles with 5%/10% of its loss allocation
unassigned in period 5. Note that all remaining contracts expire at
the end of this period.
TABLE-US-00028 TABLE 26 0 22 Settled Settled Settled
[0153] Table 26 shows the settlement prices of the bond recovery
rate contracts at the end of period 5. For the purpose of
determining the final settlement prices of these contracts the
realized recovery rates are as follows: R.sub.21=40%, R.sub.22=35%,
R.sub.23=25%, R.sub.24=55%, R.sub.25=65% while R.sub.1 to R.sub.20
and R.sub.26 to R.sub.100 take on the value of 0. The contract on
the 20-30% tranche settles at
100.times.(0.40+0.35+0.25+0.55+0.65)/10=22. All other recovery
contracts expiring at the end of period 5 settle at 0. All other
settlement prices are market determined as per the usual daily
settlement procedure of the exchange.
Example 3
[0154] In the final example, we demonstrate the situation where the
incremental loss in an intermediate period overwhelms a mezzanine
tranche. This example also shows that all tranches may experience
losses by the last maturity date. The following vector of number of
defaults per period, or equivalently of incremental loss
percentages (since the index in this example contains 100 names)
may be used:
x=[1 4 12 27 40].
[0155] and, for simplicity, we assume that all realized recovery
rates are 40%.
[0156] Tables 27 through 36 provide the settlement prices at the
end of periods 1 though 5, ordered as in the previous two
examples.
TABLE-US-00029 TABLE 27 100 MDDS MDDS MDDS MDDS 100 MDDS MDDS MDDS
MDDS 100 MDDS MDDS MDDS MDDS 100 MDDS MDDS MDDS MDDS 66.67 MDDS
MDDS MDDS MDDS
[0157] Table 27 shows the settlement prices of the credit default
contracts at the end of period 1. As shown, the incremental loss of
1% is absorbed by the lowest tranche, which settles with 2%/3%
unused, while the other tranches maturing at the end of period 1
settle at 100 and all other settlement prices are market determined
as per the usual daily settlement procedure of the exchange.
TABLE-US-00030 TABLE 28 0 MDDS MDDS MDDS MDDS 0 MDDS MDDS MDDS MDDS
0 MDDS MDDS MDDS MDDS 0 MDDS MDDS MDDS MDDS 13.33 MDDS MDDS MDDS
MDDS
[0158] Table 28 shows the settlement prices of the bond recovery
rate contracts expiring in all periods at the end of period 1. In
this example, for the contracts expiring in period 1, R.sub.1=40%,
while R.sub.2 to R.sub.100 take on the value of 0. The settlement
prices of the 0-3% tranche will be, 100*0.4/3=13.33, while all
other tranches expiring at the end of period 1 will have final
settlement prices of 0. All other settlement prices are market
determined as per the usual daily settlement procedure of the
exchange.
TABLE-US-00031 TABLE 29 100 MDDS MDDS MDDS 100 MDDS MDDS MDDS 100
MDDS MDDS MDDS 71.43 MDDS MDDS MDDS 33.33 100 100 100
[0159] Table 29 shows the settlement prices of the credit default
contracts that expire in periods 2 to 5 at the end of period 2. As
shown, the incremental loss exhausts the maximum capacity of the
lowest tranche and the remainder of the loss is assigned to the
second tranche. In particular, 2% of the incremental loss is
assigned to the lowest tranche, which settles with 1%/3% unused
this period, and 2% of the incremental loss is assigned to the
second tranche, which settles with 5%/7% unassigned. In this
embodiment, all contracts of the lowest tranche expire at the end
of this period at an expiration value of 100, all other contracts
expiring at the end of period 1 settle at 100, and all other
settlement prices are market determined as per the usual daily
settlement procedure of the exchange.
TABLE-US-00032 TABLE 30 0 MDDS MDDS MDDS 0 MDDS MDDS MDDS 0 MDDS
MDDS MDDS 11.43 MDDS MDDS MDDS 26.66 0 0 0
[0160] Table 30 shows the settlement prices of the bond recovery
rate contracts expiring periods 3 to 5 at the end of period 3. In
this example, for the contracts expiring in period 3, R.sub.1=0%,
R.sub.2=R.sub.3=R.sub.4=R.sub.5=40%, while R.sub.6 to R.sub.100
take on the value of 0. The settlement price of the 0-3% tranche
expiring in period 2 will be 100.times.(0.4+0.4)/3=26.66 and the
futures contracts on this tranche expiring in later periods are
settled early at a settlement value of 0. The settlement price of
the 4-10 default tranche expiring in period 2 will be
100.times.(0.4+0.4)/7=11.43. All other tranches expiring at the end
of period 2 will have final settlement prices of 0. All other
settlement prices are market determined as per the usual daily
settlement procedure of the exchange.
TABLE-US-00033 TABLE 31 100 MDDS MDDS 100 MDDS MDDS 30 MDDS MDDS
28.57 100 100 Settled Settled Settled
[0161] Table 31 shows the settlement prices of the credit default
contracts that expire in periods 3 to 5 at the end of period 3. The
table also includes the previously settled contracts of the lowest
tranche. As shown, the incremental percentage loss exhausts the
maximum remaining loss of the second tranche of 5% and the middle
tranche absorbs the remainder of the incremental percentage loss.
Since 5% is assigned to the second tranche, it settles with 2%/7%
unallocated in period 3. The middle tranche settles with 3%/10%
unallocated as it receives the remaining 7% of the incremental loss
for this period. All contracts of the second tranche settle at the
end of period 3, with contracts with later initially determined
expiration dates settling at 100. All other settlement prices are
market determined as per the usual daily settlement procedure of
the exchange.
TABLE-US-00034 TABLE 32 0 MDDS MDDS 0 MDDS MDDS 28 MDDS MDDS 28.57
0 0 Settled Settled Settled
[0162] Table 32 shows the settlement prices of the bond recovery
rate contracts expiring periods 3 to 5 at the end of period 3. In
this example, for the contracts expiring in period 3, R.sub.6= . .
. =R.sub.17=40%, while R.sub.1 to R.sub.5 and R.sub.18 to R.sub.100
take on the value of 0. The settlement price of the 0-3% tranche
expiring in period 3 will be 100.times.(5.times.0.4)/7=28.57 and
the futures contracts on this tranche expiring in later periods are
settled early at a settlement value of 0. The settlement price of
the 10-20% tranche expiring in period 3 will be
100.times.(7.times.0.4)/10=28. All other tranches expiring at the
end of period 3 will have final settlement prices of 0. All other
settlement prices are market determined as per the usual daily
settlement procedure of the exchange.
TABLE-US-00035 TABLE 33 80 MDDS 0 100 70 100 Settled Settled
Settled Settled
[0163] Table 33 shows the settlement prices of the credit default
contracts that expire in periods 4 and 5 at the end of period 5 as
well as the settled contracts of the lowest two tranches. As shown,
the middle tranche absorbs its remaining portion of the incremental
percentage loss, 3%, and its capacity is exhausted. The capacity of
the fourth tranche, 10%, is completely exhausted in this period and
thus it settles at 0. The remainder of the loss, 14%, is assigned
to the most senior tranche, using up 14%/70% of its loss capacity.
The futures contracts of the middle and fourth tranches expiring in
period 5 are settled at the end of period 4 at a value of 100 and
the only remaining contract expiring in period 5 has a settlement
price that is market determined as per the usual daily settlement
procedure of the exchange.
TABLE-US-00036 TABLE 34 8 MDDS 40 0 12 0 Settled Settled Settled
Settled
[0164] Table 34 shows the settlement prices of the bond recovery
rate contracts expiring periods 4 and 5 at the end of period 4. In
this example, for the contracts expiring in period 4, R.sub.18= . .
. =R.sub.44=40%, while R.sub.1 to R.sub.17 and R.sub.45 to
R.sub.100 take on the value of 0. The settlement price of the
10-20% tranche expiring in period 4 will be
100.times.(3.times.0.4)/10=12 and the futures contracts on this
tranche expiring in later periods are settled early at a settlement
value of 0. The settlement price of the 20-30% tranche expiring in
period 4 will be 100.times.(10.times.0.4)/10=40 and the futures
contracts on this tranche expiring in later periods are settled
early at a settlement value of 0. The settlement price of the
30-100% tranche expiring in period 5 will be
100.times.(14.times.0.4)/70=8 and the only remaining contract
expiring in period 5 has a settlement price that is market
determined as per the usual daily settlement procedure of the
exchange.
TABLE-US-00037 TABLE 35 42.86 Settled Settled Settled Settled
[0165] Table 35 shows the settlement prices of the one surviving
credit default contract that expires in period 5 at the end of
period 5 and the settled contracts for the four lower tranches. As
shown, the senior layer absorbs all of the incremental loss of the
fifth period, leaving 30%/70% of the tranche unassigned in period
5. This contract matures this period.
TABLE-US-00038 TABLE 36 22.86+= Settled Settled Settled Settled
[0166] Table 36 shows the settlement prices of the bond recovery
rate contracts expiring period 5 at the end of period 5. In this
example, for the contracts expiring in period 5, R.sub.45= . . .
=R.sub.84=40%, while R.sub.1 to R.sub.84 and R.sub.85 to R.sub.100
take on the value of 0. The settlement price of the 30-100% tranche
expiring in period 4 will be 100.times.(40.times.0.4)/70=22.86.
This contract matures this period.
[0167] FIG. 1A provides a context diagram that includes an
embodiment of a PODM system 112 and various entities with which the
embodiment may interact. The sundry computer systems shown in FIG.
1A, which include personal computing devices 104 and 106, a
financial institution system 110, a firewall 114, an order system
118, a clearing system 120 and an auction engine 122, may include
one or more computing devices that have at least one processor or
controller, memory and an interface. Computer systems and devices
are disclosed with further detail with regard to FIG. 10 below.
[0168] The PODM system 112 may include a variety of components such
as a firewall 114, an order system 118, a clearing system 120 and
an auction system 122 interconnected through a private network 116.
As shown, the PODM system 112 may interact a variety of external
entities, including personal computing devices 104 and 106 and
financial institution system 110, via a public network 108.
Furthermore, the PODM system 112 may also provide the personal
computing devices 104 and 106 with interfaces that enable users,
such as futures contract traders 100 and 102, to communicate with
the PODM system 112. For example, in one embodiment, the PODM
system 112 may serve browser-based interfaces to the personal
computing devices 104 and 106 to allow futures contract traders 100
and 102 to place trade requests with the PODM system 112. Futures
contract traders 100 and 102 may be entities taking long or short
positions or may be representatives of these market participants,
e.g. dealers or brokers. To ensure secure transactions, the trade
requests may be transmitted through the public network 108 using a
variety of security measures including TSL, SSL and/or VPN among
other security techniques. The PODM system 112 may serve the user
interfaces using any suitable protocol including HTML, DHTML, XML
and PHP among others.
[0169] Both the public network 108 and the private network 116 may
include any communication network through which member computer
systems may exchange data. For example, in one embodiment, public
network 108 may be a TCP/IP based network employing both wired and
wireless connections, such as the Internet. Private network 116 may
further restrict member computer systems based on one or more
characteristics of each member computer system. For example,
private network 116 may restrict member computer systems to only
those devices collocated in the same computing facility and/or rack
enclosure. Furthermore, while FIG. 1A depicts the communication
conduit between entities and components as networks, any form of
communication conduit may be used including specialized and/or
standard computing bus technologies such as IDE, SCSI, PCI and
InfiniBand.
[0170] As is discussed further below, in one embodiment, the credit
futures or bond recovery rate futures contract traders 100 and 102
may authorize a trading session by logging into the order system
118 via personal computing devices 104 and 106. Once the trading
session is authorized, the firewall 114 may allow data originating
on personal computing devices 104 and 106 to pass into the private
network 116. This data may be associated with specific transaction
requests, such as requests to trade various credit futures or bond
recovery rate contracts, addressed to the order system 118. After
processing the transaction request, the order system 118 may
transmit the requested transaction to the auction engine 122 for
further handling.
[0171] The auction engine 122 may facilitate the completion of
transactions by matching potentially countervailing trade requests.
Upon finding suitable matches, the auction engine 122 may
automatically finalize the matched trade requests and pass the
completed transaction to the clearing system 120.
[0172] The clearing system 120 may ensure the financial integrity
of the market in various ways. For instance, the clearing system
120 may act as an electronic central clearing and settlement agent
for a portion or all of the transactions completed by the auction
engine 122. In one embodiment, the clearing system 120 may monitor
the positions of market participants and the pricing of the various
market credit futures or bond recovery rate futures contracts.
Based on the continual monitoring, the clearing system 120 may
issue reports to market participants and may issue margin calls to
market participants. In another embodiment, the clearing system 120
may also exchange financial data with financial institution system
110, such as receiving a deposit in response to a margin call.
[0173] While FIG. 1A depicts the physical components of the PODM
system as separate, distinct computing devices, one of ordinary
skill in the art will recognize that each of these components may
be implemented in any combination of hardware and/or software, such
as a computer system including multiple computing devices.
Embodiments implementing these components using a variety of
physical configurations exist. For example, in one embodiment, the
components of the PODM system may reside on a single computing
device.
[0174] FIG. 1B illustrates another embodiment in which security is
administered via an alternate firewall configuration. More
specifically, FIG. 1B incorporates many of the elements of FIG. 1A,
but replaces the firewall 114 with firewalls 1012, 1014 and 1016.
The firewalls 1012 and 1014 help secure the order system 118 and
the clearing system 120 from unauthorized access through the public
network 108. As shown, the auction engine 112 benefits from
increased protection due to both the presence of the firewall 1014
and the isolated connection of the firewall 1014 with the order
system 118 and the clearing system 120. In addition to increased
security, this configuration may also support the distribution of
these system elements to several different physical locations.
[0175] FIG. 2 provides a more detailed illustration of the logical
elements of one embodiment of a PODM system 112. Any of the system
elements shown in FIG. 2 may be implemented in hardware, software
or any combination thereof. Software elements may be implemented
using customized software code or using existing software including
email, FTP, batch system interface, database system data movement
tools, middleware, any combination thereof, or otherwise. Moreover,
the system structure and content recited below is for exemplary
purposes only and is not intended to limit the invention to the
specific structure shown in FIG. 2. As will be apparent to one of
ordinary skill in the art, many variant system structures can be
architected without deviating from the scope of the present
invention. The particular modular arrangement presented in FIG. 2
was chosen to promote clarity.
[0176] Information may flow between these elements, components and
subsystems using any technique known in the art. Such techniques
include passing the information over the network via TCP/IP,
passing the information between modules in memory and passing the
information by writing to a file, database, or some other
non-volatile storage device.
[0177] As disclosed above, the PODM system 112 in some embodiments
includes three primary subsystems, the order entry system 118, the
clearing system 120 and the auction engine 122. According to the
embodiment depicted in FIG. 2, the order entry system 118 may
include an order interface 202, a trade requests database 204, a
trader accounts database 206 and a completed transactions database
210. The order interface 202 may receive trader and trade request
information and may provide the trader and trade request
information to the trade requests database 204 and the trader
accounts database 206. The order interface 202 may also receive
information regarding completed transactions from the completed
transactions database 210 and may provide that information to
trader 200. The trade requests database 204 may include information
regarding open trade requests including the type of credit futures
or bond recovery rate futures contract to be traded, the type of
trade (buy or sell) and any price restriction information. The
trader accounts database 206 may include trader logon credentials,
identification and contact information as well as account positions
in currency and holdings. These system elements are described in
more detail below.
[0178] In one embodiment, the order interface 202 may present the
trader 200 with less information than conventional credit
derivative trading systems. More specifically, as will be discussed
further below, embodiments disclosed herein provide for credit
futures or bond recovery rate contracts that employ standardized
terms and conditions, such as standard face values, terms,
expiration dates and settlement procedures. Consequently, the
trader 200 is not required to configure the standard terms and
conditions when placing trade requests. This standardization may
enable a more streamlined order interface 202 compared to
conventional order interfaces.
[0179] The order interface 202 may accept user credentials, such as
a user identifier and a password, from a trader 200 and
authenticate the trader 200 by comparing the user credentials to
user information received from the trader accounts database 206.
After the trader 200 has been authenticated, the order interface
202 may accept trade requests from the trader 200. In one
embodiment, the order interface 202 may validate, using information
stored in the trader accounts database 206 or elsewhere, that the
trader 200 has sufficient financial resources to complete the trade
request prior to storing the trade request in the trade requests
database 204. If the trader 200 has insufficient financial
resources to complete the trade request, the order interface 200
may notify the trader of his insufficiency. The order interface 200
may also provide facilities for a trader to augment the financial
resources he has allocated to trading activity.
[0180] In another embodiment, the order interface 202 may also
enable the trader 202 to place various price restrictions on trade
requests. A non-limiting list of price restrictions includes market
orders, limit orders, stop limit orders, stop loss orders, trailing
stop loss orders and trailing stop limit orders. Providing for
multiple price restriction options enables traders to customize
their trade requests to suit their particular needs.
[0181] The order interface 202 may present the trader 200 with a
choice of credit futures or bond recovery rate futures contracts
from which to choose when requesting a trade. A non-limiting list
of these credit futures or bond recovery rate futures contracts may
include POD.TM. futures, REC futures, POD.TM. index futures, REC
index futures, POD.TM. index tranche futures, and REC index tranche
futures. The trader 200 may use the order interface 202 to take
long or short positions respective to any of these credit futures
or bond recovery rate futures contracts. As discussed above, the
settlement values of these positions are based on the whether one
or more reference entities are in a state of credit default at an
identified point in the future. To help provide for a more
transparent market for the trader 200, according to one embodiment,
the order interface 202 may present credit futures or bond recovery
rate futures contracts that conform to a standardized set of
contract terms and conditions. These terms and conditions may be
specific to each type of futures contract and may include, among
other contractual attributes, face value, entities referenced,
maturation period and settlement procedures.
[0182] For example, according to one embodiment, the order
interface 202 may present POD.TM. futures, REC futures, POD.TM.
index futures, REC Index futures, POD.TM. index tranche futures,
and REC index tranche futures with face values of $1,000,000 or any
other pre-determined value, including $100,000 or $10,000, each. In
another embodiment the order interface 202 may present POD.TM.
futures, REC futures, POD.TM. index futures and REC index futures
that have a face value of $1,000,000 each and may present POD.TM.
indexes tranche futures and REC index tranche futures that have a
face value of $500,000 or any other pre-determined value, including
$100,000 or $10,000. The standards enforced by the order interface
202 may also include that the credit futures or bond recovery rate
futures contract have standard term, for example, quarterly or
annual, and that the entity referenced by the POD.TM. futures or
the REC futures be any of an identified list of corporate,
government, institutional and/or financial entities. With
particular regard to POD.TM. index tranche futures and REC index
tranche futures, the order interface may present a set of standard
tranche series. For instance, in one embodiment, the standard set
of tranche series may include 0%-3%, 3%-10%, 10%-20%, 20%-30% and
30%-100%. Furthermore, standard maturity periods for POD.TM.
futures and REC futures contracts traded by the PODM system 112 may
include three years for quarterly contracts and up to an additional
seven years for annual contracts.
[0183] In one embodiment, the order interface 202 may restrict
trading of credit futures or bond recovery rate futures contracts
after an identified point in time. For example, quarterly contracts
may be restricted from trading after the 20.sup.th day of the
settlement month of the quarterly contract. In another embodiment,
annual contracts may be restricted from trading after the 20.sup.th
day of December in the year that is three years before the
settlement year. As is discussed further below, according to
another embodiment, settlement procedures may also be subject to
standardization by a settlement engine.
[0184] In another embodiment, the order interface 202 may also
provide, to the trader 200, market information received from the
completed transactions database 210. For example, the order
interface 202 may provide the current trading volume and prices of
various credit futures or bond recovery rate futures contracts
traded on the PODM system 112. Additionally, the order interface
202 may provide the view of the PODM as to the probability of
default of various reference entities to external entities.
Furthermore, the order interface 202 may provide recent historical
trading activity regarding POD.TM. futures sharing a common
characteristic, such as a common reference entity.
[0185] The order interface 202 may also receive financial data,
such as an electronic deposit of cash and/or other liquid
instruments. The order interface 202 may update the account
balances included in the trader accounts database 206 to reflect
any deposits received. Thus, traders are provided with a convenient
method of managing account balances.
[0186] With continued reference to FIG. 2, as discussed above, the
auction engine 122 may match buy and sell trade requests and
steward the trade requests into completed transactions. More
particularly the auction engine 122 may periodically or continually
scan the trade requests database 204 for potentially matching
offsetting trade requests, such as, for example, a market buy and a
market sell of a POD.TM. futures associated with a particular
reference entity. In one embodiment, the auction engine 122 may
only actively attempt to complete transactions during an identified
time window. For instance, the auction engine 122 may be configured
to operate from 6:30 PM to 4:00 PM, Eastern Standard Time, Sunday
to Friday of each week. Furthermore, the auction engine may be
configured to stop trading of expiring contracts on the last
trading day at 12:00 PM, Eastern Standard Time.
[0187] Additionally, according to one embodiment, the auction
engine may give priority to trade requests with certain
characteristics. For example, a market buy may be given priority to
a limit buy. Once matching trade requests are determined, the
auction engine 122 may record them as complete and insert them into
the completed transaction database 210. Completed transactions are
settled and cleared by the clearing system 120.
[0188] Again referring to FIG. 2, the clearing system 120 may
include a clearing interface 214, a trader accounts database 216, a
settlement engine 220 and a completed transactions database 222.
The completed transactions database 222 may receive data from the
completed transactions database 210 by replication or other data
transfer methods and may provide transactional information to the
settlement engine 220 and the clearing interface 214. The
settlement engine 220 may exchange information with the completed
transactions database 222, the trader accounts database 216 and the
clearing interface 214. The trader accounts database 216 may
receive trader account information from the trader accounts
database 206 by replication or other data transfer methods. These
system elements are discussed further below.
[0189] According to one embodiment, the settlement engine 220 may
periodically attempt to settle any unsettled transactions included
in the completed transactions database 222. The processes used by
the settlement engine 220 may vary based, at least in part, on the
type of credit futures or bond recovery rate futures contract being
settled because each type of credit futures or bond recovery rate
futures contract has different characteristics. For example, as
discussed above, the value of a POD.TM. futures is based on the
probability of default of a reference entity as determined by the
market, while the value of a POD.TM. index futures is based on the
values of POD.TM. futures referencing several entities. According
to one embodiment, changes to credit futures or bond recovery rate
futures contract prices may cause daily settlement. As discussed
above, daily settlement causes the changes in futures contract
price to be settled to the accounts of owners of long and short
positions after each trading day. This practice may help manage
risk by ensuring that relatively smaller increments of money are
exchanged more frequently, thus limiting the exposure of all
participants to a daily amount.
[0190] FIG. 3 illustrates of a process 300 used to settle POD.TM.
futures and REC futures contracts daily, in kind and at maturity.
At block 302, process 300 begins. At block 304, each POD.TM.
futures or REC futures targeted for processing may be reviewed to
determine if the entity referenced in the POD.TM. futures or REC
futures is in a credit default state as of 11:59 PM, Greenwich Mean
Time, on the maturity date. A credit default state may be any
indication that an entity may be insolvent. According to one
embodiment, an entity is deemed to be in a credit default state if
that entity is either bankrupt or insolvent as evidenced by the
failure to pay principal payments due on loans or bonds and which
payment requirements are beyond their contractual cure period. Each
processed POD.TM. futures or REC futures that references an entity
deemed to be in a credit default state may be targeted for
processing by block 306. Each processed POD.TM. futures or REC
futures that references an entity deemed to not be in a credit
default state may be targeted for processing by block 312.
[0191] At block 306, each POD.TM. futures or REC futures targeted
for processing may be reviewed to determine whether the default
occurred during its risk period. According to one embodiment, a
POD.TM. futures or REC futures contract's risk period is from the
beginning of a specific quarter, starting on the 21.sup.st calendar
day of March, June, September or December, to the end of the
quarter, which will be the business day before the 21.sup.st
calendar day of the next quarterly settlement month in the cycle.
Annual POD.TM. futures and REC futures contracts would have
exposures beginning on the 21.sup.st calendar day of December at
12:00 AM Greenwich Mean Time and ending at 11:59 PM Greenwich Mean
Time on the 20.sup.th calendar day of December the following year.
Thus the settlement engine breaks up credit and bond recovery rate
exposures into short term exposures, which allows market
participants to express their credit market view with greater
temporal precision. If the reference entity defaulted during the
risk period of the contract, then the contract proceeds to block
308. If the reference entity defaulted in a period that is earlier
than the beginning of the risk period of the contract, then it
proceeds directly to block 320.
[0192] At block 308, each POD.TM. futures or REC futures targeted
for processing may be reviewed to determine if it is a POD.TM.
futures or a REC futures. Each contract that is deemed to be a REC
futures is targeted for processing at block 310. At block 310, the
settlement recovery rate is determined for each REC futures and the
REC futures then proceeds to block 320 with a settlement price that
is at least in part determined by the settlement recovery rate.
Each contract that is deemed to be a POD.TM. futures is directly
targeted for processing at block 320.
[0193] At block 312, each POD.TM. futures or REC futures targeted
for processing may be reviewed to determine if the POD.TM. futures
or REC futures has a maturity date equal to an identified date and
an exposure period equal to a certain time period. For example, the
identified date may be three years from the current settlement date
and a one-year exposure period. If the POD.TM. futures or REC
futures has the identified maturity date and exposure period, the
POD.TM. futures or REC futures proceeds to block 314. At block 314,
the POD.TM. futures or REC futures is settled in kind, with short
positions delivering short positions on four quarterly equivalent
contracts and vice versa. A system executing block 314 may record
this settlement by updating the trader accounts database 216 to
reflect the new long or short positions. The quarterly contracts
will be priced according to equation (1):
P.sub.Quarterly=(Last traded price of annual contract-Face value
price of annual contract)/4+Face value price of quarterly contract
(1)
[0194] After processing at block 314, the POD.TM. futures or REC
futures proceeds to block 316. If a POD.TM. futures or REC futures
has a maturity date that is not equal to an identified date and an
exposure period equal to a certain time period, then it proceeds
directly to block 316.
[0195] At block 316, the maturity date of each unsettled
transaction may be compared to the current date. In this example,
the method may target all transactions for settlement daily. In one
embodiment, the final settlement dates of each POD.TM. futures and
REC futures are fixed to one of a set of standard settlement dates.
For example, POD.TM. futures may have a final settlement date of
the second business day after the 21.sup.st day of a settlement
month and REC futures may have a final settlement date of the
business day after 45 calendar days following the final settlement
date of the POD.TM. futures on the name for the same risk period.
For quarterly POD.TM. futures, settlement months may include March,
June, September and December. Correspondingly, REC futures
settlement months for REC futures, in this example, would be
February, May, August and November. For annual POD.TM. futures, the
settlement month may be December and annual REC futures may have
settlement months in February. If a contract is not maturing, it
proceeds to block 318. At block 318, the settlement engine assigns
the contract a daily settlement price based on recent market
trading activity. The act of settling contracts daily may include
updating the trader accounts database 216 to reflect the inflow or
outflow of cash from the settled contracts, if any. If a contract
is maturing, it proceeds to block 320.
[0196] At block 320, each POD.TM. futures or REC futures targeted
for processing is given its final settlement value and cash
settled. The act of settling may include updating the trader
accounts database 216 to reflect the retirement of the POD.TM.
futures and inflow of cash from the settled contracts, if any.
POD.TM. futures contracts coming from blocks 306 and 316 are cash
settled at a settlement price of $100, while POD.TM. futures
contracts coming from block 308 are cash settled at a settlement
price of $0. REC futures contracts coming from blocks 306 and 316
are settled at a settlement price of $0, while REC futures
contracts coming from block 310 are settled at a settlement price
that is related to the realized recovery rate.
[0197] At block 322, process 300 ends.
[0198] In another embodiment, the settlement engine 220 may settle
POD.TM. index futures and REC index futures, both daily and at
maturity. Daily settlement of POD.TM. index futures may be
performed based on the change in POD.TM. index futures market
value, as discussed above. FIG. 4 illustrates a process 400 used to
settle POD.TM. index futures daily, in kind and at maturity. At
block 402, process 400 begins. At block 404, the settlement date of
each unsettled transaction may be compared to the current date. For
each unsettled transaction with a maturity date equal to the
current date, the method targets that transaction for processing at
block 406.
[0199] In one embodiment, the settlement date of each POD.TM.
futures or REC futures index is fixed to one of a set of standard
settlement dates. For example, POD.TM. futures or Recovery indexes
may have a settlement date of the second business day after the
21.sup.st day of a settlement month. For quarterly POD.TM. futures
or REC futures indexes, settlement months may include March, June,
September and December. For annual POD.TM. futures or REC futures
indexes, the settlement month may be December. Thus the settlement
engine breaks up credit exposures into short term exposures, which
allows market participants to express their credit market view with
greater temporal precision.
[0200] At block 406, the term of each POD.TM. futures or REC
futures index targeted for final settlement will be given its final
settlement price. In this embodiment, the final settlement price of
an index of POD.TM. futures will be the sum of the final settlement
prices of the POD.TM. futures contained in the index, divided by
the initial number of names in the index. Similarly, the final
settlement price of an index of REC futures will be the sum of the
final settlement prices of the REC futures contained in the index,
divided by the initial number of names in the index. Once they have
received their final settlement price, contracts proceed to block
408.
[0201] At block 408, each POD.TM. futures or REC futures index
targeted for processing may be settled to the POD.TM. futures or
REC futures index final settlement price in cash. The act of
settling may include updating the trader accounts database 216 to
reflect the inflow of cash from the settled contracts, if any.
Following cash settlement, the contract proceeds to block 416.
[0202] If the current date is not the maturity date of the POD.TM.
futures or REC futures index contract, then the contract proceeds
to block 410. At block 410, the contract's risk period and time to
maturity may be compared to an identified risk period and time to
maturity to determine subsequent processing actions. In this
example, for each POD.TM. futures or REC futures index targeted for
settlement whose term is equal to the identified time to maturity
or risk period, for example, three years and one year, the method
may target that POD.TM. futures or REC futures index for processing
by block 412.
[0203] At block 412, each POD.TM. futures or REC futures index
targeted for processing is settled in kind, with both long and
short positions delivering four quarterly equivalent contracts
each. A system executing block 412 may record this settlement by
updating the trader accounts database 216 to reflect the new long
and short positions. The quarterly contracts will be priced
according to equation (1):
P.sub.Quarterly=(Last traded price of annual contract-Face value
price of annual contract)/4+Face value price of quarterly contract
(1)
[0204] Once they are settled in kind, contracts proceed to block
414. Contracts that do not have a term equal to the identified risk
period and a time to maturity equal to the identified time to
maturity proceed directly to block 414. At block 414, contracts
targeted for processing are cash settled based on the daily change
in their market value. Contracts then proceed to block 416.
[0205] At block 416, process 400 ends.
[0206] In still another embodiment, the settlement engine 220 may
settle POD.TM. index tranche futures only at maturity. FIG. 5
illustrates of a process 500 used to settle POD.TM. index tranche
futures and REC tranche futures daily, in kind and at maturity. At
block 502, process 500 begins. At block 504, the maturity date of
each contract may be compared to the current date. For each
contract with a maturity date equal to the current date, the method
targets that transaction for processing at block 506.
[0207] At block 506, each POD.TM. or REC index tranche futures
targeted for processing may be reviewed to determine if it is a
POD.TM. or a REC index tranche futures. Each contract that is
deemed to be a REC index tranche futures is targeted for processing
at block 508. At block 508, the Recovery rates that will be
averaged are assigned to each tranche based on the order of the
occurrence of the defaults. In this embodiment, recovery rates are
assigned a value of 0 if the default occurred in a previous period,
while keeping their rank. Recovery rates occurring in the current
period are given a rank and take the value used to settle their
corresponding REC futures contracts. For example, if 5 defaults
occur in the current period and one default has occurred on the
index in the previous period, R.sub.1 takes the value of 0, R.sub.2
to R.sub.6 take the values of the recovery rates determined for the
corresponding REC futures and R.sub.7 to R.sub.100 take the value
of 0 to price the expiring REC tranche index futures. REC index
tranche futures contracts then proceeds to block 512 with a
settlement price that is the average of the recovery rates assigned
to the tranche. Each contract that is deemed to be a POD.TM. index
tranche futures contract is targeted for processing at block
510.
[0208] At block 510, each POD.TM. index tranche futures targeted
for processing may be allocated losses up to the detachment point
of the POD.TM. index tranche futures. Each POD.TM. index tranche
futures may be reviewed to determine the settlement price for the
POD.TM. index futures referenced by the POD.TM. index tranche
futures. A POD.TM. index futures loss calculation may be performed.
In one embodiment, the POD.TM. index futures loss may be the
difference between the face value of the POD.TM. index futures and
the settlement price of the index. The POD.TM. index futures loss
may be first allocated to the lowest tranche, for example a 0-3
tranche, to the degree that it has not been allocated to in
previous quarters in the same series and to the degree the loss
does not exceed the detachment point for the POD.TM. index tranche
futures. In this embodiment, the final settlement price of a
POD.TM. index tranche futures is the face value of the tranche
minus any POD.TM. index futures loss allocated to the tranche. Once
a POD.TM. index tranche futures contract is assigned its final
settlement price, it proceeds to block 512. At block 512, expiring
contracts are targeted for final cash settlement and proceed to
block 522.
[0209] If the current date is not the maturity date of the POD.TM.
futures or Recovery futures, the tranche futures proceeds to block
514. At block 514, the contract is reviewed to determine whether it
has reached its exhaustion point. If it has, it proceeds to block
506. Otherwise, it proceeds to block 516.
[0210] At block 516, each POD.TM. futures or REC futures index
tranche futures targeted for processing may be reviewed to
determine if the POD.TM. futures or REC futures tranche index
futures has a maturity date equal to an identified date and an
exposure period equal to a certain time period. For example, the
identified date may be three years from the current settlement date
and a one-year exposure period. If the POD.TM. or REC tranche index
futures has the identified maturity date and exposure period, the
POD.TM. or REC tranche index futures proceeds to block 518. At
block 518, the POD.TM. or REC index tranche futures is settled in
kind, with short positions delivering short positions on four
quarterly equivalent contracts and vice versa. A system executing
block 518 may record this settlement by updating the trader
accounts database 216 to reflect the new long positions. The
quarterly contracts will be priced according to equation (1):
P.sub.Quarterly=(Last traded price of annual contract-Face value
price of annual contract)/4+Face value price of quarterly contract
(1)
[0211] After processing at block 518, the POD.TM. or REC index
tranche futures proceeds to block 520. If a POD.TM. or REC index
tranche futures has a maturity date that is not equal to an
identified date and an exposure period equal to a certain time
period, then it proceeds directly to block 520.
[0212] At block 520, the settlement engine assigns the contract a
daily settlement price based on recent market trading activity. The
act of settling contracts daily may include updating the trader
accounts database 216 to reflect the inflow or outflow of cash from
the settled contracts, if any. Contracts then proceed to block
522.
[0213] At block 522, process 500 ends.
[0214] In another embodiment, the settlement engine 220 may settle
the changes in the price of credit futures or bond recovery rate
futures contracts, only at maturity or on a less frequent basis.
For example, in at least one embodiment, the settlement engine 220
may settle the changes in the price of credit futures or bond
recovery rate futures contracts only after their last trading day.
As discussed above, each type of credit futures or bond recovery
rate futures contract has a particular pricing mechanism. The
settlement engine 220 may employ any of these mechanisms and/or
others to determine the final settlement price based on the state
of the reference entity and possibly another variable for bond
recovery rate futures contract traded each day. The settlement
engine 220 may then update the trader accounts database 216 to
reflect inflows or outflows of cash based on the change of the
price of each credit futures or bond recovery rate futures contract
at maturity.
[0215] Each of processes 300, 400 and 500 depicts one particular
sequence of acts in a particular embodiment. Other actions can be
added, or the order of actions can be altered in these methods
without departing from the scope of the present invention.
[0216] Referring again to FIG. 2, the clearing interface 214 may
monitor account positions included in the trader accounts database
216 to ensure traders are able to honor their contractual
commitments. More specifically, the clearing interface 214 may
process completed transaction information retrieved from the
completed transactions database 222 to maintain near real-time
pricing information regarding the various credit futures or bond
recovery rate futures contracts traded using the PODM system 112.
Furthermore, the clearing interface 214 may access the impact of
changing market conditions on trader accounts included within the
trader accounts database 216. If changing market conditions will
take a trader's account resources below an identified level, the
clearing interface 214 may issue a margin call to the trader. In
one example, the margin call may be issued to a dealer who, in
turn, is responsible to the clearing house for executing the margin
call with the entity holding the long or short position. The margin
call may use any form of communication including email, fax, pager,
POTS and VIOP among others.
[0217] The clearing interface 214 may also receive financial data,
such as an electronic deposit of cash and/or other liquid
instruments, in response to the margin call. The clearing interface
214 may update the account balances included in the trader accounts
database 216 to reflect any deposits received. Moreover, the
clearing interface may be configured to issue the margin call
directly to the financial institution system 110. Thus providing an
automated method of replenishing trader account resources as
needed.
[0218] The clearing interface 214 may also interact with other
exchanges. More particularly, the clearing interface 214 may be
configured to execute trading strategies in response to changing
market conditions and information. For example, in one embodiment
the clearing interface 214 may issue a buy order for stock of in a
reference entity when the probability of default implied by the
POD.TM. futures price for the reference entity to be below a
defined level for a defined series of contracts. Similarly, the
clearing interface 214 may issue a sell order for the stock of a
reference entity when probability of default implied by the POD.TM.
futures price for the reference entity to be above a defined level
for a defined series of contracts.
[0219] The clearing interface 214 may also perform transaction
clearing functions. In one embodiment, for example, the clearing
interface 214 may record the long and short positions of market
participants after for each completed trade transaction. This
record may be made in the trader accounts database 216.
Alternatively, the clearing interface 214 may clear a transaction,
and record the resulting long and short positions, after ensuring
that the buyer's credit is sufficient to limit the risk of default,
such as when the buyer is trading on margin.
[0220] In one embodiment, the clearing interface 214 may also
transfer funds from and to the accounts of holders of long and
short positions daily, after daily settlement has been completed.
This funds transfer may be made to the trader accounts database 216
or may be made using an interface to a financial institution.
[0221] In another embodiment, the clearing interface 214 may
perform clearing functions using a central clearing entity as a
counterpart to both parties of a transaction. For example, the
clearing interface may transfer funds between the holders of long
and short positions and the central clearing entity. In another
embodiment, the central clearing entity may be a PODM exchange. Use
of a central clearing entity may provide market participants with
increased confidence that transactions conducted on the exchange
will be honored.
[0222] The databases 204, 206, 210, 216 and 222 may take the form
of any logical construction capable of storing information on a
computer readable medium including flat files, indexed files,
hierarchical databases, relational databases and/or object oriented
databases. The data may be modeled using unique and foreign key
relationships and indexes. The unique and foreign key relationships
and indexes may be established between the various fields and
tables to ensure both data integrity and data exchange
performance.
[0223] The order interface 202 and the clearing interface 214 each
exchange information with various providers and consumers. These
providers and consumers may include users and system interfaces. In
the exemplary embodiment illustrated in FIG. 2, the trader 200
exchanges information with both the order interface 202 and the
clearing interface 214. In an alternative embodiment, this
information may be exchanged with other applications or storage
media using system interfaces exposed by each of these elements.
Each of these elements may both restrict input to a predefined set
of values and validate any information entered prior to using the
information or providing the information to other components.
[0224] The PODM system 112 may be used to perform various processes
in accord with the present inventions. For example, FIG. 6
illustrates one such embodiment, process 600. At block 602, process
600 begins. At block 604, a system executing process 600 receives a
trade order. The trade order may be any trade request as discussed
above including a request to buy a credit futures or bond recovery
rate futures contract or a request to sell a credit futures or bond
recovery rate futures contract. The trade order may be subject to
price restrictions, as discussed above. Referring back to FIG. 2,
in one embodiment, the system may receive the trade order via the
order interface 202.
[0225] More particularly, FIG. 7 shows one embodiment of a process
700 for placing a trade request, by which a system executing
process 600 may receive a trade order. At block 702, process 700
begins. At block 704, a trader may enter information required to
place a trade into a user interface. This information may include
various characteristics of the credit futures or bond recovery rate
futures contract, including futures contract type (e.g. POD.TM.
futures, REC futures, POD.TM. index futures, REC index futures, or
POD.TM. index tranche futures), face value, term, entity or
entities referenced, tranche series, price restrictions and
position sought (long or short) etc. . . .
[0226] At block 706, the trader may submit the trade request by
actuating a user interface element designated for submission of
trade requests. After the trader submits the trade request, a
system executing process 600 may further process the trade request
as discussed further below. Alternatively, at block 708, a trader
may cancel the trade request by actuating a user interface element
designated for cancellation of trade requests. At block 710,
process 700 ends.
[0227] Referring back to FIG. 6, at block 606, a system executing
process 600 stores the order. The system may store the order in any
computer readable medium including volatile and non-volatile memory
implemented in magnetic media, optical media or otherwise.
Furthermore, the system may store the order in any logical data
structure including flat files, indexed files or databases.
Referring back to FIG. 2, in one embodiment the system may store
the order in the trade requests database 204.
[0228] At block 608, a system executing process 600 may match
countervailing orders. The system may perform this matching
continuously or periodically. As discussed above, in one
embodiment, the matching process may actively only during specified
time periods, for example 6:30 PM to 4:00 PM, Eastern Standard
Time, Sunday to Friday of each week. Referring back to FIG. 2, in
one embodiment, the system may match orders using the auction
engine 122 and may move completed transactions to the completed
transactions database 210.
[0229] More particularly, FIG. 8 illustrates one embodiment of a
process 800 for matching trade requests. At block 802, process 800
begins. At block 804, a system executing process 800 may determine
a matching methodology. In one embodiment, trade requests may be
matched continuously and may be given priority on a first-come,
first-served basis. In another embodiment, the system may attempt
to match all trade requests belonging to by priority group or tier,
prior to matching other trade requests. Membership in a tier may be
based on any characteristic of trade requests, such as, for
example, the price restrictions included in a trade request. For
instance, the system may group all market buy and sell orders into
a first tier and attempt match the first tier requests prior to
identifying and matching other tiers. This embodiment may provide
for a more efficient matching process as market buy and sell orders
are less restrictive than other types of orders, and thus are more
likely to be matched by the system.
[0230] Other embodiments may employ other matching methodologies
and may combine matching methodologies, for example, one embodiment
may use tier based priority matching with first-come, first-served
matching within each tier.
[0231] At block 806, a system executing process 800 may employ the
matching methodology to match offsetting orders based at least in
part on any of the characteristics that may vary according to
credit futures or bond recovery rate contract. For example, the
system may match based on the futures contract type (e.g. POD.TM.
futures, REC futures, POD.TM. index futures, REC index futures or
POD.TM. index tranche futures), face value, term, entity or
entities referenced, tranche series and price restrictions. The
system may employ indexes into the trade orders while searching for
matches. In one embodiment, the system may search using the most
statistically discriminating index first, followed by other indexes
or sequential searching until a match for the current target trade
request is found. Once a match is found, the two offsetting orders
may form the basis of a completed transaction. At block 808,
process 800 ends.
[0232] Referring back to FIG. 6, at block 610, a system executing
process 600 may complete a transaction including the matched
orders. In one embodiment, a system executing process 600 may
complete the transaction by modifying the trade orders to have a
"complete" status. In another embodiment, the system may also
complete a transaction by removing the orders from their current
storage location and placing the orders, or some transformation of
them, in the same or a different logical or physical storage
location. Referring back to FIG. 2, in one embodiment, the system
may complete a transaction by, at least in part, removing the
orders that make up the transaction from the trade requests
database 204 and storing the completed transaction in the completed
transactions database 210.
[0233] At block 612, a system executing process 600 may clear a
transaction. FIG. 9 shows, with more particularity, one embodiment
of a process 900 for clearing a transaction. At block 902, process
900 begins. At block 906, the system may insert the central
clearing entity as the counterparty for each original party to the
transaction. Record of the introduction of a central clearing
entity may be made in a database administered by the system, such
as completed transactions database 222. As central clearing
entities are typically well capitalized institutions, this aspect
may provide less risk to each original party.
[0234] At block 910, the system may determine if one of the parties
to the transaction has sufficient credit and/or holdings within
their account to meet margin requirements prior to continuing with
the clearing process. These margin requirements may be set by
various industry or exchange standards. If the margin requirements
are not met, the system may abort the transaction using block
614.
[0235] At block 912, a system executing process 900 may clear the
transaction by transferring currency from one trading account to
another. More specifically, the system may transfer funds to or
from the counterparty of the seller to the seller. The system may
also transfer funds to or from the buyer to the counterparty of the
buyer. Alternatively, the system may clear a transaction by
requesting a funds transfer through a user or system interface to a
separate financial institution.
[0236] At block 914 process 900 ends. Referring back to FIG. 2, in
one embodiment, the system clears transactions using the clearing
interface 214.
[0237] Referring again to FIG. 6, at block 614, a system executing
process 600 may abort a transaction. In one embodiment, the system
may notify the party that is unable to honor the transaction of its
deficiency. The system may request that the deficient party remedy
its current state by providing any resources required to complete
the transaction, for example by issuing a margin call to the
deficient party. As previously discussed, the system may also have
replaced the deficient party with another party, such as a central
clearing entity, thus enabling partial settlement of the
transaction with the non-deficient party. In one embodiment, if the
deficient party does meet its margin call obligations, a system
executing process 600 may close the deficient party's positions via
appropriate trade orders. Referring back to FIG. 2, in one
embodiment, the system may abort a transaction using the clearing
interface 214.
[0238] At block 616, a system executing process 600 forms a
contract. In one embodiment, the system forms the contract by
recording each party's contractual long and short positions.
[0239] At block 618, process 600 ends.
[0240] Each of process 600, 700, 800 and 900 depicts one particular
sequence of acts in a particular embodiment. Other actions can be
added, or the order of actions can be altered in these methods
without departing from the scope of the present invention.
[0241] As discussed above, various aspects disclosed herein may be
implemented as specialized software executing in a computer system
1000 such as that shown in FIG. 10. Computer system 1000 may
include one or more output devices 1001, one or more input devices
1002, a processor 1003 connected to one or more memory devices 1004
through an interconnection mechanism 1005 and one or more storage
devices 1006 connected to interconnection mechanism 1005. Output
devices 1001 typically render information for external presentation
and examples include a monitor and a printer. Input devices 1002
typically accept information from external sources and examples
include a keyboard and a mouse. Processor 1003 typically performs a
series of instructions resulting in data manipulation. Processor
1003 is typically a commercially available processor such as an
Intel Xeon, Itanium, Core, Celeron, or Pentium, AMD Opteron, Sun
UltraSPARC, IBM Power5+, or IBM mainframe chip technology, but may
be any type of processor. Memory devices 1004, such as a disk
drive, memory, or other device for storing data is typically used
for storing programs and data during operation of the computer
system 1000. Devices in computer system 1000 may be coupled by at
least one interconnection mechanism 1005, which may include, for
example, one or more communication elements (e.g., busses) that
communicate data within system 1000.
[0242] The storage device 1006, shown in greater detail in FIG. 11,
typically includes a computer readable and writeable nonvolatile
recording medium 1111 in which signals are stored that define a
program to be executed by the processor or information stored on or
in the medium 1111 to be processed by the program. The medium may,
for example, be a disk or flash memory. Typically, in operation,
the processor causes data to be read from the nonvolatile recording
medium 1111 into another memory 1112 that allows for faster access
to the information by the processor than does the medium 1111. This
memory 1112 is typically a volatile, random access memory such as a
dynamic random access memory (DRAM), static memory (SRAM). Memory
1112 may be located in storage device 1006, as shown, or in memory
device 1004. The processor 1003 generally manipulates the data
within the memory 1004, 1112 and then copies the data to the medium
1111 after processing is completed. A variety of mechanisms are
known for managing data movement between the medium 1111 and the
memory 1004, 1112, and embodiments are not limited thereto.
Embodiments are not limited to a particular memory device 1004 or
storage device 1006.
[0243] Computer system 1000 may be implemented using specially
programmed, special purpose hardware, or may be a general-purpose
computer system that is programmable using a high-level computer
programming language. For example, computer system 1000 may include
cellular phones, personal digital assistants and/or other types of
mobile computing devices. Moreover, a computing device may include
any sort of computer such as a personal computer, a workstation, a
mainframe, a networked client, a server, media servers and
application servers. Computer system 1000 usually executes an
operating system which may be, for example, the Windows XP, Windows
Vista or other operating systems available from the Microsoft
Corporation, MAC OS System X available from Apple Computer, the
Solaris Operating System available from Sun Microsystems, or UNIX
operating systems available from various sources (e.g., Linux).
Many other operating systems may be used, and embodiments are not
limited to any particular implementation. For example, an
embodiment may process a trade request using a general-purpose
computing device with a Sun UltraSPARC processor running the
Solaris operating system.
[0244] Although computer system 1000 is shown by way of example as
one type of computer system upon which various aspects of
embodiments may be practiced, it should be appreciated that
embodiments are not limited to being implemented on the computer
system as shown in FIG. 11. Various aspects of embodiments may be
practiced on one or more computer systems having a different
architecture or components than that shown in FIG. 11. To
illustrate, one embodiment may receive search criteria using
several general-purpose computing devices running Windows Vista
with Intel processors and several specialized computing devices
running proprietary hardware and operating systems.
[0245] As depicted in FIG. 12, one or more portions of the system
may be distributed to one or more computers (e.g., devices
1209-1211) coupled to communications network 1208. These computer
systems 1209-1211 may also be general-purpose computer systems. For
example, various aspects may be distributed among one or more
computer systems configured to provide a service (e.g., servers) to
one or more client computers, or to perform an overall task as part
of a distributed system. More particularly, various aspects may be
performed on a client-server system that includes components
distributed among one or more server systems that perform various
functions according to various embodiments. These components may be
executable, intermediate (e.g., IL) or interpreted (e.g., Java)
code which communicate over a communication network (e.g., the
Internet) using a communication protocol (e.g., TCP/IP). To
illustrate, one embodiment may report market information though a
browser interpreting HTML forms and may replicate account balance
information using a data translation service running on a separate
server.
[0246] Various embodiments may be programmed using an
object-oriented programming language, such as SmallTalk, Java, C++,
Ada, or C# (C-Sharp). Other object-oriented programming languages
may also be used. Alternatively, functional, scripting, and/or
logical programming languages may be used. Various aspects may be
implemented in a non-programmed environment (e.g., documents
created in HTML, XML or other format that, when viewed in a window
of a browser program, render aspects of a graphical-user interface
(GUI) or perform other functions). Various aspects may be
implemented as programmed or non-programmed elements, or any
combination thereof. For example, an order interface may be
implemented using a Microsoft Excel spreadsheet while the auction
engine may be written in C++.
[0247] It should be appreciated that a general-purpose computer
system may perform functions outside the scope of the invention.
For instance, aspects of the system may be implemented using an
existing commercial product, such as, for example, Database
Management Systems such as SQL Server available from Microsoft of
Seattle Wash., Oracle Database from Oracle of Redwood Shores,
Calif., and MySQL from MySQL AB of UPPSALA, Sweden and WebSphere
middleware from IBM of Armonk, N.Y. If SQL Server is installed on a
general-purpose computer system to implement an embodiment, the
same general-purpose computer system may be able to support
databases for sundry applications.
[0248] Based on the foregoing disclosure, it should be apparent to
one of ordinary skill in the art that the invention is not limited
to a particular computer system platform, processor, operating
system, network, or communication protocol. Also, it should be
apparent that the present invention is not limited to a specific
architecture or programming language.
[0249] Having now described some illustrative aspects of the
invention, it should be apparent to those skilled in the art that
the foregoing is merely illustrative and not limiting, having been
presented by way of example only. While the bulk of this disclosure
is focused on embodiments including futures contracts with a
settlement value based on a credit default state that is trigger by
a credit default event, other binary reference events may be the
basis of future contracts in accordance to the present invention.
For example, according to one embodiment, market participants may
deal in futures contracts with a binomial settlement value based on
the occurrence, or non-occurrence, of an event that damages insured
property, such as a hurricane. Similarly, aspects of the present
invention may be used to achieve other objectives including
allowing insurance companies to hedge against the occurrence of a
hurricane in a specific part of the country. Numerous modifications
and other illustrative embodiments are within the scope of one of
ordinary skill in the art and are contemplated as falling within
the scope of the invention. In particular, although many of the
examples presented herein involve specific combinations of method
acts or system elements, it should be understood that those acts
and those elements may be combined in other ways to accomplish the
same objectives. Acts, elements and features discussed only in
connection with one embodiment are not intended to be excluded from
a similar role in other embodiments.
* * * * *