-109-
an AA-rated entity took into account the risk of nonpayment of
the cashflows by an AA-rated entity.
2. Role of FNBC’s Devon System
The Devon system had a critical role in FNBC’s risk
management and hedging operations. The Devon system was used by
FNBC’s Chicago office traders to risk-manage and to hedge their
swaps. The Devon system calculated not only the current
mid-market value for the book, but also how much the value would
change with particular interest rate movements.
B. Accounting for Devon Value
At least monthly, FNBC recorded the change in the midmarket
value of a performing swap in two pieces.34 The first piece,
described by FNBC as the accrual,35 reflected a proportion of the
next scheduled net cashflow. This accrual of interest was
computed by multiplying the amount of the net interest payment by
a fraction. The fraction’s denominator was the number of days in
the payment period (the period between the scheduled cashflows or
34 FNBC removed “nonperforming VEP transactions” (discussed
infra p. 148) from its trading portfolio and valued these swaps
at a “modified lower of cost or market”.
35 In the accounting sense, an “accrual” is the process of
recognizing noncash events or circumstances as they occur, not
necessarily when cash is paid or received. Accrued assets or
liabilities and the related revenues, expenses, gains, or losses
represent amounts expected to be received or paid in the future.
Common examples of accruals include (1) purchases and sales of
goods or services on account and (2) unpaid but incurred amounts
of interest, rent, wages, salaries, and taxes.
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