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PURPOSE
This banking circular provides guidance on risk
management practices to national banks and federal
branches and agencies engaging in financial derivatives
activities. The guidelines in this circular represent
prudent practices that will enable a bank to conduct
financial derivatives activities in a safe and sound
manner. National banks engaged in financial
derivatives transactions are expected to follow these
guidelines. * * *
* * * * * * *
SCOPE
Financial derivatives transactions currently represent
a relatively small portion of the total credit, market,
liquidity, and operational risk to which most banks are
routinely exposed. However, because of their
complexity, many banks involved in financial
derivatives transactions have developed sophisticated
approaches in managing those traditional types of risk.
These guidelines reflect such approaches and,
therefore, represent sound procedures for risk
management generally. Therefore, to the extent
possible, they should be applied to all of a bank’s
risk-taking activities.
As to the valuation of derivatives, BC-277 stated:
4. Valuation Issues
Banks that engage in financial derivatives activities
should ensure that the methods they use to value their
derivatives positions are appropriate and that the
assumptions underlying those methods are reasonable.
Dealers and active position-takers should have systems
that accurately measure the value of their financial
derivative portfolios. The pricing procedures and
models the bank chooses should be consistently applied
and well-documented. Models and supporting statistical
analyses should be validated prior to use and as market
conditions warrant.
The best approach is to value derivatives portfolios
based on mid-market levels less adjustments.
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