-90-
2. Closeout Costs (Liquidity)
The G-30 report recommended an adjustment for closeout
costs. The closeout costs (liquidity) adjustment reflects the
cost to buy out, assign, or otherwise unwind one or all of the
reporting entity’s swaps.
The need for a closeout costs adjustment is relatively
strong in some cases. Midmarket pricing from models based on the
prices of benchmark instruments that are liquid overstates the
pricing of assets that are exotic, or infrequently traded, or
have a limited set of potential buyers. Such assets should be
marked down for their liquidity.
During the relevant years, no sound or implementable
approaches existed as to close out costs adjustments. Nor did
many entities (including FNBC) make closeout costs adjustments
during those years.
3. Dealer Margin
The fair market value of a swap (inclusive of profit) is not
normally zero at inception. Dealers capture profits on the
origination of swaps, especially swaps with end users. As a
result, the fair market value of a swap between a dealer and an
end user is generally positive at origination. The midmarket
value of a swap at origination often includes the present value
of the dealer’s expected profit on the transaction.
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