Overview

Valuing and analyzing exotic options, over-the-counter (OTC) exotic derivatives, and debt and credit-based derivatives are part of the Basel II requirements. The following provides quick excerpts of the required aspects of some of these derivatives, direct from the Basel Committee on Banking Supervision s June 2004 publication.

Section 112 The comprehensive approach for the treatment of collateral will also be applied to calculate the counterparty risk charges for OTC derivatives and repo-style transactions booked in the trading book.

Section 140

Where guarantees or credit derivatives are direct, explicit, irrevocable and unconditional, and supervisors are satisfied that banks fulfill certain minimum operational conditions relating to risk management processes they may allow banks to take account of such credit protection in calculating capital requirements.

Section 189

Other than non-payment by a protection purchaser of money due in respect of the credit protection contract it must be irrevocable; there must be no clause in the contract that would allow the protection provider unilaterally to cancel the credit cover or that would increase the effective cost of cover as a result of deteriorating credit quality in the hedged exposure. Paragraph 203 sets forth the treatment of call options in determining remaining maturity for credit protection.

Section 203

The maturity of the underlying exposure and the maturity of the hedge should both be defined conservatively . For the hedge, embedded options which may reduce the term of the hedge should be taken into account so that the shortest...