For new and amended deals completed intraday, the MTM values or premiums reflecting these values, will either be retrieved directly from the product systems (assuming that appropriate pricing parameters and market data were specified at the time of input) or entered manually by the trader.
The referenced FPE, calculated with risk factor based on a transaction’s product type and underlying attributes, is then added to this MTM value to come up with the replacement risk for the deal. The overall replacement risk calculation is restricted to MAX [(0, MTM)] + FPE, such that in no instances will a negative MTM be considered in the calculation.
The formula based approach is mostly reserved for OTC equity derivatives, like Equity Forward and Equity Option, in which a diffusion model is used to determine replacement risk on a particular position. For long calls, long equity forwards and long mutual fund forwards, the 95th percentile level (1.65 sigma) of the equity price is estimated under a diffusion process with drift equal to the expected return under the CAPM formula and volatility set to the greatest of the 1, 3 and 5-year standard deviations (see https://finpricing.com/lib/FxVolIntroduction.html).
The percentage replacement risk factor is determined using the ratio of the upward diffused price over the strike price. For long puts, short equity forwards and short mutual fund forwards, the current price of the equity is diffused downwards with drift equal to 0 (i.e., no directional bias) and volatility set to the greatest of the 1, 3, and 5-year standard deviations.
The percentage replacement risk factor is determined using the ratio of the downward diffused price over the strike price. Where product types that are fed into the system are unknown, or where specific transactions are denoted as non-standard, then the most conservative application would be to estimate replacement risk at 100% of the notional.
Add-on factor tables (profile basis) are uploaded to the production system to monitor the replacement risk. The system could easily pick up the tables for exposure calculation. A complete term profile of add-on factors for FX Forward trades and FX Option trades (including buy/sell domestic currency and sell/buy foreign currency, with gross exposure and collateralized exposure) are stored in production system.