Patent Application
20160063629
Aspects of the invention relate to processing of financial instruments. More particularly, aspects of the invention relate to processing financial instruments that decompose into other financial instruments upon occurrence of a decomposition event.
Traders of financial instruments often trade combinations of financial instruments or instruments based on combinations of financial instruments. Financial instruments include equity instruments, bonds, debt instruments, option contracts and futures contracts. Combinations of financial instruments or instruments based on combinations of financial instruments include baskets, indexes, spreads, etc. Baskets may include exempt securities, non-exempt securities, other financial obligations and commodities. One example of a financial instrument is a credit default swap. A credit default swap contract involves the transfer of the credit risk. The buyer of a credit default swap receives credit protection, whereas the seller of the credit default swap guarantees the credit worthiness of the debt security. In doing so, the risk of default is transferred from the buyer of the credit default swap to the seller of the swap. For example, the buyer of a credit default swap will be entitled to the par value of the contract by the seller of the swap, should the third party default on payments.
It can be difficult to determine a final settlement price of some financial instruments if certain events occur. For example, the value of a financial instrument may be based on a value of an index of credit default swaps. A credit event, such as a bankruptcy, can occur which can result in the timing and the method used to determine a final settlement price of an impacted index or basket constituent deviating from the timing or method used to determine the final settlement price of the original index.
Accordingly, there is a need in the art for improved systems and methods for processing combinations of financial instruments or instruments based on combinations of financial instruments when value impacting events occur.
Aspects of the invention overcome at least some of the problems and limitations of the prior art by providing systems and methods for decomposing financial instruments when certain events occur. An original financial instrument may be a futures contract that is based upon an index of credit default swaps. The credit default swap index may be viewed as a basket of single name credit default swaps. When a decomposition event, such as a bankruptcy, occurs, the original financial instrument may be decomposed into two financial instruments. The first financial instrument may be based on the single name credit default swap related to the bankruptcy. The second financial instrument may include an index that is no longer includes the single name credit default swap related to the bankruptcy. The second financial instrument may settle in a manner and at a time that is the same as the original financial instrument. The first financial instrument may settle at a different time and use a different procedure.
In other embodiments, the present invention can be partially or wholly implemented on a computer-readable medium, for example, by storing computer-executable instructions or modules, or by utilizing computer-readable data structures.
Of course, the methods and systems of the above-referenced embodiments may also include other additional elements, steps, computer-executable instructions, or computer-readable data structures. In this regard, other embodiments are disclosed and claimed herein as well.
The details of these and other embodiments of the present invention are set forth in the accompanying drawings and the description below. Other features and advantages of the invention will be apparent from the description and drawings, and from the claims.
The present invention may take physical form in certain parts and steps, embodiments of which will be described in detail in the following description and illustrated in the accompanying drawings that form a part hereof, wherein:
Aspects of the present invention are preferably implemented with computer devices and computer networks that allow users to exchange trading information. An exemplary trading network environment for implementing trading systems and methods is shown in
The trading network environment shown in
Computer device 114 is shown directly connected to exchange computer system 100. Exchange computer system 100 and computer device 114 may be connected via a Ti line, a common local area network (LAN) or other mechanism for connecting computer devices. Computer device 114 is shown connected to a radio 132. The user of radio 132 may be a trader or exchange employee. The radio user may transmit orders or other information to a user of computer device 114. The user of computer device 114 may then transmit the trade or other information to exchange computer system 100.
Computer devices 116 and 118 are coupled to a LAN 124. LAN 124 may have one or more of the well-known LAN topologies and may use a variety of different protocols, such as Ethernet. Computers 116 and 118 may communicate with each other and other computers and devices connected to LAN 124. Computers and other devices may be connected to LAN 124 via twisted pair wires, coaxial cable, fiber optics or other media. Alternatively, a wireless personal digital assistant device (PDA) 122 may communicate with LAN 124 or the Internet 126 via radio waves. PDA 122 may also communicate with exchange computer system 100 via a conventional wireless hub 128. As used herein, a PDA includes mobile telephones and other wireless devices that communicate with a network via radio waves.
One or more market makers 130 may maintain a market by providing constant bid and offer prices for a derivative or security to exchange computer system 100. Exchange computer system 100 may also exchange information with other trade engines, such as trade engine 138. One skilled in the art will appreciate that numerous additional computers and systems may be coupled to exchange computer system 100. Such computers and systems may include clearing, regulatory and fee systems.
The operations of computer devices and systems shown in
Of course, numerous additional servers, computers, handheld devices, personal digital assistants, telephones and other devices may also be connected to exchange computer system 100. Moreover, one skilled in the art will appreciate that the topology shown in
The identification may be received at a futures contract composition computer or other device that includes a processor. The identification may include terms of the financial instrument, such as a settlement date and a settlement procedure. In some embodiments financial instruments are cash settled and in other embodiments that are settled by physical delivery.
Next, in step 204 it is determined if a decomposition event has occurred. A decomposition event may include a bankruptcy, a default on payments, a value of a financial instrument that is part of an index of financial instruments exceeding a predetermined percentage of a value of the index of financial instruments, or any other event agreed upon by the parties.
When no decomposition event has occurred, in step 206 the process waits a predetermined time period before returning to step 204 and once again determining whether a decomposition event has occurred. The predetermined time period may be one day, one hour or some other time period. When a decomposition event has occurred, in step 208, the first futures contract is decomposed into at least second and third futures contracts. The second futures contract may include or be based on all of the original financial instruments not associated with the decomposition event. The third futures contract may only include or be based on the financial instrument associated with the decomposition event. In some embodiments of the invention the third futures contract may be replaced with another financial instrument. The financial instrument may take the form of a commodity futures contract, a security futures product, an over-the-counter (OTC) forward or swap contract, an option on futures contract, a security option contract, or (6) other types of financial instruments. The regulatory characterization of the new financial instrument may be the same as, or different than, the regulatory characterization of the original first futures contract.
The decomposition event may require a change in a settlement procedure or time. For example, when a credit default swap is associated with a commercial entity, such as a corporation, that initiates bankruptcy, the value of the credit default swap may be determined at an auction, which may occur before or after the original futures contract final settlement date. Decomposing the original financial instrument into two financial instruments allows for isolating the instrument that now has a different final settlement procedure or time from the remaining financial instruments.
In one example, a primary financial instrument is based upon the value of an index of credit default swaps consisting of one-hundred corporations. A decomposition event may be defined as the default or bankruptcy of one of those corporations. Upon the occurrence of such default or bankruptcy, the primary financial instrument may continue to be valued based upon an index of credit default swaps referencing the remaining ninety-nine corporate entities. A secondary contract is based upon the value of the decomposed corporate entity that incurred a default or bankruptcy.
In another example, a primary contract is cash settled based upon an index of individual equity securities. A decomposition event may be defined as a situation where the value of an individual equity advances such that its weighting in the index exceeds a pre-specified level such as 30%. Upon the occurrence of such an event, the primary contract may continue to be valued based upon an index of individual equity securities as originally specified less the decomposed equity security. A secondary contract is based upon the value of the decomposed equity security and is settled through physical delivery or cash settlement as pre-specified in the contract specifications.
Altering financial instruments or terms of the financial instruments may impact margin account requirements. In step 210 a margin account requirement may be recalculated.
The present invention has been described in terms of preferred and exemplary embodiments thereof. Numerous other embodiments, modifications and variations within the scope and spirit of the invention will occur to persons of ordinary skill in the art from a review of this disclosure.
