The Risk of a Currency Swap : A Multivariate-Binomial Methodology

The value of a currency swap, at a future valuation date, is modelled as a function of five stochastic variables. These represent the factors that determine the term structure of interest rates in the two currencies, and the foreign exchange rate between the currencies. The joint-probability distribution of the horizon date value of the relevant variables is approximated by a multivariate binomial distribution. The proposed methodology provides a fast and flexible alternative to Monte-Carlo simulation of the swap value. The value distributions produced by the method can be employed to assist with both market and credit risk management