Net Present Value Calculation using TPM60CVA
TPM60CVA – Calculate Net Present Values – With CVA and DVA
In Treasury and Risk Management, one can use the following functions for system to calculate NPVs (or fair values):
- Transaction JBRX – Single Value Analysis: NPVto calculate NPVs for financial transactions. Please note that this transaction doesn’t save any calculated NPVs but is used for What-if analysis based on input scenario.
- Transaction TPM60 – In order to save NPVs that system has calculated and use them later, we can use TPM60 which is function for Save NPVs. For this transaction, the system calculates the NPVs in exactly the same way as transaction JBRXand saves the results in NPV table VTVBAR.
- Transaction TPM60CVA – The function is used to determine NPVs Including CVA and DVA in your NPV calculation. The results are also stored in the NPV table.
- Credit Value Adjustment (CVA) is the amount subtracted from the mark-to-market (MTM) value of positions to account for the expected loss due to counterparty defaults. Since CVA is a positive value, it is deducted from the risk free NPV calculation.
- Debit Value Adjustment (DVA) is the amount added back to the MTM value to account for the expected gain from an institution’s own default. As the DVA is negative value, it must be subtracted from the risk free NPV calculation.
The NPV of a financial transaction with the inclusion of CVA and DVA is derived as “Risk-free NPV – CVA – DVA”
CVA and DVA is calculated in the system in the following ways:
- Difference Method: With this method, the system will calculate below values based on evaluation types:
- Risk-based NPV using the yield curve stored in the evaluation type. If the settings for credit spreads is also saved, the system also takes it into account when calculating the NPV like in a composite yield curve.
- Risk-Free NPV based on risk free yield curve stored in the evaluation type
The difference between Risk-free NPV and Risk-Based NPV is equal to CVA or DVA
2. Based on Expected Exposures: In this method, CVA/DVA is calculated separately based on the expected exposures on a given date. The calculation required the credit spread curve for the reference entity for either the counterparty or your own company.
This document explains the NPV calculation of a Foreign exchange transaction based on expected exposures and below is the terminology for understanding of the process:
- Evaluation Type: This is an object where all the required yield curves are mapped that will be used to determine the NPV. The field is available as input in the TPM60CVA screen
- Reference Entity: Reference entities are created for counterparty or own company codes. These entities are mapped to the yield curves that will be used for CVA/DVA calculation.
- CVA/DVA Type: This object determines how CVA/DVA calculation is done in the system.
Customizing required for calculating NPV for CVA/DVA:
Define Expected Exposure Type
This setup control how the system calculates expected exposures (EE).
SPRO-> Financial Supply Chain Management -> Treasury and Risk Management -> Basic Analyzer Setting -> Valuation -> Settings for Calculation of Credit and Debit Value Adjustments -> Define expected Exposure Types
Define Credit and Debit Value Adjustment types
The adjustment types control how the system calculates CVA and DVA.
SPRO-> Financial Supply Chain Management -> Treasury and Risk Management -> Basic Analyzer Setting -> Valuation -> Settings for Calculation of Credit and Debit Value Adjustments -> Define Credit and Debit Value Adjustment Types
Define Valuation Rule
SPRO-> Financial Supply Chain Management -> Treasury and Risk Management -> Basic Analyzer Setting -> Valuation -> Define Valuation Rule
Define Evaluation Type
Settings for evaluation types are required for the calculation of the net present values of financial transactions/treasury positions.
SPRO-> Financial Supply Chain Management -> Treasury and Risk Management -> Basic Analyzer Setting -> Valuation -> Define and Setup Evaluation Type
Master Data Required to be maintained:
Below are the currency parameters of the Forex transaction that we are evaluating:
Position Currency: USD
Valuation Currency: EUR
Based on the composite curve structure in the evaluation type, the market data for the required date need to be maintained to make sure that NPV calculation is being done correctly.
Risk Free Yield Curve – Curve Type 1000
Reference rates maintained for Yield Curve for Currency EUR:
Reference Rates Maintained as on 31.07.2023:
FX Volatility Type –Curve Type 002
Basis Spread Curve – 1000 (Will be picked based on Tenor)
Credit Spread for Business Partner
Now, we execute TPM60CVA as on 31.07.2023.
Upon execution, system will display the NPV calculated.
The NPV value is saved in the internal table(VTVBAR)
Once NPV values are saved, execute valuation TPM1 to post the accounting entries.
TPM60CVA offers an enhanced functionality to calculate the Net present value by taking into account the credit risk associated with the external bank and own organization, thus further adjusting the value allowing for a more accurate assessment of the financial position.
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