Sumit Kumar
In this paper, we wanted to highlight the rationalization of risk post SOFR (Secured Overnight Funding Rate) discounting switch and Libor cessation. Key rate Duration (KRD) or Bucketed DV01 is a vital risk report that gives traders a critical insight into the hedging requirement of a Derivative trade or Derivative portfolio. We created four logical timeboxes, namely Pre-credit Crisis, Credit Crisis to pre-SOFR discounting, SOFR Discounting to Libor cessation, and beyond. We valued our stylized interest rate swap in all four scenarios and computed Risk. This Risk is represented in a KRD bucket in all four scenarios. We have shown further that in Timebox 1 (Pre-credit Crisis), the KRD gives rational hedge recommendations. Still, post-credit crisis, this KRD report became very complex as the same simple Swap to hedge now requires more hedging instruments to incur more hedging costs. We also showed how we had achieved some rationalization in KRD reports post SOFR. We discussed methodology in detail and analyzed the results. We have also discussed how the Risk and KRD would shape if we move towards basis products like Basis swaps or cross-currency basis swaps.