BPI Consulting project - “Structured products”

Abstract

This paper studies the best approach to valuing complex financial instruments, namely structured products. As part of a Consulting Project for Banco BPI, we aimed to develop an accurate and broad valuation model for this type of products, enabling the calculation of their Fair Value. To achieve this, we resorted to the Monte Carlo simulation model with appropriate Cholesky decomposition to predict price paths, which allowed for the computation of product cash flows and, consequently, respective fair value. These cash flows were segmented into repayment and return, which were then discounted to present value, resulting in the fair value at the valuation date. We started by benchmarking the current BPI portfolio of products and later enlarged the pool including other product characteristics present in major banks’ offering assortment. It is believed that, even though the model as is includes all major characteristics present in current financial instruments offered by the industry, given the dynamism of financial markets and constant evolution of complex products, this model may need recurring adjustments and adaptations.