Lesson 3 of 6
Market data and valuation
10 min
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A deal agreed in June is worth something different in July. Treasury accounting values open positions at each period-end, and the value depends on market data: exchange rates, interest rate curves, prices, volatilities. If the market data is wrong or late, every valuation is wrong, and the error flows straight into the income statement or other comprehensive income.
Market data
| Data | Used for | Source and control |
|---|---|---|
| FX spot rates | Valuing foreign currency positions and translating amounts | Daily feed or upload; reasonableness check against the provider |
| FX forward points or curves | Fair value of FX forwards | Provider feed; check tenors used |
| Interest rate curves | Discounting and valuing interest rate products | Provider feed; check curve date and currency |
| Security prices | Valuing securities positions | Provider feed; check stale prices |
Market data used in treasury valuation and how to control it.
Market data usually arrives through an automated interface from a market data provider (SAP's market data interfaces, often called Datafeed, or file uploads), or is entered manually for small volumes. The key controls are completeness (all rates needed for the valuation date are there), accuracy (rates match the provider's published values) and timeliness (the valuation uses rates for the right date). A rate entered manually by the same person who runs the valuation is a classic audit finding.
Valuation at period-end
Valuation runs per valuation area (for example with TPM1) and calculates the change in value of each position since the last valuation, then posts it according to the valuation area's rules. For Contoso's FX forward, the fair value at each month-end is the difference between the contracted rate and the current forward rate for the remaining term, applied to the notional and discounted. If at the end of the first month the MXN forward rate for the maturity date is 18.80, MXN 50,000,000 is worth USD 2,659,574.47 at the market rate, so the forward that locks in USD 2,688,172.04 has a positive value of about USD 28,600 before discounting.
| Item (end of month 1, illustrative) | Value |
|---|---|
| Contracted: MXN 50,000,000 at 18.60 | USD 2,688,172.04 |
| At market forward rate 18.80 | USD 2,659,574.47 |
| Undiscounted fair value of the forward | USD 28,597.57 (asset) |
| Change in value of the MXN loan receivable (spot moved similarly) | Loss of a similar size |
Valuing the FX forward. Real valuations discount the amount and use the provider's curve.
The forward gains roughly what the MXN loan loses when the peso weakens: that is what a hedge is for. Whether that gain and loss land in the same period and the same line of the income statement depends on hedge accounting, which is lesson 4.
What would you do?
At the June close, the FX forward's valuation shows a fair value 100 times larger than expected. The deal data is correct. What do you check first?
What goes wrong in testing
| Symptom | Cause | Test |
|---|---|---|
| Valuation uses yesterday's rates | Feed ran after valuation, or wrong rate date | Check rate date in the valuation log |
| Huge valuation swings | Quotation direction or factor wrong for a currency pair | Value one deal by hand at a known rate |
| Valuation posted only in 0L | Second valuation area not included in the run | Run per valuation area and compare ledgers |
| Gains not reversed next month | Wrong valuation procedure (reset versus cumulative) | Value two consecutive month-ends and check the postings |
Valuation defects and the tests that find them.
Positions and valuation areas
Valuation does not change the deal; it changes the position that the deal creates in each valuation area. A position holds the book value, accrued amounts and valuation history. The valuation area's settings decide which valuation method applies, whether changes go to the income statement or other comprehensive income, and whether the next valuation resets the previous one. Contoso uses one valuation area for US GAAP mapped to ledger 0L and one for IFRS mapped to 2L, so a test of valuation is always a test of two results.
| Valuation area (illustrative) | Ledger | FX forward not in hedge accounting | FX forward in a fair value hedge |
|---|---|---|---|
| US GAAP area | 0L | Fair value change to income | Fair value change to income, offset by the hedged loan |
| IFRS area | 2L | Fair value change to income | Fair value change to income, offset by the hedged loan |
The same forward valued in two areas. Here the rules agree; for other products and hedge types they can differ.
Where the two frameworks agree, the test confirms that both ledgers carry the same amounts. Where they differ, for example in the treatment of certain hedge costs, finance writes the expected entries for each ledger before the test, and the test compares both.
- Valuation depends on market data: rates, curves and prices for the right date.
- Control market data for completeness, accuracy, timeliness and segregation.
- Valuation runs per valuation area and posts per ledger rules.
- Value one deal per product type by hand in every test cycle.
Check your understanding · not graded
Lesson check
1. What three properties should market data controls check?
2. Contract MXN 50,000,000 at 18.60; market forward 18.80. What is the undiscounted fair value?
3. Why should the person entering rates not run the valuation?
4. A valuation is 100 times too large. What is a likely cause?