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Portfolio level analysis is an important part of managing a derivatives portfolio. The common types of portfolio anlaysis are Total Value, Aggregated Cash Flows, Risk Sensitivity, Stress testing, and Value-at-Risk.
Total Value is one of the simplest types of portfolio aggregation. Using this analysis, calculating the value of the portfolio simply requires iterating through the positions within the portfolio, valuing each one, and summing them. In other words the value of the portfolio, f(P), equals the sum of the individual trades, f(Ti).
Portfolio P image
However, if f(Ti) represents the result of a particular analysis applied to an individual trade, then it is not usually true that the result for the portfolio, f(P), equals the sum of f(Ti).
Aggregated cash flows
The future cash flows for a portfolio sorted in chronological order are sometimes required. This aggregation is not difficult if the cash flows for each trade are available; it involves marshaling the data and applying a sort algorithm.
Both total value and aggregated cash flow are relatively simple analyses and do not require sophisticated calculations at the portfolio level, as long as they are carried out at the trade level. But in other types of analysis, the aggregations are not so simple, and most require information about the risk factors that are shared by multiple positions within the portfolio.
This analysis is the rate of change of the value of the portfolio with respect to the market data. Being able to calculate this first order sensitivity is a vital component of any risk system. For example it can be used to calculate DV01 which is the sensitivity of the portfolio value to a small shift in interest rates - a parallel shift of the whole yield curve. It can also be used to calculate hedge factors which are the positions in liquid vanilla instruments that would be required to add to the portfolio to provide an instantaneous hedge of all market and credit risk.
This analysis involves revaluing the portfolio under a number of different scenarios for the market data to quantify the exposure to more extreme market movements than are captured using first order risk sensitivity.
Credit Value Adjustment and Potential Future Exposure
These are calculations performed on a set of trades with the same counterparty - CVA is an adjustment to the value of a portfolio to reflect the credit risk of the counterparty; PFE is a calculation of the maximum possible loss that would be realised if the counterparty were to default, for a given confidence level, such as 95%.
Value at Risk (VaR)
This is the maximum possible loss over a given time horizon that is suffered as a result of market fluctuations again for a given confidence level. It is a measure of market risk whereas PFE is a measure of counterparty credit risk.
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