The Derivatives Exposure Equation

Our last post provided a big picture summary of the steps required to calculate a Fund's "derivatives exposure" for purposes of new Rule 18f-4. The post may have left an impression that this process should not be that difficult. To provide additional perspective, we offer the following equation for calculating derivatives exposure. If interest rate and currency hedges satisfy the following condition: Then a Fund will be a limited derivatives user when: Where: This formula tries to resolve ambiguities to produce a smaller derivatives exposure. Admittedly, there is nothing hard about the math in this equation, although this would change if we included the formula for calculating an option's delta. For us, and we suspect many compliance officers, the most significant aspect of the equation is the sheer number of variables and the need to use different values (unadjusted and adjusted notional amounts, principal amounts, market values) for different variables. Creating a daily compliance report for derivatives exposure will require some careful data entry and programming.