Salomon Swapco Inc
To Our Clients
risk that Salomon Brothers Holding Company,
the Salomon affiliate with which Swapco
hedges all of the market risk arising from its
derivative trades, might fail to meet its
obligations to Swapco. Swapco is protected
from SBHC's credit by collateralization of its
SBHC derivative receivable balance, and by
over-collateralization to protect against adverse
market movements during a termination.
The over-collateralization (or "volatility
cushion") is calculated as a conservative
estimate of a three-standard-deviation move in
the value of Swapco/SBHC trades over an
eight-day period. The eight-day period was
chosen because it represents the maximum
number of days between the occurrence of a
trigger event and the valuation of transactions in
the termination process. In the unlikely event of
an actual termination, we expect that we would
complete the valuation process in a substantially
shorter time frame.
The volatility cushion computation is
conservative not merely in its use of the
maximum theoretical time frame but in a
number of other respects. First, the
computation involves separate
overcollateralization of equity and non-equity
transactions. This produces a more conservative
result than would be the case if we used a
combined portfolio. Second, each equity and
non-equity overcollateralization amount is,
itself, the larger of two separate tests. The first
incorporates price movement data over the
previous 60 days while the second uses data
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Salomon Swapco Inc
To Our Clients
over the previous 20 days. Finally, the cushion
calculation is increased for an add-on designed
to protect against possible added volatility
which might result from the growth of the
portfolio.
Given the conservative nature of the
computation underlying Swapco's volatility
cushion, it is not surprising that, over Swapco's
life, there has never been an occasion on which
an actual 8-day market movement - either in
Swapco's favor or against it - has exceeded the
cushion which we computed at the beginning of
that 8-day period. Swapco started trading
during the first quarter of 1993; so our history
now includes over 800 trials of the volatility
cushion and several significant market shocks.
Swapco's volatility cushion over the last year
and one-half, is shown as the top line on the
graph which follows. The bottom line shows
the
Volatility Cushion v 8-Day Market Movements
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
$500
January 1, 1995 through June 30, 1996
(Millions of Dollars)
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