Valuation of FX contracts and Derivatives
The audit procedures for valuation of FX contracts and Derivatives include:
For spot and tom contracts checking whether correct FEDAI rates are used by the Bank for marking them to market. In case of automatic feed of FEDAI rates, verifying whether the rates are correctly uploaded into the system. At the end of the reporting period, sight the process and verify the process of downloading rates from external source and the process of uploading of rates in the system by the middle/back office for all FX contracts and derivatives.
Process of computation of net present value of rates.
Re-performing and checking on a sample basis the accuracy of the MTM gain / loss booked by the bank on the outstanding forex contract.
In case of valuations of swaps, options and other derivative products most of the banks have proprietary valuation models developed by them or standard valuation software installed. In case of proprietary valuation models, a model validation coupled with checking of input parameters would provide reasonable comfort on valuations. In case of standard valuation models, auditors can resort to checking of input parameters along with limited re-performance of derivative valuations. In such cases the auditor should also check system controls and if deemed necessary, consider involving an expert to check the integrity of system logic. Further, the auditor can select certain samples as per the methodology or depending upon the nature, timing and extent for getting it re – valued from the valuation expert. Auditor should also obtain the understanding of rate upload process and verify the timing of rates upload in the system for valuation of derivative contracts. Auditors should carry out the valuation of the samples selected in a spreadsheet and compare the end results with the valuation as provided by the software system. Sometimes the software systems are not capable of valuing certain treasury products such as partly redeemable perpetual bonds, Security Receipts etc., for which the Branch has to value such products manually and the auditor should gain sufficient knowledge to
understand and confirm their valuation.