Wilson Freitas, AboutWIlson.net, Pricing Brazilian Government Bonds: LFT, here. Wilson kills it; That’s why the internet is great.
For many years I’ve been working for and with software vendors in the brazilian financial industry. The great majority of pricing and risk management aplications running on here were not developed here in Brazil. I think that is the main reason I saw many projects struggling to deliver a glimpse of what had been promissed during the software selection meetings. One thing that is usually said is that brazilian market has its jabuticabas, yeah jabuticaba. It is a sweet fruit which grows in Brazil, vastly. And like the fruit jabuticaba, the brazilian financial market has a bunch of financial instruments with annoying characteristics such as:
business days rules
truncation rules, mainly for interest rates
stupid inflation rules
the PTAX currency which yields the dirty coupon for the foreign interest rate
and many others
In this post I want to start a series where will show the steps to validate the pricing rules for a few brazilian financial instruments. I am going to start with the brazilian government floating rate bond called LFT or Letras Financeiras do Tesouro (Treasury Financial Letters). Despite being a Floating Rate Bond, LFT is traded above its face value and a spread, usually quite small and negative, is used to discount it. These calculations seem to be pretty simple but it hides some pitfalls and because of that we are going to go on step by step, paying attention to details.