Reinvestment products offer high flexibility to the purchasers in exchange for liquidity and safety. The products are over-the-counter transactions that are negotiated with the seller and can contain unique features. When determining the value of a structured investment product, it’s important that the valuation company is familiar with all of the structures. Generally speaking, these products are valued using discounted cash flow techniques.
The basic methodology for valuing reinvestment products starts with the determination of the expected future cash flows under the terms of the agreement. This may be straightforward, in the case of a single fixed coupon, or complex in the case of a forward delivery agreement with multiple securities deliverable. Once each cash flow is determined, the cash flow stream is discounted to arrive at the value. Determining the discount rate or curve of many rates to use for valuation involves analysis of the non-performance risk of the entity that is providing the interest payments. Reinvestment agreements are usually very illiquid, so an illiquidity cost is also included in the agreement value.