[Federal Register Volume 62, Number 103 (Thursday, May 29, 1997)]
[Notices]
[Pages 29188-29189]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-14072]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service
[SPR-104006-97]


Mark-to-Market Valuation Software

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Solicitation for comments.

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SUMMARY: The IRS is soliciting comments on the scope, algorithms, and 
use of its new software to provide historic market values for certain 
financial instruments.

DATES: Comments are requested on or before July 28, 1997.

ADDRESSES: Send written comments to: Internal Revenue Service, Attn: 
CC:DOM:CORP:R (SPR-104006-97), room 5226, POB 7604, Ben Franklin 
Station, Washington, DC. 20044. Alternatively, respondents may hand 
deliver written comments to CC:DOM:CORP:R (SPR-104006-97), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Ave., NW., 
Washington, DC., or may submit comments electronically via the IRS 
Internet site at: http://www.irs.ustreas.gov/prod/tax__regs/
comments.html.

FOR FURTHER INFORMATION CONTACT: Suzanne J. Boule at 212-298-2116 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    Section 475 of the Internal Revenue Code requires that dealers in 
securities use a mark-to-market method of accounting. Under that 
method, inventory securities must be included in inventory at fair 
market value. For a security that is not inventory in the hands of the 
dealer and that is held at the close of a taxable year, the dealer must 
recognize gain or loss as if the security were sold for its fair market 
value on the last business day of that taxable year.
    The IRS intends to implement mark-to-market valuation software to 
assist with the administration of section 475. The software is being 
developed by the Los Alamos National Laboratory under the supervision 
of the IRS's Office of Financial Products and Transactions. The 
software will be used to compute ranges of values for various financial 
instruments.

Comments

    The IRS is soliciting comments from the public concerning this new 
software. Comments are invited concerning the scope, algorithms, use, 
and other aspects of the software.

Scope

    The software can compute a range of values for interest rate swaps; 
currency swaps; path-independent caps, floors, and collars; path-
dependent caps, floors, and collars; ndex-amortizing swaps; European 
options on any of the above; and American and mid-Atlantic (Bermudan) 
options on path-independent instruments. The IRS invites comments 
concerning which instruments should be included in the scope of the 
software for various historic periods.

Algorithms

    The software uses models of the term structure of interest rates 
developed by Black, Derman, and Toy [1]; Black and Karasinski [2]; 
Heath, Jarrow, and Morton [3,4,5]; Ho and Lee [6]; and Hull and White 
[7]. These models are widely used in the financial products industry. 
The IRS invites comments concerning which models should be used by the 
software for various historic periods.

Use

    The software uses models and financial data appropriate to the date 
as of which a financial instrument is to be valued. The models are 
calibrated to match market data for swaps, caps, floors, and swaptions 
on that date. For this purpose, the IRS has acquired extensive 
databases of historical interest rates, currency exchange rates, and 
interest rate and currency derivative data. The IRS invites comments 
concerning the use of the models, including the derivation of inputs to 
the models from these databases.

Credit Risk, Etc.

    In industry practice, the values computed using the basic models 
are often adjusted to reflect credit risk and other factors. The IRS 
invites comments concerning which, if any, such adjustments are 
appropriate for valuations under section 475 and concerning the methods 
by which any adjustments should be effected. More generally, the IRS 
invites comments identifying any reason why there might be differences 
between the values produced by the software and the values that should 
be taken into account under section 475. The IRS also invites 
suggestions regarding appropriate ways to reconcile those differences.

Batch Processing

    The software currently supports on-line interactive processing of 
single instruments, and will soon support off-line batch processing of 
portfolios of instruments. The IRS invites comments on the 
implementation of batch processing.
    Comments are requested on or before July 28, 1997. Written comments 
should be sent to: Internal Revenue Service, Attn: CC:DOM:CORP:R (SPR-
104006-97), room 5226, POB 7604, Ben Franklin Station, Washington, DC. 
20044. Alternatively, respondents may hand deliver written comments to 
CC:DOM:CORP:R (SPR-104006-97), Courier's Desk, Internal Revenue 
Service, 1111 Constitution Ave., NW., Washington, DC., or may submit 
comments electronically via the IRS Internet site at: http://
www.irs.ustreas.gov/prod/tax__regs/comments.html.
    If a respondent is submitting written comments, a signed original 
and eight (8) copies are requested. All comments will be available for 
public inspection and copying in their entirety.

References

1. Black, Fischer, Emanuel Derman and William Toy. ``A One-Factor 
Model of Interest Rates and its Application to Treasury Bond 
Options.'' Financial Analysts Journal 46 (January-February 1990): 
33-39.
2. Black, Fischer, and Piotr Karasinski. ``Bond and Option Pricing 
When Short Rates are Lognormal.'' Financial Analysts Journal 47 
(July-August 1991): 52-59.
3. Heath, David, Robert Jarrow and Andrew Morton. ``Bond Pricing and 
the Term Structure of Interest Rates: A Discrete Time 
Approximation.'' Journal of Financial and Quantitative Analysis 25 
(December 1990): 419-440.
4. Heath, David, Robert Jarrow and Andrew Morton. ``Contingent Claim 
Valuation with a Random Evolution of Interest Rates.'' Review of 
Futures Markets 9 no. 1 (1990): 54-76.
5. Heath, David, Robert Jarrow and Andrew Morton. ``Bond Pricing and 
the Term Structure of Interest Rates: A New Methodology for 
Contingent Claims Valuation.'' Econometrica 60 (January 1992): 77-
105.

[[Page 29189]]

6. Ho, Thomas S. Y., and Sang-Bin Lee. ``Term Structure Movements 
and Pricing Interest Rate Contingent Claims.'' Journal of Finance 41 
(December 1986): 1011-1029.
7. Hull, John, and Alan White. ``Pricing Interest Rate Derivative 
Securities.'' Review of Financial Studies 3 no. 4 (1990): 573-592.
Belinda S. McCafferty,
Director, Office of Financial Products and Transactions, Office of 
Assistant Commissioner (International).
[FR Doc. 97-14072 Filed 5-28-97; 8:45 am]
BILLING CODE 4830-01-U