How to Define Financial Products with LexiFi

LexiFi provides four mechanisms for describing financial products:

Business users typically specify the values of financial product parameters with a graphical user interface (GUI) while financial engineers create domain-specific and product-specific abstractions with basic MLFi combinators and libraries of higher-level MLFi contract assembly components.

Product-Specific Abstractions

Product-specific abstractions are parametric instrument definitions that resemble term sheets or confirmations. For each product category, business users specify simple parameters—e.g., a date to describe a maturity, a float to describe a notional amount—or more complex parameters—e.g., a formula to describe a complex coupon, notional amount, or payoff. Users do not have to learn a script language: the most complex input is a formula.

Graphical Trade Entry Screen The parameter values define a contract that is redeemed as soon as the sum of coupons reaches 16%. The redemption amount depends on whether the contract terminates early or on the original maturity date. Click image to enlarge.

Contract designers may choose to restrict the set of editable instrument parameters to simplify deal capture.

Domain-Specific Abstractions

Domain-specific abstractions are more general parametric instrument definitions designed to cover entire product families.

For example, a broad range of multi-asset, multi-period products may be defined by specifying three sets of formulas, a "cell payoff", a "local payoff", and a "global payoff", as illustrated below.

The parameter values in the figure above define a contract based on a basket of twenty assets that pays 85% of the basket's initial value plus the highest positive average return calculated on ten annual observation dates. Each year, the basket's value is calculated using the following rules:

• As soon as an asset becomes the best performer on a given year, that year's performance, subject to a performance boost applicable in each of the first seven annual observation dates, is used in the calculation of the average basket's performance not only for the given year but also for the following years. The contribution of a once best performing asset to the value of the basket is effectively "frozen" on the date the asset becomes the best performer. The basket's value is therefore insensitive to future changes in the value of a once best performing asset. Note that the "freeze" feature is not controlled by the set of visible parameters: a more general definion lies underneath.
• On each of the first seven annual observation dates, if the best performing asset returns less than 100%, the performance is set to 100%.
• The basket's value on each annual observation date is equal to the arithmetic average of individual asset returns.
• The contract's payoff is equal to 85% of the basket's initial value plus the maximum of the ten average basket returns or zero if the maximum is negative.

The corresponding graphical trade entry screen is reproduced below.

Trade entry screen that illustrates how a domain-specific abstraction may be instantiated to describe a particular financial products. Click image to enlarge.

MLFi Contract Assembly Components

MLFi's finance library comprises predefined contract assembly components, including functions to handle market conventions, schedule builders, and sample product definitions. With the finance library, five to twenty lines of MLFi code generally suffice to capture the logic of a new product. The finance library is delivered with source code: users are free to modify and to extend it in order to meet specific requirements.

MLFi Basic Combinators

The twenty core constructors of MLFi's contract sub-language provide the greatest level of generality to create contract components that are eventually put together to create financial products. The basic combinators effectively form MLFi's low level assembler language.

The table below summarizes the tools that LexiFi provides to define financial contracts:

Contract Definition Tool	User Specifies	Interface	Required Skills
Product-Specific Abstractions	Parameter values.	Graphical user interface or text editor.	Ability to enter formulas.
Domain-Specific Abstractions	Parameter values.	Graphical user interface or text editor.	Ability to enter formulas.
MLFi Contract Assembly Components	Script.	Text editor.	General programming skills.
MLFi Basic Combinators	Script.	Text editor.	For complex financial contracts, reasonable skills in algorithm design.