1M USD/MXN funding valuation adjustment spreads fairly priced in

1M vol swap vs. 1M1M FVA packages are currently well priced in BRL and MXN.

Not only is the net vol carry on offer meaningful, but also risk-reward looks highly asymmetric in the desired direction.

Internally, FVA plays an essential role in providing monetary incentive for trading desks to use less funding. This can be accomplished by charging a high rate for borrowing from treasury desk and paying for posting money back to the funding desk. This is also why FVA can be interpreted by the sum of FCA (Funding cost) and FBA (Funding benefit).

For instance, the second chart compares the (vol swap - FVA) strike spread for USD/MXN (the net vol quantity being sold) with the (1M realized vol - 1M ATM vol) differential (the net quantity which the trade settles into).

The bar for losses from current levels looks high, and would need a shock on the scale of taper or worse to end up meaningfully in the red.

We do not pull the trigger on any of these this week, but they will remain on our radar as decent trades to pursue once Greek risks are out of the way.