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Analytics 3

4.

Customer wants 3 month forward contract---- i.e. customer is Importer.

Bank buys 3 month fwd from market

Bank sells 3 month fwd contract to customer.

Customer wants to cancel the contract one month before the due date ( on which the forward has to

be executed)

Original contract Sale: 36.25 (Dr)

Cancellation : 36.45 (Cr)

Gain : 0.20

Gain is Rs 20000

5.

Fixed Floating Preference

A 10 L+1 Floating

B 13 L+2 Fixed

300 basis points 100 basis points

L --- LIBOR

IRS: Interest Rate Swap

We have to structure a product which will satisfy both A and B.

Quality Spread Differential 300-100=200 basis points

This is divided in the ratio 1:1:2

A------50

B------50

Swap Bank----100

Total------------200

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If a party wants floating rate, we ask him to go for fixed and whatever u pay to the market, give to

us.

A: Pays: L+100+10

Receives: 10.50

Effective: L+50

B: Pays L+200+11.50

Receives L+100

Effective: 12.50%

Swap Bank: retains 100 basis

Steps in structuring IRS

1. Find Quality spread differential2.

Distribute the QSD between the 3 parties in an agreed manner

3. Change the preference (Floating to fixed and vice versa)4. Work out net for A using payables and receivables and satisfy A5. Work out net for B using payables and receivables and satisfy B6. Ensure the basis points for Swap bank

ASwapBank

B

10.50

L+100

11.50

L+100

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In the above problem what if the ratio is 2:1:1

A: Pays--------

Receives---

B: Pays -------

Receives--

Swap Bank:

Sometimes changing from fixed to floating may not be possible.

U can get quality spread differential when there is a change from one floating rate to another.

IRS is between fixed to floating and vice versa for the same currency

This is worked on notional principal basis

The purpose is cost reduction over a period of time

Cost reduction reduces operational exposure over a period of time.

This is financial (operations) strategy.

All derivatives have to get approval of management. From Basel III they have to come into the

balance sheet, they have to come under contingent liabilities. Reporting may be in IFRS format.

(Currently they are off balance sheet items)

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6

Importer since he has payables.

10/07 booking date 57.85

Cost of booking forward contract is 34131500

Cash Flow Method 1 =34131500

Buy 6 Futures @ 57.89

Sell @ 48.09

Loss----------------9.8

Sell in spot@ 57.95

0.60 per dollar gain on 10000 (600000-590000)

Cash Flow method 2 = 3414500

590000* 57.95 = 34190500 = Cash Flow method 3

10/09 due date

7

Expected Spot rate = 43.75

43.75 *200000= 8750000

If he buys a call at 53.60 he will not exercise his right. The call option is out of money. Then he goes

to market and the cost will be 44.15. The Rs cost will be 8830000

If 3 month forward is taken 53.60 * 200000 = 10720000

If he sells a put @ 53.50, the buyer of the put option will exercise his right. The cost is going to be

53.00. Rs cost will be

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If he buys a put @ 53.50, the premium paid is 0.50. He will exercise the right.

Buy from market @43.50