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8/8/2019 Risk Management and Introduction to Derivatives
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PRESENTATION
ON
RISK MANAGEMENT &
INTRODUCTION TODERIVATIVES
BY
B.Y.OLKAR
Former Chief Executive, FEDAI
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RISK MANAGEMENT FRAMEWORK
IDENTIFYING RISK. DEFINING RISK.
MEASURING OF RISK. MODELS SUCHAS ³VAR´.
MONITORING RISK.
CONTROLLING RISK.
PERFORMING EVALUATION.
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FEDAI Value at Risk (VaR) - Revised
Comparative Evaluation
Major Parameters Present Models Proposed (Revised)
Model
1. Confidence Level 97.5% 99.0%
2. Holding Period 3 days 3 days
3. Distribution Assumption Unconditional normality Empirical unconditionaldistribution of residuals.
4. Back Testing Not done by FEDAI Back Testing provided for
5. Coverage of instruments/
maturities
USD/INR limited to three
maturities upto 6 months
Wider coverage - $/Rupee
Spot, Forwards upto 1 year
& 10 major cross currency
pairs.6. Computation of volatility Unconditional ± uses
Standard Deviation
EWMA ± (Exponential
Weighted Moving Average)
which implies more weight
as to recent data.
7. Based on volatility data for Latest 251 days data. Latest 500 days data.
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VaR Models
³VaR Model tells you how much you will lose on good days ±
not on the one bad day´[Ethan Berman, CEO,
Risk Metrics Group set up, J P Morgan]
1. Many models do not account for liquidity risk ± (option pricing models created by brilliant minds at LTCM
assumed continuous markets).2. Assume that future will not be vastly different from
today. Assumptions are as good as the historical data fedinto them.
3. Take into account relatively short period, say 24 hours to3 days to determine their potential trading losses.
4. Focussed on two or three standard derivatives world ± system breaks down when many more events fall outsidethe two/three standard deviation.
5. More money lost than what models predicted.
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RISK MANAGEMENT
CONTROL MEASURES Internal inspection and audits.
Review of systems and procedures.
Monitoring compliance.
Risk education.
Comprehensive IT infrastructure for reduction of human errors.
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Role of Risk Management :
Disaster Strikes ! [cont.]
8. Hammersmith & Fulham counties [Disallowedswap activities] c/p loss $1.0 b.
9. Askin Capital Group (Askin) [Mortgage-backedsecurities] $600 m.
10. Deutsche Morgan Grenfell [Violation of valuation guidelines] $600 m.
11. Kidder Peabody (Jett) [Unauthorised trading]$350 m.
12. Salomon Brothers (Mozer) [Unauthorisedtrading] $290 m.
13. West Virginia (Lester) [Interest Ratespeculation] $280 m.
14. Allied Irish Banks/All First (J.Rusnak) $690 mn.
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SMALLER DISASTERS
1. Merrill Lynch (Rubin) [Unauthorised trading]$275 m.
2. Salomon Brothers [book-keeping errors] $200m.
3. Paine Webber [Misleading sale of partnerships]$200 m.
4. Mellon Bank [Securities lending: interest ratespeculation] $200 m.
5. Nolderhoffer Investments [Thailand, S&P puts]$100+m.
6. Salomon Brothers [Clerical error in programtrading] $100+m.
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SMALLER DISASTERS [cont.]
7. Procter & Gamble [Interest rate swap] $157 m.
8. First Cap. Strategists [Unauthorsied trading]
$128 m.
9. Natwest Markets [Interest rate swaps] $145 m.10. Porugal¶s central bank [Gold losses in Drexel
collapse] $100 m.
11. State of Wisconsin [Foreign interest rate
speculation] $95 m.
12. Gibson Greetings [Interest rate swap] $23 m.
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BAR ING BANK FAILUR E
1. Baring Bank Established in 1762.2. Barings set up derivative business in
Singapore to deal on SIMEX on account
of customers.3. In 1992, Nick Leeson persuadedmanagement that he could generate ³Risk Free´ profit by arbitraging stock index
future µNIKKEI 225¶.4. Nick Leeson controlled dealing as well as
backup.
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BAR ING BANK FAILUR E (Cont.)
5. Shown profits by manipulating accounts.
6. Management did not understand and didnot control risk.
7. Head office kept remitting margin money.
8. Bank failed due to huge losses.
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Allied Irish Banks (AIB)Currency Fraud at its Baltimore Subsidiary
The Man : John Rusnak. (not a µstar trader¶).Attempted to recoup money he had lost on proprietary trading strategy.
Total losses stand around $690 mn. Wiping out 60%
of AIB¶s 2001 earnings and significantly depletingcapital.
Sold number of deep in-the-money options for high premium.
Arbitrage between FX options and spot & forwardmarkets: Buying options cheap and selling whenexpensive.
1997 ± incurred serious losses on forward deals
taking position on movement of JPY.
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Allied Irish Banks (AIB)Currency Fraud at its Baltimore Subsidiary [cont.]
Created fictitious options positions to hide losses.
First option involved receipt of large premium and second oneinvolved identical amount payment. But first would expire thesame day; the second after several weeks. How can the
premium be same ? How no payouts on first option?
Exploited weaknesses in the controls.
Failure in back-office to obtain transaction confirmations.
Failure in back-office to check rates.
Manipulated VaR : (i) Bogus options appeared as µhedge¶, (ii)interferred directly with inputs into VaR calculation.
Senior Management in Dublin & Baltimore failed to pay enough
attention to All First¶s propritary trading.
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LTCM ± (Over-Leveraged Hedge Fund)
1. Founded in 1994. Managed by a dream team of best brains in finance, including Nobel Lauretsand top investment bankers and former ViceChairman of Federal Reserve Board.
2. Being hedge fund, not regulated by SEC.
3. In 4 years built up assets close to $ 125 bn. ± Capital base $ 4 bn.
4. Off-Balance Sheet business = Notional principal
amount over $ 1 trillion.5. Complex swaps, equity derivatives, total-returnswaps, index options, bets on take over targets.Single default by LTCM would trigger crossdefault on all trades.
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LTCM ± (Over-Leveraged Hedge Fund)
[cont.]
5. Return on Equity :
1995 .. 47%
1996 .. 45%
1997 .. 17%
Even planning to handing back $ 3 bn. of capital to investors.
6. Exposures (mainly by way of loan)
Chase .. $ 3.2 bn. (13%)*
Morgan .. $ 0.9 bn. (8%)
Bankers Trust .. $ 0.875 bn. (17%)
Lehman Bms .. $ 0.447 bn. (8%)
BOA .. $ 0.400 bn. (1%)
Merrill Lynch .. $ 1.40 bn.
JPM/Goldman Sachs .. Not Disclosed
(figures exclude potential losses on derivatives)
* Approximate % to tangible equity.
Total Bank Exposure (both on and off Balance Sheet) $ 200 bn.
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LTCM ± (Over-Leveraged Hedge Fund)
[cont.]
7. Investors lost 90% of their money in just twomonths.
8. Original prospectus = It would employ ³tons of
leverage and have a lot of volatility in earnings´(Leverage was 40-60 to one)
9. Rescued by Banks in their own interest & by FED
to avoid systemic risk.
10. VAR Model failed to reveal the full inpact.
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SETTLEMENT RISK
1. Settlement Risk : Risk of incorrectly funding or
not receiving consideration.
2. Lesser understood and appreciated risk. Alsocalled as Herstatt Risk.
3. Herstatt Bank in Germany failed on 26 June 74.
Banking license was withdrawn after close of
banking hours. By then DEM payments werereceived locally irrevocably. Correspondent
bank in N.Y. suspended payments in New York.
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BANK BORROWERS AT FLOATING AND
LENDS AT FIXED ± Possible Impact on Spread
[Amount = Say, US$ 100 Mn.]
HALF
YEAR
Assured
6 Month
LIBOR
Interest
Payments
USD Mn.
Interest
Receipts on
Loan at Fixed
Rate 8% p.a.
US
DMn.
Spread
(+) OR
(-)
USD Mn.
1. 6.00 % 3.00 4.00 1 (+)
2. 5.50 % 2.75 4.00 1.25 (+)
3. 7.50 % 3.75 4.00 0.25 (+)4. 8.00 % 4.00 4.00 NIL
5. 9.00 % 4.50 4.00 0.50 (-)
6. 10.00 % 5.00 4.00 1.00 (-)
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INTER EST R ATE SWAP ± (PLAIN
VANILLA SWAP)
SITUATION Amount say, US$ 100 Mn.
I. µA¶ is a Corporate
µA¶ has issued 3 year bond at Fixed Rate of 9%
µA¶ has lent funds at .. (LIBOR + 1%)
II. µB¶ is a Corporate with an exactly opposite situation i.e. hisincome is at Fixed Rate (9.25%) and payments are at aFloating Rate (LIBOR).
PR OBLEM
Mismatch in inflows and outflows in interest payments(Floating v/s. Fixed)
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INTER EST R ATE SWAP ± (PLAIN
VANILLA SWAP) [cont.]
SOLUTION
INTER EST R ATE SWAP WHER E
1. A pays Floating to B
2. A receives Fixed from B
III. An intermedium perceives the needs of both the
parties and brings them together.
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INTEREST RATE SWAPS ±
(Plain Vanilla) - Example
R ECEIVES (LIBOR + 1) R ECEIVES FIXED 9.25%
Pays LIBOR to µB¶
Receives from µB¶
Fixed At 8.5% P.A.
PAYS 9% FIXED PAYS LIBOR
A B
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INTEREST RATE SWAPS ±
(Plain Vanilla) ± Example [cont.]R ESULT OF THE ARR ANGEMENT
A¶s Income (LIBOR + 1) + Fixed8
.5 B¶s Income 9.25% + LIBOR
A¶s Payment = Fixed 9% + LIBOR B¶s Payment = LIBOR + 8.5%
I.E. LIBOR + 1 + 8.5% - 9% - LIBOR I.E. 9.25% + LIBOR ± LIBOR
± 8.5%
NET SPREAD = (0.5%) NET SPREAD = (0.75%)
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INTEREST RATE SWAP (IRS)
1. Only interest payments on Notional amount are exchanged. Theprincipal amount itself is NOT exchanged.
2. One party pays floating Rate, the other party pays a fixed rate
(Typical Coupon Swap). Floating Rate Indexes used are :
LIBOR (in most US$ Swaps ± about 75%), PR IME, CP Rate,FED Funds Rate, T-Bill Rate.
3. Notional Principal amount and maturity are specific.
4. SWAP R ATE i.e. fixed rate is quoted as spread over appropriatematurity current coupon. Treasury payments on floating Rate
side are usually (but not always) made flat, i.e. at selected Index
Rate without spread.
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Interest Rate Swap (IRS) [cont.]
Definition (IRS)
An Interest Rate Swap is a financial contract between
two parties exchanging or swapping a stream of interestpayments for a µnotional principal amount on multiple
occasions during s specified period. Such contracts
generally involve exchange of a µfixed to floating¶ or
µfloating to floating¶ rates of interest. Accordingly, on
each payment date ± that occurs during the swap period ± cash payments based on fixed/floating and floating
rates, are made by the parties to one another.
(RBI Guidelines)
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SWAP STRUCTURESA 1. BULLET SWAP (PLAIN VANILLA SWAP)
|________________ (Notional amount does not vary)
| |
| |
| |
|________________|_______ T
A 2. AMORTIZING SWAP
|___ Notional principal amount decreases (in
| |_____ regular or irregular increments) over the
| |____ life of the swap.
| |
| |___
| |
|________________|_______ T
A = Notional Principal T = Time (No. of Year)
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SWAP STRUCTURES [cont.]A 3. ACCR ETING (APPR ECIATING) SWAP
| ____ (Opposite of [2])
| ___| |
| ____| |
| __| |
|__| |
|________________|________ T
A 4. R OLLER COASTER SWAP
| ___ (Combination of 2 & 3)
|___ | | ___|
| | | | | |
| | | |___| |
| |___| |
|________________|______ T
A = Notional Principal T = Time (No. of Year)
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X Y
INTEREST RATE SWAP
(Comparative Advantage)FIXED R ATE FLOATING R ATE
µX¶ can Borrow @ 8.60% LIBOR
(Rating : µAAA¶)
µY¶ can Borrow @ 9.60% LIBOR + 0.50%
(Rating : µA¶)
FIXED R ATE FLOATING R ATE
BORR OWING BORR OWING
8.85%
SWAP
LIBOR
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INTEREST RATE SWAP
(Comparative Advantage) [cont.]
µX¶ Receives : 8.85% and PAYS : 8.60% + LIBOR
(Net Cost : LIBOR ± 0.25%)
µY¶ Receives : LIBOR and PAYS : 8.85% +
LIBOR + 0.50%
(Net Cost : 9.35%)
Both Save : 0.25%
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THE PRICING OF
INTEREST RATE SWAPSDealers quote LIBOR flat for a spread over US
treasury yield.
Example: 5-year swap quoted at 30-33, implying that
a pay-fixed side will pay 33-basis point over 5-year treasury yield.
Floating Rates LIBOR (per cent)
6 month 3.5
6 month 3.5625
12 month 3.6875
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THE PRICING OF INTEREST
RATE SWAPS [cont.]
--------------------------------------------------------Fixed Rates Spread (B.P.) Treasury Yield Swap Rate (%)
--------------------------------------------------------
2-year .18 - .21 4.09 4.27 ± 4.30
3-year .31 - .35 4.57 4.88 ± 4.92
5-year .30 - .33 5.50 5.80 ± 5.83
7-year .34 - .37 6.03 6.37 ± 6.40
10-year .35 - .38 6.53 6.88 ± 6.91
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OPTION - Definition
AN OPTION
GIVES THE HOLDER THE RIGHT
BUT NOT THE OBLIGATION
TO BUY OR SELL A SPECIFIC ASSET
AT A PREDETERMINED (SPECIFIC) PRICE AT A CERTAIN FUTURE DATE OR TIME.
THE BUYER (OR HOLDER) OF THE OPTIONPAYS PR EMIUM TO THE SELLER
THE SELLER (OR WRITER) HAS THEOBLIGATION TO BUY OR SELL THE ASSETIF THE BUYER (HOLDER) OF THE OPTIONEXERCISES HIS RIGHT.
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OPTION - Terminology
Call/Put
Volatility
Strike Price
American/European
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OPTION ± Terminology [cont.]
Exercise Intrinsic Value
Time Value
Seller/Writer
Buyer/Holder
In the Money/At the Money/Out of the Money
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DEFINITIONA ³CALL´ IS THE R IGHT TO ³BUY´ THE UNDER LYING ASSET.
CALL BUYER OR HOLDER BENEFITS FR OM INCR EASED
PR OFITS AS MAR KET PR ICES R ISE WITH THE POTENTIAL FOR UNLI
MIT
EDPR
OFITS.
IFPR
IC
ES
FALLTH
E LOSS
IS
LIM
IT
EDT
O
THE PR EMIUM PAID FOR THE OPTION.
CALL SELLER OR WR ITER KEEPS THE PR EMIUM AS PR OFITWHILE MAR KET PR ICES IN THE UNDER LYING R EMAIN STATICOR DECLINE. IF PR ICES R ISE THEN THE POTENTIAL LOSSESAR E UNLIMITED.
SELL A CALL ± SHORT CALL
BUY A CALL ± LONG CALL
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DEFINITION [Cont.]A ³PUT´ IS THE R IGHT TO ³SELL´ THE UNDER LYING ASSET.
PUT SELLER OR WR ITER KEEPS THE PR EMIUM AS PR OFITWHILE MAR KET PR ICES IN THE UNDER LYING R EMAIN STATICO
R R IS
E.
IFPR
IC
ES
FALLTH
ENTH
EP
OT
ENT
IAL LOSS
ES
AR
E
UNLIMITED.
PUT BUYER OR HOLDER BENEFITS FR OM INCR EASED PR OFITSAS MAR KET PR ICES DECLINE WITH THE POTENTIAL FOR UNLIMITED PR OFITS. IF PR ICES R ISE THE LOSS IS LIMITED TO
THE PR EMIUM PAID FOR THE OPTION.
BUY A PUT ± LONG PUT
SELL A PUT ± SHORT PUT
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SOLD CALL
1.View : Price of underlying asset will decline (or remain unchanged). [If unchanged seller gains the
rime value].
2. Maximum possible gain is the premium received.
3. Maximum possible loss is unlimited, as there is no
limit to how the asset will rise (and hence theoption will be exercised against the call seller).
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SOLD PUT
1.View : Price of underlying asset willincrease (or remain unchanged).
2. Maximum possible gain is the premium.
3. Limit of potential loss is limited to how low
the price of the asset can fall.
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WHY OPTIONS ?
1. THEY GIVE PR OTECTION FR OM ADVERSE MOVEMENTS, BUT R ETAIN
THE GAINS FR OM FAVOUR ABLE MOVEMENTS.
* AN IMPORTER OF MACHINER Y WHO HAS TO PAY JPY AFTER 2
MONTHS.
* AN EXPORTER, SELLING TEXTILES TO GERMANY, WHO HAS TO
R ECEIVE EUR O/DEM SOMETIME WITHIN THE NEXT 3 MONTHS.
2. FOR INSUR ANCE
* A CONTR ACTOR WHO IS BIDDING FOR A CONTR ACT IN EUR O,
WHER E THE R ESULTS WILL BE KNOWN SOMETIME IN THE NEXT
MONTH.
3. OTC OPTIONS AR E VER Y FLEXIBLE, AND CAN BE LOW-COST
4. CUSTOMERS WANT THEM
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Value of an Option
VALUE OF AN
OPTION = Intrinsic Value + Time Value
Intrinsic Value ± Difference between
Option Rate and Market Rate.
Time Value ± Time Left to Maturity
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PRICING AN OPTION
FACTORS INCLUDED IN PRICING
MODEL (BLACK & SCHOLES)
STRIKE PRICE
UNDERLYING PRICE
TIME TO EXPIRY
INTEREST RATE
VOLATILITY
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PR ICING AN OPTION:
An Intuitive Approach (Probability/Pay Out)
OPTION PRICES DEPEND ON THEPROBABILITY OF GIVEN CURRENCYMOVEMENTS AND THE PAYOFFS
THAT WILL OCCUR IF AND WHENTHOSE MOVEMENTS TAKE PLACE.
AN OPTION PRICE IS JUST THEPRESENT VALUE OF THE EXPECTEDPAYOUT.
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PR ICING AN OPTION:
An Intuitive Approach (Probability/Pay Out)
[cont.]
EXAMPLE* YOU AR E LOOKING TO DR ILL OIL FR OM A CERTAIN PIECE OF LAND YOU WOULD
LIKE TO BUY. THER E IS:
* 50% CHANCE OF FINDING SOMETHING WHEN Y OU DR ILL
* IF YOU DO FIND SOMETHING THER E IS:
* 30% CHANCE OF FINDING CR UDE YIELDING $500,000 PR OFIT.
* 40% CHANCE OF FINDING CR UDE AND GAS YIELDING $750,000 PR OFIT.
* 30% CHANCE OF FINDING HIGH GR ADE CR UDE YIELDING $1.5 MILLION PR OFIT.
* WHAT IS THE MAXIMUM YOU WOULD BUY IT FOR?
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KNOCK -OUT (DR OPOUT) OPTION
KNOCK -IN (DR OPIN) OPTION
European style currency Option.
Dropout level built into the Option.
If dropout level is breached at any time
during the life of the option, the contract isimmediately terminated.
If dropout level is not breached during thelifetime of the option, then the option will
behave precisely the same manner on expiryas a normal European style option.
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EXAMPLE
The spot Pound Sterling/D
ollar is 1.6000
Customer buys European style currency option which gives him theright to buy Pound Sterling and sell USD at 1.6000 with 3 monthsmaturity.
Premium is say 1.72% of Sterling amount payable with two businessdays value from the contract date.
On Expiry
Spot Rate is above 1.6000. Will he exercise ?
Spot Rate is below 1.6000. Will he exercise ?
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EXAMPLE [Cont.]
With Drop Out FeatureDropout level is say 1.5600.
Premium is say 1.05% of Sterling amount
If at any time before expiry the rate falls below 1.5600, then thecontract lapses.
With Drop in Feature
Drop in level is say 1.5600
If the spot rate falls through 1.5600 during the lifetime of the optionand if, on expiry the option is ³in-the-money´ the option will be
exercised in precisely the same manner.
If on expiry, the spot rate is below 1.6000, then the option will be³out-of-the-money´ and will not be exercised.
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EXAMPLE
Customer purchases 3-month Sterling Call Dollar PutLook Back Option (Say for Sterling Pound 10 mn.)
Premium is say, 4.37% of the Sterling amount payable.
On expiry Pound Sterling/USD is 1.6350. Highest rateduring the 3 month period is 1.6500 and the lowest1.6100.
Q. 1. What it the strike rate of the Sterling CallLook Back
Option?
Q.2. Will the customer exercise theO
ption?
E ample of Interest Rate ³CAP´
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Example of Interest Rate ³CAP´
(CAP is an Interest Rate Option)PER IOD 1 YEAR
%
2 YEAR
%
3 YEAR
%
AVER AGE R ATE
LIBOR
RATES
(AVERAGE)
6.5% 9.5% 11.0 9.00 p.a.
CAP
RATE 8.0 8.0 8.0 8.0
COST OF
PREMIUM FOR CAP
(ANNUALISED)
1.1875 1.1875 1.1875 1.1875
ALL IN
BORROWING COST 7.6875 9.1875 9.1875 8.6875
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Caps & Floor
Cap ± the right to fix the borrowingrate.
Floor ± the right to fix the lendingrate.
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Forward Rate Agreement (FRA)
DefinitionA Forward Rate Agreement (FRA) is a
financial contract between two parties to
exchange interest payments for a µnotional
principal¶ amount on settlement date, for a
specified period from start date to maturity
date.
[RBI Guidelines]
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Forward Rate Agreement (FR A) [cont.]FEATUR ES
traded in the OTC market
no standardisation of amount
in all convertible currencies
never any transaction of principal (notional principal only)
only interest differential is paid or received on the notional principal on thesettlement day
interests applied are LIBOR
front-end discounted payment
no up-front fees, except the transaction costs
contract currency, amount, contract rate, settlement date are specified in advance
(3 x 6) ³Three Sixes´ : An interest rate for 3 months to start in 3 months from thedate of contract.
FRABBA MARKET QUOTES
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FRABBA MARKET QUOTES
(ILLUSTRATIVE)
USD FRAS JPY FRAS
1/4 6.19/15 1/7 6.53/49 1/4 2.45/42 1/7 2.62/58
2/5 6.30/26 2/8 6.68/64 2/5 2.57/54 2/8 2.71/67
3/6 6.56/52 3/9 6.91/87 3/6 2.68/65 3/9 2.81/77
4/7 6.74/70 4/10 7.10/06 4/7 2.76/73 4/10 2.91/87
5/8 6.94/90 5/11 7.26/22 5/8 2.82/79 5/11 3.00/97
6/9 7.14/10 6/12 7.43/39 6/9 2.92/89 6/12 3.10/07
F d R t A t (FRA)
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Forward Rate Agreement (FRA)Examples of Confirmations
PART 1
To be Used on the Agreement Date
F.R.A. CONTR ACT
AGR EEMENT DATE
CONFIRMATION NOTICE
TO :-
FR OM :-We are pleased to confirm the following Forward Rate Agreement (F.R.A.) made
between ourselves as per FR ABBA Recommended Terms and Conditions dated
«««. 1985. (Direct/Broker «««««««««««.).
CONTR ACT CURR ENCY & AMOUNT ««««««««.«««.««««...
FIXING DATE «««««««««.
SETTLEMENT DATE ««««««.. MATUR ITY DATE ««««.«««...
CONTR ACT PER IOD (DAYS) ««««««««««««««««««««.
CONTR ACT R ATE ««««.. % per annum on an actual over 360/365
days basis (as applicable)
Forward Rate Agreement (FRA)
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Forward Rate Agreement (FRA)
EXAMPLE [Cont.]
SELLER ¶S NAME «««««««««««««««««««««««««.
BUYER ¶S NAME «««««««««««««««««««««««««..NON-STANDAR D TERMS & CONDITIONS (IF ANY)
««««««««««
Any payment to be made to us under the F.R.A. hereby confirmed should becredited to our Account Number
«««««««««««««««««««« at««««««««««««««««««««««««««««««««.
PLEASE ADVISE BY TELEX, OR CABLE US IMMEDIATELY, SHOULD
THE PARTICULARS OF THIS CONFIRMATION NOT BE IN
ACCOR DANCE WITH YOUR UNDERSTANDING.
Either :- Or :-
SIGNED : ««««««««««. TESTED TELEX CONFO
FOR AND ON BEHALF OF
««««««««««««««...
ADVANTAGES OF FRA
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ADVANTAGES OF FRAA. HEDGE : BANK CAN HEDGE ITS FUTUR E LENDING/ DEPOSIT
OPER ATIONS AND FIX FUTUR E R ATES IN A SIMPLE AND
EFFICIENT MANNER.
B. CR EDIT R ISK : CR EDIT R ISK I N FR A IS NEGLIGIBLE AS THE
EXPOSUR E IS ONLY TO THE EXTENT OF INTER ESTVAR IATIONS.
C. FLEXIBILITY : AN OPPORTUNITY TO R EVERSE OR SQUAR E THE
POSITION BY MAKING OFFSETTING CONTR ACTS.
D. CR EDIT LIMITS : FR A DOES NOT TIE UP THE BORR OWINGLIMITS TO THE SAME EXTENT AS ACTUAL BORR OWING IN
VIEW OF LIMITED R ISK AS MENTIONED IN (B) ABOVE.
E. BALANCE SHEET : SINCE THER E IS NO EXCHANGE OF
PR INCIPAL AMOUNT, FR As AR E TR EATED AS OFF BALANCE
SHEET ITEMS AND HENCE DO NOT ATTR ACT R ESERVE
R EQUIR EMENTS.
F. SAVING ON FUNDING COST : A JUDICIOUS COMBINATION OF
FR A AND MAR KET BORR OWING CAN ENABLE A BORR OWER BANK R EDUCE ITS FUNDING COST AS COMPAR ED TO THE
COST IN THE CASH MAR KET.
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THANK YOU