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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