Treasury Management

SSBM, Semester III

Batch 2011-13

1
 Week 3 Agenda
• Market Instruments – Capital Markets
• Market Instruments – Foreign Exchange
Markets
• Fixed Income Securities – Duration, Convexity
• Bond Portfolio Management

Arvind Sampath 2
 Week 4 Agenda
• Overview of Derivatives
• Forward Rates
• Swaps
– Introduction
– Illustration
– Examples
– Benefits

Arvind Sampath 3
 Week 4 Agenda
• Overview of Derivatives
• Forward Rates
• Swaps
– Introduction
– Illustration
– Examples
– Benefits

Arvind Sampath 4
 Overview of Derivatives
• Concept: Any instrument which derives its value
from another cash instrument
• Eg INR Forwards, Paneer
• Derivatives are traded in the following asset classes
– Equities
– Fixed Income
– Commodities
– Currencies
• Has both benefits and risk
• Allows hedging, speculation
Arvind Sampath 5
 Overview of Derivatives
Rapid growth and widespread use
• Global Context
– 20% CAGR from 1995 in the use of Interest Rate and Currency Derivatives
– 70% growth in the use of Credit Derivatives since inception 8 years ago
– Current Outstanding
• $400 Tn (Rs22000 lac cr) in Interest Rate and Currency Derivatives
• $ 65 Tn (Rs3575 lac cr) in Credit Derivatives
• $ 10 Tn (Rs550 lac cr) in Equity Derivative
– Daily Turnover
• $1.7 Tn in Interest Rate Derivatives
• $0.3 Tn in Currency Derivatives
– Credit derivatives - CDS, CBO, CLO viewed with caution due to the
financial sector crisis

Arvind Sampath 6
 Overview of Derivatives
Domestic Context (Fixed Income)
• Products
– Plain Vanilla IRS introduced in 1999
– OTC Currency Options in 2005
– Currency Futures introduced in 2008
– Interest Rate futures reintroduced in 2009
– Currency Options on Exchange introduced in 2010
– Credit Default Swaps permitted in 2011

Arvind Sampath 7
 Overview of Derivatives
Domestic Context (Fixed Income)
• Current Outstanding
• $1600Bn in Interest Rate Derivatives
• $ 57Bn in Currency Derivatives
– Daily Turnover
• $2Bn (Rs11,000cr) in Interest Rate Derivatives
• Key issues for banks
• Provisioning for doubtful cases
• Appropriateness of product
• Risk Management infrastructure

Arvind Sampath 8
 Overview of Derivatives
• Can be traded on Exchange or OTC
• Exchange traded contracts are standardized
– Standard face value
• Eg Rs 2lacs for Equity F&O
– Fixed Maturity schedule
• Eg 3 Months trading cycle, Equity F&O
• Eg Last Thursday of the expiry month, Equity F&O
• Exchange traded contracts require an initial margin
– Eg Purchase price Rs5250, IM 10% hence account needs
atleast Rs525 to buy this contract

Arvind Sampath 9
 Overview of Derivatives
• Exchange traded contracts are Marked to
Market daily
– Difference between settlement price and contract
price is adjusted daily
– Eg Purchase price 5250, Settlement Price 5240; then
Rs 10 is debited
• OTC contracts are custom made based on client
requirements, financing pattern
– Often sold as a package with the loan
– Current views are incorporated with the solution
Arvind Sampath 10
 Overview of Derivatives
• Since OTC contracts are not margined daily they
consume credit limit on the client/ counterparty
– Maximum probable credit loss is modeled and
monitored
• Derivatives introduce leverage and are hence
risky
– Due to margin payment or notional principal
• Derivatives are a method to redistribute existing
risk
– To those better able to absorb a specific risk
Arvind Sampath 11
 Overview of Derivatives
• Excellent tool for hedging
– Partial or fully hedging possible
– Allow an entity to freeze the risk on a position
– Remove uncertainty from floating rate assets/
liabilities
• Derivatives in isolation are just a view or
speculation
• Derivatives in conjunction with an asset are a
hedge
Arvind Sampath 12
 Overview of Derivatives
• Critique
– Introduce leverage hence make markets unstable
– Effectiveness of hedge in stressed markets
– Large Counterparty Credit Risk introduced
– Off Balance Sheet item, hence not monitored
• Situation in India
– F&O and exchange traded derivatives operating
smoothly
– OTC derivatives have seen litigations
• RBI guidelines tightened
Arvind Sampath 13
 Overview of Derivatives
• Review the turnover in F&O segment and
compare with the cash market
• Review RBI’s comprehensive guidelines (April 20,
2007) on derivatives
• http://www.rbi.org.in/scripts/NotificationUser.asp
x?Id=3432&Mode=0
• Special emphasis on
– User and Market Maker
– Benchmarks permitted
– Risk Management
– Suitability and Appropriateness
Arvind Sampath 14
 Overview of Derivatives
• Equities
– Index Futures
– Index Options
– Stock Futures
– Stock Options
• Currency
– Currency Futures
– Currency Forwards
– Currency Options (OTC, Exchange)
Arvind Sampath 15
 Overview of Derivatives
• Commodity
– Commodity Futures
• Oil, Gold, Agri
– Commodity Options (Exchange, OTC)

Arvind Sampath 16
 Overview of Derivatives
The family of derivatives includes Interest Rate,
Credit and Equity derivatives.
Interest Rate Derivatives include the following:

Interest Rate
Derivatives

InterestRate
Interest Rate Interest Rate Forward Rate Interest Rate
Swaps
Swaps Futures Agreements Options

Arvind Sampath 17
 Overview of Derivatives
• Fixed Income
– Interest Rate Futures
– Interest Rate Options
– Swaps
– FRA

Arvind Sampath 18
 Overview of Derivatives
Fixed Income
• Interest Rate Futures
– Bond Future
• Notional Coupon
• Duration Hedging
• Physical Settlement/ Price Settlement
– T bill Future
• Hedge for regular buyers at auction
• Short term interest rate future

Arvind Sampath 19
 Overview of Derivatives
Fixed Income
• Interest Rate Options
– Separately tradable Options on a Bond Eg 10 year
– Puts/ Calls based on price or yield
– Volatility Data needed
– Challenge – Same bond doesn’t trade for more
than a few months

Arvind Sampath 20
 Overview of Derivatives
Fixed Income
• FRA
– Forward Rate Agreement
– Notional Principal
– Settles at a future date
– Based on a floating rate benchmark
– Excellent hedge for single period cash flows
– Eg Hedging a CP program
– Eg Hedging a known redemption
Arvind Sampath 21
 Overview of Derivatives
Fixed Income
• Swaps
– Exchange of Cash Flows
– Notional Principal
– Net Cash Flow
– Conversion from Fixed to Floating rate possible
– Excellent tool for removing uncertainly from
floating rate assets/ liabilities

Arvind Sampath 22
 Week 4 Agenda
• Overview of Derivatives
• Forward Rates
• Swaps
– Introduction
– Illustration
– Examples
– Benefits

23 Arvind Sampath
 Who owns
• Skoda
• SEAT
• Audi
• Porsche
• Bugatti
• Lamborghini
• Bentley

Arvind Sampath 24
 Spot Curve
Yield
10%

9%

8%

7% Yield

6%

5%

4%
3mth 6mth 12mth

Arvind Sampath 25
 Spot Rates
• You have funds for 1 year
• You now have 3 options
– Invest money once for 12 months
– Put money for 6 months and rollover again
– Put money for 3 months and rollover thrice more
• Since market is in equilibrium all these should
have the same PV

Arvind Sampath 26
 Forward Rates
• Rs100 becomes Rs 101.5 in 3 months
– Yield/ Spot rate is 6%
• Rs100 becomes Rs 103.5 in 6 months
– Yield/ Spot rate is 7%
• Rs100 becomes Rs 108 in 12 months
– Yield/ Spot rate is 8%

Arvind Sampath 27
 Forward Rates
Proceeds

12m

6m

3m

T+0

98 99 100 101 102 103 104 105 106 107 108 109
Arvind Sampath 28
 Forward Rates
Proceeds

12m

6m

F1, F2
3m

T+0

98 99 100 101 102 103 104 105 106 107 108 109
Arvind Sampath 29
 Forward Rates
• Rs101.5 needs to become 103.5 in 3 months
– Forward rate is ?
• 103.5= 101.5 * (1+F1*/4)
• F1= 7.88%
• Rs103.5 needs to become 108 in 6 months
– Forward rate is ?
• 108= 103.5 * (1+F2*/2)
• F2= 8.69%
Arvind Sampath 30
 Forward Curve
10%

9%

8%

7% Spot
Forward

6%

5%

4%
3mth 6mth 12mth

Arvind Sampath 31
 Forward Rates
• For more precision use Actual/365
• Rs101.5 needs to become 103.5 in 3 months
– Forward rate is ?
• 103.5= 101.5 * (1+F1*91/365)
• F1= 7.90%
• Rs103.5 needs to become 108 in 6 months
– Forward rate is ?
• 108= 103.5 * (1+F2*182/365)
• F2= 8.72%
Arvind Sampath 32
 Forward Rates
• Forward rates are our best guess for rates in
the future based on current curves
• We can use forward rates to compute the
discount factors in the future
• We can use the Discount Factors to get the PV
of our cash flows

Arvind Sampath 33
 Forward Rates
Time Cash Flow Forward Rate Discount Factor
1 40 7.5% .964
2 40 7.8% .962
3 40 8.1% .961
4 1040 8.4% .959
Total

Arvind Sampath 34
 Week 4 Agenda
• Overview of Derivatives
• Forward Rates
• Swaps
– Introduction
– Illustration
– Examples
– Benefits

Arvind Sampath 35
 Introduction To Swaps
• A swap transaction, is a custom-tailored bilateral
agreement, in which two counter-parties agree to
exchange specified cash flows at periodic intervals over
a pre-determined life of the swap on a notional principal
– Custom
– 2 parties
– Exchange cash flows
– Notional principal
– Known dates

Arvind Sampath 36
 Interest Rate Swap

Pays
Floating Interest Rate

Bank A Corporate

Receives
Fixed Interest Rate

Arvind Sampath 37
 Interest Rate Swap
Bank A enters into a Interest Rate swap with a
corporate, on the following terms
• Nominal Principal Amt. : Rs. 25 cr.
• Corporate to pay : Rs. 9.00 % Fixed
• Corporate to receive : 3 Month NSE
MIBOR
• Tenor : 6 Months

Arvind Sampath 38
 Interest Rate Swap
• Trade Date of the swap : 22 Jul 12
• Start Date of the swap : 23 Jul 12
• Tenor of the swap : 6 months
• Maturity of the swap : 23 Jan 13
• Interest Payment Dates : 23 Oct & 23 Jan
• First Fixing : 8.60%

Arvind Sampath 39
 Interest Rate Swap
• Cash Flow On the 23 Oct 12
– 3 Month NSE MIBOR: 8.60 %
(This was the 3M NSE MIBOR on 22 Jul 12, Trade Date)
– Corporate to pay : Rs. 56.71lakhs
( Rs. 25 cr. X 9.00% X 92 days / 365 days)
– Bank to pay : Rs. 54.19lakhs
(Rs. 25 cr. X 8.60% X 92 days / 365 days)

Arvind Sampath 40
 Interest Rate Swap

• Cash Flow On the 23 Jan 13:

– 3 Month NSE MIBOR: 9.25 %
(This is say the 3M NSE MIBOR on 22 Oct 12, Fixing Date)
– Corporate to pay : Rs. 56.71 lakhs
( Rs. 25 cr. X 9.00% X 92 days / 365 days)
– Bank to pay : Rs. 58.28 lakhs
(Rs. 25 cr. X 9.25% X 92 days / 365 days)
Arvind Sampath 41
 Interest Rate Swap

Net Result
Corporate to pay (23 Oct) : Rs. 2.52 lakhs
Bank to pay (23 Jan) : Rs. 1.57 lakhs

Arvind Sampath 42
Interest Rate Swap - As a hedge

Pays
Floating Interest Rate

Bank A Corporate

Receives
Fixed Interest Rate 3M NSE MIBOR +10

Arvind Sampath 43
 Users of IRS
– Commercial banks
– Financial institutions
– Primary Dealers
– Corporates *
– Mutual Funds *

Arvind Sampath 44
 Advantages Of Interest Rate Swaps

• Minimal credit exposure - only to the extent of net interest

– No exchange of principal
– Far lower less than a cash market transaction
• Execute interest rate views
– Operationally easier
– Bearish view can be executed
• Interest rate risk management
– Remove uncertainty from floating rate liabilities/ assets
– Reduces risk by achieving re-allocation of risk
• Lock-in to an existing spread or profit

Arvind Sampath 45
 Benchmarks
• The essential characteristics of a benchmark
are:
– It should be mutually acceptable
– It should be accessible
– It should be transparent
– It should be liquid and deep
– It should be available through the lifetime of the
swap

Arvind Sampath 46
 Issues in pricing an OIS
• Pricing an OIS means determining the fixed rate of the swap

• Pricing using a nearest hedge:

– T-Bill yields / G-Sec yields

• Expectations on overnight rates and their variables

– System liquidity

• View on policy action on interest rates

• Other factors:

– Market positioning

– Counterparty credit risk

Arvind Sampath 47
 Advantages Of Interest Rate Swaps
• Significantly lower capital adequacy for Banks

Asset class Exposure Overall risk RWA Risk

(Rs cr) weightage (Rs Capital
cr) (Rs cr)
G-Secs 100 2.5% 2.50 0.225
Corporate 100 102.50% 102.5 9.225
Bonds
Swaps 100 1.08% 1.08 0.097

20% risk weightage for banks and FIs; 100% for others
OEM: 3.00% Potential Credit Equivalent for 3-5 yr maturity portfolio
80% trades with banks
CAR 9%

48
 IRS Cash Flows
Example of IRS to observe cash flows
• 3 year IRS
• Fixed Rate against 6M T-bill Rate
• Fixed Rate = 8.35%
• Rs25cr Notional Principal
• Settlement every 6 Months
• Start Date 23 Jul 12
• End Date 23 Jul 15
Arvind Sampath 49
 Interest Rate Swap

Pays 6M T Bill Rate

Bank B Bank A

Receives Fixed Rate

8.35%

Arvind Sampath 50
IRS Cash Flows – the floating rate
Dates 6 M Tbill Rate

Mon 23-Jul-12 8.25%

Wed 23-Jan-13 8.38%
Tue 23-Jul-13 8.50%
Thu 23-Jan-14 8.10%
Wed 23-Jul-14 7.85%
Fri 23-Jan-15 7.75%
Thu 23-Jul-15

Arvind Sampath 51
 IRS Cash Flows

Dates Floating Days Floating Fixed

Rate Cash Flow Cash Flow
23-Jul-12 8.25%
23-Jan-13 8.38% 184 10397260 10523288
23-Jul-13 8.50% 181 10388904 10351712
23-Jan-14 8.10% 184 10712329 10523288
23-Jul-14 7.85% 181 10041781 10351712
23-Jan-15 7.75% 184 9893151 10523288
23-Jul-15 181 9607877 10351712

Arvind Sampath 52
 IRS Cash Flows

Dates Floating Fixed Nett NPV

23-Jul-12
23-Jan-13 10397260 10523288 126027.4 121090.3
23-Jul-13 10388904 10351712 -37191.8 -35736.8
23-Jan-14 10712329 10523288 -189041 -181424
23-Jul-14 10041781 10351712 309931.5 298189.2
23-Jan-15 9893151 10523288 630137 606582.7
23-Jul-15 9607877 10351712 743835.6 716805.9
Total 1525507

Arvind Sampath 53
 Interest Rate Swap - Hedge
6M T Bill Rate

Pays 6M T Bill Rate

Bank B Bank A

Receives Fixed Rate

8.35%

Arvind Sampath 54
 Overnight Indexed Swap
Start Date 23 Jul 12
End Date 01 Aug 12
Days 10
Notional Amount Rs. 25 cr.
Fixed Rate PayerBank A
Fixed Interest Rate 8.10%
Floating Rate Payer Bank B
Floating Interest Rate NSE MIBOR O/N
Compounding Applicable
Settlement On Maturity

Arvind Sampath 55
Overnight Indexed Swap

Pays Daily Compounded

NSE MIBOR

Bank B Bank A

Receives Fixed Rate

Of 8.05%

Arvind Sampath 56
Overnight Indexed Swap – floating rate
Day Date NSE MIBOR
Mon 23-Jul-12 8.11%
Tue 24-Jul-12 8.08%
Wed 25-Jul-12 8.22%
Thu 26-Jul-12 8.25%
Fri 27-Jul-12 8.16%
Mon 30-Jul-12 8.10%
Tue 31-Jul-12 8.03%
Wed 01-Aug-12 8.30%
Thu 02-Aug-12

Arvind Sampath 57
 Overnight Indexed Swap
Interest Principal
Mon 23-Jul-12 8.11% 55547.95 250055548
Tue 24-Jul-12 8.08% 55354.76 250110903
Wed 25-Jul-12 8.22% 56326.35 250167229
Thu 26-Jul-12 8.25% 56544.65 250223774
Fri 27-Jul-12 8.16% 167821.3 250391595
Mon 30-Jul-12 8.10% 55566.35 250447161
Tue 31-Jul-12 8.03% 55098.38 250502260
Wed 01-Aug-12 8.30% 56963.53 250559223
Thu 02-Aug-12

Arvind Sampath 58
 OIS Cash Flows
• Fixed Cash Flows = 554794.5
• Floating Cash Flows = 559223.3

• Net Settlement = 4428.752

• Friday rate applicable for 3 days like Call

Money Market

Arvind Sampath 59
 Overnight Indexed Swap

NSE MIBOR
Pays Daily Compounded
NSE MIBOR

Bank B Bank A

Receives Fixed Rate

Of 8.10%

Arvind Sampath 60
 Long Term OIS

• Long Term OIS is identical in nature and

calculations as OIS for a period less than 1 year
• Shorter OIS cash flows settle at Maturity
• Long Term OIS (>1 Year) is settled every 6
months
• Cash Flows are computed and settled every 6
months

Arvind Sampath 61
 Long Term OIS
• The difference between the daily
compounded NSE MIBOR rate and the fixed
rate on a notional principal is settled every 6
months
• The tenors actively quoted are for 2, 3 & 5
years against NSE MIBOR

Arvind Sampath 62
 CCIL IRS trade reporting

https://www.ccilindia.com/IRSS_HOME.aspx
Arvind Sampath 63
 Long Term OIS
Start Date 23 Jul 12
End Date 23 Jul 17
Notional Amount Rs. 25 cr.
Fixed Payer Bank B
Fixed Interest Rate 7.00%
Floating Payer Bank A
Floating Interest Rate NSE MIBOR
Compounding Applicable
Settlement Every 6 Months

Arvind Sampath 64
 Long Term OIS

Pays Daily Compounded

NSE MIBOR

Bank A Bank B

Receives Fixed Rate

Of 7.00%

Settled every 6 Months

Arvind Sampath 65
 Interest Rate Swaps in India
• The interest rate swaps which have been
traded in the Indian markets, include:
– OIS
– INBMK Swaps (GOI Yield Swaps)
– MIFOR Swaps

Arvind Sampath 66
 INR Interest Rate Swaps

OIS MIFOR INBMK

Floating Rate - Overnight Implied rupee interest rate Concept: Market in

inter bank call money rate derived from USD vs INR equilibrium and hence
forward rates. rollover of 1 year must equal
Most Liquid . Average Daily the yield of a specific tenor
Volume INR 150 bio Hedge for Currency Swaps
Influenced by movement in Best Hedge for Interest Rate
Liquid Up to 5 years spot FX rate Risk on Bank books

67
 INBMK (GOI) Swap
• In a GOI Swap, the floating rate is the 1 year GOI
yield on the reset date
• INBMK refers to the page on which the GOI yields
are quoted daily by Reuters, hence they have been
named INBMK swaps
• Also, by convention, the floating GOI tenor is taken
as 1 year GOI yield as it appears on FIMMDA site or
Reuters page 0#INBMK= prevailing 1 day prior

Arvind Sampath 68
 INBMK (GOI) Swap
• The floating rate is reset annually before
settlement date, I.e. the 2 counterparties
know their cash flows that they would
exchange after 12 months
• On every settlement date, the floating rate is
set for the next settlement date at the Reuters
1year interpolated 0#INBMK= bid yield
prevailing 1 day prior
Arvind Sampath 69
 INBMK (GOI) Swap
Start Date 23 Jul 12
End Date 23 Jul 22
Notional Amount Rs. 25 cr.
Fixed Payer Bank B
Fixed Interest Rate 7.95%
Floating Payer Bank A
Floating Interest Rate 1Y GOI Yield
First Floating Fixing 7.93%
Settlement Annual

Arvind Sampath 70
 INBMK (GOI) Swap

Pays 1Y GOI Yield

Bank A Bank B

Receives Fixed Rate

of 7.95%

Settled every 12 Months

Arvind Sampath 71
 INBMK (GOI) Swap
10 Year
1 year
Bond @
Deposit
8.2%
Rate
Pays 1Y GOI Yield

Bank A Bank B

Receives Fixed Rate

of 7.95%

Settled every 12 Months

Arvind Sampath 72
 INBMK (GOI) Swap
Fixed Rate Bond at 10%

Pays 1Y GOI Yield + Spread

Corporate A Bank B

Receives Fixed Rate

Of 10%

Settled every 12 Months

Arvind Sampath 73
 Terminology
• Swap Buyer
– fixed rate payer
– floating rate receiver
– agrees to buy a floating rate note and sell a fixed
rate bond
• Swap Seller
– fixed rate receiver
– floating rate payer
– agrees to sell a floating rate note and buy a fixed
rate bond
Arvind Sampath 74
 MIFOR Swaps
• Here the floating rate is the product of
forward premium plus LIBOR of that day
• The floating rate gives the equivalent rate of
raising 6 month funds through the dollar route
• MIFOR swaps are not very liquid and are used
by banks for hedging Currency Swap
transactions with clients
• Expectations of Re/$ rate, forwards hence are
key in determining this rate
Arvind Sampath 75
• 6M MIFOR = (1+ 6M Forward
Premium)*(1+LIBOR)-1
• 6M MIFOR =
(1+6.3%*182/365)*(1+0.75%*180/360)-1
• 6M MIFOR = 6.95%
• Quoted against this floating rate are 2,3,5,7,10
year fixed rate swaps
• Settlement every 6 months
• These are akin to the Currency swaps in price
Arvind Sampath 76
 Currency Swap

LIBOR

Bank Corporate

Fixed Rate

LIBOR + 200

Arvind Sampath 77
 Currency Swap/ MIFOR

LIBOR

Bank Corporate

Fixed Rate

LIBOR + 200 ECB Loan

Fixed Rate MIFOR

Arvind Sampath 78
 Swap Quote
A swap quote would look like : 6.60 - 6.65%.
This has to be interpreted as
• The bank will pay a fixed rate of 6.60% as
against the floating rate benchmark.
• The bank will receive a fixed rate of 6.65% as
against the floating rate benchmark.

Arvind Sampath 79
 Settlement Conventions
• Settlement Conventions
– Following Business Day
– Previous Business Day
– Modified Following Business Day for Swaps

Arvind Sampath 80
 Day Count Conventions
• Day Count Conventions
– Actual / 365 for swaps

Arvind Sampath 81
 Settlement Conventions
• For OIS, INBMK, INCMT swaps based on Rupee
benchmarks reset lag is 1 day & settlement
conventions are MFBD, Mumbai
• For MIFOR swaps reset lag is 2 days &
settlement conventions are MFBD, Mumbai &
New York

Arvind Sampath 82
 FRA

• Forward Rate Agreement (FRA) is :

– agreement between two parties
– one counterparty agrees to pay a fixed interest
rate
– and receive a floating interest rate benchmark
– starting at a specified future date
– for a specified period
– on a specified amount

Arvind Sampath 83
 FRA
• The FRA rate is the Forward - Forward rate for
the period
– T to T+m
– where the FRA is for m time periods starting at T

t T T+m
Start Date Settlement Date Maturity Date

10 Aug 09 10 Nov 09 10 Feb 10

Arvind Sampath 84
 FRA
• Cash settlement
– The difference between the interest rate on the
settlement date and the fixed rate is settled in
cash
– No principal payment

Arvind Sampath 85
 FRA
– Contract made at time - t
– for exchange of fixed rate interest rate for
floating rate at the rate prevailing on - T
– for a notional principal
– for specified future period - m
– The net amount to be settled on T is for the
period T + m, hence the same is discounted
back at the interest rate for the period T + m to
the settlement date T

Arvind Sampath 86
 FRA

5%

Bank A Corporate

Receives
3 Month NSE MIBOR

Arvind Sampath 87
 FRA
Bank A enters into a FRA with a corporate, on
the following terms
• Nominal Principal Amt. : Rs. 25 cr.
• Corporate to pay : 5.00% Fixed
• Corporate to receive : 3 Month NSE MIBOR

Arvind Sampath 88
 FRA
• Trade Date : 07 Aug 09
• Start Date : 10 Aug 09
• Fixing Date : 09 Nov 09
• Settlement Date : 10 Nov 09
• Maturity Date : 10 Feb 10

Arvind Sampath 89
 FRA
• Cash Flow on 10 Nov 09 :
• 3 Months NSE MIBOR : 4.60%
– Corporate to pay : Rs. 31.51 lakhs
( Rs. 25 cr. X 5.00% X 92 days / 365 days)
– Bank to pay : Rs. 28.99 lakhs
( Rs. 25 cr. X 4.60% X 92 days / 365 days)
The net settlement amount of Rs. 252,055 is discounted back for 92 days
at 4.60% = 247068, paid by Bank to Corporate

Arvind Sampath 90
 FRA
• An interest rate swap can be thought of as a
series of FRAs
• Each FRA fixes today the cost of financing for
the particular periods in the future

Arvind Sampath 91
 FRA Quote
A FRA quote would look like
12X24 months: 5.15 - 5.25% p.a.
This has to be interpreted as
• The bank will borrow for 12 months starting 12 months
from now, maturing 24 months from now, at 5.15%
• The bank will lend for 12 months starting 12 months
from now, maturing 24 months from now, at of 5.25%

Arvind Sampath 92
 Interpreting The Swap Curve

• In general swaps are the cleanest interest rate instruments

since they are always of constant maturity and do not suffer
from unexpected supply like MSS or auctions etc.
• Shape of the curve reveals the markets view on impending
liquidity and rates
• Short swaps are used to express views on liquidity while long
swaps express the view on duration
• Swap spreads may not always be positive and are key
determinants of overall view
• Swaps are still not considered a credit view on interbank

93
 Swap Curve theory

Yield

Credit curve

Swap curve

G-Sec curve

Tenor

94
 Asset Management - IRS
– Portfolio diversification
– Yield pick-up
– Duration Management
– Alteration of risk profile

Arvind Sampath 95
 Trading - IRS
– Alternative asset class to cash securities
– Duration similar to that of par bond
– Execution of bearish rate view possible
– Hedging
– Capture mis-pricing

Arvind Sampath 96
 Liability Management - IRS
– Segregation of interest rate risk
– Cost reduction
– Choice of benchmark
– Tenor management

Arvind Sampath 97