Beruflich Dokumente
Kultur Dokumente
David Mengle
Vice President
J.P. Morgan Securities Inc.
Today's schedule
Basic concepts
Interest rate and currency derivatives
Pricing, valuation, and unwinds
Structure of a derivatives business
Future value
hit = -5.50
So one could invest $5 now at 10% and
receive $5.50 in one year.
Compounding: Computing future value
Solving for FV when given PV, r, t
10 L l
20 R
hit = -100
-
Streams of payments: Annuities
What is PV, of $10 for 5 years at lo%?
,
General formula
10
10 I
So, $37.90 will buy $1 0 per year for five 5
years at 1 0%.
= -37.9
Streams of payments: Annuities
What annual payment for 5 years is worth $37.90 today at lo%?
37.9
This formula is useful for caps or floors, when
calculating the annualized up-front premium. 10
7
Three forms of derivatives activity
Exchange-traded
- Futures
- Exchange-traded options
Over-the-counter (OTC)
- Swaps
- Forwards
- OTC options
Assets Liabilities
Loan Deposit
(2-year, fixed rate) (1 -year Libor)
US$100 MM US$100 MM
Interest rate risk
Situation
I -year 2-year
Libor Fixed Rate
Deposit Client Loan
Forward rate agreement (FRA)
A forward contract on interest rates
*-FI-
One year from now
Deposit Loan
1
m
Reference : Contract
Rate Rate
/ I
\ Forward rate,
Libor, determined I
rates,
- But will not benefit if rates fall A$h bfk
/ @&w"
Client assumes credit exposure to Dealer (and vice
versa)
Uses of FRAs
/L - R) x DxA
Settlement sum =
(B x 100) + (L x D)
L = Reference Rate
R = Contract Rate
D = Days in Contract Period
A = Notional Principal
FRA payout
/L-R) x D x A
Settlement sum =
(B x l o o ) + ( L x D )
Where do forward rates come from?
Yield curves
yields
Where do forward rates come from?
No-arbitrage conditions
- Two-year: 7%
Choices:
- Invest $100 for two years at two-year rate
+ R,,~36 )2 * (1 + .06) = (1 + .
+ R12x36) -
- 1.25566
+ R,,x36 = 1.120563
R12x36 = '
120563
Assume:
- 6-month Libor is 5.83%
Find:
- 12x24 forward rate
- 6x 12 forward rate
Find the 12x24 forward,rate
Libor greater than one year
Using your HP,
Assume:
- 12-month Libor is 6.12%
1.0653
- 2-year zero coupon rate is 6.53%
2
(1.0612) * (1 + RI2,,, ) = (1 .0653)2
1.0612
(1 + R12x24)
= (1 .0653)21 1.06 12
+ R~2x24= 1.0694 El
0694 .0694
R1 2x24 =
1
So 6x12 forward rate is 6.23% 2
.0623
Futures contracts
An alternative to forward contracts
- Organized exchanges
- Margin requirements - W 9@ $
- Loss-sharing arrangements
Interest rate exposure
Situation
Client has purchased a US$100 MM 5-year U.S.
Government Agency note yielding 6.5%
Purchase funded with one-year US$ deposits
Client is concerned that US$ interest rates will rise
Assets Liabilities
Fixed Rate
(6.5%)
-0
Libor
Libor . Swap
Rate
..
... (6.1%)
Dealer
Trade Date - The date on which the parties commit to the swap and
agree to its terms
Effective Date - The date on which payments begin to accrue
- Normally two days after trade date
- Forward starting swap: Effective date can be any future date
Swap cash flows
0 100 -- -- 100
1 (LIBOR) LIBOR (6.1) (6-1
2 (LIBOR) LIBOR (6.1) (6.1)
3 (LIBOR) LIBOR (6.1) (6.1)
4 (LIBOR) LIBOR (6.1) (6.1)
rn
If Dealer receives fixed, swap rate is 6.12%
But, swap rates increasingly used by market
Dealer
participants as benchmark rate instead of
treasury rates
Applications of interest rate swaps
10
0
q/,
Gain +
..........................
90
I I
100
Premiuni = 10
Strike = 100
I
Gain +
8; ...dl
I
Premium = 8
Strike = 100
Sell
..........................
I I
-1 0
BUY / y.
0
1.
1.
ilu: i 0
Loss -
Break even
at 110
I
Loss -
Break even
at 92
Up-front premium
- - (on Trade Date)
Libor
Deposit 4 Client Dealer
C Max (L-Strike,O) -
(on each Payment Date)
Definitions: Caps and floors
Interest Expense
on US$100 MM
Interest rate cap on US$ LIbor
-
-- I [(Libor-6.0%) - 0.40%]
Out of the Money 1
- & w ~ I
I
4.50 5.50 I 1 5 0 7.50 US$ Libor (%)
-- I
I
In the Money -
w e
I
6.00 Up-front Premium = 180 bp = $1,800,000
Annualized Premium = 40 bp = $400,000
Interest rate cap on US$ Libor
Cap Strike = 6.0%
million
Annualized Premium =
Interest Expense
on US$100 MM
I
Exposure
US$ million
Interest Expense
on US$100 MM
I / Collared
Exposure
Net Premium = 0
4.0 5 .O 6.0
US$ Libor (%)
5.0% < Collared Funding Cost < 6.0%
Foreign exchange basics
Quotation conventions
- Foreign currency1USD
Deutschmark (DEM), Swiss franc (CHF), Canadian dollar (CAD)
- USDIForeign currency
British pound sterling (GBP), Australian dollar (AUD)
If the DEMIUSD exchange rate rises from 1.75 to 1.80,
- The USD has appreciated of because $1 can now buy more DEM
- The DEM has depreciated because it now takes more DEM to buy
$1
Assets Liabilities
Note Deposit
(1-year, fixed rate) (1-year @ 1-year DM Libor)
US$100 MM @5.90% DM180 MM 633.95%
Currency forward
-I -
US$105.90 M M DM 187.11 MM
Note Client Deposit
Dealer
DM 187.11 MM
FWD = 1.6066
Emerging markets considerations
Situation
Risks of NDFs
- Basis risk between onshore and offshore rate movements
- Local government opposition to NDF
Assets Liabilities
Loans Note
(5-year, fixed rate) (5-year, fixed-rate)
US$100MM (236.8% DM180 MM @4.8%
Currency risk
US$ Loans
US$
Interest
,
German Bank
I US$lOO
million
A
DM DM 180
Interest million
V
DM Note
Currency swap
$ I00 million
A
DM 180
million
DM Note
Currency swap
US$ Loans
6.8%
I
German Bank 4
6.1% (US$)
w. Dealer
4.8% (DM)
Payments during swap
4.8%
DM Note
Currency swap
US$ Loans
US$l 00
m~ll~on
v
Dealer
German Bank
-
f--
A
I
DM Note
DM 180
million Final principal exchange
US$100 million
DM 180 million
Currency swap
$ I00 million
V
6.1% (US$) -_
7
Dealer
German Bank 4
4.8% (DM) -~
A
.- Payments during swap
4.8%
Final principal exchange
V
US$100 million
Assets Liabilities
Loans Deposits
(5-year, fixed rate) (1 -year)
US$lOO MM 636.8% DM 180 MM @DM Libor
m &&
Uses for currency swaps
Assets Liabilities
Loans Note
(5-year, fixed rate) (5-year, fixed rate)
US$100MM @6.8% DM180MM @4.8%
Currency options
ProfitfLoss
US$ Put
(DM million)
\
\
\
\
\
-----
Types of contracts
- Basis swaps
- Options on swaps (swaptions)
Structured notes
Underlying risks
- Credit derivatives
- Commodity derivatives
Interest rate risk
Assets Liabilities
Loans Deposits
(Prime Rate) (3-month Libor)
US$100 MM US$100 MM
Solution: Basis swap
Libor, Prime
Rate
Deposits Client Loans
rn
rn
Libor
f Prime -
' 2.75%
Dealer
Cross-currency basis swap
.
DM Libor : US$ Libor
+ 10
Dealer
Gives the holder the right, not the obligation, to enter into
a swap contract in the future
- Combines an option contract with a swap contract
Fixed
income 1
I
Derivative
Structured
Structured securities
Basic structure
7.38% + (R(10)-R(2))
Investor 4 Issuer
.
I 4
2-year rate I I 10-year rate
a
Protection buyer
X bp per annum
*
I Protection seller
Results:
- Credit swap hedges both default risk and credit concentration risk
- Buyer trades credit risk of reference credit for counterparty credit risk of
seller
Total return swaps
LIBOR + X bp p.a.
TR Receiver TR Payer
TR of reference
obligation
27.0-
Sell put
26.0--
I I
I Price
50 255 260
/ Buy put
/
I I I I
I
Fixed
Shipping
Company 4 Producer
Floating fuel Floating
oil price crude price A
v
Fuel Oil
Supplier Market
Average price ('Asian') options
Description
- Payoff is the strike compared with the average commodity price
over a specified period (e.g., monthly averages with monthly
settlements)
- Most commonly used commodity option structure
Motivation
- Useful in markets in which participants buy or sell on a continuous
basis
- Less expensive than American or European options because
volatility of average price is less than volatility of daily price
d.p +