100%(2)100% fanden dieses Dokument nützlich (2 Abstimmungen)
2K Ansichten58 Seiten
FRAs are a financial contract between two parties to exchange interest payments based on a 'notional principal' for a specified future period. The contracted rate is compared to an agreed benchmark / reference rate as reset on the fixing date. The rate agreed in the FRA has to be compared to the benchmark rate to determine the settlement date.
FRAs are a financial contract between two parties to exchange interest payments based on a 'notional principal' for a specified future period. The contracted rate is compared to an agreed benchmark / reference rate as reset on the fixing date. The rate agreed in the FRA has to be compared to the benchmark rate to determine the settlement date.
Copyright:
Attribution Non-Commercial (BY-NC)
Verfügbare Formate
Als PDF, TXT herunterladen oder online auf Scribd lesen
FRAs are a financial contract between two parties to exchange interest payments based on a 'notional principal' for a specified future period. The contracted rate is compared to an agreed benchmark / reference rate as reset on the fixing date. The rate agreed in the FRA has to be compared to the benchmark rate to determine the settlement date.
Copyright:
Attribution Non-Commercial (BY-NC)
Verfügbare Formate
Als PDF, TXT herunterladen oder online auf Scribd lesen
• Interest Rate Swaps • Interest Rate Options o Embedded bond options o Put/call options on bonds and interest rates o Interest rate Caps, Floors and Collars o Range Accruals o Swaptions • Interest Rate Futures Requirements for Development of Market in Interest Rate Derivatives • A well-developed yield curve • A liquid market • Existence of sufficient volatility • An unambiguous way of determining term structure of volatility. • Mechanisms for hedging the product. Forward Rate Agreement (FRA) • A financial contract between two parties to exchange interest payments based on a ‘notional principal’ for a specified future period • On the settlement date, the contracted rate is compared to an agreed benchmark/reference rate as reset on the fixing date • Terminology o 3 x 6- An agreement to exchange interest payments for a 3-month period, starting 3 months from now. o Buy FRA – pay fixed and receive benchmark rate o Sell FRA – receive fixed and pay benchmark rate • Settlement takes place at the start date of the FRA Quoting
A typical FRA quote would look like
6 X 9 months: 7.20 - 7.30% p.a.
This has to be interpreted as
• The bank will accept a 3 month deposit starting six months from now, maturing 9 months from now, at an interest rate of 7.20% (bid rate) • The bank will lend for a period of 3 months starting six months from now, maturing 9 months from now, at an interest rate of 7.30% (offer rate) Example of a FRA deal • A corporate has an expected requirement for funds after 3 months but is concerned that interest rates will head higher from current levels. • The corporate can enter into a FRA to hedge or fix his borrowing cost today for the loan to be raised after 3 months. • The rate agreed in the FRA has to be compared to the benchmark rate to determine the settlement • Therefore, the corporate buys a 3 X 6 FRA from a Bank at say 6.75% with the benchmark rate being the 3 month CP issuance rate. Terms of the FRA deal
• Bank & corporate enter into a 3 X 6 FRA.
Corporate pays FRA rate of 6.75%. Bank pays benchmark rate based on 3 month CP issuance rate of the above corporate 3 months later.
• Notional principal Rs 10 crore
• FRA trade date 27th July 2002 • FRA start/settlement date 27th October 2002 • FRA maturity date 27th January 2003
• Theoretically, the fixed rate of 6.75% is obtained
by pricing of the forward rate, from the current rates. Cash flows for the FRA deal • Assume, 3 month CP rate for the Corporate on fixing date (say 27/10/2002) = 7% • Cash flow Calculations o (a) Interest payable by Corporate = 10 Cr * 6.75% *90/365 = Rs 16643836 o (b) Interest payable by Bank = 10 Cr * 7% * 90/365 = Rs 17260274 o (c) Net payable by Bank on maturity date = Rs 616438 o (d) Discounted amounted payable = Rs 61,644/(1+7%*92/365) = Rs 605750
Amount payable by the Bank on settlement date
=Rs 605750 Possible benchmarks for FRAs • 3-month, 6-month OIS rates • 3-month, 6-month CP or T-bill • OIS rates could be the best benchmarks as it is then possible to hedge the FRA position by takings positions in OIS Uses of FRAs • For corporates seeking to hedge their future loan exposures against rising rates. • For inter-bank participants, for speculative purposes o Buy FRA if the view is that the realized forward rate will be higher than the agreed fixed rate o Sell FRA if the view is that the realized forward rate will be lower than the agreed fixed rate Interest Rate Swaps (IRS) • An agreement to exchange a series of fixed cash flows with a series of floating cash flows • The floating cash flows are based on the observed value of the floating rate on the previous reset date • The fixed rate in the swap is referred to as the swap rate • There is no exchange of principal in an IRS • Available benchmarks in the Indian market are o overnight NSE MIBOR and MITOR o 6-month rupee implied rate (MIFOR) o INBMK rates (GSec yields) Analogy between FRA and IRS • IRS is similar to a FRA except that o in a typical FRA the benchmark rate is reset only once whereas in a swap, there are more than one resets. o in a typical IRS the settlement happens at maturity whereas in a FRA the net settlement amount is discounted to the FRA start date • An IRS can be considered as a series of FRAs Uses of swaps • Asset-liability management • Convert floating rate exposure to fixed exposure and vice-versa • Take a speculative view on interest rates and spreads between interest rates • Change the nature of an investment without incurring the costs of selling one portfolio and buying another • Reduce cost of capital • Access new sources of funding • Credit risk is also low since there is no exchange of principal and only net interest payments are exchanged. Criteria for floating rate benchmarks • Available for the lifetime of the swap • Market determined rate • Relevant to the counterparties • The rate should be unambiguously known to all market participants • Should be liquid and deep Overnight Index Swap • The floating rate is an overnight rate such as NSE MIBOR or MITOR, which is reset daily • The interest on the floating leg is calculated on a daily compounded basis • Overnight index swaps can be categorized into o <= 1 yr maturity o > 1 yr maturity • In the <=1 yr category, exchange of cash flows takes place only at maturity, there are no intermediate cash flows • In the > 1 yr category, cash flows are exchanged every 6 months Overnight Index swap - an example • Bank A enters into a 7 day OIS with Bank B, where Bank A pays a 7 day fixed rate @ 6.50% and receives overnight NSE MIBOR. The notional amount is Rs 10 cr. Calculating Cash Flows • Let us say NSE MIBOR rates are as follows o Day 1 6.61% o Day 2 6.40% o Day 3 6.82% o Day 4 6.75% o Day 5 6.70% o Day 6 6.74% o Day 7 6.68% • The principal amount of Rs 10 cr on the floating leg gets compounded on a daily basis. Calculating Cash flows
Total accrual on a floating leg = Rs 108098
Total accrual on fixed leg = 100000000*6.50% *7/365 = Rs 124657 Settlement • Net interest payment = 124657 - 108098 = Rs 16659 • This amount will be paid by party A to party B at maturity Reversing an Outstanding OIS Position • Unwinding/reversing an existing OIS position is entails deriving the mark-to-market position of the swap • As per the example : Bank A enters into a 7 day OIS with Bank B, whereby it pays fixed and receives floating. After 3 days Bank A wants to get out of the position. What can Bank A do ? o Option 1: book a reverse swap - receive fixed and pay floating for 4 days o Option 2: cancel the outstanding OIS with Bank B Option 1: Booking a Reverse Swap • Bank A can book a reverse swap with a counterparty for the residual tenor of 4 days where it receives a fixed rate and pays Overnight MIBOR • The reverse swap would have to be booked on a revised principal which is the original principal plus the interest accrued on the floating leg • This method replicates cancellation of the outstanding swap • However, this method is credit and capital inefficient Option 2 : Cancelling the outstanding OIS • Canceling an OIS will have two components o Component 1 : The first component will be the difference between the interest accrued on the OIS fixed leg and on the floating leg from the start date to the current date
o Component 2 : The second component will be the
difference between the original fixed rate and the reversal rate Cancelling the OIS: Calculations Original OIS Principal INR 100 crores Tenor of the swap 7 days Start Date 27th July 1999 End date 3rd Aug 1999 Swap rate Bank A pays fixed rate to bank B at 8.50 % Bank A receives overnight MIBOR from Bank B Cancellation Bank A approaches Bank B to cancel the outstanding OIS on 30th July, 1999 Bank B quotes a rate of 8.25% to cancel the outstanding swap Cancelling the OIS: Calculations Component 1 Overnight rate Notional Principal Accrued interest Day 1 7.83% 1,000,000,000 214,521 Day 2 7.76% 1,000,214,521 212,648 Day 3 7.32% 1,000,427,169 200,634 Interest accrued on floating leg 627,803 payable by Bank B on unwind date
Interest accrued on floating leg payable by Bank B on maturity
= Future Value of INR 627,803 on maturity date = 627,803*(1+627,803*8.25%*4/365) = 628,371 Cancelling the OIS: Calculations Component 2 Cancellation OIS rate = 8.25% Difference in fixed rates payable by bank A on maturity date = 1,000,000,000*(8.50%-8.25%)*4/365 = 27,397
Cancellation value on maturity date payable by bank A to bank
B = Component 1 + Component 2 = 97,656
Value if settled on cancellation date
= 97,656 / (1+8.25%*4/365) = INR 97,568 Constant Maturity Swaps (CMS) • Atleast one of the legs of the swap is linked to a floating rate which has a constant tenor • The most common is the constant maturity Treasury (CMT) swap, where the floating rate is the INBMK GSec yield • Examples of a CMT swap o an agreement to receive 7.5% fixed and pay the 5-yr INBMK GSec rate every six months.In this case, the benchmark security will keep changing on each reset date such that it is close to the maturity of 5 yrs o An agreement to exchange 6-month MIFOR rate with the 5-yr OIS swap rate every 6 months, for the next 5 yrs Types of CMS Structures • One side pays fixed and the other pays a CMS rate. • Both sides are floating, one is a CMS rate and the other a floating rate such as 6-month MIFOR • Both sides pay a CMS rate Advantages of CMS over Plain Vanilla IRS • It enables to indulge in curve play- taking advantage of expectations of movements in the spreads between two rates o If one believes that the spread between the 10-year swap rate and the 6-month LIBOR rate is going to decrease in the future, one can enter into a CMS in which one will receive the 6-month LIBOR and will pay the 10-year swap rate. • It enables one to execute views on the shape of the yield curve. o A belief that the 5-10 segment of the yield curve is steep can be exploited by paying the 5-yr GSec rate in one CMS and receiving the 10-yr GSec rate in another CMS. Advantages of CMS over Plain Vanilla IRS • Investors can use CMS/CMT swap to target specific instrument maturities. • The structure of the swaps is such that you can effectively lock into a rate on a constantly rolled over instrument of specific term. This is in contrast to the investor who holds say a fixed asset instrument. o For e.g. the investor wants to hold a bond of 10 years maturity. If he buys the bond, after one year, its maturity becomes 9 years and so the investor’s purpose is not served. But by entering into a CMS, the investor can maintain constant asset duration. Other Swap Structures • Amortizing swaps • Accreting swaps • Leveraged swaps • Basis swaps • In-arrears swap • Inverse floaters • Differential swap • Forward start swap • Range Accrual swaps Amortizing Swaps • Principal amount decreases at pre-specified points of time over the life of the swap • Motivation o swap an exact series of flows derived from some form of liability financing o Hedge for an amortising asset if the investor wants to take only the credit risk and not interest rate risk Accreting Swaps • Accreting o principal amount increases at pre-specified points of time over the life of the swap • Motivation o swap an exact series of flows derived from some form of asset inflows o Hedge for an accreting asset if the investor wants to take only the credit risk and not interest rate risk Basis Swaps • A Basis swap is o contractual agreement o exchange a series of cash flows o over a period of time. o each swap leg is referenced to a floating rate index
• A Basis Swap is most commonly used when
o liabilities are tied to one floating index and o financial assets are tied to another floating index o This mismatch can be hedged via a basis swap Leveraged Swap • The counterparty on the floating leg makes payments which are a multiple of a floating benchmark • Examples o USD IRS where A receives USD 10% sa and pays 2.75 x 6-month USD LIBOR, every six months o MIFOR swap where A pays 10% fixed INR sa and receives 1.5 x 6-month MIFOR sa. Significance of Leveraged Swaps for Indian Corporates • For corporates interested in positive carry deals o Leveraged swap increases the positive carry for the first setting, though the negative carry towards the end of the swap will increase • For corporates interested in view taking o The leverage factor helps to multiply the quantum of bet with the same notional principal. It magnifies the quantum of both profits and losses • For corporates interested in hedging o In case the corporate has offered a deposit structure with leverage involved in it In-arrears Swap • Normally, in a swap, there is a time lag between the observed value of the floating rate and the payment on the floating leg. o The payment on the floating leg is based on the value of the floating benchmark at the last reset date. • In an in-arrears swap, the payment on the floating leg is based on the value of the floating rate on the payment date itself Inverse Floater Swaps • Seek to take advantage of, or protect against, a steep yield curve • Pay/receive floating rate index versus receive/pay fixed rate less floating rate index (inverse side) • Inverse side’s flows move inversely with floating rate index • Used to ‘leverage’ a specific view on the floating rate index (I.e., compound the effect of the movement) Differential Swaps • Have been used in recent years by investors and corporates who are attempting to take on a view on foreign markets, without being exposed to currency risk • Typical structure - Bank receives 6 month USD LIBOR in exchange for paying 6 month MIFOR, all in rupees • No currency risk for the bank Forward Start Swap • Let us say that a company knows that six months from today, it will borrow via a floating rate loan • The company wishes to to swap the floating liability for a fixed liability by entering into a swap where it will receive floating and pay fixed • The company can enter into a six-month forward start swap today. Range Accrual Swaps • The interest on one side accrues only when the floating rate benchmark is within a certain range • The range may be fixed for the life of the swap or may be variable • Example o Interest of 6% on fixed leg is to be exchanged every quarter with 3-month LIBOR, for a period of 3 years o Interest of 8% will accrue only on the days when 3-month LIBOR is between 0 and 6% for the first year 3-month LIBOR is between 0 and 6.5% for the first year 3-month LIBOR is between 0 and 7% for the first year Embedded Bond Options • A callable bond allows the issuer to buy back the bond at a specified price at certain times in the future • The holder of the bond has sold a call option to the issuer • The call option premium gets reflected in the yield quoted on the bond • Bonds get call options offer higher yields Embedded Bond Options • A puttable bond allows the holder early redemption at a specified price at certain times in the future. • The holder of the bond has purchased a put option from the issuer • The option premium gets reflected in the yield quoted on the bond • Bonds with put options provide lower yields Examples of Embedded Bond Options • Early redemption features in fixed rate deposits • Prepayment features in fixed rate loans • Situation where a bank quotes a particular 5-yr rate to a borrower and says that the rate is valid for the next two months o The borrower has effectively purchased a put option in this case with a maturity of two months European Put/Call Options on Bonds
• A call option refers to the right to buy a bond for
a certain price at a certain date • A put option refers to the right to sell a bond for a certain price at a certain date • The strike price could be defined to be either the clean price or dirty price • In most exchange-traded bond options, the strike price is a quoted price or clean price European Put/Call Options on Interest Rates • Here, the option underlying is some benchmark interest rate. • He strike rate is also specified in terms of the level of the benchmark interest rate • Let • R = value of benchmark rate at maturity of option • X = strike level • P= notional principal • Call option value = P x max (R-X, 0) • Put option value = P x max (X –R,0) Interest Rate Caps • They provide insurance against rising interest rates on a floating rate loan exceeding a certain level • The above level is referred to as the cap rate • It is written by the lender of interest rate funds • If the same bank or financial institution is providing both the loan and the cap, the cap premium gets reflected in a higher rate charged on the loan. The cap is of embedded type • They can be regarded as a series of call options on interest rates, with the option payoffs occurring in arrears or as a series of put options on bonds Interest Rate Cap- Example • Consider a floating rate loan with a principal amount of Rs 10 crore • The floating rate is 3-month LIBOR and it is reset every 3 months • The rate has been capped at 10%. • So, at the end of each quarter, payment made by the financial institution to the borrower = 0.25 x 10 x max (R - 0.1 , 0) where R is the 3-month LIBOR rate at the beginning of the quarter Interest Rate Floors • They guarantees a minimum interest rate level on a floating rate investment • Just like a cap, they can be either in naked form or can be embedded in a loan or swap • They are written by the borrower of interest rate funds • They can be regarded as a a series of put options on interest rates or a series of call options on discount bonds Interest Rate Collars • They put a cap on the maximum rate as well as a floor on the minimum rate that will be charged • They can be considered as a combination of a long position in a cap and a short position in a floor. • They can be structured in such a way that the price of the cap equals the price of the floor, so that the net cost of the collar is zero European Swaptions • They are options on interest rate swaps • They give the holder the right to enter into a interest rate swap at some time in the future o If the right is to receive fixed in the swap, it is referred to as receiver swaption o If the right is to pay fixed in the swap, it is referred to as payer swaption • They can be regarded as options to exchange a fixed rate bond for the principal of the swap o A payer swaption is a put option on the fixed rate bond with strike price equal to the principal o A receiver swaption is a call option on the fixed rate bond with strike price equal to the principal European Swaption - Example • Consider a corporate that knows that in 6 months, it will enter into a 5-yr floating rate loan with 6-monthly resets • Company wishes to convert the floating rate loan into a fixed rate loan • The company enters into a swaption, wherein it agrees to pay a fixed rate of X% in the swap. • If the swap rate at the end of 6 months turns out to be more than X%, the company will exercise the swaption. • If the swap rate at the end of 6 months turns out to be less than X%, the company will not exercise the swaption but will access the swap market directly. Advantages of swaptions • They guarantee to corporates that the fixed rate of interest that they will pay on the loan at some future time will not exceed a certain level • They are an alternative to forward-start swaps • Whereas forward start swaps obligate the company to enter into a swap, this is not the case with swaptions • With swaptions, the company can acquire protection from unfavourable interest rate moves as well as obtain the benefit of favourable interest rate moves Interest Rate Futures • It is a futures contract on an asset whose price is dependent on the level of interest rates. • Main types of instruments o Treasury bond futures o Treasury bill futures o Eurodollar futures. Treasury bond futures • The underlying is a government bond with more than 15 years to maturity • Depending on the particular bond that is delivered, there is a mechanism for adjusting the price received by the party with the short position, defined by a Conversion Factor • Cash received by party with short position = quoted futures price x conversion factor + accrued interest since last coupon date • Party with the short position can choose the bond that is cheapest to deliver Treasury bill futures • The underlying asset is a 90-day Treasury bill • The party with the short position delivers $1 million of Treasury bills • If Z is the quoted futures price and Y is the cash futures price Z = 100 – 4(100 – Y) Y = 100 – 0.25(100 – Z) Contract Price = 10000[100 – 0.25(100 – Z) • The amount paid or received by each side equals the change in the contract price EuroDollar futures • It is structurally the same as a Treasury bill futures contract • The formula for calculating the Eurodollar futures price is the same as that for the Treasury bill futures • For example, a Eurodollar price quote of 93.96 corresponds to a contract price of 10000[100 – 0.25(100-93.96)] = $984900 Difference between Treasury Bill Futures and Eurodollar Futures • For a Treasury bill, the contract price converges at maturity to the price of a 90-day $ 1 million face value Treasury bill • For a Eurodollars future, the final contract price will be equal to 10000(100 – 0.25R), where R is the quoted Eurodollars rate at that time • The Eurodollars future contract is a future contract on an interest rate • The Treasury bill future contract is a future contract on the price of a Treasury bill or a discount rate Thank You