Beruflich Dokumente
Kultur Dokumente
Markets
Instruments
&
Mechanisms
1
Our FX Market - From Fixed To
Market Based Exchange Rate
Mechanism
Before 1998, the country had a Managed Exchange Rate Regime.
In 1998 we switched to a composite ERM whereby all commercial
transactions were covered both from the interbank and SBP at a
fixed ratio.
In May 1999 the country switched to a Market Based Exchange
Rate Regime.
Banks are free to quote their own exchange rates.
The exchange rate is determined by the market forces of demand
& Supply.
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ntroduction to interbank FX activitie
What is a foreign exchange transaction /
Exposure
Any financial transaction that involves more than one
‘convertible’ currency is a foreign exchange
transaction.
Most important characteristic of a foreign exchange
transaction is that it involves foreign exchange
risk/Exposure.
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ntroduction to interbank FX activitie
Exchange Rate is the price of one currency in terms of
another.
Currencies are traded both in spot and forward.
Spot Transaction.
Sale or purchase of currency for settlement usually in two
working days.
Forward Transaction.
Sale or purchase of a currency for settlement at some future date,
other than spot, at rate determined on the deal date.
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ntroduction to interbank FX activitie
Fx swap Transaction.
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ntroduction to interbank FX activitie
Components of a standard FX transaction.
Base Currency (USD/PKR)
‘Dealt’ or ‘Variable’ Currency
Exchange Rate
Amount
Deal Date
Value Date
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ntroduction to interbank FX activitie
Value date conventions.
Ready
Tom
Spot
Split value transactions
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ntroduction to interbank FX activitie
In the forex market rates are always quoted ‘two way’.
Two way quote gives both ‘Bid’ and ‘Offer’.
e.g.
USD/PKR= 58.55/60 (57.90/10 ??)
Bid/Offer
‘Big Figure’ and the ‘small figure’ or ‘Points’ and
‘Pips’.
BC/VC
USD/PKR= 58.55/60
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ntroduction to interbank FX activitie
Price maker Vs. Price Taker
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ntroduction to interbank FX activitie
Prices for ‘market maker’ and ‘market
taker’.
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ntroduction to interbank FX activitie
Prices are quoted in terms of USD.
e.g.
GBP= 1.7220/30
EUR= 1.2090/91
JPY=108.98/9.03
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ntroduction to interbank FX activitie
Currencies quoted in indirect or reciprocal
way.
GBP=
AUD=
EUR=
NZD=
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ntroduction to interbank FX activitie
Almost all other currencies are quoted in ‘direct
quote’.
e.g.
JPY=
SFR=
TRL=
AED=
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ntroduction to interbank FX activitie
Forward Transaction
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ntroduction to interbank FX activitie
Forward Premium Rates
Forward rates depend upon interest rate
differential between the two currencies.
o Currency with higher interest rates is at discount
wrt currency having lower interest rate.
o Currency with lower interest rates is at premium
wrt currency having higher interest rate.
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ntroduction to interbank FX activitie
Calculating Forward
Premiums/Discounts
Interest rate of USD = 1.25%
Interest rate of PKR = 6%
Spot Rate = 58.50
DB for PKR = Actual/365
DB for USD = Actual/360
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ntroduction to interbank FX activitie
NET OPEN POSITION- A measure of
foreign exchange risk
• NOP is the Net Asset/Net Liability position in all FCs
together (Both B/S & Off B/S).
• Net Asset Position is also called “LONG” or
“Overbought “ position.
• Net liability Position is also called “SHORT” or
“Oversold “ position.
• NOP is a single statistic that provides a fairly good
idea about exchange risk assumed by the bank.
• Its major flaw is that FX exposures in third currencies
remain hidden. 21
ntroduction to interbank FX activitie
Foreign Exchange Exposure
FX Exposure is the higher of the long and short
positions in FCs.
EXAMPLE
Currency-wise NOP in equivalent PKR
CURRENCY SHORT LONG
Dollar -10
Yen 50
Euro -10
Pound 10
Total -20 60
Net Open Position is 40 while exposure is 60.
22
State Bank is the single
most important player in
both kerb as well as
interbank market
23
SBP’s role in the forex market
To manage the exchange rate mechanism.
Regulate inter-bank forex transactions and
monitoring the foreign exchange risk of the banks.
Keep the exchange rate at desirable levels.
Manage and maintain country's foreign exchange
reserves.
24
SBP’s role in the forex
market
• SBP has imposed foreign exchange
exposure limits on banks (FE 12 of
1999).
• FEEL vs NOP
26
How does SBP manages
exchange rate in the interbank
market?
• Quantitative Tools
• Non-Quantitative Tools
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Physical intervention
• Moral suasion
• facilitating large commercial outflows
• Relaxation in FEEL
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Derivative Products
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DERIVATIVES
Derivative Instrument
31
Development of Derivative Market
32
DERIVATIVES
Type of Derivative contracts
Assurance Contracts
Guarantee a price
Obligation on both parties
Protect fully against “downside” risk
No flexibility for “upside” benefit
Examples :
Forward contracts, Futures Contracts, Currency Swaps,
FRAs (Forward Rate Agreements) , Interest Rate Swaps
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DERIVATIVES
Type of Derivative Contracts
Insurance Contracts
Derivatives are like insurance contracts. For small
premium, businesses can protect themselves against
shocks and adverse market conditions.
Examples:
Foreign Exchange Calls, Puts, Collars, Interest Rate
Caps, Floors & Collars 34
Benefits of Using Derivatives
Tailor-made Instrument: Derivatives could either be
standardized or customized, over-the-counter (OTC)
instruments. The OTC derivatives are extremely flexible and
can be designed to cater any individual need.
37
Benefits of Using Derivatives
Lower Transaction Cost: Derivatives either have very lower
or no transaction cost at all.
38
Derivative Products for Hedging
Interest rate & Exchange rate
Foreign Exchange Derivatives
Forwards
Futures
Options
Interest Rate Derivatives
Forward Rate Agreements
Interest Rate Swap
Futures
39
Options
Derivatives – A New Era
SBP has allowed only three broad categories
of Derivative instruments
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Forward Rate Agreements
41
Forward Rate Agreements
They are a simplified version of forward lending or
borrowing with the difference that on the settlement
date only the difference between prevailing and
contractual interest rates is exchanged.
42
FRAs
A counterparty entering into an FRA enters into a
forward-forward transaction.
He agrees to pay / receive the difference between the
interest payout calculated using a Market Reference Rate
and the Forward Contract Rate.
The tenor and contract rate is fixed.
FRAs are transacted on Notional Amounts with no
principal exchanging hands.
The differential is paid upfront or at the end of the deal.
43
FRA -Features
Customized short term interest rate future of any
amount up to two years final maturity.
No obligation to borrow or to lend.
Compensation calculated on difference between
FRA price and market benchmark rate, example
KIBOR
Minimal dealing lines required; counter-party
risk is only on differential amount only.
BUY the FRA expecting Interest rates to rise.
SELL the FRA expecting interest rates to fall.
44
FRA Payoff
45
FRA Convention
3x6
Means 3 months rate 3 months forward
3x9
Means 6 months rate 3 months forward
6x9
1 x 7
9 x 12
46
FRA Contd.
0 1 2 3 4 5 6
Borrow Gap
3 months 3 months
47
If they have a strong view that interest rates
will rise
They should buy a “3 x 6” FRA
Current 3 Month KIBOR = 7.50%
Current 6 Month KIBOR = 8.40%
3 x 6 FRA rate = 9.12%
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FRA - Calculation
A forward KIBOR rate is determined using the following formula:
RL × Days RS × Days F×Days
1 +
L
=1 + S
×1 + F
365 365 365
RL × D ays
1 + L
365 − 365
F = the long period 1 ×
RL = spot KIBOR for RS × D ays
Days
R =spot1 +
KIBOR for the short period
S
F
KIBOR 365
S
F =
forward
DAYSL = number of days in the long period
DAYSS = number of days in the short period
DAYSF = number of days covered by the forward period
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FRA Calculation
3 month KIBOR = 7.50% Borrower locked in at 9.12%
6 month KIBOR = 8.40%
3 month forward for 3 months
If 3 months later KIBOR = 9.5%
“3 x 6” FRA = 9.12% FRA buyer receives the
following:
8.40% × 181 Rate Differential is 9.5%-9.12%
1 +
365
Present value is 0.38%/
F= 365
−1 × (1+9.5%*91/365)
1 + 7.50% × 90 91 =0.3712%
365
Settlement amount is
Principle * 0.3712%
If KIBOR is below FRA contract
F = 9.12% rate then FRA buyer will pay
under the same calculations.
51
FRAs
Worked Example
Suppose Citibank Buys “3 vs. 6” FRA from NBP
Now suppose that at the settlement date, KIBOR is 9.5%, the difference
between the contract rate and current rate comes to 0.5%. Difference
payable by Citibank comes to;
=100,000,000*(.005*181/365)
=Rs. 247,945.205 52
FRAs
Worked Example Cont’d
56
LINKAGE BETWEEN
Forward Rate Agreement
and interest rate Swaps, ;
57
FRAs & IRS
Interest Rate Swaps (IRS)
Whereas, FRA is single exchange of rates, a generic, standard or
Plain vanilla swap is an agreement between two parties to
exchange streams of interest payments one of which could be
fixed and the other could be floating.
58
FRAs & IRS
Interest Rate Swaps
Usually,
One party is the fixed rate payer (agreed at the
inception of the swap).
The other party is floating rate payer. (prevailing
rate indexed to a benchmark) 59
FRAs & IRS
60
FRAs & IRS
Interest Rate Swap
A typical interest rate swap:
Fixed Rate
Company A Swap Bank
6 Month KIBOR
2.0%
KIBOR +
6 Month
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Interest Rate Swap
IRS could be for exchange of :
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Interest Payments
Calculations
The Fixed Rate payer calculates the interest
payment by multiplying the notional principal
(though never exchanged) with the Fixed
Rate, while Floating
the Fixed Rate receiver(Floating
Rate Interest Payments
Rate payer) uses the Floating Rate
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Plain Vanilla Interest Rate
Swap
Exchange of fixed interest rate
payments for floating
Notional Amount: PKR 500,000,000
Tenor: 3 Years
Floating Rate: 6 Mth KIBOR
Fixed Rate: 11.00%
64
Futures or Futures contrac
What are future contracts ?.
Future contracts are highly standardized
forward contracts, traded on exchanges.
Parties involved in a future trade.
Buyer
Seller
Broker
Exchange
Clearing House.
65
Futures or Futures contrac
What are future contracts ?.
Specification of a standard contract:
Gold
Commodity name
Exchange Name (COMEX)
Size of Contract : 100 troy ounce
Delivery month: Feb/April/June/Aug/Oct/Dec
First delivery date, First notice date, last
delivery date.
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Futures or Futures contrac
Commodity futures
Currency futures
Financial futures.
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The World’s Leading Futures Exchanges
Chicago Board of Trade Chicago Mercantile
(CBOT) Exchange (CME)
Financial Exchange London International
(FINEX)
Financial Futures
New York Futures
Exchange (NYFE) Exchange (LIFFE)
Sydney Futures
Marche a Terme
International De France Exchange
(MATIF) Toronto Futures
Singapore Exchange LTD. Exchange (TFE)
(SGX)
68
DISTINCTIONS BETWEEN FUTURES AND
FORWARDS.
Forwards Futures
Traded in dispersed Traded in centralized
interbank market 24 hr a
day. Lacks price
exchanges during
transparency specified trading hours.
Exhibits price
transparency.
Transactions are customized
and flexible to meet Transactions are highly
customers preferences. standardized to promote
trading and liquidity.
69
DISTINCTIONS BETWEEN FUTURES AND
FORWARDS.
Forwards Futures
Counter party risk is
Being one of the two
parties, the clearing house
variable standardizes the
counterparty risk of all
contracts.
71
European Options:
72
American Options:
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Call Option: The Right to Buy an Asset:
A call option represents the right to buy an
asset at a predetermined price on or before
the expiration date.
Profit
Payoff
Profit
Strike
0 Price
Spot
Premium
Loss 74
Positions in Options
➼ A long call position has unlimited
upside potential. Downside risk is
limited to the option premium.
Profit
Strike
0 Price
Premium
Loss 75
➼ A short call position has upside
potential limited to the option
premium. Downside risk is unlimited.
Profit
Premium
0 Price
Strike
Loss 76
➼ A long put position has upside
potential limited because an asset price
cannot fall below zero. Downside risk is
limited to the option premium.
Profit
Strike
0 Price
Premium
Loss 77
➼ A short put position has upside
potential limited to the option
premium. Downside risk is limited
because an asset price cannot fall
below zero.
Profit
Premi um
0 Price
Strike
Loss 78
In, At- and Out-of-the-Money
➼ The type of option and the relationship between the spot
price of the underlying asset and the strike price of the
option determine whether an option is in-the-money, at-
the-money or out-of-the-money.
➼ Exercising an in-the-money call or in-the-money put will
result in a payoff. Neither a call nor put that is at-the-
money will produce a payoff.
Call Option Put Option
In-the-Money Spot > Strike Spot < Strike
At-the-Money Spot = Strike Spot = Strike
Out-of-the-Money Spot < Strike Spot > Strike
79
COMPARISON
FORWARD CONTRACTS CURRENCY OPTIONS
No outlay of funds until maturity date Premium is payable on the second business
day after the day on which the option is
granted
Fixes in advance the amount payable/
receivable, facilitating costing exercises Since the customer has the right and not
obligation to purchase/sell at the strike price,
only the worst amount payable/receivable is
known in advance.
Once a forward contract is booked, the While protection against downside risk is
customer is locked into a rate and cannot obtained, the customer can benefit to an
benefit from a favourable movement in the unlimited extent from any favourable
underlying currency thereafter. movement in the underlying currency.
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COMPARISON
FORWARD CONTRACTS CURRENCY OPTIONS
Through management of Currency
Options, the customer can generate
additional profit in certain
circumstances
When a forward contract is booked,
foreign exchange lines are blocked until If customer buys option, no credit lines
maturity date. are required (after receipt of premium).
Credit lines required if customer sells
option.
Should the underlying transaction not
materialise, closing out of the outstanding The loss is limited to the premium
forward contract could entail losses paid.
81
Thank you.
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