Focus on Offshore Bond Issuance-Cross Currency Swap & Basis

François ChoquetApplication Specialist

Domestic Vs International Debt Securities Issuance

0

5000

10000

15000

20000

25000

30000

International Financial institutions 20778.721

International Corporate issuers 3570.34

International Governments 2422.574

Domestic Financial institu-tions 21897.277

International Cross Currency Swaps 16346.706

In Bi

llion U

SD

Aggregate of amounts outstanding

+15% p.a +18%p.a.

+8% p.a

Source: BIS

Motivations for Offshore Issuance

• Manage Risk• Price Arbitrage• Market Completeness

– Sub Investment grade– Maturity– Size– Coupon– Structured Notes

Bond Issuer’s Perspective

Onshore

Residents Non Residents

Domestic Debt Market

Foreign Bonds (Local Currency)e.g. Kangaroo, Samurai, Yankee, Bulldog, Arirang

Offshore

Eurobonds: Local Currency

Eurobonds Local CurrencyInternational Bonds

Foreign Currency

Export IncomeSwap-CoveredUncovered

Factors Driving the Basis

• Short term: FX swaps• Medium to Long Term: Bond Issuance• Long term: Exotics, dual currency bonds• Active markets: EUR, JPY, AUD, GBP vs. USD

Distribution of Bond Types: AU Domestic vs. AU Offshore

FIXED

FLOATING

STEP CPN

VARIABLE

ZERO COUPON

050000000000

100000000000150000000000200000000000250000000000300000000000350000000000400000000000450000000000

Coupon Type

DomesticOffshore

FIXED

FLOATING RATE

STEP-UP

VARIABLE

ZERO CPN

0

5000000000

10000000000

15000000000

20000000000

Structured Notes

A AA AAA B BBB CC CCC NR0

50000000000100000000000150000000000200000000000250000000000300000000000350000000000400000000000

Domestic Offshore

Ratings2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100% corp non financial Financial Government

Top 5 Issuers Domestic OffshoreCOMMONWEALTH BANK AUST 25,982 125,767 WESTPAC BANKING CORP 40,914 90,107 NATIONAL AUSTRALIA BANK 30,857 78,471AUST & NZ BANKING GROUP 24,464 70,378 MACQUARIE BANK LTD 3,033 17,221

0 2 4 6 8 10 12 14 16 18 20 22 400

40000000000

80000000000

120000000000

160000000000

200000000000Domestic - (blank)Offshore - KangarooOffshore - (blank)

Maturity

Australia Offshore Issuance (Size in USD)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100.00E+00

2.00E+10

4.00E+10

6.00E+10

8.00E+10

1.00E+11

1.20E+11

1.40E+11

1.60E+11

1.80E+11

2.00E+11

Offshore - KangarooOffshore - (blank)

11 9.5

3.5

12.5 10.757 8 7.5

1.5

45

27.75

5 year AUD Basis Kangaroo 0

100000000000200000000000300000000000400000000000500000000000600000000000700000000000800000000000

DomesticOffshore

Bond Distribution: Japan Domestic vs. Offshore

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100%

10%20%30%40%50%60%70%80%90%

100%

corp non financial Financial Government

A AA AAA

B BA BAA

C CA CAA

NR

WR

0

5001000150020002500300035004000

Japanese Foreign Bonds - Rating Band Distribution (Number of Deals)

VARI-ABLE

FLOAT-ING

RATE

STEP-UP

ZERO CPN

DUAL INDEX

STEP-DOWN

INVERSE

DELEV-ERED

STEP CAP-

FLOAT-ING

RATE

STEP FLOOR-FLOAT-

ING RATE

RANGE

RATCHET

0

5000000000

10000000000

15000000000

20000000000

25000000000

30000000000

domestic Foreign JPY offshoreStructured Notes

Offshore Issuance in USD Mln. and % of total issuance per Issuer – TOP 5 TOYOTA MOTOR CREDIT CORP 39,449 100%SUMITOMO MITSUI BANKING 13,492 28%AMERICAN HONDA FINANCE 8,765 100%NOMURA EUROPE FINANCE NV 7,233 100%BK TOKYO-MITSUBISHI UFJ 5,077 10.13%

FIXED

FLOATING

STEP CPN

VARIABLE

ZERO COUPON

0%20%40%60%80%

100%

offshore domestic

Japan offshore Issuance(size in USD) Offshore 203,854,251,580.35

Foreign JPY 420,246,911,857.92 Domestic 1,112,722,671,272.47

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100.00

10,000,000,000.00

20,000,000,000.00

30,000,000,000.00

40,000,000,000.00

50,000,000,000.00

60,000,000,000.00

70,000,000,000.00

80,000,000,000.00

90,000,000,000.00

100,000,000,000.00

offshore - Foreign JPY - Foreign JPY - Dual Currency

-9.25 -7.25-3.25 -0.9 -2.5

3.5 3.4

-20.5

-33

-55.75

5 year JPY basis

Eurodollar and Eurobond Issuance

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 22007 2008 2009 2010 2011

0%10%20%30%40%50%60%70%80%90%

100%

Financial Government Non Financial Corp

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 42007 2008 2009 2010

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

Euro Non Dollar Euro Currency

Eurodollar

2.25 1.43749999999999-1.75 -3.3

-8.25

-14.41

-29.25

-34.5

-48

-22.7-20.55 -19.25

-22.75

-34.5

-27.25-

32.9925000000001

5 year EUR basis

Distribution of Eurobonds (EU vs. US)Top 10 Issuer (in USD) Eurobond € Eurodollar

Euro-zone Issuer

Total

SFEF 6.10.E+10 6.10.E+10RABOBANK NEDERLAND 5.63.E+10 5.63.E+10MORGAN STANLEY 5.52.E+10 5.52.E+10GE CAPITAL EURO FUNDING 5.12.E+10 5.12.E+10MERRILL LYNCH & CO 4.47.E+10 4.47.E+10ANHEUSER-BUSCH INBEV WOR 4.39.E+10 4.39.E+10ING BANK NV 4.29.E+10 4.29.E+10GOLDMAN SACHS GROUP INC 4.19.E+10 4.19.E+10JPMORGAN CHASE & CO 2.95.E+10 2.95.E+10BK NEDERLANDSE GEMEENTEN 2.95.E+10 2.95.E+10

AVG ON

BASKET OF

PRICES

CPI (CONS PRICE

INDEX)

DELEV-ERED

FIXED

FLOAT-ING

RATE

IN-VERSE

LEV-ERED

RANGE

RATCHET

RPI (RE-TAIL

PRICE INDEX)

STEP-DOWN

STEP-UP

VARI-ABLE

ZERO CPN

0

5000000000

10000000000

15000000000

20000000000

25000000000

30000000000 Euro Non Dollar Euro Currency Eurodollar

1 2 3 4 5 6 7 8 9 1011121314151617181920222325272829300

50000000000

100000000000

150000000000

200000000000

250000000000

Euro Non Dollar Euro Currency Eurodollar

A

A

A

AA

AA

AA

AAA

AAA

B

BA

BAA

BAA

BAA

CAA

CAA

NR

0

50000000000

100000000000

150000000000

200000000000

250000000000Ratings

MaturityStructured Notes

Korea Offshore Issuance

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 -

5,000,000,000.00

10,000,000,000.00

15,000,000,000.00

20,000,000,000.00

25,000,000,000.00

30,000,000,000.00

35,000,000,000.00

40,000,000,000.00

Foreign Korea Issuer Arirang-14

-127.5

5.5

-52

-159

Korean Debt Market Composition

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 24 25 300

50000000000

100000000000

150000000000

200000000000

250000000000

300000000000

Arirang Domestic Offshore

A A- A+ AA AA- AA+ AAA B+ BBB+ C0

500000000

1000000000

1500000000

2000000000

2500000000

3000000000

3500000000

4000000000

4500000000

Arirang Offshore

Offshore Bonds Export-Import Bk Korea 27,116,958,435.03 Korea Development Bank 13,587,009,961.95 Woori Bank 13,257,551,696.38 Industrial Bank Of Korea 7,893,592,018.53 Republic Of Korea 7,001,950,000.00 Arirang BondsSc First Bank Korea Ltd 5,417,686,172.07 Intl Bk Recon & Develop 359,098,159.24 Barclays Bank Plc 289,946,948.79 Jpmorgan Chase & Co 196,189,897.39 Homeplus Co Ltd 169,531,753.30

Arirang0.50%

Domestic

85.73%

Kimchi0.01%

Offshore13.77%

Asset/Liability Currency Matches

Credit Card receivables, auto Loans

USD

Toyota Financial Services

Americas Corp (Foreign

Subsidiary) USD

Toyota Motor Credit Corp

(Intercompany issuer)

USD

Toyota Corp

Swap Counterparty

$ $$

$ ¥

JPY Debt

Matching USD Assets vs. Liabilities for the Subsidiary

JN Parent with Matching Currencies through a CCS for its LT assets and Liabilities

¥

Organizational Structure: Toyota

Japanese Counterparty A

Foreign Counterparty B

X.S (JPY)

X (USD) ¥ Libor

+ α

USD Libor

USD Libor

X (USD) X.S

(JPY)

S : FX spot rate (JPY/USD)X: Principal Amount

At inception

Cross Currency Swap (basis)During the term At maturity

¥ Libor + α

Japanese Counterparty A

Foreign Counterparty B

Foreign Counterparty B

Japanese Counterparty A

Cross Currency Swap Pricing

• At inception a cross currency basis swap is similar to two floating rate bonds priced at par.

• The notional principal amounts in the two currencies is set according to the spot exchange rate e.g. JPY N1 = JPYUSD.N2

• The market prices a basis to keep this fundamental relationship. In the market, it is expressed in terms of spread to the benchmark rates.

• For example a 5 year cross currency basis swap of 3 month USD Libor flat against JPY Libor is “fair” with a spread of -42.9 basis points if USD Libor is received and a spread of -48.75 basis points is USD Libor is paid.

Toyota USD Issue (Swap Covered)

1 2 3 4 195 20

(JPY Libor0

-46bps)xΔtx¥1.6834B

(JPY Libor1 - 46bps)xΔtx¥1.6834B

(JPY Libor2

-46bps)xΔtx¥1.6834B

(JPY Libor3 - 46bps)xΔtx¥1.6834B

(JPY Libor4 - 46bps)xΔtx¥1.6834B

(JPY Libor18

-46bps)xΔtx¥1.6843B

[(JPY Libor19 -46bps)xΔtx¥1.6716B]+¥1.6834B

(USD Libor0)xΔtX$20MM

(USD Libor2)xΔtx$20MM

(USD Libor3)xΔtX$20MM

(USD Libor4)xΔtx$20MM

(USD Libor5)xΔtx$20MM

(USD Libor18)xΔtX$20MM

[(USD Libor19)xΔtx$20MM]+$20MM

¥1.6716B

$20MM

Toyota Corp

Swap Counterparty

USD JPY 5 Year Basis Swap USD 20MM

FX spot rate (JPY/USD)= 0.0118807

Valuation Principle

• Cross currency swaps requires discounting the cash flows with the discount factors of the respective currency. E.g. USD leg with USD DF and JPY leg with JPY DF.

• Using DF from standard curves show a profit or loss which should be non existent

• It is therefore required to include a spread on the less “liquid” benchmark to bring the initial PV to zero

• For the leg to which the basis applies, two curves are required: One to project cash flows (forward) and the other to discount cash flows (basis adjusted discount curve)

)1/()*1(

)1/()(*1100**)100(*

**)100(*

)1/(*1100*100*

11

100100

100100

123

12

123

12

12

1

1

1

1

couponannuitypreviouscoupondf

coupondfdfcoupondf

dfdfcouponcoupondf

coupondfcoupondfcoupondf

coupondfcoupondf

coupondfcoupondf

CAC

df

dfAdfA

dfAC

dfdfC

n

N

NNN

N

n

NNnN

NNN

N

n

NnN

:using rate discount any for solve can we So,

:rate* swap year 3 the from factor discount year three the for solve we Similarly,

:rate* swap year 2 the from factor discount year two the solve we example, For

Bootstrapping Discount Factors and Zero Rates from Swap Rates

A swap Rate is the coupon rate which the fixed side is going to pay for the par swap. The procedure to solve the discount factor from a quoted swap rate is called bootstrapping. As shown above, To solve the 2-year discount factor, we need 1 year discount factor. To solve 6-year discount factor, we need 1 year, 2 year, 3 year, 4 year, 5 year discount factors. Thus we have to go step by step to solve the discount factors.

*Par coupon adjusted for intra-currency basis for most cross currency swaps e.g JPY

Basis Adjusted Discount Curve

,...1m,)sL(1

)T(DF)sL(1

)T(DF

,...1m),T(DF)T(DF)sL(1

1)T(DF)T(DF

L

m0mm

1m

1i

i*

m0ii

m*

m

1i

m*

i*

m0i

i

i

1i

0i

Objective: Incorporate the cross currency basis spread into the valuation method to be consistent with the market.

1. Sm the market quoted fair cross currency spread for maturity Tm on top of the floating rate for the given currency relative to chosen liquidity preference i.e. USD Libor

2. The fact that Sm is the fair spread is equivalent to a floating rate bond with maturity Tm in the given currency which pays Libor plus or minus a spread Sm valued to par.

3. DF* is the basis adjusted discount factor to ensure that the floater is at par. It is obtained by recursive bootstrapping as in the formula:

The discount Factors DF* are used for discounting any fixed or floating cash flows in a cross currency swaps. The valuation is thus consistent with the cross currency quotes provided by dealers. See following slides for excel prove-out and comparison with BBG screens.

Curve Object Period Period Freq Maturity Time to Mty (yrs)

days in period

Rate 3mx6m JPY basis

Adjusted rate

discount factors

zero coupon

JPY basis

JPY basis adjusted curve

JPY basis adjusted df

JPY basis adjusted zero

JY0001W Index 1W 1 W 4/13/2011 0.019 0.0194 0.1275 0.12750 0.9999752 0.128% -25 -0.12250 1.00002 -0.122%JY0001M Index 1M 1 M 5/6/2011 0.083 0.0639 0.15 0.15000 0.9998750 0.150% -25 -0.10000 1.00008 -0.100%JY0002M Index 2M 2 M 6/6/2011 0.169 0.0861 0.1625 0.16250 0.9997247 0.163% -25 -0.08750 1.00015 -0.088%JY0003M Index 3M 3 M 7/6/2011 0.253 0.2528 0.2 0.20000 0.9994947 0.200% -25 -0.05000 1.00013 -0.050%jyfr3/6 curncy 6M 6 M 10/6/2011 0.501 0.2521 0.2 0.20000 0.9989911 0.201% -25 -0.05000 1.00025 -0.050%jyfr6/9 curncy 9M 9 M 1/6/2012 0.753 0.2521 0.2 0.20000 0.9984878 0.201% -25 -0.05000 1.00038 -0.050%JYSwap1 curncy 1Y 1 Y 4/6/2012 1.003 0.2493 0.353 -0.14766 0.20534 0.9979364 0.206% -25 -0.04466 1.00045 -0.045%JYSWAP2 Curncy 2Y 2 Y 4/8/2013 2.008 1.0055 0.39313 -0.14769 0.24544 0.9950883 0.245% -35.4 -0.10856 1.00218 -0.108%JYSWAP3 Curncy 3Y 3 Y 4/7/2014 3.005 0.9973 0.45625 -0.14901 0.30724 0.9908407 0.306% -42.2 -0.11476 1.00345 -0.114%JYSWAP4 Curncy 4Y 4 Y 4/6/2015 4.003 0.9973 0.545 -0.15037 0.39463 0.9843509 0.394% -45.5 -0.06037 1.00242 -0.060%JYSWAP5 Curncy 5Y 5 Y 4/6/2016 5.005 1.0027 0.655 -0.15429 0.50071 0.9752341 0.501% -46.7 0.03371 0.99831 0.034%JYSWAP6 Curncy 6Y 6 Y 4/6/2017 6.005 1.0000 0.788 -0.15953 0.62847 0.9628803 0.630% -46.5 0.16347 0.99020 0.164%JYSWAP7 Curncy 7Y 7 Y 4/6/2018 7.005 1.0000 0.93 -0.16483 0.76517 0.9475562 0.770% -45.8 0.30717 0.97857 0.309%JYSWAP8 Curncy 8Y 8 Y 4/8/2019 8.011 1.0055 1.075 -0.17144 0.90356 0.9296256 0.912% -44.2 0.46156 0.96333 0.467%JYSWAP9 Curncy 9Y 9 Y 4/6/2020 9.008 0.9973 1.215 -0.17810 1.03690 0.9098836 1.050% -42.2 0.61490 0.94539 0.624%JYSWAP10 Curncy 10Y 10 Y 4/6/2021 10.008 1.0000 1.345 -0.18601 1.15899 0.8889418 1.178% -39.8 0.76099 0.92535 0.776%

JPY Basis Adjusted Discount Curve

*Flat interpolation for currency basis** Mid point used for all market rates

USD JPY Basis Swap Valuationjpy usd

4/4/20114/6/2011 JPY

usd 20,000,000 jpyusd jn 1,681,096,074.64 Spread -0.464065% 0.011897ppay jpy floating

Interest Accrual start date

cash flow pay date

Time Factor Period zero Forward Rates

JPY Cash Flows basis Adjusted zeros

adjusted forwards

Adjusted Df*

JPY Cash Flows PV

1 4/6/2011 7/6/2011 0.252777778 0.2528 0.200% 0.2000% -1122125.82 -0.05000% -0.05000% 1.0001264 -1122267.662 7/6/2011 10/6/2011 0.508333333 0.2556 0.201% 0.2027% -1122658.85 -0.05041% -0.0508% 1.0002542 -1122944.243 10/6/2011 1/6/2012 0.763888889 0.2556 0.201% 0.2000% -1134468.91 -0.05022% -0.0499% 1.0003877 -1134908.744 1/6/2012 4/6/2012 1.016666667 0.2528 0.206% 0.2209% -1033146.14 -0.04481% -0.0285% 1.0005113 -1033674.425 4/6/2012 7/6/2012 1.269444444 0.2528 0.216% 0.2543% -891217.47 -0.06058% -0.1241% 1.0005251 -891685.436 7/6/2012 10/9/2012 1.533333333 0.2639 0.226% 0.2740% -843221.24 -0.07705% -0.1564% 1.0010947 -844144.327 10/9/2012 1/7/2013 1.783333333 0.2500 0.236% 0.2935% -716911.19 -0.09265% -0.1886% 1.0016058 -718062.418 1/7/2013 4/8/2013 2.036111111 0.2528 0.245% 0.3125% -643979.06 -0.10843% -0.2201% 1.0021007 -645331.859 4/8/2013 7/8/2013 2.288888889 0.2528 0.261% 0.3815% -350948.89 -0.10993% -0.1224% 1.0027572 -351916.51

10 7/8/2013 10/7/2013 2.541666667 0.2528 0.276% 0.4114% -223637.03 -0.11144% -0.1254% 1.0028211 -224267.9411 10/7/2013 1/6/2014 2.794444444 0.2528 0.291% 0.4413% -96713.85 -0.11295% -0.1285% 1.0031471 -97018.2212 1/6/2014 4/7/2014 3.047222222 0.2528 0.306% 0.4711% 29792.73 -0.11446% -0.1316% 1.0034818 29896.4613 4/7/2014 7/7/2014 3.3 0.2528 0.328% 0.5879% 526230.89 -0.10093% 0.0624% 1.0038245 528243.4514 7/7/2014 10/6/2014 3.552777778 0.2528 0.350% 0.6305% 707433.33 -0.08740% 0.0895% 1.0031752 709679.5915 10/6/2014 1/6/2015 3.808333333 0.2556 0.372% 0.6732% 898566.10 -0.07372% 0.1168% 1.0028747 901149.2416 1/6/2015 4/6/2015 4.058333333 0.2500 0.394% 0.7154% 1056445.54 -0.06034% 0.1439% 1.0025452 1059134.4117 4/6/2015 7/6/2015 4.311111111 0.2528 0.421% 0.8349% 1575974.27 -0.03694% 0.3396% 1.0020501 1579205.1918 7/6/2015 10/6/2015 4.566666667 0.2556 0.448% 0.8858% 1811643.84 -0.01328% 0.3864% 1.0007118 1812933.4019 10/6/2015 1/6/2016 4.822222222 0.2556 0.475% 0.9365% 2029676.64 0.01037% 0.4334% 0.9996202 2028905.7120 1/6/2016 4/6/2016 5.075 0.2528 0.501% 0.9866% 1683316601.05 0.03377% 0.4799% 0.9984059 1680633148.93

MV (JPY) 1,681,096,074.64 0 20,000,000.00

USD Leg ValuationReceive usd floating

Interest Accrual start date

cash flow pay date

df Time Factor

Period Reset Cash Flow PV

1 4/6/2011 7/6/2011 0.999957 0.25277778 0.2528 0.017% 860.04 860.00 2 7/6/2011 10/6/2011 0.99924 0.50833333 0.2556 0.281% 14,350.91 14,340.00 3 10/6/2011 1/6/2012 0.998379 0.76388889 0.2556 0.337% 17,247.96 17,220.00 4 1/6/2012 4/10/2012 0.997324 1.02777778 0.2639 0.401% 21,156.62 21,100.00 5 4/10/2012 7/6/2012 0.995599 1.26944444 0.2417 0.717% 34,645.54 34,493.08 6 7/6/2012 10/9/2012 0.992192 1.53333333 0.2639 1.301% 68,680.72 68,144.47 7 10/9/2012 1/7/2013 0.988472 1.78333333 0.2500 1.506% 75,278.47 74,410.63 8 1/7/2013 4/8/2013 0.984947 2.03611111 0.2528 1.416% 71,571.65 70,494.28 9 4/8/2013 7/8/2013 0.981383 2.28888889 0.2528 1.437% 72,629.69 71,277.55 10 7/8/2013 10/7/2013 0.974936 2.54166667 0.2528 2.616% 132,254.84 128,940.00 11 10/7/2013 1/6/2014 0.968489 2.79444444 0.2528 2.633% 133,135.22 128,940.00 12 1/6/2014 4/7/2014 0.962042 3.04722222 0.2528 2.651% 134,027.41 128,940.00 13 4/7/2014 7/7/2014 0.955595 3.3 0.2528 2.669% 134,931.64 128,940.00 14 7/7/2014 10/6/2014 0.947466 3.55277778 0.2528 3.394% 171,594.55 162,580.00 15 10/6/2014 1/6/2015 0.939337 3.80833333 0.2556 3.386% 173,079.52 162,580.00 16 1/6/2015 4/7/2015 0.931119 4.06111111 0.2528 3.492% 176,525.93 164,366.59 17 4/7/2015 7/6/2015 0.922977 4.31111111 0.2500 3.529% 176,425.24 162,836.41 18 7/6/2015 10/6/2015 0.913783 4.56666667 0.2556 3.937% 201,218.92 183,870.49 19 10/6/2015 1/6/2016 0.904386 4.82222222 0.2556 4.066% 207,827.86 187,956.50 20 1/6/2016 4/6/2016 0.894988 5.075 0.2528 4.154% 20,210,010.16 18,087,710.00

20,000,000.00

PV inflows = PV outflows = USD20,000 = USD20,000/0.011897 = JPY1,681,096,074.64

Appendix: Valuation of JPY leg in USD using FX Forwards

,tJPY,$,t

t

,t,tJPY,$tOutflows

,tJPY,$

,t

t

,tttInflows

FXdfdfFXΔtspreadJPY Libor,JPYPV

e (t)ent at tim) for payming (me of pric at the ti initiated JPYntract for of the collar value is the doF

df,,$dfLiborUSD ,,$PV

00

20

1

00

0

0

20

1

0

074,096,681,1074,096,6811

01

0000002000000020

pay jpy floating

Interest Accrual start date

cash flow pay date

Time Factor Period zero Forward Rates

JPY Cash Flows basis Adjusted zeros

adjusted forwards

Adjusted Df*

JPY Cash Flows PV FX Dollar Value of JPY Cash Flows

USD DF Dollar Value of PV of JPY Cash Flows

1 4/6/2011 7/6/2011 0.252777778 0.2528 0.200% 0.2000% -1122125.82 -0.05000% -0.05000% 1.0001264 -1122267.66 0.01171321 -13143.6954 0.999957 -13143.130212 7/6/2011 10/6/2011 0.508333333 0.2556 0.201% 0.2027% -1122658.85 -0.05041% -0.0508% 1.0002542 -1122944.24 0.0117235 -13161.491 0.99924 -13151.488253 10/6/2011 1/6/2012 0.763888889 0.2556 0.201% 0.2000% -1134468.91 -0.05022% -0.0499% 1.0003877 -1134908.74 0.01174082 -13319.5953 0.998379 -13298.004254 1/6/2012 4/6/2012 1.016666667 0.2528 0.206% 0.2209% -1033146.14 -0.04481% -0.0285% 1.0005113 -1033674.42 0.01176351 -12153.4249 0.997324 -12120.902355 4/6/2012 7/6/2012 1.269444444 0.2528 0.216% 0.2543% -891217.47 -0.06058% -0.1241% 1.0005251 -891685.43 0.01179572 -10512.5517 0.995599346 -10466.289586 7/6/2012 10/9/2012 1.533333333 0.2639 0.226% 0.2740% -843221.24 -0.07705% -0.1564% 1.0010947 -844144.32 0.0118423 -9985.67887 0.992192123 -9907.7119177 10/9/2012 1/7/2013 1.783333333 0.2500 0.236% 0.2935% -716911.19 -0.09265% -0.1886% 1.0016058 -718062.41 0.01190384 -8533.99608 0.988471591 -8435.6126818 1/7/2013 4/8/2013 2.036111111 0.2528 0.245% 0.3125% -643979.06 -0.10843% -0.2201% 1.0021007 -645331.85 0.01196607 -7705.89852 0.984946877 -7589.9006839 4/8/2013 7/8/2013 2.288888889 0.2528 0.261% 0.3815% -350948.89 -0.10993% -0.1224% 1.0027572 -351916.51 0.01205392 -4230.30984 0.981383 -4151.554166

10 7/8/2013 10/7/2013 2.541666667 0.2528 0.276% 0.4114% -223637.03 -0.11144% -0.1254% 1.0028211 -224267.94 0.01214178 -2715.35162 0.974936 -2647.29404811 10/7/2013 1/6/2014 2.794444444 0.2528 0.291% 0.4413% -96713.85 -0.11295% -0.1285% 1.0031471 -97018.22 0.01222963 -1182.77462 0.968489 -1145.50421312 1/6/2014 4/7/2014 3.047222222 0.2528 0.306% 0.4711% 29792.73 -0.11446% -0.1316% 1.0034818 29896.46 0.01231748 366.971332 0.962042 353.041834613 4/7/2014 7/7/2014 3.3 0.2528 0.328% 0.5879% 526230.89 -0.10093% 0.0624% 1.0038245 528243.45 0.01242166 6536.66122 0.955595 6246.40077414 7/7/2014 10/6/2014 3.552777778 0.2528 0.350% 0.6305% 707433.33 -0.08740% 0.0895% 1.0031752 709679.59 0.01252601 8861.31696 0.947466 8395.79653415 10/6/2014 1/6/2015 3.808333333 0.2556 0.372% 0.6732% 898566.10 -0.07372% 0.1168% 1.0028747 901149.24 0.01263151 11350.2467 0.939337 10661.7066616 1/6/2015 4/6/2015 4.058333333 0.2500 0.394% 0.7154% 1056445.54 -0.06034% 0.1439% 1.0025452 1059134.41 0.01273471 13453.5276 0.93111867 12526.8307117 4/6/2015 7/6/2015 4.311111111 0.2528 0.421% 0.8349% 1575974.27 -0.03694% 0.3396% 1.0020501 1579205.19 0.01286251 20270.9849 0.92297685 18709.6497518 7/6/2015 10/6/2015 4.566666667 0.2556 0.448% 0.8858% 1811643.84 -0.01328% 0.3864% 1.0007118 1812933.40 0.01299224 23537.3116 0.913783325 21508.0028819 10/6/2015 1/6/2016 4.822222222 0.2556 0.475% 0.9365% 2029676.64 0.01037% 0.4334% 0.9996202 2028905.71 0.01312197 26633.356 0.9043855 24086.8209820 1/6/2016 4/6/2016 5.075 0.2528 0.501% 0.9866% 1683316601.05 0.03377% 0.4799% 0.9984059 1680633148.93 0.01325029 22304433.1 0.894987675 19962192.74

MV (JPY) 1,681,096,074.64 0 20,000,000.00 19,968,623.60

Basis=-46.4bps

Basis Adjusted Curve vs. FX Forwards

• The large difference in valuation shows that forwards quoted by the market do not fully incorporate the CIP. Therefore, the valuation of CCS using this method is unsatisfactory!

• The valuation methodology for one and same cash flow should not depend on the type of originating trade for that cash flow. E.g USD or JPY

• Evaluating cross currency swap requires discounting the cash flows with the discount factors for the respective currency.

• In the basis adjusted curve approach, we must use TWO discount curves: one for projecting cash flows and the other for discounting all cash flows.

Study CasesBond CIP Arbitrage in AUD and CNH

Swap Covered “Bargain”--------

Eurodollar FRNCBA issued 1.6bln FRN in the eurodollar market on 3/17/2011 to obtain domestic funding through swap-covered borrowing. It was issued at par with a floating coupon referenced to the 3 month Libor + 73 basis points. The quoted margin of FRN issued by other AA Banks and financial institutions issued in 2011 with similar maturity ranges from 38 bps to 145 basis points.

Issuer Maturity Amount Issued Issue Date Floater Spread (bp)

Rating (BBG Comp)

CREDIT AGRICOLE 1/21/2014 1.25E+09 1/21/2011 145 AA-

AUST & NZ BANK 1/10/2014 1E+09 1/12/2011 74 AA

SSIF NEVADA LP 4/14/2014 1.9E+09 4/14/2011 70 NR

COM BK AUSTRALIA 3/17/2014 1.6E+09 3/17/2011 73 AA

HSBC BANK PLC 1/18/2013 9E+08 1/19/2011 40 AA

HSBC BANK PLC 1/17/2014 1.35E+09 1/19/2011 80 AA

MASSMUTUAL GLBL 1/14/2014 2.5E+08 4/14/2011 38 AA

METLIFE INSTITUT 7/12/2012 5E+08 1/12/2011 40 AA-

MET LIFE GLOB 1/10/2014 5E+08 1/11/2011 75 AA-METLIFE INSTITUT 4/4/2014 1E+09 4/5/2011 90 AA-

NATL AUSTRALIABK 4/11/2014 1.6E+09 4/11/2011 72 AA

NORDEA BANK AB 1/14/2014 1E+09 1/14/2011 90 AA-

WESTPAC BANKING 3/31/2014 1.4E+09 3/31/2011 73 AA

Cross Currency Swap

The cash flows are swapped; CBA exchanges the principal at the onset of the trade receiving AUD. Throughout the life of the swap, CBA receives Libor Flat and pays quarterly cash flows referenced to the bank bill swap rate (BBSW). The principal flow is reversed at maturity.

SWPM solves for the cross currency swap spread which represents what the issuer pays as a margin over the bank bill swap rate in the AUD domestic market. Libor +73 bps converts into BBSW + 97.45 bps.

Note that for floating for floating swap, because the respective currency NPVs of each side of the swap remain unchanged as swap curve shifts, changes in the value corresponds ONLY to changes in the basis (BR01).

Achieving covered “Bargain” AUD Domestic FRN vs. Eurodollar FRN

Comparing the spread resulting from the swap covered FRN and an outright FRN issued by CBA in the domestic market at the end of 2010, we can see that the difference is about 7 basis points at issuance.

-> Research from BIS show that savings between 4 and 18 basis points can be gained through opportunistic foreign currency bond issuance among major currencies.

Eurodollar Fixed Rate Bond

The swap covered issuance in USD through a fixed rate bond issued by CBA in the eurodollar market. The coupon is 25bps higher than that of equivalent eurodollar issues (par yield of fair market curve {C1525Y index} is ≈3% at the time of issuance).

USD/AUD Cross Currency Swap

The fixed to fixed swap is akin to a bundle of two fixed rate bonds. The two back to back “bonds” are exchanged and have equivalent NPVs when valued in a common currency. For fix-to-fix swaps, since the interest payments are locked in at initiation, changes in the value reflect changes in the IR curve as well as the cross currency basis.

The fixed equivalent rate in AUD is 6.81%. When compared to the average yield of AUD AA rated bond at the time of issuance of 6.87% (see FMC 358 C3585Y index HP) the advantage is 6bps.

Bond Fixed Equivalent rate in AUD

Offshore Fixed Rate bond vs Domestic Fixed Rate bondAUD AA Domestic 5 Year FMC Rate

AUD vs. USD Swap Covered Arbitrage (Recap) CBA USD

Float 2014CBA AUD Float 2015

CBA USD Fixed 2016

CBA AUD Fixed 2016

Offer Price 100 100 99.666 100

USD Spread / Coupon

73 bps 3.25% 6.87%

AUD Spread/ Coupon

97.85bps (Swapped)

105 bps 6.813% (Swapped)

Difference 7.15 bps 6 bps

These calculations are based on the AUD basis (see previous presentation for methodology).

The process help Aussie issuers identify the cheapest funding opportunity between Eurodollar and domestic markets.

Based on our calculations, CBA’s bonds in USD provides a lower cost of funding in both the fixed rate and floating rate euro-dollar markets than in the domestic market; the cost saving is greater in the FRN (7.15bps) than in the Fixed Rate market. (6bps) .

Summary The difference in funding cost between the USD and AUD reflects the arbitrage opportunity “covered bargain” arising from the departure of the FX market from the covered interest parity “CIP” . It is measured by the basis which reflects the credit spread differential that exists between Australian and offshore issuers in both AUD (Aussie domestic vs. kangaroo) and USD (Eurodollar vs. US domestic).

Investor Arbitrage : Dim Sum vs. US Dollar

• Limited opportunities due to lack of liquidity of CNH CCS market

• Choice between dim sum and US Dollar bonds depends more on investors’ view on RMB appreciation.

• Can apply cross currency yield calculator YAX <go> (Theoretical and based on forward rate in CNH but sufficient to identify higher yielding bond amongst US dollar and dim sum bonds.

• Comparison of two bonds from the same issuer – Evergrande- with both USD and Synthetic RMB Bonds O/S.

Dim Sum Bond: EVERGRANDE 2014

Cross Currency Swap Rate CNH/USD

USD Bond

Cross Currency Swap USD/CNH

Summary of Evergrande’s Yield Difference

RMB Fixed 2014 USD Fixed 2015

Offer Price 100 106.996

RMB Yield (YTM) 7.5% 9.106% (Swapped)

USD Yield (YTM) 9.36% (Swapped)

10.807%

Difference (implied RMB appreciation)

1.86% 1.7%

These calculations are theoretical and based on the forward rate in CNH.

The process help investors identify the higher yielding bond amongst US Dollar and Dim Sum Bonds.

Based on our calculations, Evergrande’s RMB bonds 2015 provides a higher yield than the RMB 2014 which reflects the difference in duration of the bonds (150bps)

The difference between the yield in the RMB and USD reflects the market expectations of the RMB appreciation at the time of issuance.

Investor : PAR-PAR CCS Asset Swap•At inception, the bondholder pays the swap counterparty 100-Price of the bond to enter the swap.•During the holding period, the investor pays the swap counterparty all the coupon cashflows and receives Libor + spread in return.•Reduces interest rate and currency exposure – Separates interest and currency risk which allows views on credit quality more clearly. In the event of default, the swap does not terminate.