central banking- all derivatives overview-basics
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BABUJI K
DEPUTY GENERAL MANAGER
FINANCIAL DERIVATIVES -
CONCEPTS `
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DERIVATIVE MARKETS
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DERIVATIVE MARKETS
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DERIVATIVES FOREIGN EXCHANGE DERIVATIVES/CURRENCY DERIVATIVES
FORWARDS
NON-DELIVERABLE FORWARDS
FUTURES
OPTIONS
SWAPS INTEREST RATE SWAPS
CURRENCY SWAPS
INTEREST RATE DERIVATIVES
INTEREST RATE SWAPS
INTEREST RATE FUTURES
INTEREST RATE OPTIONS
CREDIT DERIVATIVES
COMMODITY DERIVATIVES
EQUITY DERIVATIVES
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INDIAN DERIVATIVE MARKETS
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FX outright is an agreement to exchange twocurrencies at a rate agreed today, for delivery onan agreed future date
Exchange rate fixed today while currencies getexchanged at future date
Maturity can be any fixed date or any date withinfixed period
Today Future date
Transaction Delivery or value
FX FORWARDS
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FX outright consists of a spot deal and a forwards deal
Today Future dateSpot date
Buy 3 month USD outright against INR
buy USD/INR
sell USD/INR buy USD/INR
3 month USD/INR forwards
FX FORWARDS
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Premium and Discount A currency is said to be at a premium against another currency if it is
more expensive in the forward market than the spot market.
A currency is said to be at a discount against another currency if it isless expensive in the forward market than the spot market.
If forwards are quoted as premium outright = spot + forwards pips
If forwards are quoted as discount
outright = spot - forwards pips
If the forward margins are given in ASCENDING
order,(10/15,20/25),they are premium margins If the forward margins are given in DESCENDING
order,(15/10,25/20),they are discount margins
FX FORWARDS
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Quoted among dealers as differentials Premium or discount represent the interest rate differentials
between the two currencies for the period of the forwardconverted in foreign exchange
Swap points/forward points represent amount of foreignexchange that will neutralise the interest rate differentialsbetween two currencies
If a base currency A earns higher interest rate than term currencyB the base currency will trade at forward discount or below thespot rate
If a base currency A earns lower interest rate than the termcurrency B, the base currency will trade at a forward premium orabove the spot rate
The trader who losses on the interest rate will earn the forwardpremium and vice versa
In convertible currencies, the forward points would clearly reflectinterest rate differential , else arbitrage will set in and would bringit back to the correct levels equivalent to interest rate differential
FORWARD RATES - THEORY
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A company is long USD/CHF value date 6 months andwants to hedge the FX-risk. There are
two alternatives:
1. Sell USD outright against CHF or
2. Sell USD spot against CHF and refinance USD for 6 months by means of an interbank
deposit and
invest CHF for 6 months by means of an interbank deposit
The results of both alternatives must be the same.
Otherwise the market participants would do arbitrage thatmeans they would buy the cheaper alternative and closethe position by selling the other one. Hence the differencewould disappear very quickly.
FORWARD RATES INTEREST
RATE PARITY THEORY
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FORWARD RATES Interest
Rate parity - Example
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FWD RATE =
D = No. of days I b = Base currency interest rate
O = Outright rate I v = Variable currency interest rate
Spot = Spot exchange rate B B = Basis of term in base currency
B V = Basis of term in variable currency
FORWARD RATES - FORMULA
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FORWARD RATES - EXAMPLE
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Rate(USD/INR)
BuyingRate
SellingRate
Spot 47.5500 47.5600
1 MonthFR
47.5500
+0.1000
47.6500
47.5600
+0.150047.7100
2Month FR 47.5500
+0.2000
47.7500
47.5600
+0.2500
47.8100
FX FORWARDOUTRIGHT RATES
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Hedging forward currency risks, by locking into a fixed exchange rate for apredefined future date. Eg. Corporates hedge their forward exportreceivables or import payables by entering into forward USD sales orpurchases.
Assuming an exporter is due to receive USD 1 mio after 3 months, he canenter into a forward contract with a Bank to sell USD 1 mio at the end of 3months at a predetermined exchange rate of INR 46.37 / USD.
Hedging any foreign currency borrowings / investments. Eg. Bank A raises a1yr USD liability at USD LIBOR + 50 bps. The bank runs the risk of Rupee
depreciation; to hedge this risk, the bank would hedge the currency risk bybooking a forward purchase of USDs to meet his USD liability repayment.Hence the bank enters into a forward agreement with another bank to buyUSDs at the end of 1 year
FORWARDS APPLICATIONS
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CONVERSION TO PER CENTTERMS
Forward Premia (in %)[Forward rate Spot rate] * 365 *100
= ---------------------------------------------Spot rate * no. of days
=(46.37-46.10)*365*100
------------------------------------ = 2.37%46.10*90
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FX MARKETS TYPICAL SPOT
AND FORWARD RATES
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FX MARKETS Typical Forward
points in the market
BID OFFERSpot 45.65 45.66
Dec -10 27 28Jan -11 51 52
Feb-11 71 72Mar-11 89 90Apr-11 109 110
May-11 124 125
Jun-11 139 140Jul-11 154 155Aug-11 169 170Sep-11 183 184Oct-11 197 198
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Convertibility and Transferability
Currencies like INR/CNY/ TWD/KRW
BIS Survey in September 2006 estimates around USD 500 million every day
NDF on South Asian currencies traded in Singapore
Use of NDF
NDFs allow corporations, banks and other organisation to hedge theircurrency risk simply and efficiently
Whether the exposure takes the shape of overseas assets or equity
holdings, international subsidiaries or receivables in foreign currencies NDF to protect their investment
The demand for NDFs arises principally out of regulatory and liquidityissues of the underlying currencies.
Principles
As with normal forward transaction you either buy or sell the NDFdepending on your position to be hedged or your view on the currency or
its interest rates
There is no physical delivery of currency at maturity
Instead, the difference between the agreed outright price and theprevailing spot rate is multiplied by the notional amount of the contract toreturn an amount in dollars
Settlement: Payment of Netting
NON-DELIVERABLE FORWARDSNon-deliverable forwards
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NDFs are generally short term instruments, using the samestandard foreign exchange as forward market convention
Two way prices are quoted two ways bid / offer
NDFs require a fixing mechanism to establish a spot rate onwhich to settle these transactions
The purchaser of the contract pays out the foreign exchangedifferential in dollars
Advantage of NDFs
Not subject to local regulations or restrictions
Principal not subject to settlement risk only profit and loss
Simple and easy settlement
Only settlement currency in USD so no local currencyaccounts are needed
Eliminates paying spot bid/ask spreads again at maturity ofthe contract
Non-deliverable forwards
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The formula: Settlement amount in US dollar = Notional
amount in US dollar * ((NDF rate Reference
rate on Settlement date) / Reference rate). If settlement amount < zero, contract seller
pays the difference to the contract buyer.
If settlement amount > zero, contract seller
receives the difference from the contractbuyer.
Non-deliverable forwards -
Settlement
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CURRENCY FUTURES
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CURRENCY FUTURES DIFFERENCE BETWEEN
FUTURES AND FORWARDS
Forwards/OTC Exchange Traded FuturesAccessibility Restricted entry Entry not restricted
PriceTransparency
Limited access Online
High visibility
Liquidity Depth not known Depth visible
Agreements Customized Standard
Credit Exposure Yes Mitigated throughexchange
Settlement Physical Delivery Net Settled in cash
Underlyingexposure
Required Not required
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An Option gives the buyer the right, but not the Obligation,
to buy or to sell an agreed amount of FinancialInstrument (Call/Put)
on or before an Agreed Future Date (expiry)
at an Agreed Price (strike)
in exchange for a Fee (Premium)
Right to buy Call option
Right to sell Put option
CURRENCY OPTIONS
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Option is similar to forward contract with more flexibility to thecustomers
Option contracts gives the buyer the right but not the obligation
Option can be OTC contract or exchange traded contract
Recently in India exchange traded currency option has been
introduced In Indian market, banks sell options to customer banks are
option writers
Customers are options buyers
Right to exercise the Option is available for the buyers and not
the writers
CURRENCY OPTIONS
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OPTIONS TERMINOLOGY
Underlying The currency pair on the basis of which option
is tradedNotional The amount of the underlying
Strike Price The price at which the underlying is bought orsold
Expiration Date The date on which the option expires
Delivery Date The date on which the underlying is delivered ifthe option is exercised
Settlement Date The date on which the premium is settled
Maturity / Tenor Length of time till expiration date
Cut Time at which the Option expires
Option Price orPremium
The upfront cost of the option
Style American or European
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O ti i i d t i t
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Time ValueIntrinsic Value
+
Time till maturity
Interest RateDifferential
Volatility
Difference between
strike and spot rate
Strike rate
Options pricing determinants
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Three states At The Money
In The Money
Out of The Money With reference to
holder of option
State Call Put
ATM S=X S=X
ITM S>X S
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Option premium is the price for the option Premium is payable upfront which is the gain
realized by the option writer
Option buyer has unlimited profit potential butloss is limited to the premium paid
Option writer has no right but face unlimitedobligation
Option writer covers his option contracts withcustomers on back to back basis either in thedomestic market or in overseas market
CURRENCY OPTIONS -
PREMIUM
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To hedge the option positions, market makers do spottransactions
The amount of spot that the market maker buys or sells
depends on the hedge ratio of the option, also referred to as
the delta of the option
For e.g. if the market maker buys $ 100 mio of 45.75 strike
USD Put INR call for a 1 month tenor, the following table
shows the delta of the option 1m, 2w and 1w from expiry
of the option at various spot levels
GREEKS - DELTA
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Example : Market Maker Long USD 100 mio of 1 month45.50 USD Put INR Call
1 month 2 weeks 1 weekDays toExpiry/Spot
Delta Spot Hedge Delta Spot Hedge Delta Spot Hedge
43.75 -86 +$86 mio -93 +$93 mio -97 +$97mio
44.25 -76 +$76 mio -82 +$82 mio -90 +$90 mio
44.75 -63 +$63 mio -67 +$67 mio -72 +$72 mio
45.25 -50 +$50 mio -50 +$50 mio -50 +$50 mio
45.75 -37 +$37 mio -33 -$33 mio -29 +$29 mio
46.25 -26 +$26 mio -20 +$20 mio -13 +$13 mio
GREEKS DELTA(HEDGE RATIO)
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Lets say the spot at the time of trade was at 45.75, the hedgeratio is 37%, so market maker would buy $37 mio in the spot
market to hedge the option
If spot falls to 45.25, the hedge ratio would increase to 50%,
so the market maker needs to buy $ 13 mio ( 50-37) to re-hedge the option position
If spot then rises to 46.25, the hedge ratio would be 26%, so
the market maker needs to sell $24 mio ( 50-26) to rebalance
the portfolio
GREEKS DELTA(HEDGE RATIO)
DELTA HEDGING
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Trader who is short of a call option or long of a put option
Negative delta
Buys the underlying
Trader who is long of a call option or short of a put option
Positive delta
Sells the underlying
Delta denotes the sensitivity of option price to the movement of the underlying assetprice
Delta is also known as hedge ratio or the number of units of the underlying that shouldbe bought or sold
The price of the underlying and delta keeps moving and hence needs dynamic hedgingor rebalancing every day/week
Delta Call options
close to zero for deep out of the money call options
0.5 at the money
close to one for deep in the money call options
Delta Put options
close to zero for deep out of the money call options
0.5 at the money
close to minus one for deep in the money call options
DELTA HEDGING
TECHNIQUES
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Contract between two parties to exchange periodic couponpayments in two different currencies over a period of time.
Notional principals are also exchanged on the maturity ofthe swap. The initial exchange of principal is optional asnotional principals are determined at inception using the
spot exchange rate. Effectively, this implies re-denominating a liability into the
alternate currency.
Coupon payments are calculated based on notionalprincipal amounts in two different currencies. Couponpayments can be fixed vs fixed, fixed vs floating, or floatingvs floating.
As for an interest rate swap, the price is determined byequating the NPVs of both legs of the transaction.
Cross currency swaps
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Cross currency swaps
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Cross currency swaps -
ExampleSwiss bank X with A rating needs USD 100 millionfor 5 years at a fixed rate and could refinance itselfat 6.50% in USD. The current yield in capital marketis 6.25% (5 years)
X can issue a 5-year bond in Swiss franc with aninterest rate of 5.625%. The current rate in capitalmarkets is CHF 5.50%
Currency swap can be used with an exchange offixed interest rates of 6.25% in USD and 5.50% inCHF
For both initial and final exchange a USD/CHF rateof 1.4500 is fixed
With issue and simultaneous currency swap, Xcould secure the needed USD 100 million.
On the CHF side a loss of 0.125% will be incurred(5.625% expenditure for issue 5.50% interest
return in swap)Theoretically the total expenditure of the deal isUSD 6.25% in USD +0.125% in CHF = 6.375%
As refinancing cost independently for X for USD is6.50%, it saves 0.125% .
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Cross currency swaps -
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Cross currency swaps -
ExampleA corporate raised Rs. 47 crore at 12% for 5 years
interest payable semi-annually. It can convert thisloan from rupees to USD by entering into currencyswaps
Under the above structure, corporate pays USD 6month LIBOR to the bank and receives 11% every 6months.
On every 1st January and 1st July the corporatereceives from the swap bank 11% on Rs.47 crore i.e.Rs.2.59 crore
Corporate pays USD LIBOR on USD 10 million and
suppose that on first reset date USD LIBOR is 5%then it pays 5% on USD 10 million in rupee termsconverted at the then prevailing exchange rate whichin this example is say Rs.48.00 per USD.
The interest payable is (10000000 x 5% x 0.5) x 48= 1.20 crore
In effect corporate receives Rs.1.39 crore.
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INTEREST RATE
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INTEREST RATEDERIVATIVES
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TYPES OF INTEREST RATE
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Forward rate greements
Interest rate Futures
Interest Rate SwapsInterest Rate Options Not allowed inRupees Yet
TYPES OF INTEREST RATE
DERIVATIVES
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FORWARD RATE
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While futures and forward contracts are similar,forward contracts differ because
they are negotiated between counter-parties,
there is no daily settlement or marking-to-market,
no exchange guarantees performance FRAs are cash-settled at the settlement date with
no interim cash flows.
FORWARD RATE
AGREEMENTS
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The two counterparties to an FRA agree to a notionalprincipal amount that serves as a reference figure indetermining cash flows.
notional refers to the condition that the principaldoes not change hands, but is only used to
calculate the value of interest payments. The buyer of the FRA agrees to pay a fixed-rate
coupon payment and receive a floating-ratepayment against the notional principal at somespecified future date.
The seller of the FRA agrees to pay a floating-ratepayment and receive the fixed-rate paymentagainst the same notional principal.
NOTIONAL AMOUNT
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FIX FUTURE INTEREST RATE WHO USES
HEDGERS AGAINST FUTURE INTEREST RATERISK BY SETTING FUTURE INTEREST RATETODAY
SPECULATE ON FUTURE INTEREST RATE ARBITRAGE BETWEEN FUTURES AND FRA
OTC PRODUCT AT AGREED FUTURE RATE SETTLEMENT
PAYMENT DIFFERENCE . NO OBLIGATION TO EXCHANGE PRINCIPAL CASH SETTLED
FEATURES
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I t t t F t
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Short term interest rate futures
Standardised exchange traded forward contracts on money marketinstruments such as treasury bill
Cash settlement and not physical settlement
Future price quoted as discount
Future price = 100 Interest rate
Forward interest rate of 5.50% equals a future price of 94.50 = 100-5.50
Purchase the futures contract on day 1 at a market price of 95.00, andat maturity the final settlement price is 96.00, then the settlementamount =
o Notional * (SP-PP/100)*days/basis
o 10000000 *(96.00-95.00)/100*90/360) = Rs. 25000
If the underlying interest rate decreases, the price will increase and viceversa
Interest rate Futures
I t t t F t
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Bond futures
Exchange traded interest rate derivative contract to buyor sell a notional security or any other interest bearinginstrument or an index of such instruments or interest
rate at a specified future date at a price determined atthe time of contract
Each future will have a standard contract specifications
Normally they are contracts on Government securities
Expecting interest rate to rise, sell the future and viceversa
Interest rate Futures
I t t t F t (IRF) i
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Introduction of IRS/FRA in 1999 IRF introduced in June 2003
Cash settled Futures on 10 year notional GOI security with coupon of 6%
Cash settled Futures on 10 year notional zero coupon GOI security
Cash settled Futures on 91 day treasury bill
Valuation based on ZCYC Banks allowed to use IRF only for hedging
PDs for hedging and trading
Interest rate futures directions dated August 28, 2009
Notional coupon bearing GOI security with physical settlement was relaunchedon August 31, 2009
April RBI Annual policy announced the proposal to introduce interestrate future on 2-year and 5-year notional coupon bearing securitiesand 91-day treasury bills
Interest rate Futures (IRF) in
India Genesis
I t t t F t
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Participants
Banks and primary dealers
Mutual fund and insurance companies
Corporate houses and financial institutions FIIs
Member broker and retail investors
Members in exchange
Net worth of Rs. 1 crore for trading members
Net worth of Rs.10 crore for clearing members
Interest rate Futures
I t t t F t
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August 28, 2009 directions Residents may purchase or sell IRF for hedging interest rate risk or otherwise
FII may purchase or sell IRF up to their individual limit of investment in Gsec
Banks to get permission from respective regulatory departments
Banks not allowed to undertake transactions in IRF on behalf of clients
September 1, 2009 Stand alone PDs allowed to deal in IRF both for hedging and trading on own account and
not on behalf of clients
September 18, 2009
NBFCs can participate as clients only for hedging their underlying exposures
October 28, 2009
UCBs can participate only for hedging their underlying exposures and not on behalf ofclients
Interest rate Futures
Contract specifications
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Contract size Rs 2,00,000
Contract base 10-year, 7 per cent notional GoI security with semi-annual compounding
Delivery grades GoI securities maturing at least 8 years but not more than 10.5 years from the first day of thedelivery months with minimum total outstanding stock of at least Rs 10,000 crores. Invoice priceequals the future settlement price times a conversion factor plus accrued interest. The conversionfactor is the price of delivered security (Rs 1 par value) to yield 7 per cent
Tick size Minimum price fluctuations shall be in multiples of Rs 0.0025
Settlement Daily settlement mark to market daily - volume weighted average price of the last half an hourperiod specified by the exchange
Final settlement Physical on delivery day on delivery month ., last working day of the month
Contract month Maximum maturity : 12 months March, June, September and December, to start with NSEintroduced two quarterly contracts
Margins As stipulated by the exchange
Last trading day Two business day preceding the last business day of delivery month
Last delivery day Last business day of the delivery month
Delivery method Physical delivery of deliverable grade securities from the first business day of delivery month tolast business day of the delivery month with owner of short deciding the date of delivery. CSGLaccounts of CDSL and NSDL
Trading hours 9:00 hrs to 17:00 hrs on weekdays
p
Trends in interest rate futures at
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Trends in interest rate futures at NSE
Month/year No. of contracts traded Trading value (Rs. In crore)
Aug-09 14559 267
Sep-09 79648 1473
Oct-09 21198 394
Nov-09 18134 337
Dec-09 11687 215Jan-10 6443 119
Feb-10 3124 57
Mar-10 6101 111
Apr-10 407 7
May-10 1177 22
Jun-10 917 17
Jul-10 205 4
Aug-10 26 0.49
NSE
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Interest rate Futures (IRF) in India
Key points
Interest rate Futures (IRF) in India
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Conversion factorIn order to allow a wide range of bonds to be delivered, the exchange applies adelivery mechanism which approximately equalizes the cost of a wider set ofbonds which can be delivered which is called conversion factor
Cost of delivering the bond decided on the basis of conversion factor
To put all the deliverable bonds (which have a wide variety of couponsand maturity) on roughly equal footing making the cost of delivery similar
Choice as to which contract to deliver will be made by the short and theprice received by him will depend on the bond that he chooses to deliver
The conversion is the value of the bond per Rs.100 face value ascalculated on the first day of the delivery month using an annual YTM of7% with semi-annual compounding.
Conversion factor makes the seller indifferent between what bonds tochoose in the environment where the yield curve is flat at a specified yield
The bond where difference between Quoted price of the bond (Futuresprice * Conversion factor) is most beneficial to the seller
Interest rate Futures (IRF) in India
Key points
Interest rate Futures (IRF) in India
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( )Key points Conversion factor NSE
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Interest rate Futures (IRF) in
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IRF did not take off - Probable Reasons ?Markets discomfort with ZCYC pricing
Derived pricing of ZCYC
Banks not allowed to trade which was asymmetrical with whatthey were permitted to do in IRS
Jan 2004: A new product based on YTMCash settled IRF on a 10-year coupon bearing notional bond,
priced on a basket of liquid securities
Not introduced on stock exchanges
TAC appoints a committee to recommend measures to activate
IRF chairmanShri V K Sharma report submitted onFebruary 22, 2008
Joint RBI-SEBI technical Committee formed currency futures andinterest rate futures
Interest rate Futures (IRF) in
India Recap
Interest rate Futures (IRF) in India
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Money market futures cash settledBond futures physically settled
Why Cash futures arbitrage would takeplace if physically settled which wouldguarantee that futures prices would be alignedwith underlying prices
Product specifications to be decided byexchanges
Short-selling to be permitted and co-terminuswith futures contract introduction to ensurecash-futures arbitrage
Interest rate Futures (IRF) in India
Recommendations of committee
Interest rate Futures (IRF) in India
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Cash settlement Avoids of short squeeze
Cornering of bonds in cash market by those with long futures position creatingartificial shortage
Avoids problems relating to settlement and clearing
Possibility of actual price not exactly in alignment with the traded price of thebond because of manipulation of prices
Physical settlement
Deliverable basket of bonds rather than single security
Motivation liquidity concerns if there was only one deliverable bond and itlost liquidity the future contracts would also lose its liquidity
Repo squeeze if there was only one bond, buying the futures and thedeliverable bond in large size will be profitable and cause a squeeze in therepo market for the issue
Interest rate Futures (IRF) in India
Key points
RUPEE INTEREST RATE
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Exchange of stream of cash flows Converting Fixed payments to Floating rate
payments or vice versa
Introduced in 1999
Overnight Indexed swap MIBOR
INBMK
MIFOR
RUPEE INTEREST RATE
SWAPS
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Tailored bilateral agreement Exchange of Interest Flows on a notional
Principal
A receives (pays) Floating
B pays (receives) Fixed
At periodic intervals over a pre-determined lifeof the swap
Swap is a combination of FRAs
INTEREST RATE SWAPS
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MOTIVATION
DIFFERENCES IN CREDIT QUALITY
LESS CREDIT WORTHY ENTIRY A WAY OFBORROWING FIXED RATE FUNDS FOR ALONGER TERM AT A CHEAPER RATE THANTHEY COULD RAISE SUCH FUNDS IN CAPITAL
MARKETS
INTEREST RATE SWAPS
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INTEREST RATE SWAPS
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Currently swaps are the only hedgingtools available since futures have nottaken off.. ( more about that later)
Benchmarks usedOvernight MIBOR ( Mumbai Inter
Bank Offer Rate)MIFOR ( Mumbai Inter Bank Forward
Offer Rate) INBMK ( Indian Benchmark Reuters)
INTEREST RATE SWAPS
BENCHMARKS
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OIS (OVERNIGHT INDEXED
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Floating rate is NSE overnight MIBOR ( reset everymorning) remains fixed for the day
Compounded on a daily basis
Fixed rate is on simple interest basis
Available upto 10 year tenors
Cash flows are exchanged..
Quarterly basis up to 1 year tenor
Half-yearly basis for beyond 1 year
O S (O G
SWAPS)
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Over the Counter instruments Designed to transfer or assume credit risk
Bilateral contracts
Examples of Credit Derivatives
Single name Credit default swaps
Credit Linked Notes
Collateralized Debit Obligations
CDS indices
Total Return Swaps
CREDIT DERIVATIVES
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ROLE OF CREDIT
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Hedge or mitigate credit exposure Transfer credit risk
Generate leverage or yield enhancement
Decompose and separate credit risk embedded in
securities Proactively manage portfolio credit risk
Manage regulatory capital ratios
DERIVATIVES
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Credit derivatives - Market
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Pension funds Insurers
Mutual Funds
CorporatesHedge funds
Banks
participants
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OTC contract between buyer and seller of protection against risk of default ona set of debt obligations issued by reference entity
Insurance that protects the buyer against loss of principal on a bond or loan
Protection pays a periodic premium expressed as a basis points over notionalamount which is called CDS Spreads and payable quarterly
If pre-specified credit events occur, premium payment stops and seller paysbuyer par value of bond
If no event occurs, buyer continues to pay premium until maturity
Credit event can be anything ranging from bankruptcy or default of a bond ordebt issued by reference entity.
On occurrence of credit event, contract is settled and terminated withprotection buyer having a right to deliver any deliverable debt obligation of thereference entity to the protection seller in exchange for par
Can also be cash settled in which case protection seller pays an amount parless the market value of deliverable debt obligation
Credit default swaps
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Credit Default Swaps Chart of cashflows
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flows
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Risk profile similar to bonds but with following differences No initial funding which allows leverage
CDS can be transacted even if a cash bond of reference entityof particular maturity does not exist
By selling protection, the seller can synthetically create a short
position in the reference credit Notional usually of USD 10 to 20 million
Maturity ranges from 1 to 10 years with 5 years being the mostcommon
Risks
Default risk of reference entity
Credit spread risk (market risk)
Counterparty risk
p
characteristics
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Investor
LoanBorrower
Bank
Premium payments
Loss recovery
Credit
($10 mln)
High-risk entity for default
No default: Zero
Credit Default Swaps Mechanism
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Financial contract to exchange returns on a bond,index or reference entity including cash flows andcapital appreciation or depreciation from one party toanother for LIBOR Plus spread
Reference asset and reference rate are defined whenthe contract initiates
Used to hedge the risk of an asset but it still keeps itin books
Party that agrees to pay floating rate payments andreceive total return is total return receiver
Party that agrees to receive floating rate paymentsand pay total return is total return payer
Total Return Swaps
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Status of Credit Derivatives
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RBI by Working group on credit derivatives inMarch 2003
Draft guidelines on CDS May 2007
Was put on hold in view of adverse marketconditions following global financial crisis
Working group report on Introduction ofCredit Default Swaps for Corporate bonds
placed in website for comments in August2010
in India
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India has 21 commodity exchanges and/or associations including 3national exchanges viz., Multi-commodity exchange (MCX), Nationalcommodity and Derivative Exchange (NCDEX) and National Multi-Commodity exchange (NMCE)
Forward Markets Commission headquartered in Mumbai is theregulatory authority and overseen by Ministry of Consumer Affairs, Food
and Public Distribution Organized Commodities trading began in India in 1875
Futures trading in commodities gained momentum between 1900 and1920
Option trading in cotton barred in 1939
Ban on forward trading in oil seeds and some essential commodities in1943
Forward Contracts Regulation Act was passed in 1952 to regulatecommodity futures trading
Commodity Derivatives
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Commodity Derivatives
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Products - Futures
Bullion ( Gold, Platinum, Silver)
Metals (Aluminium, Copper, Lead, Nickel, Tin, Zinc, Mid Steel)
Energy (Crude oil, Heating Oil, Gasoline, Natural Gas)
Oil and oil seeds (Crude palm oil, Kapasia, Refined Soya oil, Soya bean)
Cereals (Barely, Wheat, Maize)
Fibre ( Kapas)
Plantation (Rubber)
Pulses (Chana)
Spices ( Cardamon, Coriander, Turmeric)
Others ( Almond, Gaur, Mentha Oil, Potato, Red Chilli, Pepper, Jeera)
Most actively traded
Crude oil, Silver, Mentha Oil, Copper, Natural Gas, Gold, Nickel
Electricity exchanges
Indian Energy Exchange
Power Exchange India Ltd
National Power Exchange
Exchange Traded Carbon Instruments launched in 2008
Ban on Electricity futures with effect from August 23, 2010
Products
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Commodity Derivatives
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MCX has the following indices both based on spot and futuresprices
No index trading as of now approved
Composite commodity index based on commodity futures price
MCXCOMDEX Weighted average of the three group indices from
2005 MCXAGRI (20%)
MCXMETAL (40%)
MCXENERGY(40%)
Indices
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Derivative Products Index Futures
Index Options
Stock Futures
Stock Options
Maximum three month cycle
Expiry last Thursday of every month
Permitted lot size informed by exchange
Equity Derivatives
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Equity Derivatives - NSE NSE CASH Traded 1360 securities
Listed 1388 (June 2010) S & P Nifty
CNX Nifty Junior
CNX 100
S & P CNX Defty
S & P CNX 500
CNX MIDCAP NIFTY MIDCAP 50
Major Sectoral indices
Bank, IT, FMCG, PSE, MNC,Energy, Pharma, Infrastructure,PSU Bank, Realty
NSE derivatives
S & P CNX Nifty Futures & Options
Market lot 50
No. of scrips - 50
Mini Nifty Futures & Options
Market lot 20
No. of scrips 50
CNX IT Futures & options
Market lot 50
No. of scrips 20
Nifty Mid Cap 50 Futures & Options
Market lot 75
No. of scrips 50
Bank NIFTY Futures & Options
Market lot 25
No. of scrips 12
Stock Futures & Options in 202 securities
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Equity Derivatives - BSE BSE-CASH
Traded 3133 securities Listed8214 (June 2010)
SENSEX 30 SCRIPS
MIDCAP 273 SCRIPS
SMALLCAP 531 SCRIPS
BSE 100, 200, 500
BSE DOLLEX
BSE-IPO 44 scrips
Major SECTORAL INDICES
CG, IT, METAL,TECk, OIL & GAS,PSU, POWER, FMCG,BANKEX,REALTY, AUTO,HC , CD
Stock futures and options on 106securities
Derivative Products same as BSE
BSE 30 SENSEX Futures & Options
Market lot 15
No. of scrips - 30
BSE 30 SENSEX Mini futures &Options
Market lot 5
No. of scrips - 30 BSE TECH Futures & Options
Market lot 70
No. of scrips - 30
BSE BANKEX Futures & Options
Market lot 20
No. of scrips - 14 BSE OIL and GAS Futures & Options
Market lot 20
No. of scrips - 10
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