interest rate derivative case analysis

8/12/2019 Interest Rate Derivative Case Analysis

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Interest Rate

Derivatives

February 7

2014Submitted by,

Anadi Kaistha

Nabin Basha

Naveen Kumar

Sanoop S

Sreenandan Nambiar P


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Exercise 1

ACME Manufacturin has t!o choices" either raise debt b#

$%#ear &i'ed (ate Note" Cost )*+ for ACME

$ #ear &,oatin (ate Note" Cost) -one #ear ./B(" $*+ 2 + spread3

he compan# prefers to have a &i'ed (ate .iabi,it#5 ho!ever ,oo6in at the above scenarios" the fi'edrate cost of 7ebt is *+ !hich is reater than the &,oatin rate .iabi,it# !hich at current ,eve, of .ibor is

8*+

So it !ou,d be prudent to o for &,oatin rate .iabi,it# !hich is ,o!er than fi'ed rate and subse9uent,# ta6e

7erivative contracts for e'chanin f,oatin rate ,iabi,it# into a fi'ed rate ,iabi,it#

he 7erivative contracts avai,ab,e from Nationa, rust are S!aps" &(As" Cap and &,oor

he &i'ed rate cost ca,cu,ation is as under for each 7erivative Contract

Solution:

;iven 7etai,s

1 #r ./B( -+3 $*

.oan Amount -< mn3 100

$ #r =S %bi,, rate-+3 48

7uration -#rs3 $

2 #r =S %bi,, rate -+3 41

$ #r =S %bi,, rate -+3 48&,oatin Case 1 #r ./B( 2+

Additiona, -+3 2

Acmes Initial Position:

#pe Condition Actua, (ate Net Pa#ment -< mn3 &ina, .oan Cost toACME -+3

&i'ed $ #r =S %bi,, rate 280basis

*0 21 *0

&,oatin 1 #r ./B( 2+ 8* NA NA

Comments:

/n case compan# oes for a &i'ed rate of interest pa#ment than Acme>s tota, interest cost !i,, be 7%

(amount $ 21 million)and in case of f,oatin rate of interest Acme>s tota, cost !ou,d be 5.7% for the first#ear and thereafter as per the prevai,in ./B( for the concerned period at that point in time

ational !rust o""ers:


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#""er 1 SAP

&i'ed pa# $ #r =S t rate $0 bps 4? 204

&,oatin rec 1 #r ./B( $* 111

Case%1 % S@AP

?Pa# -4?%$* 11+ of 100 mn3 ie $$ mn

/f ACME enters into a S@AP contract !ith Nationa, rust

/t !ou,d pa# a fi'ed rate of 48+0$+4?+ to the Nationa, rust

/t !ou,d receive a one #ear ./B( f,oatin rate from Nationa, rust

ACME has to pa# 2+ spread to meet the ,iabi,it# of &,oatin rate note

!otal cost to AC&E is '.%2%* +.%.

Comments:

/n case of first offer of S@AP if compan# oes for conversion of f,oatin rate to fi'ed rate than compan#>s

tota, cost of ,oan !ou,d be +.% (amount $ 2,.' million)" because in this set up Acme has to pa# 4?+as fi'ed pa#ment p,us 2+ spread he ./B( cost prevai,in in the mar6et for the respective periods!ou,d be netted off b# the receipt of ./B( pa#ment from the counterpart#

As the averae rate for $ #ears boi,s do!n to ?+" compan# miht thin6 it as an a,ternative to option offi'ed interest pa# of *+

#""er 2 -A

2 instruments re9uired" one for #ear 2 -12243 and another for #ear $ -24$3

Instrument 1:

Characteristics of the instrument:

-12'243 ie the contract !i,, e'pire in 12 months and due date is 24 months

&(A reference rate: 8+ pa -iven3

=nder,#in rate: 1 #ear ./B(

Scenario(a):Assume if 1 #ear ./B( e'ceeds from 8+ to + pa

1 #ear ./B( stands at + pa /n this case" the compan# !ou,d receive differentia, pa#off of 1+discounted at 1 #ear ./B(

Pa#off --1 #ear ./B(3%-&(A reference rate3D-Period of under,#in ./B( in months1233-1--1 #ear./B(3D3D-Period of under,#in ./B( in months1233

--00%0083D12123-1-00D121233 00110 000F4$$F

Net pa#off to be received b# the compan# 000F4$$FD100"000"000F4$"$F

Scenario(/):/n case if ./B( oes do!n" 1 #ear ./B( reduces from 8+ to 4+ pa


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Assumption is that 1 #ear ./B( stands at 4+ pa /n this case" the compan# !ou,d pa# differentia, pa#offof 1+ discounted at 1 #ear ./B(

Pa#off --004%0083D12123-1-004D121233 %001104 %000F18$?Net pa#off to be paid b# the compan# 000F18$?D100"000"000F1"8$?

Instrument 2:

Characteristics of the instrument:

-24'$3 ie the contract !i,, e'pire in 24 months and due date is $ months

&(A reference rate: + pa -iven3

=nder,#in rate: 1 #ear ./B(

Scenario(a):Considerin 1 #ear ./B( e'ceeds from + to *+ pa

Assumption is that 1 #ear ./B( stands at *+ pa /n this case" the compan# !ou,d receive differentia,pa#off of 1+ discounted at 1 #ear ./B(

Pa#off --00*%003D12123-1-00*D121233 00110* 000F$48*F

Net pa#off to be received b# the compan# 000F$48*FD100"000"000F$4"8*F

Scenario(/):/n case if ./B( oes do!n" 1 #ear ./B( reduces from + to 8+ pa

Assumption is that 1 #ear ./B( stands at 8+ pa /n this case" the compan# !ou,d pa# differentia, pa#offof 1+ discounted at 1 #ear ./B(

Pa#off --008%003D12123-1-008D121233 %001108 %000F82$?0

Net pa#off to be paid b# the compan# 000F82$?0D100"000"000F82"$?0

=sin data%tab,e function in e'ce," !e have p,otted a raph bet!een tota, pa#off -


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&or Eas# Mone# radin Compan# fo,,o!in Strateies cou,d be ,i6e,# course of action to earn arbitraefrom the iven 9uotes b# the Nationa, rust

Strate3 1

Strate# 1 SE.. S@AP &i'ed 4?+

B=H Co,,ar $ &i'ed 8+

Not iona, Principa, 10"00"000 -


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Strate# $ /nvest reasur# 2#rs (eceived fi'ed % 41 +

SE.. &(A -24'$3 &i'ed +

B=H Co,,ar 4 &i'ed +

Notiona, Principa, 10"00"000 -


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Strate# 4 /nvest reasur# $#rs (eceived fi'ed % 48 +

B=H Co,,ar 4 &i'ed +

Notiona, Principa, 10"00"000 -

interest rate derivative case analysis

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