FX Swaps Options1

7/29/2019 FX Swaps Options1

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Basix Forex & Financial Solutions Pvt.Ltd.

UNDERSTANDINGFOREX MARKETS


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Global Foreign Exchange Market

Facilitates

Cross border trade in goods & services

Financial & Investment flows

Borrowing & Lending


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The largest market in the world

More than 10 times the average daily turnover of global equitymarkets

More than 35 times the average daily turnover of the NYSE

Nearly $500 a day for every man, woman, and child on earth

An annual turnover more than 10 times world GDP

The spot market accounts for just under one-third of daily

turnover


$3.2 trillion average daily turnover, equivalent to:


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The US & UK markets account for just over 50% of turnover

Major markets: London, New York, Tokyo

Trading activity is heaviest when major markets overlap

Nearly two-thirds of NY activity occurs in the morning hours

while European markets are open

Major Markets


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Round-the-clock market

Three major time zones

Sunday 5pm EST through Friday 4pm EST. Rollover at 5pm EST Trading begins in New Zealand, followed by Australia, Asia, the

Middle East, Europe, and America

Positions get passed from one time zone to another

Major banks operate 24-hour desks

Overnight orders can be placed



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9:30p.m8:30p.m6:00p.m1:30p.m12:30p.m7:30a.m6:30a.m4:30a.m

Los Angeles

London Zurich

Mumbai9:00a.m7:30a.m

DubaiHong kong

11:30a.m

Tokyo12:30p.m

Singapore11:30a.m

Sydney1:30p.m

7:30p.m

10:30p.m3:30a.m

4:30a.mN.York9:30p.m

Chicago

Global Forex Market


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Other features

More than 90% of the turnover is speculative

Market lot $ 3 mn to $ 5 mn

US $ predominant currency of trade (86% of total trade)

Reuters, Bloomberg & EBS big facilitators

Electronic market

OTC market

Global Foreign Exchange Market...


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Players

Individuals

Commercial banks

Institutional players

Pension Funds

Insurance Cos.

Trusts and postal

savings Mutual Funds

Hedge Funds

Corporates

Central banks Brokers


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Indian Forex Market

Daily volume approximately $ 34 bn

Market lot $ 1.0 mio

9:00 a.m - 5:00 p.m market

Main centres - Mumbai, Kolkata, Delhi, Chennai

Real market only in USD/INR - other currency rates are

derived


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Indian Forex Market.

Participants

Individuals

Corporates and FIIs Banks and FIs

RBI

Brokers

Forward market active upto 1 year

Getting more integrated with money markets


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Economic

Growth prospects

Current Account balance

Investment outlook and

reforms scenario

Inflation and Interest rates

Budget deficit / surplus

Political

Factors Affecting Exchange Rates

Technical

Psychological / Sentiment /

Speculation

Random shocks (Gulf war/ U.K.

ERM entry)

Resource discoveries

Exchange rate policy/Central bankintervention


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Relative Inflation

Nominal Exchange rates of major trading partners and

competitors Budget Deficit

Current Account Deficit

Politics

Ratings Investment outlook for India

Factors affecting Rupee exchange rates


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Capital Flows

FDI/FII/NRI

GDR/ECB

Official Transactions

Reserves

Herd Mentality - Leads & Lags

Random Shocks - Unexpected Events (Pokhran/Kargil)

RBI policy

Factors affecting Rupee exchange rates


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Exchange Rate Quotations

Direct Quote

USD/INR 48.75/76

USD/JPY 91.35/38

Buy Dollar at 48.75 and Sell Dollar at 48.76

Indirect Quote

EUR/USD 1.4650/55GBP/USD 1.6651/53

Sell Dollars 1.4650 against 1 euro

Buy Dollars 1.4655 against 1 euro

Direct Quote Indirect Quote

Variable Unit Home Currency Foreign Currency


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Delivery - Value Dates

Cash/Ready - Settlement today

Tom - Settlement on the next working day

Spot - Settlement on the 2nd working day

Forward - Settlement any date beyond spot


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Interest Parity Principle

Currency with lower interest rate will be at a premium

Currency with higher interest rate will be at a discount

Forward rate is no indication of future spot rate


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Purchase and Sale Transaction

Spot Dollar / Rupee : 48.75 48.76

From Bankers point of viewPurchase - Bank acquires foreign currency and parts

with home currency at 48.75

Sale - Bank parts with foreign currency and acquires

home currency at 48.76


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Forward Contracts

Booking

Delivery

Cancellation - Automatic cancellation

Rollover

Early Delivery

h l


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Exchange Control Aspects

Existence of a genuine underlying exposure

No Doc proof required up to higher of last 3 years avg or last years

imp/exp turnover

Choice of currency & tenor left to customer Maturity of cover should not exceed maturity of transaction

No restrictions on rebooking cancelled contracts in respect of export

and cross-currency exposures.

No limit on rebooking cancelled contracts in respect of payableexposures falling due within one year. Contracts booked to cover

exposures due beyond 1 year cant be rebooked after cancellation.

Details in prescribed format to be submitted to Bank

E h C l A


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Exchange Control Aspects

Transactions involving cross currencies remain out of the purview of

this rule

The customer can be given the facility of booking a single forward

contract for several orders provided that the receivables are in the same

currency and the likely cash flow period falls within the same contract

period

Banks are allowed to permit substitution of export contracts if

circumstances so warrant Exporters are allowed to deliver exchange representing a portion of the

export value in part utilisation of the forward contract


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Financial Derivatives

A derivative is like a razor. You can use it toshave yourself. Or you can use it to commitsuicide.

- James Morgan, Financial Times

Fi i l D i i


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Derivatives are off balance sheet products that enable a

corporate to hedge risks arising out of its core business in

terms of FX, interest rates or commodities

So called because their value is derived from basic products

like the forward exchange cover and dependent on

underlying assets like bonds, stocks, and commodities

Financial Derivatives

T Fi i l D i i


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Firm Derivatives

Optional Derivatives

Types - Financial Derivatives

Fi D i ti


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Forward Rate Agreements

Interest Rate Swaps

Currency Swaps

Single Rate Forward Contract

Firm Derivatives

O ti l D i ti


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Currency Options

Caps & Floors

Collars

Options on FRAs

Swaptions

Optional Derivatives


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Forward Rate Agreement

Wh FRA ?


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What are FRAs?

It is an agreement between two parties that determines

the forward interest rate that will apply to an agreed

notional principal (loan or deposit amount) for a specifiedperiod.

The Buyer ( or the Seller) of the FRA compensates the

Seller (or the Buyer) any difference between the agreed

rate and the cash rate prevailing on the start date of the

specified period

B i t t f FRA


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Basic structure of an FRA

Deal dateFixing date

Interest taken

from cash market

Period of depo

Maturity dateSettlement date

F t f FRA


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Features of a FRA

It is an off balance sheet transaction.

Allows forward fixing of rates

Transactions can be closed at any stage before expiry. Interest difference between the FRA rate and the cash rate is

settled at the beginning of the agreed period.

Can be tailor made to meet specific requirements.

FRAs are used to eliminate interest rate risk

A borrower buys the FRA while a lender sells the FRA.


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Interest Rate Swaps

An Interest Rate Swap


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is an off-balance sheet contract

between two counter parties

to exchange a stream of payments (interest obligations)

on specified dates

based on a notional principal

An Interest Rate Swap

B i Ch t i ti IRS


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Contractual agreement

Exchange a series of cash flows

Over a period of time

Not in itself either a borrowing or lending

No exchange of principal

The size of the swap is referred to as the notionalamount and is the basis for calculation

Basic Characteristics - IRS

I t t R t S


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Interest Rate Swap

Borrower

Lender

Swap C/P

Floating

Fixed

Floating

T f IRS


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Standard Swap

One side is Fixed stream of interest while the other side is Floatingstream of interest linked to an index

Basis Swap

Both the streams of interest payments are linked to two different

indices.

Fixed rate

Floating rate

CorporateBank

Floating rate

CorporateBank

Types of IRS

I t t R t O ti


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Interest Rate Options

Interest Rate Cap

Interest rate caps protect floating rate borrowers from upward

movements in rates, as a maximum rate can be reserved by the buyer of

the option Interest Rate Floor

Interest rate floors protect floating rate lenders from downward

movements in rates, as it guarantees a minimum rate

Interest rate CollarA collar is a simultaneous purchase and sale of a cap and a floor. It can

be a zero cost option by way of selling and buying the option


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Currency Swaps


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Currency Swap transactions


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Currency Swap could be any of the following between two

currencies

Fixed to Fixed Rate

Fixed Rate to Floating Rate (and vice-versa)

Floating rate to Floating Rate (based on different

benchmarks) Basis Swap

Currency Swap transactions

Regulations


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Approvals

Internal approval (Board authorisation required) and

adequate control systems should be in place

Documentation

ISDA (International Swap and Derivatives Dealers

Association) Master Document supported by individual deal

confirmations Capital Adequacy

as per RBI guidelines

Regulations

Corporates Existing Liability


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Corporates Existing Liability

Corporate's underlying borrowing

Currency USD

Principal Amount $ 10 mn

Maturity 5 years bullet

Interest rate payable bythe Corporate

USD 6M LIBOR + X % p.a.

Interest payment dates Mar 15, Jun 15, Sept 15 and Dec 15

Appetite for ExchangeRisk

Low

Can enter into a Currency Swap or Principal only swap or

Coupon only Swap

Illustration Currency Swap


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CorporateDraw down of $10 mn

Pays $10 mn

Receives Rs 49.5 cr.

Dollar

Loan

Swap Counterparty

6m Libor + spread

Pays INR fixed (8%)

Receives USD floating

6m Libor

CorporateSwap CounterpartyExisting

$ Loan

CorporateRepays $10 mn

Receives $10 mn

Pays Rs 49.50 cr.

Swap CounterpartyDollar

Loan

Interest payment dates: Exchange interest flows @ Spot rate of the initial exchange (49.50)

On Maturity : Exchange of Principals Mandatory@ Spot rate of the initial exchange (49.50)

On Start Date : Exchange flows @ Spot rate prevailing on swap date (39.50)

Illustration - Currency Swap

Illustration Principal only Swap


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CorporateReceives $10 mn

Pays $10 mn

Receives Rs 49.50 cr.Existing

$ Loan

Swap Counterparty

CorporatePays $10 mn

Receives $10 mn

Pays Rs 49.50 cr.

Swap CounterpartyExisting

$ Loan

Interest payment dates: No Exchange of interest flows

On Maturity : Exchange of Principals Mandatory @ Spot rate of the initial exchange (49.50)

On Start Date : Exchange flows @ Spot rate prevailing on swap date (49.50)

Illustration Principal only Swap

Coupon only Swap


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Coupon payments in one currency is swapped into fixed

or floating coupon payments in another currency

To take advantage of views on interest and exchange

rates of the two currencies

Notional Principal Amount

No Exchange Risk on Principal

Coupon only Swap

Illustration Coupon only Swap


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6m LIBOR

CorporateSwap Counterparty

Lender

1yr IRS (4.24%)

Corporate has an existing loan benchmarked

to 6m LIBOR for a tenure of say 1 year

If corporate has a view Libor is set to

increase, it can enter into a swap deal where

by;

Corporate receives floating- 6m Libor

Corporate will pay fixed say the one-year IRS rate

Illustration - Coupon only Swap


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CURRENCY OPTIONS

What is an Option?


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Holder buys theright but not the obligationto

buy or sell an agreed amount of an underlying

currency / commodity at a predetermined price,

over a specified time period.

What is an Option?

Forward Contract vs Options


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Forward Contract vs Options

Forward Contracts Options

Fixes the rate irrevocably Cannot take advantage

of favorable movement

in the rate

No upfront costs

Protects the downside Can let the option lapse

& take advantage of spot

rate

Premium payable

upfront

Option Terminologies


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Call Option

Gives the holder the right but not the obligation to

BUY an underlying at a fixed price from the writer of

the option

Put Option

Gives the holder the right but not the obligation to

SELL an underlying at a fixed price to the writer of

the option

Option Terminologies

Risk / Profit Profile


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Buyer Seller

Profit Unlimited Premium

Loss Premium Unlimited

Risk / Profit Profile

Types of Option


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American Option

May be exercised at any time during the life of a contract

European Option

May be exercised only at maturity or expiry date

Types of Option

Price of an option


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Premium

It is the price of an option, paid by the buyer / holder tothe writer / seller

Usually paid upfront

Price of an option

Strike Price or Exercise Price


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The fixed price at which the option holder has the right to

buy or sell the underlying currency.

Strike Price or Exercise Price

Expiry Date


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The last day on which the option may be exercised

Expiry Date

Life or Exercise Period


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The period of time during which the option holder enjoys the

right to exercise under the option contract

Life or Exercise Period

In The Money


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The option isIn the Money when the Strike Price is favourable to

the option holder in relation to the current market rate.

Illustration:

A USD Call option has a strike of 49.15. The current forward

market is 49.60

The option is said to be In-the-Money

In The Money

Out of The Money


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The option is Out of the Money when the Strike Price is

unfavourable to the option holder in relation to the current

market rate.

Illustration:

A USD call option has a strike of 49. The current forward

market is 47.60.

The option is said to be Out of the Money

Out of The Money

At The Money


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The option isAt the Money when the Strike Price is equal

to the current market rate.

Illustration:

A USD call option has a strike of 49.60. The current

forward market is 49.60.

The option is said to be At the Money

At The Money

Factors determining Premium Value


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:Pricing

Model

Strike Price

Underlying Price

Time to Expiry

Interest Rate

Volatility

Premium

Factors determining Premium Value

OTC and Exchange Traded Options


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Over the Counter (OTC)

Options negotiated between writer and buyer, and traded

bilaterally.

Exchange Traded

Standardized options traded on a Central Exchange, where

the underlying is often a futures contract. These types of

options have standard instrument/quality, expiry date andcontract amount.

They also have standard strike price intervals

OTC and Exchange Traded Options

Options available in the market


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Plain Vanilla options

Low cost options

Zero Cost options

Range Forward options

Knock in /Knock out (Barrier) options

Average rate options

Options available in the market

Regulations


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Currency Options can be used for genuine exposures or

contingent exposures like tender bids

The amount & maturity of an option hedge cannot exceed theamount & maturity of the underlying exposure

Corporate cannot be a net receiver of premium

Option deals can be freely booked and cancelled.

Regulations

Documentation


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Copy of Board Resolution authorizing duly approved

documented policy on currency risk management and specific

personnel to enter into derivative transactions and authorizing

signing of relevant documents

ISDA Master Agreement (International Swap Dealers

Association Master Agreement)

Copy of underlying exposure

Deal confirmation

Documentation


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Any Questions?

Presenter :

Mr. K. N. Dey

Director, Basix Forex & Financial Sol. Pvt. Ltd.

Documents

FX Swaps Options1