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Analytics 3

Customer wants 3 month forward contract---- i.e. customer is Importer. Bank buys 3 month fwd from market Bank sells 3 month fwd contract to customer. Customer wants to cancel the contract one month before the due date ( on which the forward has to be executed) Original contract Sale: 36.25 (Dr) Cancellation Gain Gain is Rs 20000 : 36.45 (Cr) : 0.20

Fixed 10 13 300 basis points Floating L+1 L+2 100 basis points Preference Floating Fixed

A B L --- LIBOR IRS: Interest Rate Swap

We have to structure a product which will satisfy both A and B. Quality Spread Differential 300-100=200 basis points This is divided in the ratio 1:1:2 A------50 B------50 Swap Bank----100 Total------------200



Swap Bank



If a party wants floating rate, we ask him to go for fixed and whatever u pay to the market, give to us. A: Pays: L+100+10 Receives: 10.50 Effective: L+50 B: Pays L+200+11.50 Receives L+100 Effective: 12.50% Swap Bank: retains 100 basis

Steps in structuring IRS 1. 2. 3. 4. 5. 6. Find Quality spread differential Distribute the QSD between the 3 parties in an agreed manner Change the preference (Floating to fixed and vice versa) Work out net for A using payables and receivables and satisfy A Work out net for B using payables and receivables and satisfy B Ensure the basis points for Swap bank

In the above problem what if the ratio is 2:1:1 A: Pays-------Receives--B: Pays ------Receives-Swap Bank:

Sometimes changing from fixed to floating may not be possible. U can get quality spread differential when there is a change from one floating rate to another. IRS is between fixed to floating and vice versa for the same currency This is worked on notional principal basis The purpose is cost reduction over a period of time Cost reduction reduces operational exposure over a period of time. This is financial (operations) strategy. All derivatives have to get approval of management. From Basel III they have to come into the balance sheet, they have to come under contingent liabilities. Reporting may be in IFRS format. (Currently they are off balance sheet items)

Importer since he has payables. 10/07 booking date 57.85

Cost of booking forward contract is 34131500 Cash Flow Method 1 =34131500 Buy 6 Futures @ 57.89 Sell @ 48.09


Sell in spot@ 57.95 0.60 per dollar gain on 10000 (600000-590000)

Cash Flow method 2 = 3414500

590000* 57.95 = 34190500 = Cash Flow method 3

10/09 due date

Expected Spot rate = 43.75 43.75 *200000= 8750000 If he buys a call at 53.60 he will not exercise his right. The call option is out of money. Then he goes to market and the cost will be 44.15. The Rs cost will be 8830000 If 3 month forward is taken 53.60 * 200000 = 10720000

If he sells a put @ 53.50, the buyer of the put option will exercise his right. The cost is going to be 53.00. Rs cost will be

If he buys a put @ 53.50, the premium paid is 0.50. He will exercise the right. Buy from market @43.50