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DERIVATIVE PRODUCTS:

Interest Rate swaps:


An interest rate swap is an agreement entered into between two counter-parties
under which each agrees to make periodic payment to the other for an agreed period of
time based upon a notional amount of principal. The principal amount is notional because
there is no need to exchange actual amounts of principal in a single currency transaction.
However a notional amount of principal is required in order to compute the actual cash
amounts that will be periodically exchanged.
Under the commonest form of interest rate swap, a series of payments calculated
by applying a fixed rate of interest to a notional principal amount is exchanged for a
stream of payments similarly calculated but using a floating rate of interest. This is a
fixed-for-floating interest rate swap. There are other types as well e.g. floating to floating,
floating to fixed, there could be a future possibility of fixed to fixed (depends on the
market at that time and structure of the deal as to how the same has been built in
considering the other factors).

Different types of IRS:

Single Currency SwapsIRS :


Rupee IRS: Where the currency involved is rupee (INR) i.e. both interest for both
floating and fixed part to be fixed (fixed rate is fixed at the time of the deal, whereas
floating rate is fixed as per the fixing dates/schedule agreed) , calculated and settled in
INR as per the terms and conditions of the deal.
USD IRS: Where the currency involved is US dollars (USD) i.e. both interest for both
floating and fixed part to be fixed, calculated and settled in USD as per the terms and
conditions of the deal. Same as above for all types of IRS (any currency, any index)
Similarly IRS can be done for other currencies also.

Cross Currency SwapsIRS:


Where there are two currencies involved in the deal i.e. if fixed part is to be settled in a
particular currency then the floating part would be fixed, calculated and settled in the
other currency.

Rupee IRS:
The fixing of the deal is done on a daily basis based on the overnight Mumbai
Inter Bank Offer Rate (MIBOR) rate. The market lot of the deals is Rs. 25 Cr. Placed
below is the various attributes:
1) Deal date: The date on which the deal is done.
2) Start date: This is the spot tom date i.e. If deal date is 29th October’ 2003 then Start
date would be 30th 1st October’ 2003.
3) Maturity date: The date on which the deal would mature or expired.
4) Settlement dates: The dates on which the interest settlement would be done i.e.
quarterly, half yearly, yearly, on maturity etc.(there could be a possibility of having
two difference settlement dates for receipt and pay side of the interest)
5) Notional Value: Principal amount of the deal.
6) Fixed and floating rate details.
7) Fixing rate Index
8) Coumpounding of interest
9) holidays

Deal Confirmation:
The deals done are send to the counter-party for their confirmation by way of a
confirmation letter. This letter contains the entire deal details on which the counter-party
gives the confirmation.
Mark to market:
The process of mark to market (finding of profit or loss for a deal) is done on a
daily basis. The difference between fixed rate and floating rate (Based on Reuters
published rates) is the mark to market profit or loss depending on the deal done. If the
floating rate for a particular date is not available then the same is calculated (using
extrapolation or interpolation) depending on when the mark to market is calculated.
The MTM also considers the accruals happened till date. Pl have a look at the MTM
sheet, there are other columns as well e.g. after discounting, PSR to be blocked etc.
For any mark to market loss, the following accounting entry is passed every month end:
Dr. MTM loss on Rupee derivatives
Cr Unrealised depreciation on Rupee derivatives

After month end, the above entries are reversed. No accounting entries are passed for
MTM profits.

Settlement:
The settlement of the deals are done on the settlement dates fixed during the deal. For
each type of currency the bank does a net settlement on the settlement date.

Accounting entries:
On deal date:
For fixed payment, contingent line – fixed rate payment account is debited and for
floating payment the contingent line – floating rate payment account is debited.
The second entry is to offset accounts
Vice-versa for the receipts.

Every month-end:
For receivables, Accrued Interest receivable account (fixed/float) is debited and Income
account (fixed/float) is credited.
For payments, Expenses account (fixed/float) is debited and Accrued Interest payable
account (fixed/float) is credited.

Settlement Entries:
Accrued Interest payable account is debited and Accrued Interest receivable account is
credited (difference adjusted to settlement account).
In case settlement is done before a month end then for those numbers of days the month
end entries are passed and then settlement entries are passed.

Final settlement entries:


Accrued Interest payable account is debited and Accrued Interest receivable account is
credited (different adjusted to settlement account). The contingent account entries are
reversed for the fixed and floating parts.

Pl cover the PSR blocking process, Interest fixing and compounding, settlement
process at Fort i.e. sending msg, settling by rbi / i/B cheque at fort etc., deal
processing in system, supporting for booking i.e. reuters confirmation/bloomberg
confirmation etc., daily/ monthly/weekly reports (including reports to RBI), stub at
the end/beginning or both etc.

Unwinding process.

Various benchmark of the rates, various types of IRS e.g. MIFOR, Quanto, MITOR,
CP linked, FRA etc.

Exception report, underlying endorsements etc.


USD IRS:

The process flow w.r.t USD IRS is the similar as that of INR IRS (as mentioned above).
The differences are as mentioned below:
The benchmark rate for floating interest rate is the LIBOR (London Inter Bank Offer
Rate). For LIBOR deals the fixing done on the deal date for the first setting whereas for
LIBOR in Arrears deals the fixing is done 2 days prior to first settlement date.
Other processes remain similar except the following variations from INR IRS:
For all currencies other than Rupee, the Accrued Interest Payable or Receivable account
is common for fixed and floating parts.
For MTM, the LIBOR rates (bid and ask) rates are taken from Teller express and based
on the same the Cubic Spline rate (arrived based on formula) is applied for the floating
part. The difference between the floating and fixed part (depending on the deal) is
calculated as MTM profit or loss.
THE MTM entries are passed only for Rupee products of derivatives and not for FX
derivatives.
For any mark to market loss, the following accounting entry is passed every month end:
Dr. MTM loss on USD derivatives
Cr Unrealised depreciation on USD derivatives

After month end, the above entries are reversed. No accounting entries are passed for
MTM profits.

Other terminology’s:
1. Stub in the beginning: Where the number of days is not equal to the tenure of
settlement. E.g. Start date is 10/09/2003 and for a 3 month LIBOR settlement, first
settlement date is fixed as 31/12/2003 then the period from 10/09/2003 to 30/09/2003
is known as Stub in the beginning.
2. Stub in the end: This is the reverse of Stub in the beginning. E.g. Maturity date is
10/01/2004 and for a 3 month LIBOR settlement the last settlement period start from
01/10/2003. In this case the period from 01/01/2004 to 10/01/2004 is known as Stub
in the end.
3. Coupon only swaps: Where only the interest part is exchanged for cross-currency
deals.
4. Void deals: These are deals which are cancelled by either of the parties. Once a deal is
void, the same is no longer valid for settlement.
5. Unwind deals: These are deals which are unwound by either of the parties. Once a
deal is unwound, whatever is settled till the time of unwind is valid but there will be
no settlement after the unwind date.
6. Pre-settlement Risks: For each deal, a pre-settlement risk amount is decided for each
counter-party. The same is calculated for each deal and send to Bank’s LSS
department for Risk Management purposes.
E.g
Deals to be settled less than or equal to 6 mths, PSR = 0.5% of Notional Value.
Deals to be settled greater than 6 but less than 1 year, PSR = 1% of Notional Value.
Deals to be settled between 1 year to 2 years, PSR = 2% of Notional Value.
Deals to be settled greater than 1 year, PSR = 3% of Notional Value.

Points mentioned for Rupee IRS to be covered here as well. Further, you have covered
only IRS deals. I shall await for the remaining types of IRS and other products.