Asset Liability management

Components of a Bank Balance sheet Liabilities
Capital Reserve & Surplus Deposits Borrowings Other Liabilities

Assets
Cash & Balances with RBI Bal. With Banks & Money at Call and Short Notices Investments Advances Fixed Assets 6. Other Assets

Liabilities in more details
1.Capital:

Capital represents owner’s contribution/stake in the bank.
-It serves as a cushion for depositors and creditors. -It is considered to be a long term sources for the bank. -

Liabilities in more details 2. Reserves & Surplus
Components under this head includes :
I. II. III. IV. V. Statutory Reserves Capital Reserves Investment Fluctuation Reserve Revenue and Other Reserves Balance in Profit and Loss Account

Liabilities in more details
3. Deposits This is the main source of bank’s funds. The deposits are classified as deposits payable on ‘demand’ and ‘time’. They are reflected in balance sheet as under: I. Demand Deposits II. Savings Bank Deposits III. Term Deposits

Liabilities in more details
4 . Borrowings ( Borrowings include Refinance / Borrowings from RBI , Inter bank & other institutions ) I. Borrowings in India i) Reserve Bank of India ii) Other Banks iii) Other Institutions & Agencies II. Borrowings outside India

Liabilities in more details
5 . Other Liabilities & Provisions
It is grouped as under: I. II. III. IV. V. Bills Payable Inter Office Adjustments (Net) Interest Accrued Unsecured Redeemable Bonds (Subordinated Debt for Tier-II Capital) Others(including provisions)

assets in more details
1 . Cash

RBI

& Bank Balances with

I. Cash in hand (including foreign currency notes) II. Balances with Reserve Bank of India In Current Accounts In Other Accounts

assets in more details
2. BALANCES WITH BANKS AND MONEY AT CALL & SHORT NOTICE
I. In India i) Balances with Banks a) In Current Accounts b) In Other Deposit Accounts ii) Money at Call and Short Notice a) With Banks b) With Other Institutions II. Outside India a) In Current Accounts b) In Other Deposit Accounts c) Money at Call & Short Notice

assets in more details
3 . Investments
A major asset item in the bank’s balance sheet. Reflected under 6 buckets as under: I. Investments in India in : *
i) Government Securities ii) Other approved Securities iii) Shares iv) Debentures and Bonds v) Subsidiaries and Sponsored Institutions vi) Others (UTI Shares , Commercial Papers, COD & Mutual Fund Units etc.) II. Investments outside India in ** Subsidiaries and/or Associates abroad

assets in more details 4 . Advances
The most important assets for a bank.
A. i) Bills Purchased and Discounted ii) Cash Credits, Overdrafts & Loans repayable on demand iii) Term Loans B. Particulars of Advances : i) Secured by tangible assets (including advances against Book Debts) ii) Covered by Bank/ Government Guarantees iii) Unsecured

assets in more details
5. Fixed Asset
I. Premises II. Other Fixed Assets (Including furniture and fixtures)

6. Other Assets
I. Interest accrued II. Tax paid in advance/tax deducted at source (Net of Provisions) III. Stationery and Stamps IV. Non-banking assets acquired in satisfaction of claims V. Deferred Tax Asset (Net) VI. Others

Contingnt liability
Bank’s obligations under LCs, Guarantees, Acceptances on behalf of constituents and Bills accepted by the bank are reflected under this heads.

Banks Profit & Loss Account A bank’s profit & Loss Account has the following components: I. Income: This includes Interest Income and Other Income. II. Expenses: This includes Interest Expended, Operating Expenses and Provisions & contingencies.

Components of Income
1. INTEREST EARNED 2.
I.  II.  III.
  

IV.

Interest/Discount on Advances / Bills Income on Investments Interest on balances with Reserve Bank of India and other inter-bank funds Others

Components of Income
 

2. OTHER INCOME

I. II. III. IV.

Commission, Exchange and Brokerage Profit on sale of Investments (Net) Profit/(Loss) on Revaluation of Investments Profit on sale of land, buildings and other  assets (Net) V. Profit on exchange transactions (Net) VI. Income earned by way of dividends etc. from subsidiaries and Associates abroad/in India VII. Miscellaneous Income

Components of Expenses
1. INTEREST EXPENDED 2.
I. II.
  

III.

Interest on Deposits Interest on Reserve Bank of India / Inter-Bank borrowings Others

Components of Expenses
 

2. OPERATING EXPENSES
Payments to and Provisions for employees Rent, Taxes and Lighting Printing and Stationery Advertisement and Publicity Depreciation on Bank's property Directors' Fees, Allowances and Expenses Auditors' Fees and Expenses (including Branch Auditors) Law Charges Postages, Telegrams, Telephones etc. Repairs and Maintenance Insurance Other Expenditure

I. II.  III. IV.  V. VI.  VII.  VIII.  IX.  X.  XI.  XII.

ALM Assets Liability Management It is a d y n a m ic p ro ce ss o f P la n n in g , O rg a n izin g & C o n tro llin g o f A sse ts & L ia b ilitie s - th e ir v o lu m e s , m ix e s , m a tu ritie s , y ie ld s a n d co sts in o rd e r to m a in ta in liq u id ity a n d N II.

Significance of ALM
Volatility  Product Innovations & Complexities  Regulatory Environment  Management Recognition

Purpose & Objective of ALM

An effective Asset Liability Management Technique aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ration. It is aimed to stabilize short-term profits, longterm earnings and long-term substance of the bank. The parameters for stabilizing ALM system are: 1. Net Interest Income (NII) 2. Net Interest Margin (NIM) 3. Economic Equity Ratio

   

RBI DIRECTIVES

Issued draft guidelines on 10th Sept’98. Final guidelines issued on 10th Feb’99 implementation of ALM w.e.f. 01.04.99. for



To begin with 60% of asset &liabilities will be covered; 100% from 01.04.2000. Initially Gap Analysis to be applied in the first stage of implementation. Disclosure to Balance Sheet on maturity pattern on Deposits, Borrowings, Investment & Advances w.e.f. 31.03.01


Liquidity Management

Bank’s liquidity management is the process of generating funds to meet contractual or relationship obligations at reasonable prices at all times. New loan demands, existing commitments, and deposit withdrawals are the basic contractual or relationship obligations that a bank must meet.

Adequacy of liquidity position for a bank
Analysis of following factors throw light on a bank’s adequacy of liquidity position: a.Historical Funding requirement c.Current liquidity position e.Anticipated future funding needs g.Sources of funds i. Options for reducing funding needs k.Present and anticipated asset quality m.Present and future earning capacity and h. Present and planned capital position
 

Funding Avenues To satisfy funding needs, a bank must perform one or a combination of the following: a.Dispose off liquid assets c.Increase short term borrowings e.Decrease holding of less liquid assets g.Increase liability of a term nature e. Increase Capital funds

Types of Liquidity Risk
 Liquidity

Exposure can stem from both internally and externally.  External liquidity risks can be geographic, systemic or instrument specific.  Internal liquidity risk relates largely to perceptions of an institution in its various markets: local, regional, national or international

Other categories of liquidity risk
Funding Risk  - Need to replace net outflows due to unanticipated withdrawals/nonrenewal  Time Risk  - Need to compensate for nonreceipt of expected inflows of funds  Call Risk - Crystallization of contingent liability

Statement of Structural Liquidity
All Assets & Liabilities to be reported as per their maturity profile into 8 maturity Buckets : i 1 day . i. 2 to 7 days i ii i. 8 to 14 days i . 15 to 28 days v v . 29 days and up to 3 months vi Over 3 months and up to 6 months . vi. Over 6 months and up to 1 year i vii i. Over 1 year and up to 3 years i . Over 3 years and up to 5 years x x . Over 5 years

STATEMENT OF STRUCTURAL LIQUIDITY
Places all cash inflows and outflows in the maturity ladder as per residual maturity  Maturing Liability: cash outflow  Maturing Assets : Cash Inflow  Classified in to 8 time buckets  Mismatches in the first two buckets not to exceed 20% of outflows  Shows the structure as of a particular date  Banks can fix higher tolerance level for other maturity buckets.

An Example of Structural Liquidity Statement
15-28 1-14Days Days 30 Days- 3 Mths - 6 Mths - 1Year - 3 3 Years - Over 5 3 Month 6 Mths 1Year Years 5 Years Years Total

300 200 350 400 50 50 700 650 200 150 50 50 200 150 Loans BPLR Linked 100 150 Others 50 50 Total Inflow 600 550 Gap -100 -100 Cumulative Gap -100 -200 -14.29 Gap % to Total Outflow -15.38

Capital Liab-fixed Int Liab-floating Int Others Total outflow Investments Loans-fixed Int Loans - floating

200 600 600 300 200 350 450 500 450 450 0 550 1050 1100 750 650 250 250 300 100 350 0 100 150 50 100 200 150 150 150 50 200 500 350 500 100 0 0 0 0 0 650 1000 950 800 600 100 -50 -150 50 -50 -100 -150 -300 -250 -300
18.18 -4.76 -13.64 6.67 -7.69

200 200 450 200 1050 900 100 50 100 200 1350 300 0
28.57

200 2600 3400 300 6500 2500 600 1100 2000 300 6500 0 0

ADDRESSING THE MISMATCHES

Mismatches can be positive or negative Positive Mismatch: M.A.>M.L. and Negative Mismatch M.L.>M.A. In case of +ve mismatch, excess liquidity can be deployed in money market instruments, creating new assets & investment swaps etc. For –ve mismatch,it can be financed from market borrowings (Call/Term), Bills rediscounting, Repos & deployment of foreign currency converted into rupee.

  

 

STRATEGIES…
To meet the mismatch in any maturity bucket, the bank has to look into taking deposit and invest it suitably so as to mature in time bucket with negative mismatch.  The bank can raise fresh deposits of Rs 300 crore over 5 years maturities and invest it in securities of 1-29 days of Rs 200 crores and rest matching with other out flows.

Maturity Pattern of Select Assets & Liabilities of A Bank L ia b ility / A sse ts I. a. b. c. d. D e p o sits Up to 1 year Over 1 yr to 3 yrs Over 3 yrs to 5 yrs Over 5 years R upees ( In Cr ) 15200 8000 6700 230 270 450 180 00 150 120 8800 3400 3000 400 2000 5800 1300 300 900 3300 In P e rce n ta g e 100 52.63 44.08 1.51 1.78 100 40.00 0.00 33.33 26.67 100 38.64 34.09 4.55 22.72 100 22.41 5.17 15.52 56.90

II. Borrowings a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years III. Loans & Advances a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years Iv. Investment a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years

STATEMENT OF INTEREST RATE SENSITIVITY

Generated by grouping RSA,RSL & OFF-Balance sheet items in to various (8)time buckets.

RSA:  MONEY AT CALL  ADVANCES ( BPLR LINKED )  INVESTMENT RSL  DEPOSITS EXCLUDING CD  BORROWINGS
 

MATURITY GAP METHOD (IRS)
 THREE

OPTIONS:  A) RSA>RSL= Positive Gap  B) RSL>RSA= Negative Gap  C) RSL=RSA= Zero Gap

SUCCESS OF ALM IN BANKS : PRE - CONDITIONS

1.Awareness for ALM in the Bank staff at all levels–supportive Management & dedicated Teams. 2.Method of reporting data from Branches/ other Departments. (Strong MIS). 3.Computerization-Full computerization, networking. 4.Insight into the banking operations, economic forecasting, computerization, investment, credit. 5. Linking up ALM to future Risk Management Strategies.

Interest Rate Risk Management Interest Rate risk is the exposure of a bank’s financial conditions to adverse movements of interest rates.  Though this is normal part of banking business, excessive interest rate risk can pose a significant threat to a bank’s earnings and capital base.  Changes in interest rates also affect the underlying value of the bank’s assets, liabilities and off-balancesheet item.

Interest Rate Risk
 Interest

rate risk refers to volatility in Net Interest Income (NII) or variations in Net Interest Margin(NIM).  Therefore, an effective risk management process that maintains interest rate risk within prudent levels is essential to safety and soundness of the bank.

Sources of Interest Rate Risk
 Interest

rate risk mainly arises from:

Gap Risk  Basis Risk  Net Interest Position Risk  Embedded Option Risk  Yield Curve Risk  Price Risk  Reinvestment Risk

Measurement of Interest Rate Risk

Gap Analysis- Simple maturity/repricing Schedules can be used to generate simple indicators of interest rate risk sensitivity of both earnings and economic value to changing interest rates. - If a negative gap occurs (RSA<RSL) in given time band, an increase in market interest rates could cause a decline in NII. - conversely, a positive gap (RSA>RSL) in a given time band, an decrease in market interest rates could cause a decline in NII.

Measurement of Interest Rate Risk
 Duration

Analysis: Duration is a measure of the percentage change in the economic value of a position that occur given a small change in level of interest rate.

Government securities

Structure of Bond Markets in India
 Central   State   Corporate   Securitised

Government Securities

Government Securities Bond Market Debt

Institutional Arrangements with RBI
 Banker   Banker

and Debt Manager to Central Government by Statute to 26 State Governments and Debt Manager to 28 State Governments by Voluntary Agreements

 

Central Government

Trends in Centre’s Budget Deficit
 Three

Phases

Ø1991-92 to 1996-97: Sharp Fiscal Correction Ø1997-98 to 2001-02: Deterioration Ø2002-03 onwards: Fiscal Correction 1990- 1991- 1995Resumed 2000- 2001- 2002- 2003- 2004- 2005- 200691 92 96 01 02 03 04 05
 

Gross Fiscal Deficit Revenue Deficit Gross Primary Deficit

7.85

5.56

5.07

5.64

6.18

5.92

4.47

06 07 (RE) (BE) 4.01 4.14 3.76


3.26 4.07

2.49 1.49

2.50 0.86

4.01 0.93

4.39 1.47

4.40 1.11

3.56 -0.03

2.51 -0.06

2.60 0.46

2.14 0.22

Financing Pattern of Centre’s Gross Fiscal Deficit
 Low

Share of External Borrowings  Substantial Increase in Share of Domestic Open Market Borrowings

1990- 1991- 1995- 2000- 2001- 2002- 2003- 2004- 2005- 200691 92 96 01 02 03 04 05 06 07 (RE) (BE) 7.1 14.9 0.5 6.3 4.0 -8.2 -10.9 11.8 5.1 5.6 17.9 49.5 20.7 45.5 56.4 26.8 61.8 32.9 64.4 32.7 71.8 35.2 72.1 42.0 40.7 54.0 69.2 15.4 76.5 17.9

External Finance Market Borrowing Others Borrowing

Trends in Government Debt-GDP Ratio
 Similar
 
Per cent 90 80 70 60 50 40 30 20 10 0 1980-81 1990-91 1996-97 2000-01 2004.05 2006-07 (BE)

to the Trends in Budget Deficit

Centre

States

Total

Centre’s Fiscal Responsibility Act
Enactment of FRBM Act : August 26, 2003  Came into force from July 5, 2004  Elimination of RD by 2008-09 (3.6% in 200304) and revenue surplus thereafter  Containment of GFD to 3 % of GDP by 200809 (4.5% in 2003-04)  RD and GFD placed at 2.0% and 3.7% of GDP in 2006-07 (RE)  RD and GFD budgeted to decline to 1.5% and 3.3% of GDP in 2007-08  RBI prohibited from Participation in Primary Issuances of G-Secs
  

Central G-Sec Market: Pre-Reform Period
 Features
 Administered

and Low Interest Rates  High Statutory Liquidity Ratio (SLR)  Automatic Monetisation of Budget Deficit  High Cash Reserve Ratio (CRR)
 Impact
 Preemption

of Financial Savings  No possibility of Price Discovery  Dormant Debt Market

Reforms in the Central G-Sec Market
Three Phases  First Phase (1992-95)

Creation of Enabling Environment
Elimination of Automatic Monetisation  Introduction of Auctions  SLR reduced

Second Phase (1995-2000)

Institutional Development
 DvP  Primary

Dealers  FIMMDA and PDAI

Instrument Diversification
 Floating

Rate Bonds  Capital Indexed Bonds

Reforms in the Central G-Sec Market (Cont’d)

Third Phase

Enhance Liquidity and Efficiency
 Indicative

Auction Calendar  Non-Competitive Bidding Facility  Liquidity Adjustment Facility  Repo and collateralised borrowing lending system  Negotiated Dealing System (NDS), STP and CCP  Interest Rate derivatives  Market Stabilisation Scheme  Foreign investment in local currency debt instruments  Conversion of special securities into marketable debt

Reforms in the Central G-Sec Market (Concl’d)

Reforms undertaken in the context of FRBM Act
Functional Separation of Debt and Monetary Management: Creation of FMD  Extension of PD business to Banks  Revised Scheme of Underwriting by PDs: 100% Underwriting by PDs  NDS-OM  Short-Sale  When Issued market  Considering Active Consolidation

Snapshot of the Central G-Sec Market


1992 Outstanding stock (Rs. in billion) 769 Outstanding stock as ratio of GD P (per 14.68 cent) Turnover / GD P (per cent) -Average maturity of the securities issued during the year (in Years) -Weighted average cost of the securities issued during the year (Per cent) 11.78 Minimum and maximum maturities of stock issued during the year (in Years) N.A. 1996 1375 14.2 34.21 5.7 13.77 2-10 2002 5363 27.89 157.68 14.3 9.44 5-25 2003 6739 27.29 202.88 13.8 7.34 7-30 2004
8,243 29.87 217.3 14.94 5.71 4-30

Increase in Stock and Turnover
2005
8,953 28.69 239.9 14.13 6.11 5-30

2006
9,767 27.67 212.9 16.9 7.34 5-30

Maturity and Yield
Elongation of Maturity Profile  General Reduction in Weighted Average Yield


18


Per cent / Years

16 14 12 10 8 6 4 2 0 1996-97 1998-99 1999-00 2000-01 2002-03 1995-96 1997-98 2001-02 2003-04 2004-05 2005-06

Weighted Average Yield (per cent)

Weighted Average Maturity (years)

Yield Curve
 Development

of a Smooth Yield Curve

16 14 12 10 8 6 4 2 0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 M aturity (Years) Mar-97 Mar-04 Jan-07

Per cent

Ownership Pattern of Central G-Secs
 

1% 3

More Diversification
C at 5 O n r h P t e no C nr l GS c : h r : we s ip at r f e t a - e s 19 91
R s r e ak fI da o n c o n) eev B n o n i ( w ac ut

% 0 1 0% 5 % 2% 5

C mecaB ns o m i l ak r Lf I s r ne op r to o I da i enuac C r oai n f n i # Ui Tuto I da n r s f ni t NB R AAD E po esPo i etF n S hm m ye r v n ud c e e l d C aM e Po id n F n S hm o l i s r v et ud c e e n Pi ay el r rm d a s r e Ohr t es

5% 6

0 % 0 % 2 % 0 % 0 %

C a 6 O n rs ipP tte no C n a G e s h rt : w e h a r f e tr l -S c : 20 05
1% 6 7 %

R se eB n o In ia e rv a k f d (o na c u t) w con C m e ia B n s o m rc l a k L In ra c ife su n e C rp ra no In ia# o o tio f d U it T st o In ia n ru f d NBR AA D

2% 0 5% 3

E p ye P v e t m lo e s ro id n F n Sh m ud ce e CaMe P v e t o l in s ro id n F n Sh m ud ce e P a d a rs rim ry e le Oe th rs

External Borrowings
Low Share of External Debt  External Borrowings only from Multilateral and Bilateral Sources


100.0 80.0 Per cent 60.0 40.0 20.0 0.0 1950-51 1980-81 1990-91 2000-01 2006-07 (BE) External Liabilities

Domestic Liabilities

Measures to Deal with External Account Pressures Development Bonds (IDBs) (1991): US$1.6 billion  Resurgent India Bonds (RIBs) (1998): US$4.2 billion  India Millennium Deposits (IMDs) (2000): US$5.5 billion
 India

State Governments

Trends in Budget Deficit
 Strong

Improvement since early part of this decade  Build up of Surplus Cash Balance in Recent Years: Buyback of Securities by some States

GFD

1990 1991 1995- 2000 2001 2002 2003 2004 2005 2006 91 92 96 01 02 03 04 05 06 07 (R E ) (B E ) 3.3 2.89 2.65 4.25 4.21 4.17 4.46 3.5 3.23 2.68

R evenue D eficit 0.93 0.87 0.69 2.54 2.59 2.25 2.22 1.17 0.49 0.05 G ross P rim ary D eficit 1.78 1.22 0.8 0.09 -0.15 -0.61 -0.75 -1.65 -2.03 -2.47

Financing Pattern of Fiscal Deficit Share of Central Loans has reduced  Share of Market Loans has increased since early 1990s  NSSF continues to predominate


Loan Fro m Central Gov. Market Borrowing NSSF Others 33.3 1990 - 1991 - 1995 - 2000 - 2001 - 2002 - 2003 - 2004 - 2005 - 2006 91 92 96 01 02 03 04 05 06 07 (RE) (BE) 53.1 49.6 47.1 9.4 11.4 -0.9 11.5 -15.1 2.3 4.8 12.0 17.5 18.7 14.0 18.0 27.9 38.4 30.1 15.7 21.0

32.9

34.2

36.4 40.2

37.1 33.5

51.2 21.9

16.9 33. 2

66.5 18.5

65.0 17.0

53.5 20.7

Fiscal Reforms
 Twelfth

Finance Commission

ØFiscal Restructuring Plan: Fiscal Discipline ØIncentivised Enactment of FRL through Debt Consolidation and Relief Facility (DCRF) ØFinancial Disintermediation by Centre
 Experience

ØFRL Enactment – 24 States ØRD to be nearly eliminated and GFD-GDP ratio to decline to 2.7% in 2006-07

Market Borrowings of State Governments
 Till

1998-99: Tap Issuances  States encouraged to adopt auction route:

100 % of market borrowing in 2006-07 so far as against 48.5% in 2005-06 and 2% in 2004-05 conducted through auctions

 Auction 

calendar proposed to be issued by States

State Government Securities - issues
 Negligible
 Low

Secondary Market Liquidity

level of outstanding stock  Predominance of buy-and-hold investors  Disconnect between the uniform coupon fixed in tap issues and secondary market yield  Fragmentation across issuers and securities
 Proposed

Measures

 Non-competitive

bidding  Issuance calendar  Use for Liquidity adjustment facility

Treasury Management:
Treasury management; concepts and functions; instruments in the treasury market; development of new financial products; control and supervision of Treasury management; linkage of domestic operations with foreign operations. Asset-liability management; Interest rate risk; interest rate futures; stock options; debt instruments; bond portfolio strategy; risk control and hedging instruments. Investments – Treasury bills – Money markets instruments such as CDs, CPs, IBPs; Securitization and Forfeiting; Refinance and rediscounting facilities.

Capital Management and Profit Planning  Prudential Norms- Capital Adequacy-Basel IIAsset Classification-provisioning  Profit and Profitability-Historical Perspective of the Approach of Banks to profitability-Effects of NPA on profitability-A profitability ModelShare holders value Maximization & EVAProfit Planning-Measures to improve profitability

RISK MANAGEMENT -Treasury Management

 Treasury

Products  Treasury Risk Management  Derivative Products

 

Integrated Treasury

   

 

Integrated Treasury refers to integration of money market, securities market and foreign exchange operations. -Meeting reserve requirements -Efficient merchant services -Global cash management -Optimizing profit by exploiting market opportunities in forex market, money market and securities market -Risk management -Assisting bank management in ALM

Treasury
Function Responsible for

Front office Mid-Office Back office

Dealing Risk management, accounting Confirmations, settlement and and management information reconciliation

Dealing

settlement MIS

Treasury

SLR
SLR is to be maintained in the form of the following assets:  Cash balances (excluding balances maintained for CRR)  Gold (valued at price not exceeding current market price)  Approved securities valued as per norms prescribed by RBI.

Principles
 

 

Direct Quotation: Buy Low, Sell High: The prime motive of any trader is to make profit. By purchasing the commodity at lower price and selling it at a higher price a trader earns the profit. In foreign exchange, the banker buys the foreign currency at a lesser price and sells it at a higher price. Indirect Quotation: Buy High, Sell Low: A trader for a fixed amount of investment would acquire more units of the commodity when he purchases and for the same amount he would part with lesser units of the commodity when he sells.

Spot and Forward Transactions

 ‘A’

Bank agrees to buy from ‘B’ Bank USD 100000. The actual exchange of currencies i.e. payment of rupees and receipt of US Dollars, under the contract may take place :  on the same day or  two days later or  some day later, say after a month.

Interpretation of Quotation
The market quotation for a currency consists of the spot rate and the forward margin. The outright forward rate has to be calculated by loading the forward margin into the spot rate. For example US Dollar is quoted as under in the inter-bank market on a given day as under :  Spot 1 USD = Rs.44.1000/1300  Spot/November 0200/0500  Spot/December 1500/1800

TT Buying Rate
TT Buying Rate (TT stands for Telegraphic Transfer)  This is the rate applied when the transaction does not involve any delay in realization of the foreign exchange by the bank. In other words, the nostro account of the bank would already have been credited. The rate is calculated by deducting from the inter-bank buying rate the exchange margin as determined by the Bank.

Bills Buying Rate
 This

is the rate to be applied when a foreign bill is purchased. When a bill is purchased, the proceeds will be realized by the Bank after the bill is presented to the drawee at the overseas center. In the case of a usance bill the proceeds will be realized on the due date of the bill which includes the transit period and the usance period of the bill.

Problem
You would like to import machinery from USA worth USD 100000 to be payable to the overseas supplier on 31st Oct [a] Spot Rate USD = Rs.45.8500/8600 Forward Premium September 0.2950/3000 October 0.5400/5450 November 0.7600/7650 [b] exchange margin 0.125% [c] Last two digits in multiples of nearest 25 paise  Calculate the rate to be quoted by the bank ?

Solution
This is an example Forward Sale Contract . Inter Bank Spot Selling Rate Rs. 45.8600 Add Forward Margin .5450  ------------- 46.4050 Add Exchange Margin .0580  --------------Forward Rate 46.4630 Rounded Off to multiple of 25 paise Rs.46.4625 Amount Payable to the bank Rs.46,46,250

Swap
A

swap agreement between two parties commits each counterparty to exchange an amount of funds, determined by a formula, at regular intervals, until the swap expires.  In the case of a currency swap, there is an initial exchange of currency and a reverse exchange at maturity.

Mechanics
 Firm

A needs fixed rate loan –AAA rated  Firm B needs floating rate -A rated  Firm A enjoys an absolute advantage in both credit markets. B Firm A Firm

Fixedrate finance Floatingrate finance

9%

11%

LIBOR LIBOR +0.0% +1%

Mechanics
STEP ! Firm A will Firm B will STEP 2 Firm A will Firm B will
  

borrow at Fixed rate 9% borrow at floating rate (LIBOR +1)% pay Floating rate [LIBOR] to Firm B Pay Fixed rate [9.5%] only

Gain Net interest cost LIBOR- .5% Net Interest cost 9+[ 1%+0.5%]=10.5%

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