DERIVATIVES

PROFILE OF DERIVATIVE
PRODUCTS
A. Currency Derivatives
 Forward Contracts
 Currency Options

B. Interest Rate Derivatives:

 Interest Rate Swaps

Forward Rate Agreement

C. Credit Default Swap

OBJECTIVES

 To manage balance sheet exposure to various

risks such as interest rate risk, currency risk,
arising from the banking operations.
 To offer derivative products to existing and new
corporate clients so as to help them in managing
interest and currency risk and in the process
earn non-interest income.
 To have trading book and thus to undertake
derivative transactions to earn profits.
CURRENCY OPTIONS
 Currency options are contracts that give the buyer the
right, but not the obligation, to buy or sell a foreign
currency against another foreign currency or Indian Rupee,
at a predetermined price called Strike Price and for a
delivery on or before a predetermined date
 European Option
 American option
 Call Option
 Put Option
CURRENCY FUTURES

 Currency Futures: Currency Future means a Standardized foreign exchange

derivatives contract traded on a recognized stock exchange to buy or sell
one currency against another on a specified future date, at a price specified
on the date of contract, but does not include a forward contract.

 USD-INR, EUR-INR, GBP-INR and JPY-INR contracts are allowed to be traded.  

 The size of each contract shall be USD 1000 for USD-INR contracts, Euro 1000 for
Euro-INR contracts, GBP 1000 for GBP-INR contracts and JPY 100,000 for JPY-INR
contracts.
 
 The contracts shall be quoted and settled in Indian Rupees.
 
 The maturity of the contracts shall not exceed 12 months.
 
 The settlement price for USD-INR and Euro-INR contracts shall be the Reserve
Bank’s Reference Rates and for GBP-INR and JPY-INR contracts shall be the
exchange rates published by the Reserve Bank in its press release on the last
trading day.
RISK MANAGEMENT MEASURES -I

 Initial Margin
 Extreme Loss Margin:
 Calendar Spread Margin
 Final Settlement Day
INTEREST RATE SWAPS
 Interest rate swaps are transactions in which two
counter parties agree to exchange interest
payment obligations. Interest rate swaps do not
generally require any exchange of principals.
EXAMPLE OF AN INTEREST RATE
SWAP
 Though the above is a representation of a pure interest rate
swap, to avoid the risk of default borrowers will often approach a
bank as an intermediary. Accordingly the bank will act as a swap
banker.
 Borrower MN Ltd. has a fixed liability of 6.5 per cent
 Borrower CN Ltd. has a floating liability of MIBOR + 100 bp

 They both approach Punjab & Sind Bank to act as an intermediary

to convert these cash flows from fixed to floating and vice versa
to secure their liabilities. Punjab & Sind Bank enters into the
following transactions to earn a spread of say 10 basis point.
 A swap with Borrower MN Ltd. where Punjab & Sind Bank Ltd.
pays 6.5% fixed and receives MIBOR floating + 110 basis points.
 A swap with Borrower CN Ltd. where Punjab & Sind Bank receives
6.5% fixed and pays MIBOR + 100 bps floating.
CREDIT DEFAULT SWAP
 A credit default swap (CDS) is a financial swap agreement
that the seller of the CDS will compensate the buyer in the
event of a loan default or other credit event. The buyer of
the CDS makes a series of payments (the CDS "fee" or
"spread") to the seller and, in exchange, receives a payoff
if the loan defaults.