derivative products- 241007
TRANSCRIPT
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DERIVATIVE PRODUCTS
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FLOW O
FPRESENTATION
� INTRODUCTION
G L OBAL F OREX MARKETS
� DERIVATIVE PRODUCTS
� REGU L ATORY INSTRUCTIONS
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INTRODUCTION� MARKETS:
� Extreme Volatility� Expanding F ast� Basket of Products Available� Interconnectivity of Global Markets
� CUSTOMER� Higher Expectations� Ample Information Availability� Marketing by Rival Banks� Education, Advice & Access
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INTRODUCTION� OUR BANK
Out of Sync With Customer Needs
L ack of Coordination Between the Various Armsof the Bank
L ack of Proactive Coordinated Marketing Effort� Need for sanction of F orward/Derivative L imits
on a Proactive basisL ack of Product Information & Knowledge of product usage
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GL OBAL AVERAGE DAI L YF OREX TURNOVER
Instrument 2001 2004 2007
Spot 386 621 1005
F x. Swaps 656 944 1714
Others 158 315 491
Total 1200 1880 3210
$ in Bn
Geographical distribution (2007)
UK ± 34.1%(1359), US ± 16.6% (664), India ± 1.1% (34)
Source : BIS
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GL OBAL AVERAGE DAI L Y
DERIVATIVE TURNOVER
Instrument 2001 2004 2007
F orex 67 140 291
Interest rate 489 1025 1686
Gaps 19 55 113
Total 575 1220 2090
$ in Bn
Geographical distribution (2007)
UK ± 42.5%(1081), US ± 23.8% (607), India ± 0.3% (8)
Source : BIS
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FOREX TURNOVER
Trading Hours� 24 hour market� Sunday 5pm EST through F riday 4pm EST.� Trading begins in New Zealand, followed by Australia, Asia, the Middle
East, Europe, and AmericaSize
L argest financial market in the world� $3.2 trillion average daily turnover, equivalent to:
� More than 10 times the average daily turnover of global equity markets
� 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
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F OREX TURNOVER
Structure� Decentralised, over-the-counter market, also known as the
'interbank' market� Main participants: Central Banks, commercial and investment banks,
hedge funds, corporations & private speculators� The free-floating currency system began in the early 1970's and wasofficially ratified in 1978
� Online trading began in the mid to late 1990'sMajor Markets� The US & UK markets account for just over 50% of turnover � Major markets: L ondon, New York, Tokyo� Trading activity is heaviest when major markets overlap5� Nearly two-thirds of NY activity occurs in the morning hours while
European markets are open
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F OREX TURNOVER
Currencies
� The US dollar is involved in over 80% of all foreign exchangetransactions, equivalent to over US$2.7 trillion per day
Currency Pairs� Majors: EUR/USD, USD/JPY, GBP/USD, USD/CH F � Dollar bloc: USD/CAD, AUD/USD, NZD/USD� Major crosses: EUR/JPY, EUR/GBP, EUR/CH F
Average Turnover by Currency Pair � EUR / USD 27%, USD/JPY 13%, GBP/USD 12%, AUD/USD 6%
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ATTRACTIONS
� The main enticements of currency dealing to private investors and attractions for short-term F orex trading are:
� 24-hour trading, 5 days a week with nonstop access to global F orex dealers.� An enormous liquid market making it easy to trade most currencies.� Volatile markets offering profit opportunities.� Standard instruments for controlling risk exposure.� The ability to profit in rising or falling markets.
L everaged trading with low margin requirements.� Many options for zero commission trading.
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DERIVATIVE EXPOSURE
BANKS CURRENCYDERIVATIVES
INTEREST RATEDERIVATIVES
2006 2007 2006 2007
STANDARDCHARTERED BANK
47,021 114,504 215,374 457,204
CITI BANK 46,314 286,697 149,640 359,320
HSBC 126,691 212,219 179,024 349,636
ABN AMRO 10,636 16,576 142,451 249,303
DEUSTCHE BANK 16,163 46,473 207,187 387,320
SBI 9,672 49,939 97,968 186,611
ICICI BANK 42,858 73,237 221,576 293,981
SOURCE : BSRB
Rs In Crores
total to 07-08.xls
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INDIAN RUPEE
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EURO
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YEN
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CH F
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G BP
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USD 6 MTH LIBOR
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MOVEMENT OF
EXCHANGE RATES� ECONOMIC F UNDAMENTALS Calendar.xls
� TECHNICA L ANAL YSIS
The method of predicting future currency price movements basedon observation of historical currency price movements.
� DEMAND AND SUPP L Y
� NEWS
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SUB PRIME LENDIN G
Subprime lending , also called "B-Paper", "near-prime" or "second chance" lending,is a general term that refers to the practice of making loans to borrowers who do notqualify for market interest rates because of problems with their credit history.
� Generally, subprime mortgages are for borrowers with credit scores of under 620.Subprime loans have higher rates than equivalent prime loans. How much higher depends on factors such as credit score, size of down payment, delinquencies historyof the borrower in the recent past etc. A subprime loan is also more likely to have aprepayment penalty.
� Subprime lending encompasses a variety of credit instruments, including subprimemortgages, subprime car loans, and subprime credit cards, among others.
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Through securitization, mortgage risks are passed through from subprime lenders to banks andultimately to investors
SUB PRIME MONEY TRIA L
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TREASURY PRODUCTSEXCHAN G E RATE
F ORWARD CONTRACTS� USD / INR F orward Contracts� Cross Currency F orward Contracts� Third Currency F orward Contracts
� OPTIONSPlain Vanilla Ratio SpreadRange F orwards Bull spreadSea Gull Bear SpreadStraddle Strangle
� SWAPSPrincipal only SwapCurrency and Interest rate Swap
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TREASURY PRODUCTS
INTEREST RATE
F ORWARD RATE AGREEMENT
� SWAPS� Interest Rate Swaps ( F C)
� Interest Rate Swaps (INR ) ± Overnight Indexed Swaps
± INBMK Swaps
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What are Derivatives?
F inancial instruments whose value is derivedfrom some other asset. Typically rates are basedon movement in the value of that asset.
Examples of DerivativesF utures & F orwards
� Swaps� Options
� Underlying Assets� Equity Shares� Interest rates
F oreign Exchange� Commodities
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NO VIEW TAKEN
� A simple sell or buy of currency on the date of maturity of theexposure .
� Advantage ± simple , transparent and liquid.
� Disadvantage
If not view based, then open to risks due tovolatility
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F ORWARD CONTRACT
F orward Contract is a contract to buy or sell a specified amountof currency at a specified price for a specific future date.
� Advantage ± Simple , liquid , less transparent and requiresno outlay of funds upfront.
� Disadvantage
� No participation in market volatility
� Profit and loss only crystallised on due date� Opportunity profit / opportunity loss unlimited
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Option Basics
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Options
An option is a financial contract in which the
buyer of the option has the right, but not the
obligation, to buy or sell an asset, at a pre-
specified price, on or upto a specified date.
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OPTIONS
C O N F I D E N C E
H I G H L O W
U S D
F I R M I N G
F O R W A R D
R A T E T O B E
L O C K E D I N
B U Y A N U S D
C A L L
O P T I O N
V
I
E
W
U S D F A L L I N G K E E P T H E
E X P O S U R E
O P E N
B U Y A N U S D
C A L L
O P T I O N
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OPTIONS
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Call Option
� An option but not an obligation to buy theunderlying at a pre-specified rate on / beforea pre-specified future date
� Buyer of the option pays a premium for thesame
� Seller / writer of the option receives thepremium from the buyer of the option
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Put Option
� An option but not an obligation to sell theunderlying at a pre-specified rate on / beforea pre-specified future date
� Buyer of the option pays a premium for thesame
� Seller / writer of the option receives thepremium from the buyer of the option
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European Option
� European Type ± which expire only on a particular pre-specified date
� E.g. An importer wants to hedge rising USD risk atthe current exchange rate of Rs 41.20 / USD. Hebuys a USD call option, where he has the right butnot the obligation to buy USD at Rs 41.20 / USD onlyat the end of 6 months
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Strike Price
� Strike price is the price at which the optionhas been struck, I.e. the price at which theoption buyer has the option to buy / sell theunderlying for the call / put option it hasbought
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Strike Price
� The premium of the option depends upon thestrike price
� Higher the strike price lower the premium inthe case of a call option and higher thepremium in case of a put option
� The strike price decides the ³moneyness´ of the option
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At The Money Strike
� The strike price of the option is at the sameprice at the spot price
� In the case of currency options it is the sameas spot + forward premia for the maturity
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In The Money Strike� In the money options - the strike price of the
option is below the the spot price, i.e. theoption is already in a profitable position
� In the case of currency options it is more thanas spot + forward premia for the maturity
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Out Of The Money Strike� Out of the money options - the strike price of
the option is above the spot price, I.e. theoption is not profitable now, but if the pricemoves up, it would become in the money
� In the case of currency options it is more thanas spot + forward premia for the maturity
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Volatility
� The volatility is a measure of uncertainty.
� The higher the uncertainty the higher theprice of the option
� Simply speaking, it is ³how many sleeplessnights will the traders spend, having taken aposition´
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OPTIONS
F ACTORS A FF ECTING PREMIUM
� Type of Option (Call, Put)� Market Price
� Strike Price
� Time to expiry
� Volatility
� Interest rates in two currencies
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Option Pricing ± BS Model
T
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f r
S d N rT X p
d N rT X d N T
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Option Strategies
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Building BlocksBuy Call Option
� Unlimited profitL oss limited to premium
� Breakeven: When spot above strike issame as premium
Call Strike
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Building BlocksBuy Put Option
� Unlimited profitL oss limited to premium
� Breakeven: When spot below strike issame as premium
Pu t Strike
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Bull SpreadBuy a call at A, sell a call at higher strike B
� Profit limited to difference between two strikes
L oss limited to initial premium
� Breakeven: When spot above strike A issame as premium
A
B
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Bear Spread� Sell a put at A, buy a put at higher strike B
� Profit limited to difference between strikes
L oss limited to net premium at B
� Breakeven: When spot below strike B is sameas premium
A
B
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Exporter Range F orward
� Buy a put at A, sell a call at higher strike B
� Profit ± Unlimited in a falling market
L oss ± Unlimited in a rising market
A
B
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Importer Range F orward
� Sell a put at A, buy a call at higher strike B
� Profit ± Unlimited in a rising marketL oss ± Unlimited in a falling market
A
B
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Seagull Spread
� Buy call at B, sell call at C, sell put at A
� Profit ± L imited, greatest at or above C
L oss ±Unlimited in a falling market
A
C
B
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Straddle� Buy a put at A, buy a call at same strike
� Profit ± Unlimited in a rising/falling market
L oss ± L imited to premium, greatest at A
A
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Strangle� Buy a put at A, buy a call at strike B
� Profit ± Unlimited in a rising/falling market
L oss ± L imited to premium, greatest between A and B
A B
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Exotic Options
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Barrier Options
� Barrier options are path-dependent options,which come in many flavors and forms, but
their key characteristic is that these types of options are either initiated (in the case of Knock-in options) or exterminated (in the
case of Knock-out options) upon reaching acertain barrier level; that is, they are either knocked in or knocked out.
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Barrier Options
� They can be in the form of a call option or a putoption
� A ³Knock-In" barrier means that the underlying optionbecomes active once it crosses the barrier level
� A ³Knock-Out" barrier means that the underlying
option becomes inactive once it crosses the barrier level
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Barrier Options� There are single barrier options and double barrier
options
� A single barrier option has one barrier that may beeither greater than or less than the strike price
� A double barrier option has barriers on either side of the strike (i.e. one trigger price is greater than thestrike and the other trigger price is less than thestrike)
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Barrier Options
� Barrier options are cheaper than buying the plainvanilla option and we have a specific view about the
path that spot will take over the lifetime of thestructure.
� Intuitively, barrier options should be cheaper thantheir plain vanilla counterparts because they riskeither not being knocked in or being knocked out.
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Barrier Options
� A double knockout option is cheaper than asingle knockout option because the doubleknockout has two trigger prices either of which could knock the option out of existence.How much cheaper a barrier option is
compared to the plain vanilla option dependson the location of the trigger.
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Swaps
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SWAPS
SWAP is a contract u al agreement to exchange specified cash
flows at f u tu re dates
Contracts that can be constr u cted with m u ltiple forwardcontracts
Some key u ses of Swaps
Cost saving or Yield enhancement on existing activity.� H edging of existing risk � M echanism to access the benefits available in the markets
which are otherwise closed to them
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A
USD LIBOR 6M + 200 BPFLO AT ING R ATE OF INTE R EST
F IXED R ATE OF INTE R EST7.60 %
7.60%
INTEREST RATE SWAP
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A INTE R EST R ATE D IFF ER E NTIAL
BET WEE N US D A ND INR IN INR
P RINCI PAL O NLY SWAP
USD P RINCI PAL
EQ UIV INR P RINCI PAL
EQ UIV INR P RINCI PAL
USD P RINCI PAL
USDCH F POS.xls
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A
FLO AT ING R ATE OF INTE R EST IN US D
6M USD L IBO R
F IXED R ATE OF INTE R EST ININR 6.90%
USD P RINCI PAL 10 M io
EQ UIV INR P RINCI PAL 41.25 Crores
EQ UIV INR P RINCI PAL 41.25 Crores
USD P RINCI PAL 10 M io
CROSS CURRENCY INTEREST RATE SWAP
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RE G ULATORY INSTRUCTIONS
� RBI allows the following Derivative instruments:
Forwards
Interest Rate Swaps
Cross Currency Interest rate Swaps
Cross Currency Options
Foreign Currency/Rupee Options
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RE G ULATORY REQUIREMENTS
Necessary Board approval to u ndertake the transaction
The Derivative transaction sho u ld be u sed to cover expos u re on the
balance sheet
Size and tenor of the transaction sho u ld not be in excess of theu nderlying expos u re
The risks associated with the transaction sho u ld be u nderstood
There sho u ld be no net receipt of premi u m
The str u ctu re of the Derivative transaction sho u ld not enhance the risk profile
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Business Potential
FCNRB / ECB/FCCB customers,
To manage the exchange rate risk
To manage the interest rate risk
Cost Reduction Structures
Rupee Loan Borrowers,
To manage interest rate risk
Exporters
Importers
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TAR G ETIN G
� INTERNA L RATING - SB 3 OR BETTER
� TWO YEAR BANKING REL ATIONSHIP WITH A
SATIS F ACTORY CONDUCT O F ACCOUNT
� MINIMUM SIZE O F TRANSACTION PRE F ERRED
� SWAPS - USD 1 MIO� OPTIONS - USD 0.25 MIO
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What are o u r expectations «
Customer Database - Preparation and sharing of information with Treasury
Margin Matrix ± Complete the exercise.Credit assessment by Branches and Presumptive Credit
Limits based on potential levels of business
ISDA Documentation for all potential customers
irrespective of whether trades are in the pipeline ornot
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Treasury Marketing
Initiatives
F ormation of Regional Treasury Marketing Units to marketTreasury products
� Develop joint account plans with the Relationship Managers
� Mercury F x on line for customer F orex transactions
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RO L ES - RTMU
L iaise with the Treas u ry and the Branch.
�M aintain contact with c u stomers, by way of seminars, personalmeetings, prod u ct presentations and daily c u rrency reports etc
P rovide inp u ts for specialized treas u ry prod u cts to the c u stomers.
Work towards a s u stained increase of market share/ penetration in termsof prod u cts and vol u mes.
Contin u ou sly monitor c u stomer portfolio
Gather market intelligence on client needs, prod u cts trends andcompetition .
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Straight Through Processing ±
MercuryF
x SolutionsProvides on line rates for Customer Transactions
L imits� Margins
F acility of online chat for negotiation of ratesWould be implemented for all Treasury Products
� Would include F orex, Money, F ixed Income and Derivative ProductsData warehousing for Customer Relationship Management
� Customer wise turnover
� Profitability of account� Product bias� Customer behavior and risk tolerance� Mark to market and Potential future exposures
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THANK YOU
C.VENKAT NAGESWAR
DGM, TMG, CORP CENTRE
TREASURY, MUMBAI