hedging product
TRANSCRIPT
STARTERS1. WHAT ARE VARIOUS TYPES OF RATES?2. WHY DO RATES MOVE?3. WHAT IS THE IMPACT?4. WHAT ARE HEDGING PRODUCTS?5. IS FOREX BUSINESS RISKY / PROFITABLE?6. DO WE NEED THIS BUSINESS?7. HOW DO WE IDENTIFY NEED (POTENTIAL)?8. HOW DO WE ASSESS / MONITOR THE LIMITS?9. WHAT CHECKS & BALANCES ARE NEEDED?
1. WHAT ARE VARIOUS TYPES OF RATES?2. WHY DO RATES MOVE?3. WHAT IS THE IMPACT?4. WHAT ARE HEDGING PRODUCTS?5. IS FOREX BUSINESS RISKY / PROFITABLE?6. DO WE NEED THIS BUSINESS?7. HOW DO WE IDENTIFY NEED (POTENTIAL)?8. HOW DO WE ASSESS / MONITOR THE LIMITS?9. WHAT CHECKS & BALANCES ARE NEEDED?
LEARNING TOPICS
1. PRODUCTS2. RBI GUIDELINES3. BANK GUIDELINES
A. ASSESSMENT OF LIMITSB. MONITORINGC. DOCUMENTATIOND. ISSUES
1. PRODUCTS2. RBI GUIDELINES3. BANK GUIDELINES
A. ASSESSMENT OF LIMITSB. MONITORINGC. DOCUMENTATIOND. ISSUES
COMMON EXPOSURES
• EXPORTS / IMPORTS• FCNRB LOANS• PCFC/EBR• TRADE CREDITS
– BUYER’S CREDIT– SUPPLIER’S CREDIT
• EXTERNAL COMMERCIAL BORROWINGS (ECB)• FOREIGN CURRENCY CONVERTIBLE BONDS (FCCB)• ANY OTHER EXPOSURE TO INTEREST RATES /
CURRENCIES
• EXPORTS / IMPORTS• INWARD / OUTWARD REMITTANCES• FCNRB LOANS• PCFC/EBR• TRADE CREDITS
– BUYER’S CREDIT– SUPPLIER’S CREDIT
• EXTERNAL COMMERCIAL BORROWINGS (ECB)• FOREIGN CURRENCY CONVERTIBLE BONDS (FCCB)• FOREIGN CURRENCY EXCHANGEABLE BONDS
(FCEB)• ANY OTHER EXPOSURE TO INTEREST RATES /
CURRENCIES
• EXPORTS / IMPORTS• FCNRB LOANS• PCFC/EBR• TRADE CREDITS
– BUYER’S CREDIT– SUPPLIER’S CREDIT
• EXTERNAL COMMERCIAL BORROWINGS (ECB)• FOREIGN CURRENCY CONVERTIBLE BONDS (FCCB)• ANY OTHER EXPOSURE TO INTEREST RATES /
CURRENCIES
POTENTIAL IDENTIFICATION.ppt
• EXPORTS / IMPORTS• INWARD / OUTWARD REMITTANCES• FCNRB LOANS• PCFC/EBR• TRADE CREDITS
– BUYER’S CREDIT– SUPPLIER’S CREDIT
• EXTERNAL COMMERCIAL BORROWINGS (ECB)• FOREIGN CURRENCY CONVERTIBLE BONDS (FCCB)• FOREIGN CURRENCY EXCHANGEABLE BONDS
(FCEB)• ANY OTHER EXPOSURE TO INTEREST RATES /
CURRENCIES
24 hour Market
Mumbai
New YorkBahrain
Frankfurt
Zurich
London
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Tokyo
HK
Singapore
Mumbai Los Angeles
Sydney Sydney
RISK & IMPACT• TYPES:
– CURRENCY RISK OR EXCHANGE-RATE RISK– INTEREST RATE RISK
• IMPACT:– THE UNCERTAINTY OVER THE ULTIMATE
COSTS LEADS TO INEFFICIENT PRICINGESPECIALLY IN A COMPETITIVE ENVIRONMENT
• RESULT:• SUDDEN CHANGES IN CASH FLOW• PROJECT COST ESCALATION• LOSS OF BUSINESS ETC.
• TYPES:– CURRENCY RISK OR EXCHANGE-RATE RISK– INTEREST RATE RISK
• IMPACT:– THE UNCERTAINTY OVER THE ULTIMATE
COSTS LEADS TO INEFFICIENT PRICINGESPECIALLY IN A COMPETITIVE ENVIRONMENT
• RESULT:• SUDDEN CHANGES IN CASH FLOW• PROJECT COST ESCALATION• LOSS OF BUSINESS ETC.
RISK-HEDGINGo FACTS
o RETURN IS A FUNCTION OF RISK- NO RISK NO REWARD
o A “HEDGE” IS A WAY OF TRANSFORMING RISK NOTELIMINATING
o HEDGING INVARIABLY INVOLVES VIEW TAKING
o EVERYBODY DOES NOT HAVE THE SAME INFORMATION
o PROBABILITY IS GOOD THEORY BUT DOES NOT REPLACEREAL LIFE
o NOTHING COMES FREE – EXCEPT RISK
o FACTS
o RETURN IS A FUNCTION OF RISK- NO RISK NO REWARD
o A “HEDGE” IS A WAY OF TRANSFORMING RISK NOTELIMINATING
o HEDGING INVARIABLY INVOLVES VIEW TAKING
o EVERYBODY DOES NOT HAVE THE SAME INFORMATION
o PROBABILITY IS GOOD THEORY BUT DOES NOT REPLACEREAL LIFE
o NOTHING COMES FREE – EXCEPT RISK
DERIVATIVESFINANCIAL INSTRUMENTS WHOSE VALUE/ PAY OFF ISDERIVED FROM VALUE OF AN UNDERLYING ASSET.
COMMON DERIVATIVEPRODUCTSFORWARD CONTRACTS-USD/INR, CROSS, THIRD
COMMON UNDERLYINGASSETS
COMMODITIESFORWARD CONTRACTS-USD/INR, CROSS, THIRDOPTIONS-PUT, CALL & COMBINATIONSSWAPS-PRINCIPAL, INTEREST & BOTHFUTURES-CURRENCY, EQUITY
COMMODITIES
FOREIGN EXCHANGE (ASSETS& LIABILITIES AND REVENUEFLOWS)INTEREST RATES
EQUITY SHARES
Value Date - Time Scale
Time Scale
Cash Tom Spot Forward Maturities
Cash Deal is done today for delivery Today
Tom Deal is done today for delivery Tomorrow
Spot Deal is done today for delivery on 2nd Business Day
Forward Deal is done today for delivery beyond Spot Date
FORWARD CONTRACTS• A CONTRACT TO BUY OR SELL A SPECIFIED AMOUNT
OF CURRENCY AT A SPECIFIED PRICE FOR A SPECIFICFUTURE DATE.
• BOTH A RIGHT AND AN OBLIGATION TO BUY OR SELL• ADVANTAGE:
– SIMPLE , LIQUID , TRANSPARENT– REQUIRES NO OUTLAY OF FUNDS UPFRONT.
– WINDOW OPTION OF 30 DAYS
• DISADVANTAGE:– NO PARTICIPATION IN MARKET VOLATILITY– PROFIT AND LOSS ONLY CRYSTALLIZED ON DUE DATE– OPPORTUNITY PROFIT / OPPORTUNITY LOSS UNLIMITED
• A CONTRACT TO BUY OR SELL A SPECIFIED AMOUNTOF CURRENCY AT A SPECIFIED PRICE FOR A SPECIFICFUTURE DATE.
• BOTH A RIGHT AND AN OBLIGATION TO BUY OR SELL• ADVANTAGE:
– SIMPLE , LIQUID , TRANSPARENT– REQUIRES NO OUTLAY OF FUNDS UPFRONT.
– WINDOW OPTION OF 30 DAYS
• DISADVANTAGE:– NO PARTICIPATION IN MARKET VOLATILITY– PROFIT AND LOSS ONLY CRYSTALLIZED ON DUE DATE– OPPORTUNITY PROFIT / OPPORTUNITY LOSS UNLIMITED
FORWARD CONTRACTS
EXPORTER: SPOT: 50.00 + 3M FWD 0.50 Ps
RIGHT:PROTECTED RANGE
47.50 51.5050.50
RIGHT:PROTECTED RANGE
OBLIGATION:OPPORTUNITY LOSS RANGE
• Rate Calculation:– Exports/Imports Bid / Ask– Cash/Tom/Spot
• Forward Rates– Example: Spot Rate:50.50/51
FORWARD CONTRACTS
• Rate Calculation:– Exports/Imports Bid / Ask– Cash/Tom/Spot
• Forward Rates– Example: Spot Rate:50.50/51
PERIOD PREMIUM FWD. RATE
1 MONTH 0.30/0.31 50.30/50.32
2 MONTHS 0.40/0.41 50.40/50.42
3 MONTHS 0.50/0.51 50.50/50.52
FORWARD CONTRACTS• IMPORTANT OPERATIONAL GUIDELINES:
– CANCELLATIONS:• PROFIT/LOSS PASSED ON TO THE CUSTOMER (PROFIT WILL BE
PASED ON ONLY IF BOOKED UNDER DE METHOD)• CANCELLATION TO BE DONE ON OR BEFORE DUE DATE.
– ELSE PROFIT NOT GIVEN TO THE CUSTOMER BUT LOSS PASSEDON
• FOR EARLY CANCELLATIONS OPTION TO RECEIVE PROFIT ATDISCOUNTED RATE (PLR). LOSS TO BE DEBITED IMMEDIATELY.
• OVERDUE CONTRACTS MUST BE CANCELLED WITH IN 3 DAYS.AT CARD RATES.(FEDAI clarification dated 12/03/2013)
• PERIOD IS ALLOWED FOR BANK TO COMPLETE PROCESS NOTFOR CUSTOMER TO WAIT FOR RATE ADVANTAGE.
**
• IMPORTANT OPERATIONAL GUIDELINES:– CANCELLATIONS:
• PROFIT/LOSS PASSED ON TO THE CUSTOMER (PROFIT WILL BEPASED ON ONLY IF BOOKED UNDER DE METHOD)
• CANCELLATION TO BE DONE ON OR BEFORE DUE DATE.– ELSE PROFIT NOT GIVEN TO THE CUSTOMER BUT LOSS PASSED
ON• FOR EARLY CANCELLATIONS OPTION TO RECEIVE PROFIT AT
DISCOUNTED RATE (PLR). LOSS TO BE DEBITED IMMEDIATELY.• OVERDUE CONTRACTS MUST BE CANCELLED WITH IN 3 DAYS.
AT CARD RATES.(FEDAI clarification dated 12/03/2013)• PERIOD IS ALLOWED FOR BANK TO COMPLETE PROCESS NOT
FOR CUSTOMER TO WAIT FOR RATE ADVANTAGE.
**
OPTIONSA CONTRACT WHEREBY THE BUYER ACQUIRES RIGHT BUT NOT
OBLIGATION TO PURCHASE/ SELL A SPECIFIED ASSET AT A
PREDETERMINED PRICE ON A SPECIFIED DATE. ( EUROPEAN
OPTION)
• ADVANTAGE:– OPPORTUNITY PROFIT UNLIMITED– OPPORTUNITY LOSS LIMITED TO THE PREMIUM PAID
• DISADVANTAGE:– PRICING LESS TRANSPARENT THAN FORWARD.
FACTOR OF A) SPOT B) STRIKE C) MATURITY D) INT. DIFF E) VOLATILITY
– UPFRONTPREMIUM PAYMENT(RBI has allowed for staggered pa.– SPECIFIC DATE MATURITY- NOWINDOW OPTION
A CONTRACT WHEREBY THE BUYER ACQUIRES RIGHT BUT NOT
OBLIGATION TO PURCHASE/ SELL A SPECIFIED ASSET AT A
PREDETERMINED PRICE ON A SPECIFIED DATE. ( EUROPEAN
OPTION)
• ADVANTAGE:– OPPORTUNITY PROFIT UNLIMITED– OPPORTUNITY LOSS LIMITED TO THE PREMIUM PAID
• DISADVANTAGE:– PRICING LESS TRANSPARENT THAN FORWARD.
FACTOR OF A) SPOT B) STRIKE C) MATURITY D) INT. DIFF E) VOLATILITY
– UPFRONTPREMIUM PAYMENT(RBI has allowed for staggered pa.– SPECIFIC DATE MATURITY- NOWINDOW OPTION
OPTION
RIGHT:PROTECTED RANGE
EXPORTER: SPOT: 50.00 + 3M FWD 0.50 Ps
47.5051.5050.50
ATM
1.00
RIGHT:PROTECTED RANGE
NO OBLIGATION:OPPORTUNITY PROFITRANGE
OPTIONS- GLOSSARY
• CALL OPTION
• PUT OPTION
• OPTION BUYER
• OPTION SELLER
• EXPIRATION
• STRIKE RATE
• PREMIUM
• IN THE MONEY
• OUT OF MONEY
• AT THE MONEY
• AMERICAN OPTION
• EUROPEAN OPTION
• BARRIERS
• CALL OPTION
• PUT OPTION
• OPTION BUYER
• OPTION SELLER
• EXPIRATION
• STRIKE RATE
• PREMIUM
• IN THE MONEY
• OUT OF MONEY
• AT THE MONEY
• AMERICAN OPTION
• EUROPEAN OPTION
• BARRIERS
OPTIONS
CALL PUT
BUYER RIGHT BUT NOTOBLIGATION TOBUY
RIGHT BUT NOTOBLIGATION TOSELL
RIGHT BUT NOTOBLIGATION TOBUY
RIGHT BUT NOTOBLIGATION TOSELL
SELLER POTENTIALOBLIGATION TOSELL
POTENTIALOBLIGATION TOBUY
HOW TO CHOOSE?
VIEW
IMPORTERSCONFIDENCE
HIGH LOW
USDFIRMING
FORWARDRATE TO BELOCKED IN
BUY AN USDCALL
OPTION
USD FALLING KEEP THEEXPOSURE
OPEN
BUY AN USDCALL
OPTION
VIEW
IMPORTERSCONFIDENCE
HIGH LOW
USDFIRMING
FORWARDRATE TO BELOCKED IN
BUY AN USDCALL
OPTION
USD FALLING KEEP THEEXPOSURE
OPEN
BUY AN USDCALL
OPTION
HOW TO CHOOSE?
VIEW
EXPORTERSCONFIDENCE
HIGH LOW
USDFIRMING
KEEP THEEXPOSURE
OPEN
BUY USDPUT OPTION
USD FALLING FORWARDRATE TO BELOCKED IN
BUY USDPUT OPTION
VIEW
EXPORTERSCONFIDENCE
HIGH LOW
USDFIRMING
KEEP THEEXPOSURE
OPEN
BUY USDPUT OPTION
USD FALLING FORWARDRATE TO BELOCKED IN
BUY USDPUT OPTION
OPTION- VARIETIES
RANGE FORWARD
RIGHT:PROTECTEDRANGE
NO RIGHT & NOOBLIGATIONRANGE-OPEN
Sell Call
48.0050.00
52.5051.00
50.50ATM
RIGHT:PROTECTEDRANGE
OBLIGATION:OPPORTUNITYLOSS RANGE
NO RIGHT & NOOBLIGATIONRANGE-OPEN
BuyPut
OPTION-VARIETIES
+0.50
SEA GULLRIGHT:PROTECTEDRANGE
NO RIGHT & NOOBLIGATIONRANGE-OPEN
RIGHT &OBLIGATIONRANGE
4850.25
5251.0049.75
+0.50
50.50ATM
OBLIGATION:OPPORTUNITYLOSS RANGE
SWAPS• SWAP IS A CONTRACTUAL AGREEMENT TO EXCHANGE
SPECIFIED CASH FLOWS AT FUTURE DATES
• WITHOUT ALTERING THE EXPOSURE, RIGHTS AND OBLIGATIONS AREEXCHANGED
• IN CASE OF AMORTISATION WORKS AS MULTIPLE FORWARDCONTRACTS
• KEY USES:– COST SAVING OR YIELD ENHANCEMENT ON EXISTING EXPOSURE– HEDGING OF EXISTING RISK– MECHANISM TO ACCESS THE BENEFITS AVAILABLE IN THE
MARKETS WHICH ARE OTHERWISE CLOSED TO THEM– ALTERING THE NATURE OF ASSET OR LIABILITY SYNTHETICALLY
WITHOUT ANY CHANGE IN THE UNDERLYING.
• SWAP IS A CONTRACTUAL AGREEMENT TO EXCHANGESPECIFIED CASH FLOWS AT FUTURE DATES
• WITHOUT ALTERING THE EXPOSURE, RIGHTS AND OBLIGATIONS AREEXCHANGED
• IN CASE OF AMORTISATION WORKS AS MULTIPLE FORWARDCONTRACTS
• KEY USES:– COST SAVING OR YIELD ENHANCEMENT ON EXISTING EXPOSURE– HEDGING OF EXISTING RISK– MECHANISM TO ACCESS THE BENEFITS AVAILABLE IN THE
MARKETS WHICH ARE OTHERWISE CLOSED TO THEM– ALTERING THE NATURE OF ASSET OR LIABILITY SYNTHETICALLY
WITHOUT ANY CHANGE IN THE UNDERLYING.
USD Cash FlowsUSD
Liability
PRINCIPAL ONLY SWAP
Bank A Corporate
INR Cash Flows @ spot(pays premium x%)
Bank
Bank PaysFloating Interest Rate
6mL(1.60)+300
INTEREST RATE SWAP
Bank
Corp PaysFixed $ Interest Rate
5.40%
Corporate
USD Cash Flows
USD Liability(FCL)
CIRS
Pays Floating Interest Rate (L+300)
INR Cash Flows @ spot
Corp PaysRs Fixed Interest Rate
11.95%
BANK CORPORATE
USD loan converted into a INR loan synthetically
GUIDELINES1. Comprehensive Guidelines on derivatives: Modifications:RBI Circular
02 Nov 2011
2. RBI Circular: 15 Dec 2011:limit reduced to 25% for importers on pastperformance basis
3. RBI Circular 13 Jan 2014:100% Cancellation and rebooking allowed forcurrent account transactions( if contract booked under D.E.)
4. FEDAI Clarification :
• FC booked in respect of all current account transaction irrespective oftenor can be cancelled and rebooked freely.
• FC booked in case of capital account transaction where the residualmaturity of underlying is less than one year can be freely cancelled andrebooked
• RBI Circular :18 June 2013: Deferment of option premium is allowed.
• RBI: 15.01.2014 :Monitoring of Un-hedged FC exposure : Provisioning
1. Comprehensive Guidelines on derivatives: Modifications:RBI Circular02 Nov 2011
2. RBI Circular: 15 Dec 2011:limit reduced to 25% for importers on pastperformance basis
3. RBI Circular 13 Jan 2014:100% Cancellation and rebooking allowed forcurrent account transactions( if contract booked under D.E.)
4. FEDAI Clarification :
• FC booked in respect of all current account transaction irrespective oftenor can be cancelled and rebooked freely.
• FC booked in case of capital account transaction where the residualmaturity of underlying is less than one year can be freely cancelled andrebooked
• RBI Circular :18 June 2013: Deferment of option premium is allowed.
• RBI: 15.01.2014 :Monitoring of Un-hedged FC exposure : Provisioning
GENERAL GUIDELINES
CUSTOMER SHOULD HAVE:
BOARD APPROVAL
RISK POLICY & PROCEDURES
BALANCE SHEET EXPOSURES
SIZE AND TENOR
UNDERSTANDING OF RISKS
NO ENHANCEMENT OF RISK PROFILE
PROPER LIMITS IN PLACE
CUSTOMER APPROPRIATENESS
CUSTOMER SHOULD HAVE:
BOARD APPROVAL
RISK POLICY & PROCEDURES
BALANCE SHEET EXPOSURES
SIZE AND TENOR
UNDERSTANDING OF RISKS
NO ENHANCEMENT OF RISK PROFILE
PROPER LIMITS IN PLACE
CUSTOMER APPROPRIATENESSCAS & MARGIN MATRIX.ppt
PAST PERFORMANCE DOCUMENTARY EVIDENCE
BOOKING ON DECLARATION BOOKING ON PRODUCTION OFUNDERLYING(15 DAYS TIMEALLOWED FOR PRODUCTION OFUNDERLYING)
SEPARATE LIMITS FOR EXPORTS ANDIMPORTS(reduced to 25%)
CAN BE CANCELLED AND REBOOKEDWITHOUT RESTRICTIONS
CONTRACTS BOOKED >75% OF LIMITONLY ON DELIVERY BASIS ANDCANNOT BE CANCELLED
SIZE AND TENOR OF CONTRACT NOTTO EXCEED UNDERLYING.
CONDUCT
CONTRACTS BOOKED >75% OF LIMITONLY ON DELIVERY BASIS ANDCANNOT BE CANCELLED
SIZE AND TENOR OF CONTRACT NOTTO EXCEED UNDERLYING.
PERIODIC CERTIFICATIONANNUAL ; >50% LIMIT; EVIDENCEBEFORE MATURITY/CANCELLATION
PROFIT WILL BE PASSED ONCANCELLATION (ON OR BEFORE DUEDATE)
AGGREGATE BOOKED DURING THEYEAR AND OUTSTANDING AT ANYTIME NOT TO EXCEED LIMITIF CANCELLED PROFIT WILL NOT BEPASSED ON
SME-LIBERALISATION• SME’S HAVING DIRECT AND / OR INDIRECT EXPOSURES
TO FOREIGN EXCHANGE RISK ARE PERMITTED TO BOOK/ CANCEL / REBOOK FORWARD CONTRACTS WITHOUTPRODUCTION OF UNDERLYING DOCUMENTS SUBJECTTO :– THE ENTITY SHOULD QUALIFY AS SME AS DEFINED BY RBI.
(ME >5-10 & >2-5CR )(SE <5 &<2CR)– CONTRACTS CAN BE BOOKED THROUGH AD’S WITH WHOM THE
SME’S HAVE CREDIT FACILITIES.– THE TOTAL FORWARD CONTRACTS BOOKED SHOULD BE IN
ALIGNMENT WITH CREDIT FACILITIES AVAILED BY THEM.– SME’S ARE ALSO PERMITTED TO USE FOREIGN CURRENCY
RUPEE OPTIONS FOR HEDGING THEIR EXPOSURES AFTERPRODUCTION OF UNDERLYING DOCUMENTS OR UNDER PASTPERFORMANCE ROUTE.
– CAS NEEDS TO BE APPROVED **
• SME’S HAVING DIRECT AND / OR INDIRECT EXPOSURESTO FOREIGN EXCHANGE RISK ARE PERMITTED TO BOOK/ CANCEL / REBOOK FORWARD CONTRACTS WITHOUTPRODUCTION OF UNDERLYING DOCUMENTS SUBJECTTO :– THE ENTITY SHOULD QUALIFY AS SME AS DEFINED BY RBI.
(ME >5-10 & >2-5CR )(SE <5 &<2CR)– CONTRACTS CAN BE BOOKED THROUGH AD’S WITH WHOM THE
SME’S HAVE CREDIT FACILITIES.– THE TOTAL FORWARD CONTRACTS BOOKED SHOULD BE IN
ALIGNMENT WITH CREDIT FACILITIES AVAILED BY THEM.– SME’S ARE ALSO PERMITTED TO USE FOREIGN CURRENCY
RUPEE OPTIONS FOR HEDGING THEIR EXPOSURES AFTERPRODUCTION OF UNDERLYING DOCUMENTS OR UNDER PASTPERFORMANCE ROUTE.
– CAS NEEDS TO BE APPROVED **