Description
The PPT explaining on Currency Options.
Currency Options
Currency Options in OTC Markets
• • • • • • • • • Customised Options Two parties to a contract One of the parties has the right to enforce the contract The other party does not have the right to enforce the contract but has the obligation to fulfill the contract, if enforced by first party Party having the right to enforce : Buyer of option Other party : Seller or Writer of option Buyer of option pays an upfront premium to seller of option Buyer of option will not make a loss on the contract Seller of option may make a loss on the contract, if contract is enforced by buyer
Currency Options in OTC Example
• An importer has to pay after 3 months USD 10,000 • Current rate is say 1 USD = Rs. 48 • Option Contract can be entered into for say 1 USD = Rs. 48.50 • The importer can buy USD 10,000 from the other party after 3 months on the agreed date at 1 USD = Rs. 48. 50
– If the spot rate is lower than Rs. 48.50, importer will not exercise the option
• In this case, when the importer allows the option to lapse, he loses the option premium that he has paid upfront
– If the spot rate is higher than Rs. 48.50, importer will exercise the option
• In this case, the seller of the option i.e. the one who sells USD, in this case, will incur a loss
How is the Option Strike Price Determined in OTC Markets ?
• In the OTC markets, all terms and conditions of options are agreed to between the parties
– The strike price is also agreed to between the buyer and seller of the option
• (eg) the buyer of the option may specify a ‘at-themoney’ strike price
– at-the-money strike price is the same as the forward rate in the OTC market
Exchange Traded Currency Options - Features
• Standardisation of features
– – – – – – – Size of contracts Number of contracts (number of expiry months) Months of expiry Dates of expiry Last date for trading Trading hours Settlement value
• No counterparty risk
– Clearing house is the counterparty
• Margin requirements for seller of option only • Buyer of an option can close his contract at any time before expiry by entering into an ‘opposite’ contract
Currency Options
Examples
NASDAQ OMX – PHLX
• Option on AUD (USD settled) • Contract Size : AUD 10,000 • No. of Contracts : Call : 140 Put : 140
– No. of strike prices : Call & Put each : 21 to 24 per month at USD 1 price intervals – No. of expiry months : Call & Put each : 6
• Day of expiry : Saturday following the 3rd Friday of expiring month • Last trading day : 3rd Friday of expiring month • Settlement Value : Spot price of underlying at 12 noon of last trading day • Settlement Mode : USD settled i.e. cash settled • Trading hours : 9.30 a.m. to 4 p.m.
Option on AUD (contd.)
• Expiry Months : Jan, Feb, Mar, Jun, Sep, Dec • Strike Prices : Jan, Feb, Mar and Jun - from USD 77 to USD 100 in increments of USD 1 : Sep - from USD 78 to USD 100 in increments of USD 1 : Dec – from USD 80 to USD 100 in increments of USD 1
Example
• U.S. Exporter exports in December, 2009
– Exports worth – Expected realisation in – – – – AUD 1 mn 3 months
• He enters into a PUT option in NASDAQ for March, 2010
Strike Price : USD 80 (per 100 AUD) Settlement date will be 20.3.2010 Contract size is AUD 10,000 No. of contracts required is 1 mn / 10,000 = 100
• • • • •
He waits till 20th March, 2010 On 20th March, 2010 the contract matures Settlement method is cash settlement Settlement Value on 19th March, 2010 is USD 78 (per 100 AUD) Profit : USD 2 per 100 AUD or USD 2O,OOO
Example (contd.)
• The exporter would receive USD 20,000 from the exchange • Go to the spot market and convert AUD 1 mn @ USD 78 per 100 AUD
A clarification
• We used NASDAQ and not CME for currency options. Why ? • CME does not have currency options. It only has options on currency futures
Class Assignment
• Find out similar details for other currency options in NASDAQ – OMX- PHLX
– For list of currencies
• http://nasdaqomxtrader.com/Micro.aspx?id=phlxwcopr oductspecs
Related Concepts
Currency Basket Options
• Options on a basket of multiple currencies
– A single option contract on multiple currencies
• The basket has more than one currency in defined weightages
– Need not enter into options for each currency
• On expiry, the buyer of the option has a right to buy or sell a specified (pre-determined) amount of currencies in the basket
– The quantum is fixed at the time of entering into the contract and the buyer of the option has to exercise his option to buy or sell the basket and not individual currencies in the basket
– Overall premium on option also works out lesser than individual options
• This is because the buyer of the option has to exercise his option for the basket as a whole and not for individual currencies in the basket
Option Strips
• Instead of getting into one or more Call or Put Options for hedging, the hedger would enter into ‘n’ number of at-the-money Call Options and ‘2n’ number of at-the-money Put Options for the same strike price and strike date
– Profit is unlimited – Risk is limited – Outlook is bearish
• Profit calculation
– If on strike date, spot price > strike price, exercise call option – If on strike date, spot price < strike price, exercise put option
• Either way, a profit is made
• Why more number of ‘puts’ than ‘calls’ ?
– Bearish outlook – Chances of profit booking more with puts
Option Straps
• Similar to Option Strips • ‘2n’ Call options and ‘n’ Put Options
– Profit is unlimited – Risk is limited – Outlook is bullish
• Profit calculation
– If on strike date, spot price > strike price, exercise call option – If on strike date, spot price < strike price, exercise put option
• Either way, a profit is made
• Why more number of ‘calls’ than ‘puts’ ?
– Bullish outlook – Chances of profit booking more with calls
Comparison with Straddle
• Compare strips and straps with Straddle • One buys equal number of call options and put options simultaneously in a straddle
Swaps
• Using swaps for hedging against currency risk
– Currency swaps or cross-currency swaps – Three Scenarios
• Involves only exchange of principal amounts at commencement and at maturity • Involves periodical payment of interest and exchange of principal amounts • Involves only periodical payment of interest – no exchange of principal amounts
Example Borrowed Funds
• Scenario 1
– Funds borrowed on zero coupon basis
• Simple swap with two cashflows – one at beginning and one at end
– Conversion of foreign currency to local currency when amount is borrowed – Conversion of local currency to foreign currency when amount is repaid
• Both parties agree on the exchange rate to be adopted for conversion at the beginning and at the end • Similar to a forward contract but are usually for a much longer period
Scenario 1 (contd.)
• How is the exchange rate at the time of loan repayment determined ?
– Assume that the swap tenor is 1 year – Let party A convert GBP 2 mn to USD at the beginning @ GBP 1 = USD 0.4875 i.e. a total sum of USD 0.9747mn – Let interest rate on GBP be 6% p.a. and on USD be 4% p.a. – At the end of the period, party A would have earned an interest of USD (0.9747*4%) = USD 0.03898 mn by investing the amount that it received – The other party would have earned GBP (2 * 6%) = GBP 0.12 mn – Party A would have USD 0.9747 + 0.03898 = USD 1.013688 mn – The other party would have GBP 2 + 0.12 = GBP 2.12 mn – The exchange ratio will be 1.013688 / 2.12 = 0.478155
• i.e. GBP 1 = USD 0.478155
Scenario 1 (contd.)
• Is this rate correct ?
– Applying this exchange rate, Party A has to pay
• USD 0.4782*2 = USD 0.9564 mn
– The other party pays GBP 2 mn – The gain to Party A is USD 0.9747 – 0.9564 = USD 0.0183 mn
Scenario 1 (contd.)
• If Party A had not gone in for the swap, it would have earned 6% interest on GBP 2 mn
– i.e. interest of GBP 0.12 mn – i.e. interest of USD 0.12 * 0.4782 = USD 0.057384 – Difference between potential interest earning and actual interest earned is
• USD 0.05738 - USD 0.03898 = USD 0.0183 mn
• The favourable movement in the exchange rate compensates for the loss of interest
Example Borrowed Funds
• Scenario 2
– Funds borrowed with periodical interest payment
• Initial conversion • Periodical exchange of cash flows in different currencies • Conversion at the end
– Both parties will agree on exchange rates for the beginning and end conversions – The periodical payments will be based on prevailing swap rates in two different currencies
Scenario 2 (contd.)
• Refer to Exhibit 14.8 in page 452 of your text book • The rates in this exhibit are used for the swapping of interest cash flows
– (eg) a 5 year fixed rate EURO cash flow@ 3.67% can be swapped for USD cash flow @ 5.76%
Example of Borrowed Funds
• Scenario 3
– Swap only for periodical interest payments
• The periodical payments will be based on prevailing swap rates in two different currencies • For determining notional principal of target currency, the prevailing exchange rate at commencement of the contract is used
– (eg) if the principal is USD 10,000,000 and USD / GBP rate is 1 GBP = USD 0.4875, the notional principal in GBP is 4,875,000
• Interest rate applicable for USD and GBP will be used for the respective legs of the periodical payments • Swap could be fixed rate to fixed rate OR fixed rate to floating rate OR floating rate to floating rate
Example of Imports or Exports over a long Period of Time
• Say an exporter has a contract to export every quarter for the next three years • He can enter into a swap arrangement for the quarterly receipt of foreign currency • Similarly for imports
Swaps Bid-Ask Quotes
• Use of Swap Dealers as counter-parties • Swap Dealers provide bid-ask quotes • Bid is the fixed rate of interest that they will pay against receiving a standard floating rate of interest • Ask is the fixed rate of interest that they will receive against paying a standard floating rate of interest • The bid-ask spread is the profit element for the dealers • The standard floating rate of interest will be expressed in terms of 6 month or 3 month LIBOR of the respective currency
Swaps Bid-Ask Quotes (contd.)
• If two currencies are involved for the fixed and floating rates respectively, then the bid and ask of the respective currencies will be applied
– (eg) if USD bid-ask is 4.50-4.60 and JPY bid-ask is 6.50-6.60, it means that the dealer will pay USD at 4.50% and receive JPY at 6.60% OR – The dealer will pay JPY at 6.5% and receive USD at 4.60%
• Refer Exhibit 14.8 in page 452 of your text book
Ask swap rates quoted as of close of London business. US$ is quoted annual money actual/360 basis against 3 month Libor. £ are quoted on a semi-annual actual/365 basis against 6 month Libor EURO quoted on an annual bond 30/360 basis against 6 months Euribor/Libor with the exception of the 1 year rate which is quoted against 3 months Euribor/Libor.
Swap Rates as on 22/1/2010
ASK SWAP RATES
USD 1 year 0.51% GBP 0.95% EURO 1.22%
2 year
3 year 5 year 7 year 10 year 12 year 15 year 20 year 25 year 30 year Source : www.swapratesonline.com
1.15%
1.74% 2.67% 3.24% 3.72% 3.94% 4.16% 4.30% 4.36% 4.40%
1.84%
2.47% 3.24% 3.66% 4.02% 4.18% 4.33% 4.36% 4.30% 4.24%
1.68%
2.08% 2.65% 3.07% 3.47% 3.66% 3.85% 3.98% 3.97% 3.92%
Exiting from a Swap
• Either party may wish to exit (unwind) from the swap at any time during the swap arrangement • One of the parties will have to pay to the other, the NPV of the two sets of cash flows still remaining in the swap • To calculate the amount, discount the remaining portion of each set of cash flows at the current interest rates
– ( if the two cash flows are in two different currencies, apply the respective interest rates)
• Convert the PV of the foreign currency cash flow to home currency • Find out the difference between the two sets of cash flows • See example in page 455 of your text book
Exiting from a Swap Example
• • • • Swap involving INR and USD INR Principal USD Principal Swap rate
– INR interest rate – USD interest rate
900 mn 20 mn
9% p.a. 6% p.a. 8% p.a. 6% p.a.
• Current interest rate
– INR interest rate – USD interest rate
• Current exchange rate • Remaining period of swap
INR 45 3 annual cash flows
Exiting from a Swap Example (contd.)
• PV of INR leg
– Interest amount = INR 81 mn (@9%p.a. on 900 mn) – PV = INR 923.337 mn (discount rate 8% - 3 annual cash flows for interest + principal repayment of 900)
• PV of USD leg
– Interest amount = 1.2 mn (@6% on 20 mn) – PV = USD 20.008 mn (discount rate 6% - 3 annual cash flows for interest + principal repayment of 20) – In terms of INR = USD 20.008*45 = INR 900.342 mn
• NPV
– INR 923.337 mn – INR 900.342 mn = INR 22.995 mn
Some General Theories
Balance of Payment
• BOP represents where a country stands with respect to its economic status with respect to other countries • It records all economic transactions with other countries
– Imports and exports of goods and services – Capital inflows and outflows
• It comprises
– Current Account – Capital Account and – Official Reserve Account
Balance of Payment (contd.)
• Current Account
– Records all imports and exports of goods and services – Also records receipts and payments of interest, dividend and other income/payment on investments – Also records transactions such as grants, aids and gifts
Balance of Payment (contd.)
• Capital Account
– Records purchase and sale of assets in the form of shares, bonds, real estate, bank balances and business
• Official Reserve Account
– Records purchase and sale of international reserve assets
• Gold, foreign exchange and special drawing rights with IMF
Balance of Payment (contd.)
• Ideally,
– Current Account + Capital Account + Official Reserve Account = 0 – If Central Banks do not interfere in the markets, Current Account + Capital Account = 0
Balance of Payment and Exchange Rate
• When the current account in BOP shows a deficit, it means that imports are more than exports and so local currency will depreciate against foreign currency and vice versa
Trade Finance
Letters of Credit
Forex Remittance
• Any remittance of funds across countries should be through authorised channels
– Banks
• Electronic fund transfers • Physical payment instruments • Account to account transfers
– Other authorised entities
• (eg) Western Union Money Transfer
• Among banks, normally SWIFT is used to transfer funds electronically
Nostro and Vostro Accounts
• A nostro is our account of our money, held by you • A vostro is your account of your money, held by us • Nostro Account: is a foreign currency current account maintained with another bank. The account is used to receive and pay currency assets and liabilities denominated in the currency of the country in which the bank is resident.
– (eg) SBI, Mumbai maintaining a USD denominated account with Citibank, New York
• Vostro Account: is a local currency account maintained by a local bank for a foreign (correspondent) bank. For the foreign bank it is a nostro account.
– (eg) HSBC, Tokyo maintaining a INR denominated account with SBI, Mumbai
Trade Finance for Exports
• Refer to http://www.tradeport.org/tutorial/financing/i ndex.html • http://www.meridianfinance.com/internation al_leasing.html (private financiers) • http://www.statebankofindia.com/user.htm (SBI’s trade finance options)
Financing / Guarantees / Insurance / Currency Risk Cover for Exports
• Refer to http://www.eximbankindia.com/ • Refer to https://www.ecgc.in/Portal/index.aspx
Factoring and Forfaiting
• Refer to http://tefo.com/products/internationalimport-factoring.php • http://tefo.com/products/forfaitfinancing.php • http://www.gtfindia.com
doc_514926521.pptx
The PPT explaining on Currency Options.
Currency Options
Currency Options in OTC Markets
• • • • • • • • • Customised Options Two parties to a contract One of the parties has the right to enforce the contract The other party does not have the right to enforce the contract but has the obligation to fulfill the contract, if enforced by first party Party having the right to enforce : Buyer of option Other party : Seller or Writer of option Buyer of option pays an upfront premium to seller of option Buyer of option will not make a loss on the contract Seller of option may make a loss on the contract, if contract is enforced by buyer
Currency Options in OTC Example
• An importer has to pay after 3 months USD 10,000 • Current rate is say 1 USD = Rs. 48 • Option Contract can be entered into for say 1 USD = Rs. 48.50 • The importer can buy USD 10,000 from the other party after 3 months on the agreed date at 1 USD = Rs. 48. 50
– If the spot rate is lower than Rs. 48.50, importer will not exercise the option
• In this case, when the importer allows the option to lapse, he loses the option premium that he has paid upfront
– If the spot rate is higher than Rs. 48.50, importer will exercise the option
• In this case, the seller of the option i.e. the one who sells USD, in this case, will incur a loss
How is the Option Strike Price Determined in OTC Markets ?
• In the OTC markets, all terms and conditions of options are agreed to between the parties
– The strike price is also agreed to between the buyer and seller of the option
• (eg) the buyer of the option may specify a ‘at-themoney’ strike price
– at-the-money strike price is the same as the forward rate in the OTC market
Exchange Traded Currency Options - Features
• Standardisation of features
– – – – – – – Size of contracts Number of contracts (number of expiry months) Months of expiry Dates of expiry Last date for trading Trading hours Settlement value
• No counterparty risk
– Clearing house is the counterparty
• Margin requirements for seller of option only • Buyer of an option can close his contract at any time before expiry by entering into an ‘opposite’ contract
Currency Options
Examples
NASDAQ OMX – PHLX
• Option on AUD (USD settled) • Contract Size : AUD 10,000 • No. of Contracts : Call : 140 Put : 140
– No. of strike prices : Call & Put each : 21 to 24 per month at USD 1 price intervals – No. of expiry months : Call & Put each : 6
• Day of expiry : Saturday following the 3rd Friday of expiring month • Last trading day : 3rd Friday of expiring month • Settlement Value : Spot price of underlying at 12 noon of last trading day • Settlement Mode : USD settled i.e. cash settled • Trading hours : 9.30 a.m. to 4 p.m.
Option on AUD (contd.)
• Expiry Months : Jan, Feb, Mar, Jun, Sep, Dec • Strike Prices : Jan, Feb, Mar and Jun - from USD 77 to USD 100 in increments of USD 1 : Sep - from USD 78 to USD 100 in increments of USD 1 : Dec – from USD 80 to USD 100 in increments of USD 1
Example
• U.S. Exporter exports in December, 2009
– Exports worth – Expected realisation in – – – – AUD 1 mn 3 months
• He enters into a PUT option in NASDAQ for March, 2010
Strike Price : USD 80 (per 100 AUD) Settlement date will be 20.3.2010 Contract size is AUD 10,000 No. of contracts required is 1 mn / 10,000 = 100
• • • • •
He waits till 20th March, 2010 On 20th March, 2010 the contract matures Settlement method is cash settlement Settlement Value on 19th March, 2010 is USD 78 (per 100 AUD) Profit : USD 2 per 100 AUD or USD 2O,OOO
Example (contd.)
• The exporter would receive USD 20,000 from the exchange • Go to the spot market and convert AUD 1 mn @ USD 78 per 100 AUD
A clarification
• We used NASDAQ and not CME for currency options. Why ? • CME does not have currency options. It only has options on currency futures
Class Assignment
• Find out similar details for other currency options in NASDAQ – OMX- PHLX
– For list of currencies
• http://nasdaqomxtrader.com/Micro.aspx?id=phlxwcopr oductspecs
Related Concepts
Currency Basket Options
• Options on a basket of multiple currencies
– A single option contract on multiple currencies
• The basket has more than one currency in defined weightages
– Need not enter into options for each currency
• On expiry, the buyer of the option has a right to buy or sell a specified (pre-determined) amount of currencies in the basket
– The quantum is fixed at the time of entering into the contract and the buyer of the option has to exercise his option to buy or sell the basket and not individual currencies in the basket
– Overall premium on option also works out lesser than individual options
• This is because the buyer of the option has to exercise his option for the basket as a whole and not for individual currencies in the basket
Option Strips
• Instead of getting into one or more Call or Put Options for hedging, the hedger would enter into ‘n’ number of at-the-money Call Options and ‘2n’ number of at-the-money Put Options for the same strike price and strike date
– Profit is unlimited – Risk is limited – Outlook is bearish
• Profit calculation
– If on strike date, spot price > strike price, exercise call option – If on strike date, spot price < strike price, exercise put option
• Either way, a profit is made
• Why more number of ‘puts’ than ‘calls’ ?
– Bearish outlook – Chances of profit booking more with puts
Option Straps
• Similar to Option Strips • ‘2n’ Call options and ‘n’ Put Options
– Profit is unlimited – Risk is limited – Outlook is bullish
• Profit calculation
– If on strike date, spot price > strike price, exercise call option – If on strike date, spot price < strike price, exercise put option
• Either way, a profit is made
• Why more number of ‘calls’ than ‘puts’ ?
– Bullish outlook – Chances of profit booking more with calls
Comparison with Straddle
• Compare strips and straps with Straddle • One buys equal number of call options and put options simultaneously in a straddle
Swaps
• Using swaps for hedging against currency risk
– Currency swaps or cross-currency swaps – Three Scenarios
• Involves only exchange of principal amounts at commencement and at maturity • Involves periodical payment of interest and exchange of principal amounts • Involves only periodical payment of interest – no exchange of principal amounts
Example Borrowed Funds
• Scenario 1
– Funds borrowed on zero coupon basis
• Simple swap with two cashflows – one at beginning and one at end
– Conversion of foreign currency to local currency when amount is borrowed – Conversion of local currency to foreign currency when amount is repaid
• Both parties agree on the exchange rate to be adopted for conversion at the beginning and at the end • Similar to a forward contract but are usually for a much longer period
Scenario 1 (contd.)
• How is the exchange rate at the time of loan repayment determined ?
– Assume that the swap tenor is 1 year – Let party A convert GBP 2 mn to USD at the beginning @ GBP 1 = USD 0.4875 i.e. a total sum of USD 0.9747mn – Let interest rate on GBP be 6% p.a. and on USD be 4% p.a. – At the end of the period, party A would have earned an interest of USD (0.9747*4%) = USD 0.03898 mn by investing the amount that it received – The other party would have earned GBP (2 * 6%) = GBP 0.12 mn – Party A would have USD 0.9747 + 0.03898 = USD 1.013688 mn – The other party would have GBP 2 + 0.12 = GBP 2.12 mn – The exchange ratio will be 1.013688 / 2.12 = 0.478155
• i.e. GBP 1 = USD 0.478155
Scenario 1 (contd.)
• Is this rate correct ?
– Applying this exchange rate, Party A has to pay
• USD 0.4782*2 = USD 0.9564 mn
– The other party pays GBP 2 mn – The gain to Party A is USD 0.9747 – 0.9564 = USD 0.0183 mn
Scenario 1 (contd.)
• If Party A had not gone in for the swap, it would have earned 6% interest on GBP 2 mn
– i.e. interest of GBP 0.12 mn – i.e. interest of USD 0.12 * 0.4782 = USD 0.057384 – Difference between potential interest earning and actual interest earned is
• USD 0.05738 - USD 0.03898 = USD 0.0183 mn
• The favourable movement in the exchange rate compensates for the loss of interest
Example Borrowed Funds
• Scenario 2
– Funds borrowed with periodical interest payment
• Initial conversion • Periodical exchange of cash flows in different currencies • Conversion at the end
– Both parties will agree on exchange rates for the beginning and end conversions – The periodical payments will be based on prevailing swap rates in two different currencies
Scenario 2 (contd.)
• Refer to Exhibit 14.8 in page 452 of your text book • The rates in this exhibit are used for the swapping of interest cash flows
– (eg) a 5 year fixed rate EURO cash flow@ 3.67% can be swapped for USD cash flow @ 5.76%
Example of Borrowed Funds
• Scenario 3
– Swap only for periodical interest payments
• The periodical payments will be based on prevailing swap rates in two different currencies • For determining notional principal of target currency, the prevailing exchange rate at commencement of the contract is used
– (eg) if the principal is USD 10,000,000 and USD / GBP rate is 1 GBP = USD 0.4875, the notional principal in GBP is 4,875,000
• Interest rate applicable for USD and GBP will be used for the respective legs of the periodical payments • Swap could be fixed rate to fixed rate OR fixed rate to floating rate OR floating rate to floating rate
Example of Imports or Exports over a long Period of Time
• Say an exporter has a contract to export every quarter for the next three years • He can enter into a swap arrangement for the quarterly receipt of foreign currency • Similarly for imports
Swaps Bid-Ask Quotes
• Use of Swap Dealers as counter-parties • Swap Dealers provide bid-ask quotes • Bid is the fixed rate of interest that they will pay against receiving a standard floating rate of interest • Ask is the fixed rate of interest that they will receive against paying a standard floating rate of interest • The bid-ask spread is the profit element for the dealers • The standard floating rate of interest will be expressed in terms of 6 month or 3 month LIBOR of the respective currency
Swaps Bid-Ask Quotes (contd.)
• If two currencies are involved for the fixed and floating rates respectively, then the bid and ask of the respective currencies will be applied
– (eg) if USD bid-ask is 4.50-4.60 and JPY bid-ask is 6.50-6.60, it means that the dealer will pay USD at 4.50% and receive JPY at 6.60% OR – The dealer will pay JPY at 6.5% and receive USD at 4.60%
• Refer Exhibit 14.8 in page 452 of your text book
Ask swap rates quoted as of close of London business. US$ is quoted annual money actual/360 basis against 3 month Libor. £ are quoted on a semi-annual actual/365 basis against 6 month Libor EURO quoted on an annual bond 30/360 basis against 6 months Euribor/Libor with the exception of the 1 year rate which is quoted against 3 months Euribor/Libor.
Swap Rates as on 22/1/2010
ASK SWAP RATES
USD 1 year 0.51% GBP 0.95% EURO 1.22%
2 year
3 year 5 year 7 year 10 year 12 year 15 year 20 year 25 year 30 year Source : www.swapratesonline.com
1.15%
1.74% 2.67% 3.24% 3.72% 3.94% 4.16% 4.30% 4.36% 4.40%
1.84%
2.47% 3.24% 3.66% 4.02% 4.18% 4.33% 4.36% 4.30% 4.24%
1.68%
2.08% 2.65% 3.07% 3.47% 3.66% 3.85% 3.98% 3.97% 3.92%
Exiting from a Swap
• Either party may wish to exit (unwind) from the swap at any time during the swap arrangement • One of the parties will have to pay to the other, the NPV of the two sets of cash flows still remaining in the swap • To calculate the amount, discount the remaining portion of each set of cash flows at the current interest rates
– ( if the two cash flows are in two different currencies, apply the respective interest rates)
• Convert the PV of the foreign currency cash flow to home currency • Find out the difference between the two sets of cash flows • See example in page 455 of your text book
Exiting from a Swap Example
• • • • Swap involving INR and USD INR Principal USD Principal Swap rate
– INR interest rate – USD interest rate
900 mn 20 mn
9% p.a. 6% p.a. 8% p.a. 6% p.a.
• Current interest rate
– INR interest rate – USD interest rate
• Current exchange rate • Remaining period of swap
INR 45 3 annual cash flows
Exiting from a Swap Example (contd.)
• PV of INR leg
– Interest amount = INR 81 mn (@9%p.a. on 900 mn) – PV = INR 923.337 mn (discount rate 8% - 3 annual cash flows for interest + principal repayment of 900)
• PV of USD leg
– Interest amount = 1.2 mn (@6% on 20 mn) – PV = USD 20.008 mn (discount rate 6% - 3 annual cash flows for interest + principal repayment of 20) – In terms of INR = USD 20.008*45 = INR 900.342 mn
• NPV
– INR 923.337 mn – INR 900.342 mn = INR 22.995 mn
Some General Theories
Balance of Payment
• BOP represents where a country stands with respect to its economic status with respect to other countries • It records all economic transactions with other countries
– Imports and exports of goods and services – Capital inflows and outflows
• It comprises
– Current Account – Capital Account and – Official Reserve Account
Balance of Payment (contd.)
• Current Account
– Records all imports and exports of goods and services – Also records receipts and payments of interest, dividend and other income/payment on investments – Also records transactions such as grants, aids and gifts
Balance of Payment (contd.)
• Capital Account
– Records purchase and sale of assets in the form of shares, bonds, real estate, bank balances and business
• Official Reserve Account
– Records purchase and sale of international reserve assets
• Gold, foreign exchange and special drawing rights with IMF
Balance of Payment (contd.)
• Ideally,
– Current Account + Capital Account + Official Reserve Account = 0 – If Central Banks do not interfere in the markets, Current Account + Capital Account = 0
Balance of Payment and Exchange Rate
• When the current account in BOP shows a deficit, it means that imports are more than exports and so local currency will depreciate against foreign currency and vice versa
Trade Finance
Letters of Credit
Forex Remittance
• Any remittance of funds across countries should be through authorised channels
– Banks
• Electronic fund transfers • Physical payment instruments • Account to account transfers
– Other authorised entities
• (eg) Western Union Money Transfer
• Among banks, normally SWIFT is used to transfer funds electronically
Nostro and Vostro Accounts
• A nostro is our account of our money, held by you • A vostro is your account of your money, held by us • Nostro Account: is a foreign currency current account maintained with another bank. The account is used to receive and pay currency assets and liabilities denominated in the currency of the country in which the bank is resident.
– (eg) SBI, Mumbai maintaining a USD denominated account with Citibank, New York
• Vostro Account: is a local currency account maintained by a local bank for a foreign (correspondent) bank. For the foreign bank it is a nostro account.
– (eg) HSBC, Tokyo maintaining a INR denominated account with SBI, Mumbai
Trade Finance for Exports
• Refer to http://www.tradeport.org/tutorial/financing/i ndex.html • http://www.meridianfinance.com/internation al_leasing.html (private financiers) • http://www.statebankofindia.com/user.htm (SBI’s trade finance options)
Financing / Guarantees / Insurance / Currency Risk Cover for Exports
• Refer to http://www.eximbankindia.com/ • Refer to https://www.ecgc.in/Portal/index.aspx
Factoring and Forfaiting
• Refer to http://tefo.com/products/internationalimport-factoring.php • http://tefo.com/products/forfaitfinancing.php • http://www.gtfindia.com
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