Description
It explains basic of Forward Rate Agreements.It also covers the indian context.
Forward Rate Agreements
Agenda
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.
FRA: Definition. Derivatives in India. Usage and Need for FRA. Working and Settlement of FRA. Timelines in a FRA FRA: An Example. Valuation of FRA. FRA: Advantages and Disadvantages. Interest Rate Futures v/s FRA. FRA: Global Market. FRA: Indian Market.
Consider the following:
?
Situation 1: Your firm will have $1,000,000 in three months' time for a six month period. You think that interest rates may fall. You want to protect the return you will get and you are looking at ways of doing this.
?
Situation 2: Your company will have a borrowing requirement for six months in three months time. You believe that interest rates may be trading at levels detrimental to your cost of borrowing in three months time. You want to protect yourself against this happening.
. . . a Forward-Rate Agreement (FRA) can offer you a solution in these circumstances.
What is FRA??
FRA is an agreement between two parties who agree on a fixed rate of interest to be paid/received on a fixed date in the future. The interest exchange is based on the notional principal amount (the principal is not exchanged), and these contracts settle in cash. The contract between two counterparties can also be to fix on a future currency exchange rate. 7%
3 months deferment period
3 months contract period
dealing date
spot date
fixing date
settlement date
maturity date
contract rate agreed 7% vs 3-mo LIBOR
reference rate determined 5%
settlement sum paid $4,938 County Bank pays since 5% < 7%
Similarity to a futures position
?
County Bank would pay fixed-rate and receive floating-rate as a hedge if it was exposed to a loss in a rising rate environment. This is analogous to a short futures position since with short futures, rising rates means falling prices. Falling prices mean selling for higher at the beginning and buying for cheaper at the end.
?
?
Similarity to a futures position
?
Metro Bank would pay floating-rate and receive fixed-rate as a hedge if it was exposed to a loss in a falling rate environment. This is analogous to a long futures position since with long futures, falling rates means rising prices.
?
?
Rising prices means buying for cheaper at the beginning and selling for higher at the end.
Valuation Of a FRA
An FRA can be valued by assuming that the forward interest rate is certain to be realized. The value of the FRA to the party who is to receive RK is: ? L(RK – RF)(T2 – T1)e-R2T2. ? This is the present value of L(RK – RF)(T2 – T1) at time T2 . ? The netted payment made at the effective date is:
?
? is the day count fraction, i.e. the portion of a year over which the rates are calculated.
Advantages of FRA
Disadvantages of FRA
? ?
?
Tailor-made in terms of dates and amount. No Premium or payments required upfront. Can be reversed at any stage at prevailing rate.
? ?
Difficult to liquidate. Involves credit risk.
Advantages and Disadvantages
Derivatives similar To FRA
Interest Rate Swap (IRS) ? An Interest Rate Swap is a financial contract between two parties exchanging or swapping a stream of interest payments for a `notional principal’ amount on multiple occasions during a specified period. Such contracts generally involve exchange of a `fixed to floating’ or `floating to floating’ rates of interest. Accordingly, on each payment date - that occurs during the swap period – cash payments based on fixed/ floating and floating rates, are made by the parties to one another. Interest Rate Futures (IRF) ? Interest Rate Future is a standardized, exchange-traded contract with an actual or notional interest-bearing instrument(s) as the underlying asset.
FRA v/s Interest Rate Futures
An FRA traded in an exchange. ? More standardized, has a wider participant base, hence more liquidity. ? Underlying:
?
? T-bills (91 days notional ) or ? Treasury Bond (10 year notional G-secs)
Option to deliver from a basket of different treasury bonds. ? Marked to market on a daily basis.
?
The difference….
Both lock-in interest rate in future period T1-T2. ? For short maturities (up to a year), both contracts yield same interest rate. ? For longer maturities, following differences arise:
?
? Interest Rate futures are settled daily, FRAs are not. ? Final settlement for IR Futures is at T1 while (ideally) for FRAs it’s at T2.
The difference contd…
Assuming Rm-Rf is payoff at T1. Daily settlement tends to give higher cash in margin account whenever rates are high, hence attractive option. (Futures Rate > Forward Rate). ? Final Settlement of payoff at T1(IR Future) is always better than T2 (FRA). The foregone value in FRA is compensated by lower implied rate (Forward Rate < Futures Rate). ? Convexity Adjustment: Forward Rate = Futures Rate – 0.5?^2T1T2.
? ?
Global Scenario of FRA
Exists in various currencies: USD, Pound, Deutsche marks, Swiss Francs, Yen. ? Ease Currencies: USD, Pound Sterling, Deutsche mark, Swiss Franc, French Franc, Canadian Dollar, Japanese Yen. ? Working is similar to actively traded securities market. ? Closing is parallel to the foreign
?
Global Scenario.. Contd.
FRA is dealt with not only foreign exchange and interest rates but also commodity prices. ? $362 billion outright forwards in $3210 billion market of foreign exchange market turnover, approximately 11%. ? Most of the business is done in London.
?
Global locations
Far East Tokyo Hong Kong Singapore Sydney Middle East Bahrain Europe London Paris Zurich Geneva America New York Chicago Toronto San Francisco
Frankfurt
• Other small centers include Brussels, Luxembourg, Madrid, Milan, Amsterdam, Munich, Hamburg, Kuwait, Kuala Lumpur, Los Angeles, Montreal, Johannesburg.
FRA in India
? ? ?
? ?
?
IRS and FRA were introduced by the RBI in India in July 1999. Over the counter products traded at NSE and BSE. Players Include Scheduled Commercial Banks excluding RRBs & LABs, Primary dealers and Financial Institutions. Benchmark interest Rates. Banks are allowed to hedge their interest rate risks and also take trading positions in interest rate futures(since Oct 2008). Settlements of FRA takes place through CCIL (Clearing Corporation of India Ltd.)
Benchmark rates
? ? ? ?
?
?
MIBOR (Mumbai Inter Bank Offer Rate), MIFOR (Mumbai Inter – Bank Forwards Offer Rate), MIOCS (Mumbai Inter – Bank Currency Offered Swaps), MIOIS (MIBOR Overnight Interest Swaps), T. Bill rates. MIBOR & MIFOR benchmark rates are published by FIMMDA (Fixed Income Money Markets & Derivatives Association of India) & NSE. MIOCS (Mumbai Interbank Offered Currency Swaps) –Calculated by averaging the Dollor-Swap rate quoted by 11 market participants. MIFOR(Mumbai Interbank Forward Offer rate): It is derived from USD Libor and the USD/INR Forward Premia, both of which are extremely deep and liquid markets. MIOIS (MIBOR Overnight Indexed Swaps): The FIMMDA-REUTERS overnight Indexed swaps is an average quoted by 17 market participants. In this swap, the floating rate is the daily compounded call rate (accrued over holidays). For short tenor swaps (up to 1– year), settlements occur on the maturity of the swap. In case of longer tenor swaps, settlements generally occur every six months. Time Period Available
? Overnight, 3 day, 14 day, 1 month, 3 months ? 3 day MIBID-MIBOR released on Fridays since June 6, 2008.
Settlement of FRA contracts through CCIL
•
CCIL provides a trade reporting platform operational on 30th Aug 2007.Banks and PDs are required to report FRA & IRS deals on daily basis. Settlement of Rupee derivative products IRS & FRA on guaranteed basis. (CCIL assumes the counterparty risk). Settlement is through members’ account with the RBI using the RBI’s RTGS system. The difference between the floating rate of interest and the fixed rate of interest on the notional principal is settled.
•
•
•
Market share in MIBOR & MIFOR Swaps
Total Notional Principal (on MIBOR) for Oct’09: Rs2027160 Million Total number of deals: 254
References
Rakshitra – Nov’09 published by CCIL ?http://www.fimmda.org/Reuter/docs/re uter.htm ?http://www.rbi.org.in/scripts/AnnualRe portPublications.aspx?Id=823 ?http://www.ccilindia.com/CCIL/DATA/T opic/Topic-13-01-2005125203.pdf ? Managing Financial Risk: Charles Smithson
?
Thank you!
doc_409466806.ppt
It explains basic of Forward Rate Agreements.It also covers the indian context.
Forward Rate Agreements
Agenda
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.
FRA: Definition. Derivatives in India. Usage and Need for FRA. Working and Settlement of FRA. Timelines in a FRA FRA: An Example. Valuation of FRA. FRA: Advantages and Disadvantages. Interest Rate Futures v/s FRA. FRA: Global Market. FRA: Indian Market.
Consider the following:
?
Situation 1: Your firm will have $1,000,000 in three months' time for a six month period. You think that interest rates may fall. You want to protect the return you will get and you are looking at ways of doing this.
?
Situation 2: Your company will have a borrowing requirement for six months in three months time. You believe that interest rates may be trading at levels detrimental to your cost of borrowing in three months time. You want to protect yourself against this happening.
. . . a Forward-Rate Agreement (FRA) can offer you a solution in these circumstances.
What is FRA??
FRA is an agreement between two parties who agree on a fixed rate of interest to be paid/received on a fixed date in the future. The interest exchange is based on the notional principal amount (the principal is not exchanged), and these contracts settle in cash. The contract between two counterparties can also be to fix on a future currency exchange rate. 7%
3 months deferment period
3 months contract period
dealing date
spot date
fixing date
settlement date
maturity date
contract rate agreed 7% vs 3-mo LIBOR
reference rate determined 5%
settlement sum paid $4,938 County Bank pays since 5% < 7%
Similarity to a futures position
?
County Bank would pay fixed-rate and receive floating-rate as a hedge if it was exposed to a loss in a rising rate environment. This is analogous to a short futures position since with short futures, rising rates means falling prices. Falling prices mean selling for higher at the beginning and buying for cheaper at the end.
?
?
Similarity to a futures position
?
Metro Bank would pay floating-rate and receive fixed-rate as a hedge if it was exposed to a loss in a falling rate environment. This is analogous to a long futures position since with long futures, falling rates means rising prices.
?
?
Rising prices means buying for cheaper at the beginning and selling for higher at the end.
Valuation Of a FRA
An FRA can be valued by assuming that the forward interest rate is certain to be realized. The value of the FRA to the party who is to receive RK is: ? L(RK – RF)(T2 – T1)e-R2T2. ? This is the present value of L(RK – RF)(T2 – T1) at time T2 . ? The netted payment made at the effective date is:
?
? is the day count fraction, i.e. the portion of a year over which the rates are calculated.
Advantages of FRA
Disadvantages of FRA
? ?
?
Tailor-made in terms of dates and amount. No Premium or payments required upfront. Can be reversed at any stage at prevailing rate.
? ?
Difficult to liquidate. Involves credit risk.
Advantages and Disadvantages
Derivatives similar To FRA
Interest Rate Swap (IRS) ? An Interest Rate Swap is a financial contract between two parties exchanging or swapping a stream of interest payments for a `notional principal’ amount on multiple occasions during a specified period. Such contracts generally involve exchange of a `fixed to floating’ or `floating to floating’ rates of interest. Accordingly, on each payment date - that occurs during the swap period – cash payments based on fixed/ floating and floating rates, are made by the parties to one another. Interest Rate Futures (IRF) ? Interest Rate Future is a standardized, exchange-traded contract with an actual or notional interest-bearing instrument(s) as the underlying asset.
FRA v/s Interest Rate Futures
An FRA traded in an exchange. ? More standardized, has a wider participant base, hence more liquidity. ? Underlying:
?
? T-bills (91 days notional ) or ? Treasury Bond (10 year notional G-secs)
Option to deliver from a basket of different treasury bonds. ? Marked to market on a daily basis.
?
The difference….
Both lock-in interest rate in future period T1-T2. ? For short maturities (up to a year), both contracts yield same interest rate. ? For longer maturities, following differences arise:
?
? Interest Rate futures are settled daily, FRAs are not. ? Final settlement for IR Futures is at T1 while (ideally) for FRAs it’s at T2.
The difference contd…
Assuming Rm-Rf is payoff at T1. Daily settlement tends to give higher cash in margin account whenever rates are high, hence attractive option. (Futures Rate > Forward Rate). ? Final Settlement of payoff at T1(IR Future) is always better than T2 (FRA). The foregone value in FRA is compensated by lower implied rate (Forward Rate < Futures Rate). ? Convexity Adjustment: Forward Rate = Futures Rate – 0.5?^2T1T2.
? ?
Global Scenario of FRA
Exists in various currencies: USD, Pound, Deutsche marks, Swiss Francs, Yen. ? Ease Currencies: USD, Pound Sterling, Deutsche mark, Swiss Franc, French Franc, Canadian Dollar, Japanese Yen. ? Working is similar to actively traded securities market. ? Closing is parallel to the foreign
?
Global Scenario.. Contd.
FRA is dealt with not only foreign exchange and interest rates but also commodity prices. ? $362 billion outright forwards in $3210 billion market of foreign exchange market turnover, approximately 11%. ? Most of the business is done in London.
?
Global locations
Far East Tokyo Hong Kong Singapore Sydney Middle East Bahrain Europe London Paris Zurich Geneva America New York Chicago Toronto San Francisco
Frankfurt
• Other small centers include Brussels, Luxembourg, Madrid, Milan, Amsterdam, Munich, Hamburg, Kuwait, Kuala Lumpur, Los Angeles, Montreal, Johannesburg.
FRA in India
? ? ?
? ?
?
IRS and FRA were introduced by the RBI in India in July 1999. Over the counter products traded at NSE and BSE. Players Include Scheduled Commercial Banks excluding RRBs & LABs, Primary dealers and Financial Institutions. Benchmark interest Rates. Banks are allowed to hedge their interest rate risks and also take trading positions in interest rate futures(since Oct 2008). Settlements of FRA takes place through CCIL (Clearing Corporation of India Ltd.)
Benchmark rates
? ? ? ?
?
?
MIBOR (Mumbai Inter Bank Offer Rate), MIFOR (Mumbai Inter – Bank Forwards Offer Rate), MIOCS (Mumbai Inter – Bank Currency Offered Swaps), MIOIS (MIBOR Overnight Interest Swaps), T. Bill rates. MIBOR & MIFOR benchmark rates are published by FIMMDA (Fixed Income Money Markets & Derivatives Association of India) & NSE. MIOCS (Mumbai Interbank Offered Currency Swaps) –Calculated by averaging the Dollor-Swap rate quoted by 11 market participants. MIFOR(Mumbai Interbank Forward Offer rate): It is derived from USD Libor and the USD/INR Forward Premia, both of which are extremely deep and liquid markets. MIOIS (MIBOR Overnight Indexed Swaps): The FIMMDA-REUTERS overnight Indexed swaps is an average quoted by 17 market participants. In this swap, the floating rate is the daily compounded call rate (accrued over holidays). For short tenor swaps (up to 1– year), settlements occur on the maturity of the swap. In case of longer tenor swaps, settlements generally occur every six months. Time Period Available
? Overnight, 3 day, 14 day, 1 month, 3 months ? 3 day MIBID-MIBOR released on Fridays since June 6, 2008.
Settlement of FRA contracts through CCIL
•
CCIL provides a trade reporting platform operational on 30th Aug 2007.Banks and PDs are required to report FRA & IRS deals on daily basis. Settlement of Rupee derivative products IRS & FRA on guaranteed basis. (CCIL assumes the counterparty risk). Settlement is through members’ account with the RBI using the RBI’s RTGS system. The difference between the floating rate of interest and the fixed rate of interest on the notional principal is settled.
•
•
•
Market share in MIBOR & MIFOR Swaps
Total Notional Principal (on MIBOR) for Oct’09: Rs2027160 Million Total number of deals: 254
References
Rakshitra – Nov’09 published by CCIL ?http://www.fimmda.org/Reuter/docs/re uter.htm ?http://www.rbi.org.in/scripts/AnnualRe portPublications.aspx?Id=823 ?http://www.ccilindia.com/CCIL/DATA/T opic/Topic-13-01-2005125203.pdf ? Managing Financial Risk: Charles Smithson
?
Thank you!
doc_409466806.ppt