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CRDB BANK LTD

The Bank that Listens

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Presentation to Clients on KYB

Cotton Workshop14 March 2005

MwanzaBy KYB Team and

CRMG

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Introduction: Product Concept & PrincipalHow it worksExperienceTimingPricingTransaction Flow Important DocumentationClosing the ContractsWay Forward

Outline

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CRDB Bank and CRMG - World Bank partnered 2 years ago to develop and offer Kinga Ya Bei (KYB) to clients

KYB offers opportunity for farmers/ exporters to hedge against price risk for their physical products through the world financial market for futures and options.

CRDB & CRMG assist in risk exposure assessment while CRDB also serves as market intermediary in purchase of KYB

Introduction

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Risk ExposureIf you –Sell before you Buy, ORBuy before you Sell

You have risk.

VOLUME (MT)

APR

MAY

JUNE

JULY AUG

SEPT

OCT

NOV

DEC

JAN

FEB

PURCHASE 200 1000 100 50 20

SALES 300 800 200 50 20

LONG 200 1200 1000

250 70 20

Risk Assessment

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Risk Positions

• Long position – Purchase before selling– Risk is market will move up

• Short position– Sell before purchasing– Risk is market will move down

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Breakeven Analysis - I• Determine the price you need to protect by

determining you breakeven point

Costs (ginning, transportation, levies,etc) 150

+ Purchase Price 250

Breakeven Price 1kg/ seed 400

X 3 (conversion to lint) 1200

- Profits from sale of cotton seed (140)

Breakeven w/ Purchase Price 250 tsh/ kg 1060

Conversion to $/lb 0. 44 $/lb

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Adding in Costs to Determine Protection Price

Breakeven Costs 0. 44 $/lb

+ FOB Costs (Dar Port) .06

+CIF Costs

Protection Price on the International Market (CIF)

.50 $/lb

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Breakeven Analysis - II• Determine the price you need to protect by

determining you breakeven point

Costs (ginning, transportation, levies,etc) 150

+ Purchase Price 300

Breakeven Price 1kg/ seed 450

X 3 (conversion to lint) 1350

- Profits from sale of cotton seed (140)

Breakeven w/ Purchase Price 250 tsh/ kg 1210

Conversion to $/lb 0. 50 $/lb

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Adding in Costs to Determine Protection Price

Breakeven Costs 0.50 $/lb

+ FOB Costs (Dar Port) .06

+CIF Costs

Protection Price on the International Market (CIF)

.56 $/lb

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Option Contract

Definition:A tool that provides price protection on the global market (New York)

It can protect a global price minimum or a global price maximum for a cost (premium).

The right to buy or sell a futures contract within a specific period of time at a specific price level (exercise price).

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How does it work?Options Contract – Simple

Example:

in June …

Ginner purchases or sets price for cotton in June

Ginner does not know the market prices from Sept – March when cotton sales are made

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What should be done?In June:Can purchase option contract

for Sept-March to protect global market price from going down

Will have a chance to select strike price to be protected

Have to pay premium as the purchase cost

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Throughout Sept – March

As ginner fixes price on sale of physical cotton, can settle or sell option contract to close it

If prices have fallen below strike price, union receives the settlement price which is close to the difference between market and strike price when the option is closed

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Put Option -provides a "floor" price

-gives protection against prices moving down

0.48

0.5

0.52

0.54

0.56

0.58

0.6

0.62

0.64

0.66

0.68

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28Time

Pri

ce i

n $

/LB

Strike Price

Market Price

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Transaction Flow

Purchase or Price Cotton

with Farmers

Purchase a Put Option Contract

Sell Cotton to Buyers

Pass Cotton

Through Gin

Close out position

Physical Transaction

Financial Transaction

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TimingThe purchase and sale of options

contracts must be linked to the purchase/sale of your physical stock

Buy protection immediately when you have bought/sold the physical stock

Sell protection immediately when you have sold/bought physical stock

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PricingThe price of options contracts

changes every day/ minute The cost of the option contract is

like an insurance premiumOnce you pay it you will not get it back

The broker and CRDB both add small commission

The cost of the option is quoted in dollars per pound (LB)Multiply by quantityCurrency Risk

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{End of Protection}{Level of

Protection}{Type of

Protection} {Price of Protection}

Actual Costs with Cotton Market (NYBOT) at $.53 11/3/05

MONTH STRIKE $/ lb P/C PRICE $/ lb

Jul  2005  .48 P .01

Jul  2005  .49 P .0126

Jul  2005  .50 P .0158

Jul  2005  .51 P .0194

Jul  2005  .52 P .0234

Jul  2005  .53 P .0280

MONTH STRIKE P/C PRICE

Oct  2005  .50 P .0179

Oct  2005  .51 P .0212

Oct  2005  .52 P .0249

Oct  2005  .53 P .0289

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AN EXAMPLE

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Breakeven Analysis - I• Determine the price you need to protect by

determining you breakeven point

Costs (ginning, transportation, levies,etc) 150

+ Purchase Price 250

Breakeven Price 1kg/ seed 400

X 3 (conversion to lint) 1200

- Profits from sale of cotton seed (140)

Breakeven w/ Purchase Price 250 tsh/ kg 1060

Conversion to $/lb 0. 44 $/lb

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Adding in Costs to Determine Protection Price

Breakeven Costs 0.44 $/lb

+ FOB Costs (Dar Port) .06

+CIF Costs

Protection Price on the International Market (CIF)

.50 $/lb

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{End of Protection}{Level of

Protection}{Type of

Protection} {Price of Protection}

Actual Costs with Cotton Market (NYBOT) at $.53 11/3/05

MONTH STRIKE $/ lb P/C PRICE $/ lb

Jul  2005  .48 P .01

Jul  2005  .49 P .0126

Jul  2005  .50 P .0158

Jul  2005  .51 P .0194

Jul  2005  .52 P .0234

Jul  2005  .53 P .0280

MONTH STRIKE P/C PRICE

Oct  2005  .50 P .0179

Oct  2005  .51 P .0212

Oct  2005  .52 P .0249

Oct  2005  .53 P .0289

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Sample Cost of Transaction

Nybot indications (web) $.0289

+ Cost of OTC Commission

$.002

+ Broker Commission $.002

= Total Cost per pound $.0329

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Cost per pound $.0329

X Number of lbs of cotton to protect**

220,462

= Total Cost USD for 100 MT

$7253

+CRDB Transaction Cost

TBD

**Number of lbs per ton 2204.62 100 MT = 220,462 lbs

Sample Cost of Transaction for 100 MT

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Outcome – Sell Physical in Sept, Close Out Options Contracts (Global Market is $.44)

Physical Financial (Put Option at $.53)Purchase Price Global Equivalent

$.50

Sale Price Global Equivalent

$.44

Total Loss/ Gain on physical

- $.06

Payout From Contract** $.09

Cost of Protection .0329

Total Loss/ Gain on* contract

+$.0571

*This is only approximate

Loss on Physical Gain on Financial

- $0.06 $0.571

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In July Purchased

100 MT for NY

Equivalent of $.50

Purchase a Put Option Contract to

$.53 at Cost of $.0329

In Sept, Sell Cotton to Buyers at

NY Price of $.44

Pass Cotton

Through Gin

Close out position

by selling contract back*

Physical Transaction

Financial Transaction

Three months pass and market falls to $.49

*Receive approximately the difference between the strike price and the market price for the contract

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Closing the ContractsOnce you purchase the option you

own it and monitoring the value of it is an ongoing activity

You must watch the market and "do something with it" every time you make a physical sale.

You should close the contracts when you no longer need the protection, i.e. when you have sold your physical stock

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Cont……Option contract has to be settled or sold

very soon after physical sales contracts have been made.

If timing is not correct, NYBOT price can move back up and payout would not be available

In order to close out the contract you must communicate with CRDB who will contact the broker for finalizing the transaction

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Important Documentation

Application Form – Purchase Order

Purchase Order Legal Agreement

Purchase Confirmation

Settlement Document

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Way ForwardThe goal of CRDB’s Kinga Ya Bei program is to

have clients implementing price risk management strategies that help them improve their overall financial condition and protect from losses.

• Commit a day within the next four days for KYB team (CRDB & CRMG) to come and discuss with you a suitable plan.

• CRDB will provide a market update with premium indications (please sign up with CRDB for this service)

• If you are not available in the next four days you can contact CRDB

• Review contract documents and legal agreement

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Thank You