41
Application : Hedging and Derivatives Interest Rate Swap and Futures Aramsri Choowongse, CFA Nopadol Prateepratana
Application : Hedging and Derivatives
Interest Rate Swap and Futures
Aramsri Choowongse, CFA
Nopadol Prateepratana
2Major heading
Presentation Outline
Hedging : Basics
BIBOR : Development in Derivative Market
Interest Rate Swap (IRS)
BIBOR Futures
3Major heading
Hedging : Basics
4Major heading
Hedge Accounting
IFRS 9 Roadmap : Implemented by 2013 to replace IAS 39
BOT’s Requirements
Study and Gap Analysis : H2/2011 – Q1/2012
System Planning : 2012-2013
Parallel Run : 2014
Implementation : 2015
Schedule for Corporate Implementation is not yet confirmed.
5Major heading
Types of Hedges
1. Cash Flow Hedge (CFH)
Change floating-rate profile to fixed-rate profile to reduce interest rate
risk.
Need to prove effectiveness of floating profile and floating index.
No mark-to-market for accounting.
6Major heading
Types of Hedges
1. Cash Flow Hedge (CFH)
Up-trend Interest Rate Cycle
Corporate/State Enterprises/MoF Standard Chartered Bank (Thai) PLC
BIBOR Liabilities
(Corporate Loans)
(BOT/MOF Floating Rate Bonds)
BIBOR
BIBOR
Fixed Rate
7Major heading
Types of Hedges
1. Cash Flow Hedge (CFH)
Down-trend Interest Rate Cycle
Corporate Standard Chartered Bank (Thai) PLC
BIBOR Assets
(Floating Rate Bond Investment)
BIBOR
BIBOR
Fixed Rate
8Major heading
Types of Hedges
2. Fair Value Hedge (FVH)
Change fixed-rate profile to floating-rate profile to reduce interest rate
risk.
Need to mark-to-market both underlyings and hedges.
Neutral PnL impact if 100% hedged.
9Major heading
Types of Hedges
2. Fair Value Hedge (FVH)
Up-trend Interest Rate Cycle
Corporate/Bank Standard Chartered Bank (Thai) PLC
Fixed Rate Asset
(Fixed Rate Bonds)
BIBOR
Fixed Rate
Fixed Rate
10Major heading
Types of Hedges
2. Fair Value Hedge (FVH)
Down-trend Interest Rate Cycle
Corporate/Bank Standard Chartered Bank (Thai) PLC
Fixed Rate Liabilities
(Fixed Rate Bonds)
BIBOR
Fixed Rate
Fixed Rate
11Major heading
Types of Hedges
3. Economic Hedge
All kinds of hedges can be done.
Need to mark-to-market.
Impact on PnL.
Some companies or banks might have internal guidelines that prohibits
economic hedge to avoid PnL volatility.
12Major heading
BIBOR : Development in Derivative Market
13Major heading
Floating Rate Index vs. Underlying assets/liabilities
How deep the floating market in Thailand ?
Floating Rate Index Underlying Assets/Liabilities Current Exposure (THB mio)
MLR Loans to Corporates 500,000
Average rate of 4 banks Loans to MoF/State Enterprises
(BBL/KTB/SCB/KTB) Loans to Retails (mortgages) - MLR/MRR 1,000,000
Corporate Debentures 2,000
Fixed Rate Deposit (6mths) Loans to Corporates 100,000
Average rate of 4 banks Loans to State Enterprises 40,000
(BBL/KTB/SCB/KTB) Loans to MoF/State Enterprises 120,000
Corporate Debenture 26,019
THBFIX Loans to Corporates 50,000
Interbank borrowing and lending (via swap market) 1m and up 500,000
Corporate Debentures 2,710
BOT BIBOR Loans to Corporates 150,000
Loans to State Enterprises -
Loans to MoF 180,000
Floating Rate Bonds (BOT) 149,575
Floating Rate Bonds (MoF) 99,000
Interbank borrowing and lending (1m-9m) 44,900
14Major heading
Interest Rate Swap (IRS)
15Major heading
Interest Rate Swap (IRS)
IRS: two counterparties exchange future interest rate streams.
Party A pays fixed rate.
Party B pays floating rate based on floating-rate index.
Net payment on notional amount on payment dates.
Use
Convert floating-rate exposure to fixed-rate exposure, or vice versa.
Lock in fixed rate (paid or received) to achieve cash flow certainty or to
monetise interest rate view.
Hedge basis risk through swap between two floating indices.
16Major heading
THB Floating Rate Indices
THBFIX : Market standard floating rate index
Reuters page “THBFIX”, 11:00 BKK time
BIBOR : Bangkok Interbank Offered Rate
Reuters page “BOT101”, www.bot.or.th, 11:00 BKK time
MLR : Average MLR of 4 largest local banks (BBL, KBANK, SCB, KTB)
www.bot.or.th, 15:00 BKK time
Fixed Deposit Rate (FDR) : Average of 6-month fixed deposit rate from 4
largest local banks (BBL, KBANK, SCB, KTB)
www.bot.or.th, 15:00 BKK time
17Major heading
Interest Rate Swap (IRS)
Swap BIBOR FRN into Fixed-Rate Loan
INVESTOR BANK
BOND
Receives
Fixed Rate
Pay Floating
BIBOR Rate
Pay Floating
BIBOR Rate
THB
18Major heading
Interest Rate Swap (IRS)
Swap Floating-Rate Loan into Fixed-rate Loan
COMPANY BANK
BOND
Receives
Fixed Rate
Pay Floating
BIBOR Rate
Pay Floating
BIBOR Rate
THB
19Major heading
Interest Rate Swap (IRS)
Variations
Swaps against other floating rate indices (e.g. BIBOR, T-Bill rate)
Accrete or amortise notional amount to match underlying exposure
Add spread to floating leg
In arrears swap : fixing of floating leg occurs at the end of each period
Change spread on fixed or floating rate to match interest rate view or
reduce carry
20Major heading
IRS Trading Mechanism
4% 4% 4%
PVCF
PVCF4% 5% 6%3%
Expected yield
Bond fixed rate
Party A pays 4% fixed rate in the market.
Market rate adjusts upward to 4.5%.
A B
4%
4.5%
21Major heading
IRS Trading Mechanism
4% 4% 4%
PVCF
PVCF3.5% 4% 4.5%3%
Expected yield
Bond fixed rate
Party B receives 4% fixed rate in the market.
Market rate adjusts downward to 3.75%.
A B
4%
3.75%
22Major heading
BIBOR Fixing
BIBOR is the average of borrowing rates quoted by predetermined banks.
BIBOR is derived by eliminating the top and bottom quartiles of the quotes
and arithmetic-averaging the remaining quotes.
BIBOR is a reference rate which is fixed at 11:00 of each working day and
published by BOT at 11:15.
23Major heading
BIBOR Fixing
24Major heading
Basis Quotation
Tenor FDR MLR BIBOR
Bid Offer Bid Offer Bid Offer
1Y -1.05 -0.9 3.7 3.9 0.1 0.3
2Y -0.95 -0.8 3.8 4 0.1 0.3
3Y -0.85 -0.7 3.8 4 0.1 0.3
4Y -0.85 -0.65 3.8 4 0.1 0.3
5Y -0.85 -0.65 3.8 4 0.1 0.3
7Y -0.85 -0.6
10Y -0.85 -0.6
6M Fix 2.1125 6.87375 3.2975
25Major heading
IRS BIBOR
TenorIRS FDR MLR BIBOR
Bid Offer Bid Offer Bid Offer Bid Offer
1Y 3.27 3.30 2.25 2.40 7.00 7.20 3.40 3.60
2Y 3.40 3.43 2.48 2.63 7.23 7.43 3.53 3.73
3Y 3.52 3.55 2.70 2.85 7.35 7.55 3.65 3.85
4Y 3.60 3.63 2.78 2.98 7.43 7.63 3.73 3.93
5Y 3.67 3.70 2.85 3.05 7.50 7.70 3.80 4.00
6M FIX THBFIX 3.16
26Major heading
IRS BIBOR
Bid-offer spread of BIBOR IRS is wider than normal IRS.
Cash BIBOR market to become more active soon.
Illiquid and non-tradable cash borrowing and lending.
Illiquid and sizable in future market.
Banks need to allocate reserves for illiquid index.
Market players run basis risk among the curve.
27Major heading
IRS Curve
Drivers
Historical rate movement
Market view of future rate movement
Market demand and supply
28Major heading
MLR vs BIBOR vs FDR
29Major heading
Trading Ideas
Risk and Opportunity in BIBOR vs MLR : market may misprice given
market demand and supply.
BIBOR swap allows investors to achieve higher return than fixed rate
bond
BIBOR swap is a better hedge if client wants to pay fixed rate
BIBOR can move faster than MLR in tightening cycle
MLR fixed rate at historical high offers investment opportunity
Make no sense to convert to fixed
30Major heading
BIBOR Futures
31Major heading
BIBOR Futures
Eurodollar futures (ED)
A future contract based on eurodollar deposits.
Prices are determined by expected 3-month USD LIBOR that are
expected to prevail on settlement date.
Settlement price is 100 minus 3-month LIBOR fixing on settlement date.
32Major heading
BIBOR Futures
3-Month BIBOR Futures
Underlying : 3-month BIBOR
Size : 10,000,000 Baht / contract
Settlement : 2 nearest quarter months (March, June, September,
December)
Quote : 100 – Yield
1 Tick = 0.005 → 125 Baht / contract
Limit : + 2.50% of previous-day settlement price
33Major heading
Trading Hours
Pre-open : 9:15 - 9:45
Morning session : 9:45 - 12:30
Pre-open : 14:00 - 14:30
Afternoon session : 14:30 - 16:00
Position Limit : net 2,000 contracts of 3M BIBOR Futures on one side of the
market in any contract month or all contract months combined.
Last Trading Day : 3rd Wednesday of contract month
Trading on expiring series cease after 11:00 on last trading day.
Final Settlement Price: 3-month BIBOR fixing at 11:00 BKT on the last trading
day
Cash Settlement
BIBOR Futures
34Major heading
Hedging with BIBOR Futures
Case 1 :
Bank uses BIBOR futures to lock in interest rate today for future borrowing/lending.
Bank buys BB3 Sep11 contract at 96.65 (implied 3-month BIBOR = 3.35%).
Later, 3-month BIBOR is 3.50%.
Bank makes a loss of 3.35%-3.50% = 0.15%
Bank loses 15 bps but can lend at a rate higher than the implied forward of 15
bps.
35Major heading
Hedging with BIBOR Futures
Case 2 :
Client uses BIBOR Futures to lock in interest rate today for future borrowing/lending.
Client sells BB3 Sep11 contract at 96.60 (implied 3-month BIBOR = 3.40%).
Later, 3-month BIBOR is 3.50%.
Client gains 3.40%-3.50% = 0.10%
Client gains 10 bps to offset borrowing cost that is higher than the current
implied forward of 10 bps.
36Major heading
BIBOR Future
BIBOR Future Day DF FRA Contract Price
1M 3.0425 31 0.9974 1 x 4 3.2781 96.72
2M 3.1025 62 0.9948 2 x 5 3.3441 96.66
3M 3.1925 91 0.9921 3 x 6 3.3583 Sep 96.64
4M 3.2246 122 0.9893 4 x 7 3.3837 96.62
5M 3.2567 153 0.9865 5 x 8 3.4044 96.6
6M 3.2888 182 0.9839 6 x 9 3.4152 Dec 96.58
7M 3.3092 215 0.9809 9 x 12 3.4928
8M 3.3296 245 0.9781
9M 3.3500 274 0.9755 3.5500 96.45
12M 3.4075 365 0.967
Example: 3M Discount factor (DF) =
3M FRA =
365
90
31
1
BIBORM
90180
1365
6
3
MBIBOR
MBIBOR
DF
DF
37Major heading
Forward Contract
Forward Rate Agreement (FRA)
Over-the-counter (OTC) forward contract
Specify interest rate and notional amount to be paid or received on an
obligation beginning at a future start date (expiration date).
Similar to futures but with more customized tenor e.g. 1x4, 1x7, 3x6, 3x9,
6x12 and 12x18
38Major heading
Forward Contract
Forward Rate Agreement (FRA)
Notation Effective Date Termination Date Underlying Rate
1 x 4 T + 1M T + 4M 4-1 = 3-month LIBOR
1 x 7 T + 1M T + 7M 7-1 = 6-month LIBOR
3 x 6 T + 3M T + 6M 6-3 = 3-month LIBOR
3 x 9 T + 3M T + 9M 9-3 = 6-month LIBOR
6 x 12 T + 6M T + 12M 12-6 = 6-month LIBOR
12 x 18 T + 12M T + 18M 18-12 = 6-month LIBOR
39Major heading
Q + A
40Major heading
Any other questions, please contact …
Rate Trading Desk
Derivatives : 02-724-8830-31
Teerapol Rattakul (Pom) / Pichanun Aranyanark (Om)
Bonds : 02-724-8820-22
Nopadol Prateepratana (Nop) / Pathamaporn Tankanit (Dew)
Assets and Liabilities Management (ALM) Desk
at 02-724-8825-7 and 724-8953-5
Aramsri Choowongse, CFA (Pui)
Achavaphol Chabchitrchaidol, CFA (Ome)
Wanthicha Kanjanaouthai, CFA (Toey)
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