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Systems Support
Basix Online -www.basixfx.com
Treasury Reviews
Currency Risk Management
Interest Rate Risk Management
Training
Commodity Price Risk
Management
Basix Forex & Financial Solutions
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Basix Forex & Financial Solutions Pvt.Ltd.
UNDERSTANDINGFOREX MARKETS
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Global Foreign Exchange Market
Facilitates
Cross border trade in goods & services
Financial & Investment flows
Borrowing & Lending
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The largest market in the world
More than 10 times the average daily turnover of global equitymarkets
More than 35 times the average daily turnover of the NYSE
Nearly $500 a day for every man, woman, and child on earth
An annual turnover more than 10 times world GDP
The spot market accounts for just under one-third of daily
turnover
Global Foreign Exchange Market
$3.2 trillion average daily turnover, equivalent to:
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The US & UK markets account for just over 50% of turnover
Major markets: London, New York, Tokyo
Trading activity is heaviest when major markets overlap
Nearly two-thirds of NY activity occurs in the morning hours
while European markets are open
Major Markets
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Round-the-clock market
Three major time zones
Sunday 5pm EST through Friday 4pm EST. Rollover at 5pm EST Trading begins in New Zealand, followed by Australia, Asia, the
Middle East, Europe, and America
Positions get passed from one time zone to another
Major banks operate 24-hour desks
Overnight orders can be placed
Global Foreign Exchange Market
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9:30p.m8:30p.m6:00p.m1:30p.m12:30p.m7:30a.m6:30a.m4:30a.m
Los Angeles
London Zurich
Mumbai9:00a.m7:30a.m
DubaiHong kong
11:30a.m
Tokyo12:30p.m
Singapore11:30a.m
Sydney1:30p.m
7:30p.m
10:30p.m3:30a.m
4:30a.mN.York9:30p.m
Chicago
Global Forex Market
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Other features
More than 90% of the turnover is speculative
Market lot $ 3 mn to $ 5 mn
US $ predominant currency of trade (86% of total trade)
Reuters, Bloomberg & EBS big facilitators
Electronic market
OTC market
Global Foreign Exchange Market...
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Global Foreign Exchange Market
Players
Individuals
Commercial banks
Institutional players
Pension Funds
Insurance Cos.
Trusts and postal
savings Mutual Funds
Hedge Funds
Corporates
Central banks Brokers
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Indian Forex Market
Daily volume approximately $ 34 bn
Market lot $ 1.0 mio
9:00 a.m - 5:00 p.m market
Main centres - Mumbai, Kolkata, Delhi, Chennai
Real market only in USD/INR - other currency rates are
derived
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Indian Forex Market.
Participants
Individuals
Corporates and FIIs Banks and FIs
RBI
Brokers
Forward market active upto 1 year
Getting more integrated with money markets
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Economic
Growth prospects
Current Account balance
Investment outlook and
reforms scenario
Inflation and Interest rates
Budget deficit / surplus
Political
Factors Affecting Exchange Rates
Technical
Psychological / Sentiment /
Speculation
Random shocks (Gulf war/ U.K.
ERM entry)
Resource discoveries
Exchange rate policy/Central bankintervention
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Relative Inflation
Nominal Exchange rates of major trading partners and
competitors Budget Deficit
Current Account Deficit
Politics
Ratings Investment outlook for India
Factors affecting Rupee exchange rates
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Capital Flows
FDI/FII/NRI
GDR/ECB
Official Transactions
Reserves
Herd Mentality - Leads & Lags
Random Shocks - Unexpected Events (Pokhran/Kargil)
RBI policy
Factors affecting Rupee exchange rates
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Exchange Rate Quotations
Direct Quote
USD/INR 48.75/76
USD/JPY 91.35/38
Buy Dollar at 48.75 and Sell Dollar at 48.76
Indirect Quote
EUR/USD 1.4650/55GBP/USD 1.6651/53
Sell Dollars 1.4650 against 1 euro
Buy Dollars 1.4655 against 1 euro
Direct Quote Indirect Quote
Variable Unit Home Currency Foreign Currency
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Delivery - Value Dates
Cash/Ready - Settlement today
Tom - Settlement on the next working day
Spot - Settlement on the 2nd working day
Forward - Settlement any date beyond spot
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Interest Parity Principle
Currency with lower interest rate will be at a premium
Currency with higher interest rate will be at a discount
Forward rate is no indication of future spot rate
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Purchase and Sale Transaction
Spot Dollar / Rupee : 48.75 48.76
From Bankers point of viewPurchase - Bank acquires foreign currency and parts
with home currency at 48.75
Sale - Bank parts with foreign currency and acquires
home currency at 48.76
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Forward Contracts
Booking
Delivery
Cancellation - Automatic cancellation
Rollover
Early Delivery
h l
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Exchange Control Aspects
Existence of a genuine underlying exposure
No Doc proof required up to higher of last 3 years avg or last years
imp/exp turnover
Choice of currency & tenor left to customer Maturity of cover should not exceed maturity of transaction
No restrictions on rebooking cancelled contracts in respect of export
and cross-currency exposures.
No limit on rebooking cancelled contracts in respect of payableexposures falling due within one year. Contracts booked to cover
exposures due beyond 1 year cant be rebooked after cancellation.
Details in prescribed format to be submitted to Bank
E h C l A
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Exchange Control Aspects
Transactions involving cross currencies remain out of the purview of
this rule
The customer can be given the facility of booking a single forward
contract for several orders provided that the receivables are in the same
currency and the likely cash flow period falls within the same contract
period
Banks are allowed to permit substitution of export contracts if
circumstances so warrant Exporters are allowed to deliver exchange representing a portion of the
export value in part utilisation of the forward contract
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Financial Derivatives
A derivative is like a razor. You can use it toshave yourself. Or you can use it to commitsuicide.
- James Morgan, Financial Times
Fi i l D i i
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Derivatives are off balance sheet products that enable a
corporate to hedge risks arising out of its core business in
terms of FX, interest rates or commodities
So called because their value is derived from basic products
like the forward exchange cover and dependent on
underlying assets like bonds, stocks, and commodities
Financial Derivatives
T Fi i l D i i
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Firm Derivatives
Optional Derivatives
Types - Financial Derivatives
Fi D i ti
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Forward Rate Agreements
Interest Rate Swaps
Currency Swaps
Single Rate Forward Contract
Firm Derivatives
O ti l D i ti
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Currency Options
Caps & Floors
Collars
Options on FRAs
Swaptions
Optional Derivatives
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Forward Rate Agreement
Wh FRA ?
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What are FRAs?
It is an agreement between two parties that determines
the forward interest rate that will apply to an agreed
notional principal (loan or deposit amount) for a specifiedperiod.
The Buyer ( or the Seller) of the FRA compensates the
Seller (or the Buyer) any difference between the agreed
rate and the cash rate prevailing on the start date of the
specified period
B i t t f FRA
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Basic structure of an FRA
Deal dateFixing date
Interest taken
from cash market
Period of depo
Maturity dateSettlement date
F t f FRA
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Features of a FRA
It is an off balance sheet transaction.
Allows forward fixing of rates
Transactions can be closed at any stage before expiry. Interest difference between the FRA rate and the cash rate is
settled at the beginning of the agreed period.
Can be tailor made to meet specific requirements.
FRAs are used to eliminate interest rate risk
A borrower buys the FRA while a lender sells the FRA.
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Interest Rate Swaps
An Interest Rate Swap
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is an off-balance sheet contract
between two counter parties
to exchange a stream of payments (interest obligations)
on specified dates
based on a notional principal
An Interest Rate Swap
B i Ch t i ti IRS
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Contractual agreement
Exchange a series of cash flows
Over a period of time
Not in itself either a borrowing or lending
No exchange of principal
The size of the swap is referred to as the notionalamount and is the basis for calculation
Basic Characteristics - IRS
I t t R t S
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Interest Rate Swap
Borrower
Lender
Swap C/P
Floating
Fixed
Floating
T f IRS
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Standard Swap
One side is Fixed stream of interest while the other side is Floatingstream of interest linked to an index
Basis Swap
Both the streams of interest payments are linked to two different
indices.
Fixed rate
Floating rate
CorporateBank
Floating rate
CorporateBank
Types of IRS
I t t R t O ti
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Interest Rate Options
Interest Rate Cap
Interest rate caps protect floating rate borrowers from upward
movements in rates, as a maximum rate can be reserved by the buyer of
the option Interest Rate Floor
Interest rate floors protect floating rate lenders from downward
movements in rates, as it guarantees a minimum rate
Interest rate CollarA collar is a simultaneous purchase and sale of a cap and a floor. It can
be a zero cost option by way of selling and buying the option
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Currency Swaps
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Currency Swap transactions
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Currency Swap could be any of the following between two
currencies
Fixed to Fixed Rate
Fixed Rate to Floating Rate (and vice-versa)
Floating rate to Floating Rate (based on different
benchmarks) Basis Swap
Currency Swap transactions
Regulations
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Approvals
Internal approval (Board authorisation required) and
adequate control systems should be in place
Documentation
ISDA (International Swap and Derivatives Dealers
Association) Master Document supported by individual deal
confirmations Capital Adequacy
as per RBI guidelines
Regulations
Corporates Existing Liability
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Corporates Existing Liability
Corporate's underlying borrowing
Currency USD
Principal Amount $ 10 mn
Maturity 5 years bullet
Interest rate payable bythe Corporate
USD 6M LIBOR + X % p.a.
Interest payment dates Mar 15, Jun 15, Sept 15 and Dec 15
Appetite for ExchangeRisk
Low
Can enter into a Currency Swap or Principal only swap or
Coupon only Swap
Illustration Currency Swap
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CorporateDraw down of $10 mn
Pays $10 mn
Receives Rs 49.5 cr.
Dollar
Loan
Swap Counterparty
6m Libor + spread
Pays INR fixed (8%)
Receives USD floating
6m Libor
CorporateSwap CounterpartyExisting
$ Loan
CorporateRepays $10 mn
Receives $10 mn
Pays Rs 49.50 cr.
Swap CounterpartyDollar
Loan
Interest payment dates: Exchange interest flows @ Spot rate of the initial exchange (49.50)
On Maturity : Exchange of Principals Mandatory@ Spot rate of the initial exchange (49.50)
On Start Date : Exchange flows @ Spot rate prevailing on swap date (39.50)
Illustration - Currency Swap
Illustration Principal only Swap
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CorporateReceives $10 mn
Pays $10 mn
Receives Rs 49.50 cr.Existing
$ Loan
Swap Counterparty
CorporatePays $10 mn
Receives $10 mn
Pays Rs 49.50 cr.
Swap CounterpartyExisting
$ Loan
Interest payment dates: No Exchange of interest flows
On Maturity : Exchange of Principals Mandatory @ Spot rate of the initial exchange (49.50)
On Start Date : Exchange flows @ Spot rate prevailing on swap date (49.50)
Illustration Principal only Swap
Coupon only Swap
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Coupon payments in one currency is swapped into fixed
or floating coupon payments in another currency
To take advantage of views on interest and exchange
rates of the two currencies
Notional Principal Amount
No Exchange Risk on Principal
Coupon only Swap
Illustration Coupon only Swap
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6m LIBOR
CorporateSwap Counterparty
Lender
1yr IRS (4.24%)
Corporate has an existing loan benchmarked
to 6m LIBOR for a tenure of say 1 year
If corporate has a view Libor is set to
increase, it can enter into a swap deal where
by;
Corporate receives floating- 6m Libor
Corporate will pay fixed say the one-year IRS rate
Illustration - Coupon only Swap
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CURRENCY OPTIONS
What is an Option?
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Holder buys theright but not the obligationto
buy or sell an agreed amount of an underlying
currency / commodity at a predetermined price,
over a specified time period.
What is an Option?
Forward Contract vs Options
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Forward Contract vs Options
Forward Contracts Options
Fixes the rate irrevocably Cannot take advantage
of favorable movement
in the rate
No upfront costs
Protects the downside Can let the option lapse
& take advantage of spot
rate
Premium payable
upfront
Option Terminologies
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Call Option
Gives the holder the right but not the obligation to
BUY an underlying at a fixed price from the writer of
the option
Put Option
Gives the holder the right but not the obligation to
SELL an underlying at a fixed price to the writer of
the option
Option Terminologies
Risk / Profit Profile
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Buyer Seller
Profit Unlimited Premium
Loss Premium Unlimited
Risk / Profit Profile
Types of Option
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American Option
May be exercised at any time during the life of a contract
European Option
May be exercised only at maturity or expiry date
Types of Option
Price of an option
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Premium
It is the price of an option, paid by the buyer / holder tothe writer / seller
Usually paid upfront
Price of an option
Strike Price or Exercise Price
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The fixed price at which the option holder has the right to
buy or sell the underlying currency.
Strike Price or Exercise Price
Expiry Date
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The last day on which the option may be exercised
Expiry Date
Life or Exercise Period
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The period of time during which the option holder enjoys the
right to exercise under the option contract
Life or Exercise Period
In The Money
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The option isIn the Money when the Strike Price is favourable to
the option holder in relation to the current market rate.
Illustration:
A USD Call option has a strike of 49.15. The current forward
market is 49.60
The option is said to be In-the-Money
In The Money
Out of The Money
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The option is Out of the Money when the Strike Price is
unfavourable to the option holder in relation to the current
market rate.
Illustration:
A USD call option has a strike of 49. The current forward
market is 47.60.
The option is said to be Out of the Money
Out of The Money
At The Money
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The option isAt the Money when the Strike Price is equal
to the current market rate.
Illustration:
A USD call option has a strike of 49.60. The current
forward market is 49.60.
The option is said to be At the Money
At The Money
Factors determining Premium Value
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:Pricing
Model
Strike Price
Underlying Price
Time to Expiry
Interest Rate
Volatility
Premium
Factors determining Premium Value
OTC and Exchange Traded Options
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Over the Counter (OTC)
Options negotiated between writer and buyer, and traded
bilaterally.
Exchange Traded
Standardized options traded on a Central Exchange, where
the underlying is often a futures contract. These types of
options have standard instrument/quality, expiry date andcontract amount.
They also have standard strike price intervals
OTC and Exchange Traded Options
Options available in the market
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Plain Vanilla options
Low cost options
Zero Cost options
Range Forward options
Knock in /Knock out (Barrier) options
Average rate options
Options available in the market
Regulations
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Currency Options can be used for genuine exposures or
contingent exposures like tender bids
The amount & maturity of an option hedge cannot exceed theamount & maturity of the underlying exposure
Corporate cannot be a net receiver of premium
Option deals can be freely booked and cancelled.
Regulations
Documentation
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Copy of Board Resolution authorizing duly approved
documented policy on currency risk management and specific
personnel to enter into derivative transactions and authorizing
signing of relevant documents
ISDA Master Agreement (International Swap Dealers
Association Master Agreement)
Copy of underlying exposure
Deal confirmation
Documentation
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Any Questions?
Presenter :
Mr. K. N. Dey
Director, Basix Forex & Financial Sol. Pvt. Ltd.