Docstoc

Risk

Document Sample
Risk Powered By Docstoc
					Risk Management and Basel II




         31.10.11




                               1
What is Risk ?
   Risk is something that can jeopardize
    businesses overnight eg server failure.
    Technical risk
   Can ruin a brand image built up over
    years in moments eg bad customer
    service ;an operational risk
   Can take a business from profits to
    losses e.g with small variation in a key
    variable.. Interest.                       2
    How do banks make money?
 By playing “term” of funds: Long v/s
  short.
Risks are:
 Interest risk

 Trading risk

 Asset quality risk etc.



…..
                                         3
4
         CAPITAL ADEQUACY RATIO
Objectives of CAR : The fundamental objective behind the norms
is to strengthen the soundness and stability of the banking system.

Capital Adequacy Ratio or CAR or CRAR : It is ratio of capital
fund to risk weighted assets expressed in percentage terms i.e.

Minimum requirements of capital                fund    in   India:
*Existing Banks 09 %
•New Private Sector Banks 10 %
•Banks undertaking Insurance business 10 %
•* Local Area Banks 15%

Tier I Capital should at no point of time be less than 50% of the
total capital. This implies that Tier II cannot be more than 50% of
the total capital.                                                    5
      Risk Definition and features
Risk:
Event likely to cause loss/variability/damage to income
  and reputation
Features:
 Fairly known- Cannot be avoided.

 Probabilistic and generic

 Ascertainable, although not always quantifiable

 Essential for intermediation process.

 Risk and Reward go together

 Interrelated/ Collectively exhaustive but not
  mutually exclusive


                                                     6
Generic and Unique risks

    Industry
    Unit/firm/company related
    Location specific
    Ownership related
    Sector specific
    HRD/Structure related

                                 7
              Sources of Risk

   Decision ,Indecision      Political compulsions
   Business cycles/          Regulations
    Seasonality               Human resources,
   Economic/Fiscal            skill sets
    changes                   Competition
   Policy Changes            Technology
   Market movements          Non-availability of
   Events                     information

                                                  8
            Types of Risks
   Credit: Default/delay: Impacts Solvency-
    Capacity to service obligation,
   Liquidity: Inability to meet committed
    payments, inability to exit an investment.
   Interest Rate: Changes in the market rate
    causing income variability
   Exchange: Fluctuation in currency rates,
    prices becoming adverse for the company
   Market: Interplay of above on trading profits
   Legal: Unpredictable
   Operational: Failure of Men, Machine,
    Monitoring, Methods                             9
 The global financial regulatory framework is
       undergoing important changes…

         Market Risk
                            USA PATRIOT
         Credit Risk            ACT


       Operational
          Risk




                             FATF
    Basel II            RECOMMENDATIONS




 Risk Management       Anti-Money Laundering   Corporate Governance


…and money laundering and corporate governance issues have
    become entwined with operational risk management
                                                                      10
        Goals of risk Management
Safety and soundness of
  banks.
Ensuring a level playing
  field.

Capital Adequacy Ratio
(1) own funds (i.e.
  available capital and
  reserves)
(2) risk-weighted assets
  (i.e. the amount of
  money the bank has
  put at risk in the
  course of its business)


                            A level playing field !!
                                             Source: BIS
                                                           11
How to manage risk
   Hedging
   Exposure limits
   Reserves and Provisioning




                                12
Basel I
   IRAC norms- uniform across
    institutions, products and performance
   Capital adequacy- Uniform across the
    commercial banking- coop banking will
    catch up shortly




                                             13
Lessons Of Basel I
   Better NPA Management- varieties of
    ways
   New Institutions ( ARC) Laws ( Sarfaesi)
   Almost all banks and RRBs in good
    financial health- meet CRAR norms
   Explosion of new- customer centric
    products
   More employment.
                                         14
   Hierarchy of Financial Risks


                                                                               “Specific
                                                                                  Risk”
                                                 Equity Risk    Trading Risk
                        Market Risk                                            General
                                          Interest Rate Risk
                                                                                Market
                                                                   Gap Risk       Risk
  Financial                                   Currency Risk
                         Credit Risk
      Risks                                 Commodity Risk
                                                                Counterparty
                        Operational                                     Risk
                               Risk
                                            Transaction Risk
                                                                 Issuer Risk
                                                  Portfolio
                                             Concentration
                                                       Risk     Issue Risk




* From Chapter-1, “Risk Management” by Crouhy, Galai and Mark
Basel II
   Primarily for internationally active banks
   RBI will take view on other banks- It is safe
    that all banks comply
   CRAR @ 8%on risk weight. But weights
    and loss estimates differ-
   Basel II is capital accord. Other risk
    management norms will happen
   F.M says “ Indian Banks will need
    additional 60,000 Crores in the next few
    years”- to meet with growth needs.

                                               16
The New Basel Capital Accord


                 Three Basic Pillars




     Minimum                                  Market
                         Supervisory
       Capital                             Discipline
                       Review Process
  Requirement                           Requirements



                                                        17
          Three Pillars of Basel II

                          Supervisory
 Minimum Capital            Review                   Market Discipline
             The new Basel Accord is based on Three Pillars

Advanced        Focus on
 methods for      internal
 capital          capabilities
 allocation      Supervisors to                    Focus on
                  review banks                       disclosure
Capital charge
 for operational  internal
 risk             assessment
                  and strategies

                                                                         18
    Supervisory Review _ Four
    Principles- Pillar 2

   Banks must attain solvency relative to their risk
    profile
   Supervisors should review each bank‟s own risk
    assessment & capital strategies
   Banks should maintain excess of minimum
    capital
   Regulators would intervene at an early stage
   Possibility of rewarding banks with better risk
    management systems.
   RBI has already taken steps to conduct
    supervisory review
                                                    19
Market Discipline- Pillar 3
   Improved disclosure of
      Capital structure

      Risk measurement and

       management practices
      Risk profile

      Capital adequacy


                              20
              Credit Risk -Approaches
Criteria      Standard    I. R. B
                          Foundation    Advanced

Rating        External    Internal      Internal

Risk weight Calibrated    Function      Function
            on ratings    provided by   provided by
            by Basel      Basel         Basel
            Committee     Committee     Committee

Probability   Implicitly  Provided by Provided by
of default    provided by bank on own bank on own
              Basel       estimates   estimates
              Committee                               21
              Credit Risk Approaches

Criteria     Standardized   I.R.B
                            Foundation    Advanced

Exposure     Supervisory    Supervisory Provided by
at Default   values         values      bank on
             provided by    provided by own
             Basel          Basel       estimates
Loss given   Implicitly     Implicitly  Provided by
default      provided by    provided by bank own
             Basel on       Basel on    estimates
             external       external
             estimates      estimates




                                                 22
             Credit Risk Approaches

Criteria     Standardize   I.R.B
             d             Foundation     Advanced
                           All included   All types of
Risk                       in             Collaterals
mitigation   Defined by    standardize    if
             Regulator.    d +            Bank can
                           Receivables    prove by
                           for goods      internal
                           and            estimation
                           Services,
                           Other
                           physical
                           Securities
                           subject to
                           criteria



                                                         23
          Computation of Capital
                Standardized
               No change over 1988


                Foundation
Market Risk     No change over 1988
                in VaR

                Advanced
                No change over 1988
                in VaR




                                      24
              Computation of Capital
                  Standardized
                  Capital change based on
                  single risk indicator

                  Foundation
Operational       Capital based on business
   Risk           lines and industry standards

                  Advanced
                  Capital based on business
                  lines and internally
                  calculated standards



                                                 25
           Operational Risk Approaches

Approach         Basic Indicator   Standardized         Advanced
                                                        Measurement

Calculation of      Average of        Gross income       Capital charge
Capital charge   Gross Income      per regulatory       equals internally
                 for three years   line as indicator    generated
                 as indicator          Depending on    measures based
                    Capital       business line 12,    on,
                 charge equals     15 or 18 % of the    Internal loss data
                 15% of the        indictor as          External loss data
                 indicator         capital charge       Scenario analysis
                                       Total capital   Business
                                   charge equals        environment and
                                   sum of charge        internal control
                                   per business line    factors
                                                           Recognition of
                                                        risk mitigation
                                                        (upto 20%)




                                                                             26
        Decision areas for Banks
   Choice of methodology and convincing the
    regulators
   IT supports needed
   Software requirements
   Staff training on compliance
   Consultancy requirements
   Risk mitigation opportunities
   Outsourcing possibilities
   New jobs creation
   Implementation cost and time
                                          27
BASLE II IS ALL ABOUT A RESPONSIVE AND
SOPHESTICATED RISK MANAGEMENT SYSTEM

   R = Risk = Function of Uncertainty U
   U = Function of Quality Information QI
   QI = Function of Accuracy/ Timeliness/
        Relevance/ Adequacy A, T, R, Ad
   A = Function of IT
   T = Function of IT
   R and Ad = Function of IT, Management
              Science, Modeling amenable to
    establish mathematical relationship

                                              28
        Risk Management – a data intensive function

                               Credit Risk           Market Risk       Operational Risk
          Banks


                             Borrower Data         Data on              Loss Event
                             Guarantor Data         Exchange              Data
                             Asset-specific         Rates                Causal Data
Transaction Data              Data                  Data on              Loss Effect
                             Default Data           Interest Rates       Key Risk
Operational CRM Data         Data on               Data on               Indicators
                              Recoveries             Security Prices       (KRIs)
                             External Default      Data on              Proxies
Analytical CRM Data
                              Data                   Correlations         Risk
                             Data on Rating        Data on               Inventories
Risk Management Data
                              and Migration          Instruments          Structured
                                                     (non-linear)          Self
Economy & Industry Data      Macro & Industry
                              Data                                         Assessment
                             Correlation Data                             Data
                                                                                       29
                                                                          External Data
             Basle Accord and IT

   Basle II promises significant business
    benefits to those who have systems in
    place to access and utilize far more
    detailed and precise information
   Integration of data on finance, operations
    and risk management necessary
   Opportunity to get out of legacy systems
    and procedures including IT system
   Fundamental rethinking on how a bank’s
    data and information is provided and
    controlled
   Pillars are interdependent and must be
    addressed to concurrently
                                                 30
            Basle Accord and IT
Internal Rating based approaches revolve around
   Probability of default
   Loss given default
   Exposure at default
   Other parameters
Main requirements would include
   Defining and capturing loss data
   Capturing and extracting exposure data
   Identifying and capturing risk mitigation data
Data issues would be
   Sources/ Data types/ Quality requirements and
   Granularity (level of data)


                                                    31
         Basle Accord and IT
Operational Risk Management pre-supposes
 Framework and systems in data

  integration
 Low frequency-high severity occurrences

 Structure for risk management and

  interaction amongst functionaries
 Potential for mitigation, outsourcing and

  alike issues
 Shared facilities feasibility

 More synergy and little overlap


                                              32
33
Integrated Treasury
   Integrated Treasury refers to integration of
    money market, securities market and foreign
    exchange operations.
    -Meeting reserve requirements
    -Efficient merchant services
    -Global cash management
    -Optimizing profit by exploiting market
    opportunities in forex market, money market
    and securities market
    -Risk management
    -Assisting bank management in ALM
Treasury
Money Market
   Certificate of Deposit (CD)
   Commercial Paper (C.P)
   Inter Bank Participation Certificates
   Inter Bank term Money
   Treasury Bills
   Call Money
Certificate of Deposit
   CDs are short-term borrowings in the form of
    Usance Promissory Notes having a maturity
    of not less than 15 days up to a maximum of
    one year.
   CD is subject to payment of Stamp Duty
    under Indian Stamp Act, 1899 (Central Act)
   They are like bank term deposits accounts.
    Unlike traditional time deposits these are
    freely negotiable instruments and are often
    referred to as Negotiable Certificate of
    Deposits
        Features of CD
   CDs can be issued by all scheduled commercial
    banks except RRBs
   Minimum period 15 days
   Maximum period 1 year
   Minimum Amount Rs 1 lac and in multiples of
    Rs. 1 lac
   CDs are transferable by endorsement
   CRR & SLR are to be maintained
   CDs are to be stamped
Commercial Paper
   Commercial Paper (CP) is an unsecured
    money market instrument issued in the
    form of a promissory note.
   Who can issue Commercial Paper
    (CP)
     Highly rated corporate borrowers,
    primary dealers (PDs) and satellite
    dealers (SDs) and all-India financial
    institutions (FIs)
Eligibility for issue of CP

a)   the tangible net worth of the company, as per the
     latest audited balance sheet, is not less than Rs. 4
     crore;
b)    (b) the working capital (fund-based) limit of the
     company from the banking system is not less
     than Rs.4 crore
c)    and the borrowal account of the company is
     classified as a Standard Asset by the financing
     bank/s.
Rating Requirement
   All eligible participants should obtain the
    credit rating for issuance of Commercial
    Paper
    Credit Rating Information Services of India
    Ltd. (CRISIL)
   Investment Information and Credit Rating
    Agency of India Ltd. (ICRA)
   Credit Analysis and Research Ltd. (CARE)
    Duff & Phelps Credit Rating India Pvt. Ltd.
    (DCR India)
    The minimum credit rating shall be P-2 of
    CRISIL or such equivalent rating by other
    agencies
Maturity
   CP can be issued for maturities between
    a minimum of 15 days and a maximum
    upto one year from the date of issue.
    If the maturity date is a holiday, the
    company would be liable to make
    payment on the immediate preceding
    working day.
To whom issued
CP is issued to and held by individuals,
 banking companies, other corporate
 bodies registered or incorporated in
 India and unincorporated bodies, Non-
 Resident Indians (NRIs) and Foreign
 Institutional Investors (FIIs).
Repo
   Uses of Repo
    It helps banks to invest surplus cash
    It helps investor achieve money market
    returns with sovereign risk.
    It helps borrower to raise funds at better
    rates
    An SLR surplus and CRR deficit bank can use
    the Repo deals as a convenient way of
    adjusting SLR/CRR positions simultaneously.
    RBI uses Repo and Reverse repo as
    instruments for liquidity adjustment in the
Meaning of Repo
   It is a transaction in which two parties agree
    to sell and repurchase the same security.
    Under such an agreement the seller sells
    specified securities with an agreement to
    repurchase the same at a mutually decided
    future date and a price
   The Repo/Reverse Repo transaction can only
    be done at Mumbai between parties approved
    by RBI and in securities as approved by RBI
    (Treasury Bills, Central/State Govt securities).
Coupon rate and Yield
 The difference between coupon rate
 and yield arises because the market
 price of a security might be different
 from the face value of the security.
 Since coupon payments are calculated
 on the face value, the coupon rate is
 different from the implied yield.
Example
   10% Aug 2015 10 year Govt Bond
   Face Value RS.1000
   Market Value Rs.1200
   In this case Coupon rate is 10%
   Yield is 8.33%
Call Money Market
The call money market is an integral part
  of the Indian Money Market, where the
  day-to-day surplus funds (mostly of
  banks) are traded. The loans are of
  short-term duration varying from 1 to
  14 days.
 The money that is lent for one day in this
  market is known as "Call Money", and if
  it exceeds one day (but less than 15
  days) it is referred to as "Notice Money".
Call Money Market
    Banks borrow in this market for the
    following purpose
   To fill the gaps or temporary
    mismatches in funds
   To meet the CRR & SLR mandatory
    requirements as stipulated by the
    Central bank
   To meet sudden demand for funds
    arising out of large outflows.
Factors influencing interest
rates
  The factors which govern the interest rates
  are mostly economy related and are
  commonly referred to as macroeconomic
  factors. Some of these factors are:
1) Demand for money
2) Government borrowings
3) Supply of money
4) Inflation rate
5) The Reserve Bank of India and the
  Government policies which determine some
  of the variables mentioned above.
Gilt edged securities

 The term government securities encompass
 all Bonds & T-bills issued by the Central
 Government, and state governments. These
 securities are normally referred to, as "gilt-
 edged" as repayments of principal as well as
 interest are totally secured by sovereign
 guarantee.
Treasury Bills
  Treasury bills, commonly referred to as T-
 Bills are issued by Government of India
 against their short term borrowing
 requirements with maturities ranging
 between 14 to 364 days.
 All these are issued at a discount-to-face
 value. For example a Treasury bill of Rs.
 100.00 face value issued for Rs. 91.50 gets
 redeemed at the end of it's tenure at Rs.
 100.00.
Who can invest in T-Bill

 Banks, Primary Dealers, State
 Governments, Provident Funds,
 Financial Institutions, Insurance
 Companies, NBFCs, FIIs (as per
 prescribed norms), NRIs & OCBs can
 invest in T-Bills.
What is auction of
Securities
 Auction is a process of calling of bids
 with an objective of arriving at the
 market price. It is basically a price
 discovery mechanism
Debenture
   A Debenture is a debt security issued by
    a company (called the Issuer), which
    offers to pay interest in lieu of the
    money borrowed for a certain period.
   These are long-term debt instruments
    issued by private sector companies.
    These are issued in denominations as
    low as Rs 1000 and have maturities
    ranging between one and ten years.
Difference between debenture
and bond
 Long-term debt securities issued by the
 Government of India or any of the State
 Government’s or undertakings owned
 by them or by development financial
 institutions are called as bonds.
 Instruments issued by other entities are
 called debentures.
Current yield

 This is the yield or return derived by the
 investor on purchase of the instrument (yield
 related to purchase price)
 It is calculated by dividing the coupon rate by
 the purchase price of the debenture. For e. g:
 If an investor buys a 10% Rs 100 debenture
 of ABC company at Rs 90, his current Yield on
 the instrument would be computed as:
 Current Yield = (10%*100)/90 X 100 , That is
 11.11% p.a.
Primary Dealers & Satellite
Dealers

   Primary Dealers can be referred to as
    Merchant Bankers to Government of India,
    comprising the first tier of the government
    securities market. Satellite Dealers work in
    tandem with the Primary Dealers forming the
    second tier of the market to cater to the retail
    requirements of the market.
   These were formed during the year 1994-96
    to strengthen the market infrastructure
What role do Primary Dealers
play?


 The role of Primary Dealers is to;
 (i) commit participation as Principals in
 Government of India issues through
 bidding in auctions
 (ii) provide underwriting services
 (iii) offer firm buy - sell / bid ask quotes
 for T-Bills & dated securities
 (v) Development of Secondary Debt
 Market
OMO
   OMO or Open Market Operations is a
    market regulating mechanism often
    resorted to by Reserve Bank of India.
    Under OMO Operations Reserve Bank of
    India as a market regulator keeps
    buying or/and selling securities through
    it's open market window. It's decision
    to sell or/and buy securities is
    influenced by factors such as overall
    liquidity in the system,
YIELD CURVE

   The relationship between time and yield
    on a homogenous risk class of securities
    is called the Yield Curve. The
    relationship represents the time value
    of money - showing that people would
    demand a positive rate of return on the
    money they are willing to part today for
    a payback into the future
SHAPE OF YIELD CURVE
 A yield curve can be positive, neutral or flat. A
 positive yield curve, which is most natural, is
 when the slope of the curve is positive, i.e. the
 yield at the longer end is higher than that at the
 shorter end of the time axis. This results, as people
 demand higher compensation for parting their
 money for a longer time into the future. A neutral
 yield curve is that which has a zero slope, i.e. is
 flat across time. T his occurs when people are
 willing to accept more or less the same returns
 across maturities. The negative yield curve (also
 called an inverted yield curve) is one of which the
LIBOR

   LIBOR stands for the London Interbank
    Offered Rate and is the rate of interest at
    which banks borrow funds from other banks,
    in marketable size, in the London interbank
    market.
   LIBOR is the most widely used "benchmark"
    or reference rate for short term interest rates.
    It is compiled by the British Bankers
    Association as a free service and released to
    the market at about 11.00[London time] each
    day.
CRR & SLR
 The minimum and maximum levels of CRR
 are prescribed at 4% and 26% of demand
 and term liabilities (DTL) of the bank,
 respectively, under Reserve Bank of India Act
 of 1934. The minimum and maximum SLR are
 prescribed at 25% and 40% of DTL
 respectively, under Banking Regulation Act of
 1949. The CRR and SLR are to be maintained
 on fortnightly basis. The RBI is authorized to
 increase or decrease the CRR and SLR at its
 discretion.
Demand and Time Liabilities
               Main components of DTL are:
   Demand deposits (held in current and savings
    accounts, margin money for LCs, overdue fixed
    deposits etc.)
   Time deposits (in fixed deposits, recurring
    deposits, reinvestment deposits etc.)
   Overseas borrowings
   Foreign outward remittances in transit (FC
    liabilities net of FC assets)
   Other demand and time liabilities (accrued
    interest, credit balances in suspense account etc. )
SLR
    SLR is to be maintained in the form of
    the following assets:
   Cash balances (excluding balances
    maintained for CRR)
   Gold (valued at price not exceeding
    current market price)
   Approved securities valued as per
    norms prescribed by RBI.
VaR
 Value at Risk (VaR) is the most probable
 loss that we may incur in normal market
 conditions over a given period due to the
 volatility of a factor, exchange rates, interest
 rates or commodity prices. The probability of
 loss is expressed as a percentage – VaR at
 95% confidence level, implies a 5%
 probability of incurring the loss; at 99%
 confidence level the VaR implies 1%
 probability of the stated loss. The loss is
 generally stated in absolute amounts for a
 given transaction value (or value of a
VaR
 The VaR is an estimate of potential loss, always for a
 given period, at a given confidence level.. A VaR of 5p
 in USD / INR rate for a 30- day period at 95%
 confidence level means that Rupee is likely to lose 5p in
 exchange value with 5% probability, or in other words,
 Rupee is likely to depreciate by maximum 5p on 1.5
 days of the period (30*5% ) . A VaR of Rs. 100,000 at
 99% confidence level for one week for a investment
 portfolio of Rs. 10,000,000 similarly means that the
 market value of the portfolio is most likely to drop by
 maximum Rs. 100,000 with 1% probability over one
 week, or , 99% of the time the portfolio will stand at or
 above its current value.
Exchange Rate Quotation
 Exchange Quotations :
There are two methods
 Exchange rate is expressed as the price per unit of
  foreign currency in terms of the home currency is
  known as the “Home currency quotation” or “Direct
  Quotation”
 Exchange rate is expressed as the price per unit of
  home currency in terms of the foreign currency is
  known as the “Foreign Currency Quotation” or
  “Indirect Quotation”
 Direct Quotation is used in New York and other
  foreign exchange markets and Indirect Quotation is
  used in London foreign exchange market.
Principles
   Direct Quotation: Buy Low, Sell High:
   The prime motive of any trader is to make profit. By
    purchasing the commodity at lower price and selling
    it at a higher price a trader earns the profit. In
    foreign exchange, the banker buys the foreign
    currency at a lesser price and sells it at a higher
    price.
   Indirect Quotation: Buy High, Sell Low:
   A trader for a fixed amount of investment would
    acquire more units of the commodity when he
    purchases and for the same amount he would part
    with lesser units of the commodity when he sells.
Spot and Forward
Transactions


   „A‟ Bank agrees to buy from „B‟ Bank
    USD 100000. The actual exchange of
    currencies i.e. payment of rupees and
    receipt of US Dollars, under the contract
    may take place :
   on the same day or
   two days later or
   some day later, say after a month.
Interpretation of Quotation
   The market quotation for a currency consists
    of the spot rate and the forward margin. The
    outright forward rate has to be calculated by
    loading the forward margin into the spot rate.
    For example US Dollar is quoted as under in
    the inter-bank market on a given day as
    under :
   Spot               1 USD = Rs.44.1000/1300
   Spot/November                      0200/0500
   Spot/December                     1500/1800
TT Buying Rate
   TT Buying Rate (TT stands for Telegraphic
    Transfer)
   This is the rate applied when the
    transaction does not involve any delay in
    realization of the foreign exchange by the
    bank. In other words, the nostro account
    of the bank would already have been
    credited. The rate is calculated by
    deducting from the inter-bank buying rate
    the exchange margin as determined by the
    Bank.
Bills Buying Rate


   This is the rate to be applied when a
    foreign bill is purchased. When a bill is
    purchased, the proceeds will be realized
    by the Bank after the bill is presented to
    the drawee at the overseas center. In
    the case of a usance bill the proceeds
    will be realized on the due date of the
    bill which includes the transit period
    and the usance period of the bill.
Problem
You would like to import machinery from USA
  worth USD 100000
to be payable to the overseas supplier on 31st
  Oct
[a] Spot Rate           USD = Rs.45.8500/8600
Forward Premium
September 0.2950/3000
October 0.5400/5450
November 0.7600/7650
[b] exchange margin 0.125%
[c] Last two digits in multiples of nearest 25
  paise
Solution
This is an example Forward Sale Contract .
Inter Bank Spot Selling Rate Rs. 45.8600
Add Forward Margin                  .5450
                            --------------
                                 46.4050
Add Exchange Margin                  .0580
                            ---------------
Forward Rate                     46.4630
Rounded Off to multiple of 25 paise
  Rs.46.4625
Amount Payable to the bank
  Rs.46,46,250
Swap
   A swap agreement between two parties
    commits each counterparty to exchange
    an amount of funds, determined by a
    formula, at regular intervals, until the
    swap expires.
   In the case of a currency swap, there is
    an initial exchange of currency and a
    reverse exchange at maturity.
Mechanics
   Firm A needs fixed rate loan –AAA
    rated
   Firm B needs floating rate    -A rated
   Firm A enjoys an absolute advantage in
    both credit markets.
                                  Firm A   Firm B
                         Fixed-
                          rate    9%       11%
                        finance
                       Floating- LIBOR LIBOR
                          rate
                        finance +0.0% +1%
Mechanics
STEP !
Firm A will borrow at Fixed rate 9%
Firm B will borrow at floating rate (LIBOR +1)%
STEP 2
Firm A will pay Floating rate [LIBOR] to Firm B
Firm B will Pay Fixed rate [9.5%] only

Gain
Net interest cost LIBOR- .5%
Net Interest cost 9+[ 1%+0.5%]=10.5%
Mechanics payments to each
     Interest
              other in years t 1 to t 7.
 Gain
         A                                 B
                       9.5%
Borrows at                                      Borrows at
   9.0%                                        LIBOR + 1%
   fixed              LIBOR                       floating
for 7 years                                     for 7 years
THANK YOU




            81

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:5
posted:12/23/2011
language:
pages:81