Documents
Resources
Learning Center
Upload
Plans & pricing Sign in
Sign Out

Forex and Debt Market Derivatives-0496-Raju

VIEWS: 726 PAGES: 109

									Study on Forex and Debt Market Derivatives

Project report submitted to Bangalore University towards the partial fulfillment of the requirement for the award of MBA Degree.

Submitted by
Raju.s Reg.No: 04XQCM6069

Guide
Prof,Santhanam

M.P. BIRLA INSTITUTE OF MANAGEMENT Associate Bharatiya Vidya Bhavan # 43, Race Course Road Bangalore – 560 001

1

Acknowledgement
Words are indeed and inadequate to convey my deep sense of gratitude to all those who had made to this report successfully. I wish to acknowledge with profound sense of appreciation to the help and support I received from Prof,Santhanam and Guide, M.P.Birla Institute of Management for providing the valuable guidance and suggestions for completing this project report. I owe a great debt of gratitude to my parents and other members of my family for having helped me achieve my objective. I would be failing in my duty if I do not acknowledge my friends who have helped me in completing this report.

2

Declaration
I Mr. Raju.s student of M.P.Birla Institute of Management, Associate Bharatiya Vidya Bhavan, studying 4th semester MBA hereby declare that this project report entitled “Study on forex and debt market Derivatives ” has been prepared by me during academic year 2005-06 in the partial fulfilment of Master Degree of Business Administration. I also hereby declare that this project report has not been submitted anytime to any other University or Institute for the award of any Degree or Diploma.

Date: Place: (Raju.s)

3

PRINCIPAL’S CERTIFICATE

This to certify that this report titled “Study on forex and Debt market Derivatives” has been prepared by Mr. Raju.s bearing the registration No.04XQCM6069, under the guidance and supervision of Pro.Santhanam, MPBIM, Bangalore.

Place: Date: Principal (Dr.N.S.Malavalli)

4

GUIDE’S CERTIFICATE

This is to certify that mr. Raju.s, bearing reg no.04XQCM6069 has prepared a report titled “Study on forex and Debt market Derivetives under my guidance. This has not formed the basis for the award of any degree/diploma for any university.

Place: Date:
( Raju.s)

5

Executive Summary
Derivatives are one of the instruments in the hands of the investors which are useful in fulfilling the needs of investors. This can be either to hedge the risk of the underlying or to take a speculative view and make profits or losses and arbitrage opportunities. This entirely speaks about the derivatives, its uses and the ways how the individuals, banks and corporate use this instrument to make huge profit. To make huge profit they want to take same amount of risk.

The topic of dissertation is Study on Forex and Debt market derivatives. This study entirely speaks about the ways in which the interest rate risk is hedged like interest rate futures, interest rate options, forward rate agreements and swaps, the reasons for fluctuation in interest rates, the hedge ratio that is to be used and different ways of calculating the hedge ratio like Market Value Naïve Model, Face Value Naïve Model, Hedge Ratio, Regression Model, price sensitivity model and others.

Further the study carries towards the introduction of options, the ways how the options are helpful in hedging the risk so that the profit is also reaped with less loss which occurs by paying premium. The strategies used in the options like straddle, strangle, bull spread, bear spread, and butterfly spread. It further carries towards the Black Scholes Model and the assumption made by him for calculating the prices of the options and it also speaks regarding the Delta, Gamma, Vega, RHO and Theta.

Then the study explains about the currency risk which is faced by most of the exporters, importers and to those who deal in forex market and it gives a solution how the currency risk can be hedged by using the currency futures and currency options. The factors which play the major role in determining exchange rate and the three important theories on exchange rate i.e., Interest rate parity, Purchase power parity and Fishers theory.

6

Swaps, which are more efficient than interest rate futures, currency futures, interest rate options and currency options. The various swaps used by the individual, banks and corporate to hedge the interest rate risk and currency risks and the use of interest rate swaps and currency swaps to corporate.

For most of the explanation there is a real life example how the interest rate futures and currency futures are traded in Chicago Mercantile Exchange. Based on the study there are two questioners for two different risks that is interest rate risk and currency risk. This questioners speaks about the India’s position in interest rate futures and options and currency futures and options.

At last with findings with the reasons as to why interest rate futures thinly traded in India and reasons as to why the currency risk is the most unhedged risk in India. And at the same time the conclusion which talks about the steps to be taken by the RBI and SEBI in respect how to increase the trading in Interest rate futures and options and currency futures and options

7

TABLE OF CONTENTS
Declaration Certificate by Guide Acknowledgement Executive Summary Chapter No 1 2 2.1 2.2 2.3 2.4 2.4.1 2.4.2 2.4.6 2.4.6.1 2.4.6.2 3 3.1 3.2 3.3 3.4 3.5 3.6 4 4.1 4.2 4.3 5. 5.1 5.2 5.3 5.3.1 5.3.2 Introduction to derivatives Introduction to Forward and Futures Introduction to Forward contracts Introduction to Futures Distinction between futures and forwards Futures Prices Cost-of-carry model in perfect markets The reverse cash-and-carry Payoff for derivatives contracts Payoff for a buyer of Nifty futures Payoff for a seller of Nifty futures Hedging Strategies Face Value Naive Model Market Value Naive Model Conversion Factor Model Basis Point Model Regression Model Price Sensitivity Model Interest Rate Futures Treasury-Bill Futures Eurodollar Futures Long term Treasury Futures Currency Futures Currency Exchange Risk Currency Future with example Three Theories of Exchange Rate Purchase Power Parity (PPP) International Fisher Effect (IFE) Title Page no 1 3 3 3 3 4 4 5 9 9 9 10 10 10 10 10 11 11 13 13 14 16 18 18 18 21 21 21

8

5.3.3

Purchasing Power Parity and Exchange Rate Determination

22

5.3.4 5.3.5 5.3.6 5.3.7 6 6.1 6.2 6.3 6.3.1 6.3.2 6.3.3 6.3.4 6.4 6.5 7. 7.2 7.2.1 7.2.2 7.2.3 7.2.4 7.2.5 7.3 7.4 8. 8.1 8.2 8.2.1 8.2.2 8.2.3 8.3

Interest Rate Parity IRP and Covered Interest Arbitrage IRP and Hedging Currency Risk IRP and a Forward Market Hedge Options Introduction Option Terminology The Four Basic Option Trades Long Call Long Put Short Call (Naked short call) Short Put Introduction to Option Strategies Black Scholes Option Model Interest Rate Derivatives Points of Interest: What Determines Interest Rates? Supply and Demand Expected Inflation Economic conditions Federal Reserve Actions Fiscal Policy Interest Rate Predictions Forward rate agreement (FRA) Interest rate options Hedging Pre-Issue Pricing Risk for Fixed-Rate Debt Hedging Solutions Caps-Hedging against rising interest rate Floors-Hedging against falling interest rate Treasury collars Hedging A Large Debt Issue

23 24 24 25 26 26 27 28 28 29 31 32 33 34 37 37 38 38 39 39 39 40 40 42 42 43 43 44 44 45

9

8.4 8.5 8.6

Options on interest rate futures Futures positions after option exercise. Trading Example: Hedging with Options on CME Interest Rate Futures

45 47 47

9. 9.1 9.2 10. 10.1 10.2 10.3

Currency Options Introduction Hedging with Options Swaps Introduction Interest Rate Swap Manage interest rate risk with a solution tailored to match a specific risk profile

49 49 49 53 53 53 53

10.4 10.5 10.6 10.7 10.8 10.9 10.10 10.11 11. 11.1 12. 13. 14. 15.

Why Use Swaps? Interest Rate Swaps An IRS can also be used to transform assets Swaps for a comparative advantage Swaps for Reducing the Cost of Borrowing Currency Swaps A plain vanilla foreign currency swap Swaption Research Design Questionnaire Analysis and Interpretation Findings Conclusion Bibliography

54 54 56 56 58 60 61 61 63 64 74 90 93 96

10

Graphs
Figure no. 1. Particulars Depicts the ways in which Banks/Firms have hedged there interest rates. 2 3 4 5 6 Depicts the counterparty risk faced by banks/firms Depicts the reasons for the thin trade in the Indian Interest rate futures market. Depicts that number of contracts has been increased due to the CCIL’s proposal to settle FRA and IRS. Depicts the different strategy used by the Banks and Corporate to Hedge the interest rate risk. Depicts the various methods used by the Banks and Corporate to reduce the duration of Portfolio/Balance Sheet Depicts the favourable reasons given by respondents to enter with forwards than futures. Depicts arbitrage opportunity exist with option pricing but due to the transaction cost this disappears. Depicts the various variables the respondents look at while trading in Option. Depicts the basis points which the respondent expects above the term structure of interest rate because it does not accommodate tax status, default risk, call option and liquidity risk Depicts option adjusted spread will accommodate the risks which term structure does not consider. Depicts the responses given by respondents when they asked about if they would like to lend and borrow 6 months down the line. Depicts the various features which force the respondents to enter into swaps. Comparison between to Interest rate swaps currency swaps. Depicts the factors which influence pricing the swaps. Depicts the various derivative products used by the banks and corporate to hedge the risks like default risk, basis risk, mismatch risk and interest rate risk. Depicts most of the respondents agree that swaps are superior to interest rate futures and options. Depicts swap dealers enter into Interest rate futures and options which has created more liquidity in bond markets. Depicts the favourable reasons for the investor’s preference to purchase structured notes. 74 75 76 76 77 Page no. 74

7 8 9 10

77 78 78 79

11 12

79 80

13 14 15 16

80 81 81 82

17 18 19

82 83 83

11

20 21

22 23 24

25 26 27 28 29 a 29b

Depicts the favourable reasons for the issuers to issue structured notes. Depicts the features available in the interest rate swaps which the respondents ranked according to there preference. Depicts the features available in the currency swaps which the respondents ranked according to there preference Depicts that 100% respondent banks and firms trade in foreign exchange. Depicts the various type of arbitrage opportunity the bank/firms come across when they trade in foreign currency. Depicts the exchange rate systems which the respondents liked Depicts the factors which are important in determining the exchange rate. Depicts does FDI’s and FII’s should be allowed to hedge there foreign exchange in India. Depicts does inflows will increase if FII’s and FDI’s are allowed to hedge there foreign exchange in India Depicts the various reasons for the currency risk which is most un hedged risk in India. Depicts the various reasons for the currency risk which is most un hedged risk in India.

84 84

85 85 86

86 87 87 88 89 89

12

1. Introduction to derivatives
A derivative is a financial instrument which derives its value from some other financial price. This “other financial price” is called the underlying. A wheat farmer may wish to contract to sell his harvest at a future date to eliminate the risk of a change in prices by that date. The price for such a contract would obviously depend upon the current spot price of wheat. Such a transaction could take place on a wheat forward market. Here, the wheat forward is the “derivative” and wheat on the spot market is “the underlying”. The terms “derivative contract”, “derivative product”, or “derivative” are used interchangeably. The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking–in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by lockingin asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors.

Derivative products initially emerged as hedging devices against fluctuations in commodity prices, and commodity-linked derivatives remained the sole form of such products for almost three hundred years. Financial derivatives came into spotlight in the post-1970 period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by 1990s, they accounted for about two-thirds of total transactions in derivative products. In recent years, the market for financial derivatives has grown tremendously in terms of variety of instruments available, their complexity and also turnover. In the class of equity derivatives the world over, futures and options on stock indices have gained more popularity than on individual stocks, especially among institutional investors, who are major users of index-linked derivatives. Even small investors find these useful due to

13

high correlation of the popular indexes with various portfolios and ease of use. The lower costs associated with index derivatives vis–a–vis derivative products based on individual securities is another reason for their growing use.

1.1 Products: Forwards, Futures, Options and Swaps.

1.2 Participants: Hedgers, Speculators, and Arbitrageurs

1.3 Functions

1. Prices in an organized derivatives market reflect the perception of market participants about the future and lead the prices of underlying to the perceived future level. The prices of derivatives converge with the prices of the underlying at the expiration of the derivative contract. Thus derivatives help in discovery of future as well as current prices. 2. The derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them. 3. Derivatives, due to their inherent nature, are linked to the underlying cash markets. With the introduction of derivatives, the underlying market witnesses higher trading volumes because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk. 4. Speculative trades shift to a more controlled environment of derivatives market. In the absence of an organized derivatives market, speculators trade in the underlying cash markets. Margining, monitoring and surveillance of the activities of various participants become extremely difficult in these kinds of mixed markets. 5. An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity. The derivatives have a history of attracting many bright, creative, well-educated people with an entrepreneurial attitude. They often energize others to create new businesses, new products and new employment opportunities, the benefit of which are immense 6. Derivatives markets help increase savings and investment in the long run. Transfer of risk enables market participants to expand their volume of activity.

14

2. Introduction to Forward and Futures
2.1 Introduction to Forward contracts In a forward contract, two parties irrevocably agree to settle a trade at a future date, for a stated price and quantity. No money changes hands at the time the trade is agreed upon. Suppose a buyer L and a seller S agrees to do a trade in 100 grams of gold on 31 Dec 2005 at Rs.5, 000/ten gram. Here, Rs.5,000/tola is the “forward price of 31 Dec 2005 Gold”. The buyer L is said to be long and the seller S is said to be short. Once the contract has been entered into, L is obligated to pay S Rs. 500,000 on 31 Dec 2005, and take delivery of 100 gram of gold. Similarly, S is obligated to be ready to accept Rs.500,000 on 31 Dec 2005, and give 100 gram of gold in exchange.

2.2 Introduction to Futures A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contract is same as forward contracts. But unlike forward contracts, the futures contracts are standardized and exchange traded.

2.3. Distinction between futures and forwards

Futures Trade on an organized exchange Standardized contract terms Hence more liquid Requires margin payments Follows daily settlement

Forwards OTC in nature Customised contract terms Hence less liquid No margin payment Settlement happens at end of period

15

2.4 Futures Prices 2.4.1 Cost-of-carry model in perfect markets Assume that markets are perfect in the sense of being free from transaction costs and restrictions on short selling. The spot price of gold is $370. Current interest rates are 10 percent per year, compounded monthly. According to the cost-of-carry model, the price of a gold futures contract be if expiration is six months away is In perfect markets, the cost-of-carry model gives the futures price as: F0,t = S0 (1 +C) F0,t = the future price at t=0 for delivery at t=1 S0 = the spot price at time t=0 C = the cost of carry, expressed as a fraction of the spot price, necessary to carry the good forward from the present to the delivery date on the futures. The cost of carrying gold for six months is (1+.10/12)6- 1= .051053. Therefore, the futures price should be: F0, t =$370(1.051053) = $388.89

2.4.2 Consider the information of 4.1 given above. Now let us assume that futures trading costs are $25 per 100-ounce gold contract, and buying or selling an ounce of gold incurs transaction costs of $1.25. Gold can be stored for $.15 per month per ounce. (Ignore interest on the storage fee and the transaction costs.) What futures prices are consistent with the cost-of-carry model? Answering this question requires finding the bounds imposed by the cash-and-carry and reverse cash-and-carry strategies. For convenience, we assume a transaction size of one 100-ounce contract.

2.4.2.1 For the cash-and-carry, the trader buys gold and sells the futures. This strategy requires the following cash outflows:

Transactions Buy gold Pay transaction costs on the spot Pay the storage cost Sell futures

Cash flow -$370(100) -$1.25(100) -$.15(100) (6) 0

16

Borrow to finance these outlays Six months later, the trader must: Pay the transaction cost on one future Repay the borrowing Deliver on futures

-$37,215

-$25 -$39,114.95 ?

Net outlays at the outset were zero, and they were $39,139.95 at the horizon. Therefore, the futures price must exceed $391.40 an ounce for the cash-and-carry strategy to yield a profit.

2.4.2.2 The reverse cash-and-carry incurs the following cash flows. At the outset, the trader must: Particulars Sell gold Pay transaction costs on the spot Invest funds Buy futures Cash flows +$370(100) -$1.25(100) -$36,875 0

These transactions provide a net zero initial cash flow. In six months, the trader has the following cash flows:

Collect on investment Pay futures transaction costs Receive delivery on futures

+$36,875(1+.10/12)6= $38,757.59 -$25 ?

The breakeven futures price is therefore $387.33 per ounce. Any lower price will generate a profit. From the cash-and-carry strategy, the futures price must be less than $391.40 to prevent arbitrage. From the reverse cash-and-carry strategy, the price must be at least $387.33. (Note that we assume there are no expenses associated with making or taking delivery.)

2.4.3 Consider the information given in 2.4.1 and 2.4.2 above. Restrictions on short selling effectively mean that the reverse cash-and-carry trader in the gold market receives the use of only 90 percent of the value of the gold that is sold short. Based on this new information, what is the permissible range of futures prices? 17

This new assumption does not affect the cash-and-carry strategy, but it does limit the profitability of the reverse cash-and-carry trade. Specifically, the trader sells 100 ounces short but realizes only .9($370)(100) =$33,300 of usable funds. After paying the $125 spot transaction cost, the trader has $33,175 to invest. Therefore, the investment proceeds at the horizon are: $33,175(1+.10/12)6= $34,868.69.

Thus, all of the cash flows are: Sell gold Pay transaction costs on the spot Broker retains 10 percent Invest funds Buy futures +$370(100) -$1.25(100) -$3,700 -$33,175 0

These transactions provide a net zero initial cash flow. In six months, the trader has the following cash flows: Collect on investment Receive return of deposit from broker Pay futures transaction costs Receive delivery on futures $34,868.69 $3,700 – $25 ?

The breakeven futures price is therefore $385.44 per ounce. Any lower price will generate a profit. Thus, the no-arbitrage condition will be fulfilled if the futures price equals or exceeds $385.44 and equals or is less than $391.40.

2.4.4 Consider all of the information about gold from 2.4.1 to 2.4.3. The interest rate in question 2.4.1 is 10 percent per annum, with monthly compounding. This is the borrowing rate. Lending brings only 8 percent, compounded monthly. What is the permissible range of futures prices when we consider this imperfection as well?

The lower lending rate reduces the proceeds from the reverse cash-and-carry strategy. Now the trader has the following cash flows:

18

Transactions Sell gold Pay transaction costs on the spot Broker retains 10 percent Invest funds Buy futures

Cash flow +$370(100) -$1.25(100) -$3,700 -$33,175 0

These transactions provide a net zero initial cash flow. Now the investment will yield only $33,175(1+.08/12)6= $34,524.31. In six months, the trader has the following cash flows:

Transactions Collect on investment Pay futures transaction costs Receive delivery on futures Return gold to close short sale Receive return of deposit from broker

Cash flow $34,524.31 – $25 ? 0 $ 3,700

Total proceeds on the 100 ounces are $38,199.31. Therefore, the futures price per ounce must be less than $381.99 for the reverse cash-and-carry strategy to profit. Because the borrowing rate has not changed, the bound from the cash-and-carry strategy remains at $391.40. Therefore, the futures price must remain within the inclusive bounds of $381.99 to $391.40 to exclude arbitrage.

2.4.5 Consider all of the information about gold from 2.4.1 to 2.4.4. The gold future expiring in six months trades for $375 per ounce. Given all of the market imperfections we have considered assuming that gold trades for $395.

If the futures price is $395, it exceeds the bound imposed by the cash-and-carry strategy, and it should be possible to trade as follows:

19

Cash-and-Carry Arbitrage

t=0

Borrow $37,215 for 6 months at 10%. Buy 100 ounces of spot gold. Pay storage costs for 6 months. Pay transaction costs on gold purchase. Sell futures for Total Cash Flow

+$37,215.00 -37,000.00 -90.00 -125.00 $395. 0.00 $0

t=6

Remove gold from storage. Deliver gold on futures. Pay futures transaction cost. Repay debt. Total Cash Flow

$0 +39,500.00 -25.00 -39,114.95 -$360.05

If the futures price is $375, the reverse cash-and-carry strategy should generate a profit as follows:

Reverse Cash-and-Carry Arbitrage

t= 0

Sell 100 ounces of gold short. Pay transaction costs. Broker retains 10%. Buy futures. Invest remaining funds for 6 months at 8%. Total Cash Flow

+$37,000.00 -125.00 -3,700.00 0 -33,175.00 $0

t= 6

Collect on investment. Receive delivery on futures. Return gold to close short sale. Receive return of deposit from broker. Pay futures transaction cost.

-$34,524.31 -37,500.00 0 +3,700.00 -25.00

20

Total Cash Flow

+$699.31

2.4.6 Payoff for derivatives contracts
2.4.6.1 Payoff for a buyer of Nifty futures

The figure shows the profits/losses for a long futures position. The investor bought futures when the index was at 1220. If the index goes up, his futures position starts making profit. If the index falls, his futures position starts showing losses.

2.4.6.2 Payoff for a seller of Nifty futures The figure shows the profits/losses for a short futures position. The investor sold futures when the index was at 1220. If the index goes down, his futures position starts making profit. If the index rises, his futures position starts showing losses.

21

3. Hedging Strategies
Alex Brown has to hedge $500 million of long-term debt that his firm plans to issue in May. The possible strategies Alex Brown could use to hedge his impending debt issue.

3.1 Face Value Naive Model: In this method Alex would trade one dollar of nominal futures contract per one dollar of debt face value. The major benefit of this method is the ease of implementation. Unfortunately, it ignores market values and the differential responses of the bond and futures contract prices to interest rates.

3.2 Market Value Naive Model: In this method Alex would hedge one dollar of debt market value using one dollar of futures price value. That is, the hedge ratio is determined by the market prices instead of nominal and face values. Unfortunately, it does not consider the price sensitivities of the two instruments.

3.3 Conversion Factor Model: This model can be used when the hedging instrument is a T-note or T-bond futures contract. The conversion factor adjusts the prices of deliverable bonds and notes that do not have a 6% coupon to make them “equivalent” to the 6% coupon bond or note that is called for in the contract. The hedge ratio is determined by multiplying the Face Value Naive hedge ratio by the conversion factor. The appropriate conversion factor to use is the conversion factor of the cheapest to 22

deliver T-bond or T-note. This model still ignores price sensitivity differences between the hedging and hedged instruments. The hedge ratio is calculated as below. HR= - (Cash market principal/Futures market principal)*(Conversion Factor)

3.4 Basis Point Model: This model uses the price changes of the futures and cash positions resulting from a one basis point change in yields to determine the hedge ratio. It is calculated as:

This model works well if the cash and futures instruments face the same rate volatility. If they face different volatilities and that relationship can be quantified, then the basis point model can be adjusted to account for the differing volatilities.

3.5 Regression Model: In the regression model the historic relationship between cash market price changes and futures market price changes is estimated. This estimation is accomplished by regressing price changes in the cash market on futures price changes. The slope coefficient from this regression is then used as the hedge ratio. Alex may not find this model useful, as he is trying to hedge a new debt issue. Even if Alex had an historic price stream on 30-year corporate debt issues, the historic relationship with the futures price might prove to be an unreliable indicator of the present or future relationship. This stems from the fact that the price response of the futures contract is determined by the cheapest-to-deliver bond. The cheapest-todeliver bond can vary in maturity from 15 years to 30 years. This means that the futures contract can have very different price responses to interest rates at different points in time. For the RGR model the hedge ratio is: HR= - (COVs,f/Variance of futures) COVs,f = covariance between cash and futures.

3.6 Price Sensitivity Model: This may be a good model for Alex to use. It is designed for interest rate hedging, and it accounts for the differential price responses of the hedging and the hedged instruments. The model is duration-based so that it accounts

23

for maturity and coupon rate differences of the cash and the futures positions. It is computed as:

Where: FPF and Pi are the respective futures contract and cash instrument prices; MDi and MDF are the modified durations for the cash and futures instruments, respectively, and RYC is the change in the cash market yield relative to the change in the futures yield.

Let us look at an example. Alex Brown has just returned from a seminar on using futures for hedging purposes. As a result of what he has learned, he re-examines his decision to hedge $500 million of long-term debt that his firm plans to issue in May.

Face Value Naive hedge: In this model Alex current hedge is a short position of 5,000 T-bond futures contracts ($100,000 each). Currently Alex has employed a Face Value Naive hedge. For each dollar of debt principal he plans to issue, he is short $1 of nominal T-bond futures. The benefit of the strategy is its ease of implementation. The drawback is that cash instrument and the T-bond futures may have differential price responses to interest rate changes.

Price sensitivity hedge: Alex feels that a price sensitivity hedge would be most appropriate for his situation. The additional information is if the debt could be issued today, it would be priced at 119-22 to yield 6.5%. With its 8% coupon and 30 years to maturity, the duration of the debt would be 13.09 years. On the futures side, the futures prices are based on the cheapest-to-deliver bonds, which are trading at 124-14 to yield 5.6%. These bonds have duration of 9.64 years. The price sensitivity hedge ratio is:

FPF= 124.4375%*0.1 million Pi = 119.6875%_500 million

MDF= 9.128788 MDi = 12.29108

24

To hedge the risk, 6,475 contracts should be sold.

4. Interest Rate Futures
Interest rate futures were introduced in 1975 and were an immediate success. The volume represents about one half of all future market activity. Almost all of the trading in interest rate futures is at the Chicago Board of Trade and the International Money Market (IMM) of the Chicago Mercantile Exchange. 4.1 Treasury-Bill Futures The IMM T-Bill contract calls for the delivery of treasury bills with a face value of $1 million and 90 days to maturity at the expiration of the contract. The IMM uses a special code for stating the price of T-bills; i.e., the price is given by the IMM index which is 100-DY, where DY is the discount yield in percent. An alternative way of stating this relation for bills having a year until maturity is: PRICE OF CONTRACT = 1,000,000(1 - DY/100) If the T-bills have DTM days to maturity the price is given by: PRICE OF CONTRACT = 1,000,000(1 - (DY/100)(DTM/360)) For every change in the discount yield of one basis point (1/100 of 1 percent) the price of the contract changes by $25.

25

The price of a $1,000,000 face value 90-day T-bill has a discount yield of 8.75 percent. Applying the equation for the value of a T-bill, the price of a $1,000,000 face value Tbill is $1,000,000 -DY($1,000,000)(DTM)/360, where DY is the discount yield and DTM= days until maturity. Therefore, if DY=0.0875 the bill price is:

Bill Price= $1,000,000-{(0.0875 ($1,000,000) (90))/360} = $978,125

Let us look at one more example. The IMM Index stands as 88.70. If you buy a T-bill future at that index value and the index becomes 88.90, what is your gain or loss? The discount yield = 100.00- IMM Index = 100.00- 88.70 = 11.30 percent. If the IMM Index moves to 88.90, it has gained 20 basis points, and each point is worth $25. Because the price has risen and the yield has fallen, the long position has a profit of $25(20) = $500. 4.2 Eurodollar Futures Eurodollars are any dollar denominated deposit in a bank outside of the U.S. Thus dollar deposits in Singapore are still called Eurodollars. Eurodollar accounts are not transferable but banks can lend on the basis of the Eurodollar accounts it holds. The interest rate charged for Eurodollar loans is often based upon the London Inter bank Offer Rate (LIBOR). The Eurodollar contract on the IMM is also for $1 million. Since Eurodollar accounts are not transferable it is not possible to actually make delivery on Eurodollar contracts. Instead there is a cash settlement at the end of the contract period. In the case of Eurodollar contracts the discount yield is replaced by an add-on yield which is the interest earned in proportion to the original price. Thus, Add-on Yield = DY/(1 - DY/100)

CME Eurodollar Interest Rate Futures Example Suppose a financial manager of a company wishes to borrow US$10 million for 1 year at a fixed rate. She can ask a bank for a fixed rate for 1 year directly or a floating rate and seek to hedge using an interest rate futures (eg: the CME Eurodollar futures).

26

The value of a CME Eurodollar interest rate futures contract rises when interest rates fall and vice versa, hence the manager would need a short position to hedge. Hence if interest rates rise, the value of the contract falls and a short position is “in the money” (sold high, can buy back low). The notional principal of a CME Eurodollar interest rate futures contract is US$1million. The price of the CME Eurodollar interest rate futures contract at the maturity date is 100-R where R is the 90-day Libor interest rate that starts when the contract matures on the 3rd Wednesday or each delivery month. This interest rate is then the underlying variable for this contract. The value of the CME Eurodollar interest rate futures contract on any given day before it matures is given by the formula: 10000*[100-0.25(100-Z)] where Z is the price of the futures contract at that time – given by supply and demand! This implies that for each basis point move in the price, the contract value changes by US$25. E.g.: If Z = 94.32, V = 985,800 If Z = 94.33, V = 985,825 The contract is settled daily like any futures contract with variation margin payments. Suppose the company does not hedge and interest rates and interest payments (using 90/360 convention) turn out to be: Sep 15 Dec 15 Mar 15 Jun 15 1.89% 2.44% 2.75% 2.90% 47250 61000 68750 72500

Total interest rate cost = 249500 Suppose the financial manager hedges by selling US$10 million CME Eurodollar interest rate futures short for maturities Sep, Dec and Mar and the relevant prices are as follows: Prices at Maturity Today Spot Futs Sep Dec Mar 1.89% 2.08% (97.92) 2.54% (97.46) 3.18% (96.82) 97.60 (2.4%) 97.31 (2.69%) 97.15 (2.85%) Sep Dec Mar

This implies 27

VToday/Sep=10*10000*[100-0.25(100-97.92)]=9948000 VSep/Sep= 10*10000*[100-0.25(100-97.60)]=9940000 Profit = 8000 = 10*25*(9792-9760) VToday/Dec=10*10000*[100-0.25(100-97.46)]=9936500 VDec/Dec= 10*10000*[100-0.25(100-97.31)]=9932750 Profit = 3750 = 10*25*(9746-9731) VToday/Mar=10*10000*[100-0.25(100-96.82)]=9920500 VMar/Mar= 10*10000*[100-0.25(100-97.15)]=9932750 Profit = -8250 = 10*25*(9682-9715)

Total costs Interest costs as before Sep 15 Dec 15 Mar 15 Jun 15 1.89% 2.44% 2.75% 2.90% 47250 61000 68750 72500 249500 8000 3750 -8250 3500 (profit) Futures profit/loss

Total interest rate cost

Total costs 249500-3500 = 246000 4.3 Long term Treasury Futures Regardless of your market outlook, U.S. Treasury bond and note futures are the ideal tools to help you adjust the risk/return characteristics of your fixed income securities. Here are some of the many risk-management opportunities they offer. Lock in a Purchase Price: If you plan to purchase fixed-income securities in the futures and are concerned about the possibility of higher prices, you can buy Treasury futures and secure a maximum purchase price. Preserve Investment Value: By selling Treasury futures, you can lock in an attractive selling price and protect the value of a portfolio or individual security against possible decreasing prices.

28

Cross-Hedge: U.S. Treasury bond and note futures can be used to control risk and enhance the returns of non-U.S. government securities. Treasury futures can be effective risk-management tools for corporate bonds, Eurobonds, and other fixedincome instruments. Trade Changes in the Yield Curve Because Treasury futures cover a wide spectrum of maturities from short-term notes to long-term bonds, you can construct trades based on the differences in interest rate movements all along the yield curve. Contract Specifications: Trading Unit T-bond Futures - One U.S. Treasury bond with $100,000 face value at maturity. 10-year T-note Futures - One U.S. Treasury note with $100,000 face value at maturity. 5-year T-note Futures - One U.S. Treasury note with $100,000 face value at maturity. 2-year T-note Futures - One U.S. Treasury note with $200,000 face value at maturity. Deliverable Grades T-bond Futures- Bonds with at least 15 years remaining to maturity. 10-year T-note Futures- Notes with 61/2 to 10 years remaining to maturity. 5-year T-note Futures- Notes with 4 years 3 months to 5 years 3 months remaining to maturity. 2-year T-note Futures- Notes with 1 year 9 months to 2 years remaining to maturity.

29

Tick Size T-bond Futures - 1/32 10-year T-note Futures - 1/32 5-year T-note Futures - 1/2 of 1/32 2-year T-note Futures - 1/4 of 1/32

5. Currency Futures
5.1 Currency Exchange Risk How do currency fluctuations affect import/exporters? Exchange rate volatility can work against an international company if a payment in a foreign currency has to be made at a future date. There is no way to guarantee that the price in the currency market will be the same in the future-it is possible that the price will move against the company, making the payment cost more. On the other hand, the market can also move in a business' favour, making the payment cost less in terms of their home currency. Generally, firms that export goods to other countries benefit when their home currency depreciates, since their products become cheaper in other countries. Firms that import from other countries benefit when their currency becomes stronger, since it enables them to purchase more. Hedging Against Currency Risk to Avoid the Volatility Trap so how can a business protect against a risky currency? One way is to avoid the risk by minimizing their commercial involvement with countries that have volatile currencies like the Japanese Yen. This is however not a practical solution. Another way is to hedge in the spot currency market by taking a position that effectively neutralizes the volatility in the pair.

30

5.2 Currency Future: It is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the last trading date. Typically, one of the currencies is the US dollar. The price of a future is then in terms of US dollars per unit of other currency. This can be different from the standard way of quoting in the spot foreign exchange markets. The trade unit of each contract is then a certain amount of other currency, for instance EUR 125,000. Most contracts have physical delivery, so for those held at the end of the last trading day, actual payments are made in each currency. However, most contracts are closed out before that.

Example Peter buys 10 September CME Euro FX Futures, at 1.2713 USD/EUR. At the end of the day, the futures close at 1.2784 USD/EUR. The change in price is 0.0071 USD/EUR. As each contract is over EUR 125,000, and he has 10 contracts, his profit is USD 8,875. As with any future, this is paid to him immediately. More generally, each change of 0.0001 USD/EUR (the minimum tick size), is a profit or loss of USD 12.5 per contract. Investors use these futures contracts to hedge against foreign exchange risk. They can also be used to speculate and, by incurring a risk, attempt to profit from rising or falling exchange rates. Investors can close out the contract at any time prior to the contract's delivery date. Currency futures were first created at the Chicago Mercantile Exchange (CME) in 1972, less than one year after the system of fixed exchange rates was abandoned along with the gold standard. Some commodity traders at the CME did not have access to the inter-bank exchange markets in the early seventies, when they believed that significant changes were about to take place in the currency market. They established the International Monetary Market (IMM) and launched trading in seven currency futures on May 16, 1972. Today, the IMM is a division of CME. In the

31

second quarter of 2005, an average of 332,000 contracts with a notional value of USD 43 billion were traded every day. Most of these are traded electronically nowadays

A futures contract is like a forward contract it specifies that a certain currency will be exchanged for another at a specified time in the future at prices specified today. A futures contract is different from a forward contract. Futures are standardized contracts trading on organized exchanges with daily resettlement through a clearinghouse The Standardizing Features  Contract Size  Delivery Month  Daily resettlement Initial Margin (about 4% of contract value, cash or T-bills held in a street name at your brokers). Suppose you want to speculate on a rise in the $/¥ exchange rate (specifically you think that the dollar will appreciate).
U.S. $ equivalent Wed Tue 0.007142857 0.007194245 0.006993007 0.007042254 0.006666667 0.006711409 0.00625 0.006289308 Currency per U.S. $ Wed Tue 140 139 143 142 150 149 160 159

Japan (yen) 1-month forward 3-months forward 6-months forward

Currently $1 = ¥140. The 3-month forward price is $1=¥150.  Currently $1 = ¥140 and it appears that the dollar is strengthening.  If you enter into a 3-month futures contract to sell ¥ at the rate of $1 = ¥150 you will make money if the yen depreciates.  The contract size is ¥12,500,000  Your initial margin is 4% of the contract value: $3,333.33  .04  ¥12,500,000  $1 ¥150

If tomorrow, the futures rate closes at $1 = ¥149, then your position’s value drops. 32

Your original agreement was to sell ¥12,500,000 and receive $83,333.33 But now ¥12,500,000 is worth $83,892.62 $83,892.62  ¥12,500,000  $1 ¥149

You have lost $559.28 overnight

 The $559.28 comes out of your $3,333.33 margin account, leaving $2,774.05  This is short of the $3,355.70 required for a new position.
$1 ¥149 Your broker will let you slide until you run through your maintenance margin. Then $3,355.70  .04  ¥12,500,000 

you must post additional funds or your position will be closed out. This is usually done with a reversing trade.

5.3 Three Theories of Exchange Rate
5.3.1Purchase Power Parity (PPP) Focuses on inflation and exchange rate relationship if the law of one price was true for all goods and services, we could obtain the theory of PPP. It Postulates the equilibrium exchange rate between currencies of two countries is equal to the ratio of the price levels in the two nations. Prices of similar products of two different countries should be equal when measured in a common currency

For example if nation A is US and nation B is the UK the exchange rate b/w dollar and pound is equal to the ratio of US to UK prices. If the general price level in US is twice to the general level in UK, then the absolute PPP theory postulates equilibrium rate to be Rab = S 2/Stg 1 5.3.2 International Fisher Effect (IFE) IFE Uses Interest Rates rather than inflation rate difference to explain the changes in interest rates over time. IFE is closely related to PPP because interest rates are significantly correlated with inflation rates. The relationship b/w the percentage change in the spot exchange rates in different national capital markets is known as

33

IFE. IFE suggests that given two countries, the currency with the higher interest rates will depreciate by the amount of interest rate differential. This is with a country the nominal interest rate tends to approximately equal the real interest rate plus the expected inflation The proportion that the nominal interest rate varies directly with the expected inflation rate, known as Fisher effect has subsequently been incorporated into the theory of exchange rate determination. IRP is an arbitrage condition that must hold when international financial markets are in equilibrium. Suppose that you have $ 1 to invest over, say a one-year period. Consider two alternative ways of investing your fund. 1. 2. Invest domestically at the U.S interest rate or alternatively Invest in a foreign country, say the U.K. at the foreign interest rate and hedge the exchange risk by selling the maturity value of the foreign investment forward. An increase (decrease) in the expected rate of inflation will cause a proportionate increase (decrease) in the interest rate in the country.

For the U.S., the Fisher effect is written as: i$ = $ + E($) Where, $ is the equilibrium expected “real” U.S. interest rate E ($) is the expected rate of U.S. inflation i$ is the equilibrium expected nominal U.S. interest rate

If the Fisher effect holds in the U.S. i$ = $ + E($) and the Fisher effect holds in Japan, i¥ = ¥ + E(¥) and if the real rates are the same in each country $ = ¥ then we get the International Fisher Effect E(e) = i$ - i¥ . If the International Fisher Effect holds, E(e) = i$ - i¥ and if IRP also holds E(e)  (F - S) S
i$ -i¥  (F- S) S

then forward parity holds.

5.3.3 Purchasing Power Parity and Exchange Rate Determination

34

The exchange rate between two currencies should equal the ratio of the countries’ price levels. S ($/£) = P$ P£ Relative PPP states that the rate of change in an exchange rate is equal to the differences in the rates of inflation. e = $ - £ If U.S. inflation is 5% and U.K. inflation is 8%, the pound should depreciate by 3%. The real exchange rate is
q 1  $ (1  e)(1   £ )

If PPP holds, (1 + e) = (1 + $)/(1 + £), then q = 1. If q < 1 competitiveness of domestic country improves with currency depreciations. If q > 1 competitiveness of domestic country deteriorates with currency depreciations.

5.3.4 Interest Rate Parity IRP is an arbitrage condition. If IRP did not hold, then it would be possible for an astute trader to make unlimited amounts of money exploiting the arbitrage opportunity. Since we don’t typically observe persistent arbitrage conditions, we can safely assume that IRP holds. Suppose you have $100,000 to invest for one year. You can either 1. Invest in the U.S. at i$. Future value = $100,000(1 + ius) 2. Trade your dollars for yen at the spot rate, invest in Japan at i¥ and hedge your exchange rate risk by selling the future value of the Japanese investment forward. The future value = $100,000(F/S)(1 + i¥) Since both of these investments have the same risk, they must have the same future value—otherwise an arbitrage would exist. (F/S)(1 + i¥) = (1 + ius) Formally, (F/S)(1 + i¥) = (1 + ius) or if you prefer, 1  i$  F 1  i¥ S IRP is sometimes approximated as
(i$ -i¥ )  (F- S) S

If IRP failed to hold, an arbitrage would exist. It’s easiest to see this in the form of an example.

35

Consider the following set of foreign and domestic interest rates and spot and forward exchange rates. Spot exchange rate 360-day forward rate U.S. discount rate British discount rate S($/£) = $1.25/£ $1.20/£ 7.10% 11.56%

F360($/£) = i$ i£ = =

5.3.5 IRP and Covered Interest Arbitrage A trader with $1,000 to invest could invest in the U.S., in one year his investment will be worth $1,071 = $1,000(1+ i$) = $1,000(1.071) Alternatively, this trader could exchange $1,000 for £800 at the prevailing spot rate, (note that £800 = $1,000÷$1.25/£) invest £800 at i£ = 11.56% for one year to achieve £892.48. Translate £892.48 back into dollars at F360($/£) = $1.20/£, the £892.48 will be exactly $1,071. According to IRP only one 360-day forward rate, F360 ($/£), can exist. It must be the case that F360 ($/£) = $1.20/£ Why? If F360 ($/£)  $1.20/£, an astute trader could make money with one of the following strategies:

Arbitrage Strategy I If F360 ($/£) > $1.20/£ i. Borrow $1,000 at t = 0 at i$ = 7.1%. ii. Exchange $1,000 for £800 at the prevailing spot rate, (Note that £800 =$1,000÷$1.25/£) invest £800 at 11.56% (i£) for one year to achieve £892.48 iii. Translate £892.48 back into dollars, if F360 ($/£) > $1.20/£ , £892.48 will be more than enough to repay your dollar obligation of $1,071. Arbitrage Strategy II If F360 ($/£) < $1.20/£ i. Borrow £800 at t = 0 at i£= 11.56%. ii. Exchange £800 for $1,000 at the prevailing spot rate, invest $1,000 at 7.1% for one year to achieve $1,071.

36

iii. Translate $1,071 back into pounds, if F360($/£) < $1.20/£ , $1,071 will be more than enough to repay your £ obligation of £892.48. 5.3.6 IRP and Hedging Currency Risk You are a U.S. importer of British woolens and have just ordered next year’s inventory. Payment of £100M is due in one year. Spot exchange rate 360-day forward rate U.S. discount rate British discount rate S($/£) = $1.25/£

F360($/£) = $1.20/£ i$ i£ = 7.10% = 11.56%

IRP implies that there are two ways that you fix the cash outflow a) Put your self in a position that delivers £100M in one year—a long forward Form a forward market hedge as shown below.

contract on the pound. You will pay (£100M)(1.2/£) = $120M b)

5.3.7 IRP and a Forward Market Hedge To form a forward market hedge: Borrow $112.05 million in the U.S. (in one year you will owe $120 million). Translate $112.05 million into pounds at the spot rate S($/£) = $1.25/£ to receive £89.64 million. Invest £89.64 million in the UK at i£ = 11.56% for one year. In one year your investment will have grown to £100 million—exactly enough to pay your supplier.

Forward Market Hedge Where do the numbers come from? We owe our supplier £100 million in one year— so we know that we need to have an investment with a future value of £100 million. Since i£ = 11.56% we need to invest £89.64 million at the start of the year. £100 1.1156

£89.64 

How many dollars will it take to acquire £89.64 million at the start of the year if S ($/£) = $1.25/£? $1.00 $112.05  £89.64  £1.25 37

6. Options
6.1 Introduction: An option is a contract which gives its holder the right, but not the obligation, to buy (or sell) an asset at some predetermined price within a specified period of time. An option is a contract which gives its holder the right, but not the obligation, to buy (or sell) an asset at some predetermined price within a specified period of time. A real life example Suppose you are on your way to home one day and you notice that house at the end of the street is for sale. It’s bigger then your current house and has a double bed room. All this costs only $100,000. You’ve just got to buy it! One problem is money: you don’t have any… but within a couple of months, you think you could get it. So what do you do? Wait and risk losing the house to another buyer? Here is something you could do: let’s say you go down and see the owner of the house and explain your situation. He feels for your predicament and suggests that you pay a fee of $1,000. For that $1,000 he will hold the house for exactly two months and no longer. Should you wish to buy it, you will have to pay $100,000. This means your total cost is $100,000 + $1,000 = $101,000. You’ve just bought yourself a call option! Within the two months you can raise the money and buy the house. You could forget the deal all together and lose the $1000, but not be liable for anything else. Note paying the $1000 gives you the right but not the obligation to buy the house. The 38

owner of the house would be obliged to sell it to you should you so desire, but only before the two months are up. Let’s fast forward. Two months are almost up and you have managed to secure some finance. Paying the full price for the house is not a problem. However, you have just read in the newspaper that housing prices in your area have fallen in the last two months. Your dream house now has a $90,000 price tag. What do you do? Take up the option to buy it for $10,000 for more than it’s worth? Certainly not! You would be happy to let your option expire, losing the $1,000 deposit. You could however go and buy the house at the current market price of $90,000 and save the difference. However let’s say housing prices have increased and the house is really worth $110,000. What do you do? You would take up your option to buy at $100,000 and the seller would be obliged to sell it to you. In the markets, this is the same as exercising a call option. Hey, if you were so inclined, you could then sell the house at market price and make a handsome $9,000 profit ($110,000 - $101,000 = $9,000). Then again you might just want to live in it, but that’s beside the point. 6.2 Option Terminology  Call option: An option to buy a specified number of shares of a security within some future period.  Put option: An option to sell a specified number of shares of a security with in some future period.  Exercise (or strike) price: The price stated in the option contract at which the security can be bought or sold.  Option price: The market price of the option contract.  Expiration date: The date the option matures.  Exercise value (intrinsic value): The value of a call option if it were exercised today = Current stock price - Strike price. Note: The exercise (intrinsic) value is zero if the stock price is less than the strike price.  Seller of option is called Option Writer  Covered option: A call option written against stock held in an investor’s portfolio. Naked (uncovered) option: An option sold without the stock to back it up. 39

 In-the-money call: A call whose exercise (strike) price is less than the current price of the underlying stock.  Out-of-the-money call: A call option whose exercise (strike) price exceeds the current stock price.  LEAPs: Long-term Equity Anticipation securities that are similar to conventional options except that they are long-term options with maturities of up to 2 1/2 years.

Consider the following data:

Exercise (strike) price = $25. Stock Price $25 30 35 40 45 50 Call Option Price (Premium) $ 3.00 7.50 12.00 16.50 21.00 25.50

Price of Stock(a) 25.00 30.00 35.00 40.00 45.00 50.00

Strike

Exercise Value

Intrinsic Value Mkt. Price of Option (c) $ 0.00 5.00 10.00 15.00 20.00 25.00 of Option(d) $ 3.00 7.50 12.00 16.50 21.00 25.50

Time Value (d) - (c) $ 3.00 2.50 2.00 1.50 1.00 0.50

Price(b) of Option(a)-(b) $25.00 25.00 25.00 25.00 25.00 25.00 $0.00 5.00 10.00 15.00 20.00 25.00

40

6.3 The Four Basic Option Trades These trades are described from the point of view of a speculator. If they are combined with other positions, they can also be used in hedging. 6.3.1 Long Call :A trader who believes that a stock's price will increase may buy the stock or instead, buy the right to purchase the stock (a call option). He has no obligation to buy the stock, only the right to do so until the expiry date. If the stock price increases by more than the premium paid, he will profit. If the stock price decreases, he will let the call contract expire worthless, and only lose the amount of the premium.

41

The figure shows the profits/losses for the buyer of a three-month Nifty 1250 call option. As can be seen, as the spot Nifty rises, the call option is in-the-money. If upon expiration, Nifty closes above the strike of 1250, the buyer would exercise his option and profit to the extent of the difference between the Nifty-close and the strike price. The profits possible on this option are potentially unlimited. However if Nifty falls below the strike of 1250, he lets the option expire. His losses are limited to the extent of the premium he paid for buying the option.

6.3.2 Long Put:A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price. He will be under no obligation to sell the stock, but has the right to do so until the expiry date. If the stock price decreases, he will profit by the amount of the decrease less the premium paid. If the stock price increases, he will just let the put contract expire worthless.

42

The figure shows the profits/losses for the buyer of a three-month Nifty 1250 put option. As can be seen, as the spot Nifty falls, the put option is in-the-money. If upon expiration, Nifty closes below the strike of 1250, the buyer would exercise his option and profit to the extent of the difference between the strike price and Nifty-close. The profits possible on this option can be as high as the strike price. However if Nifty rises above the strike of 1250, he lets the option expire. His losses are limited to the extent of the premium he paid for buying the option.

6.3.3 Short Call (Naked short call): A trader who believes that a stock's price will decrease can short sell the stock or instead sell a call. Both tactics are generally considered inappropriate for small investors. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer's option. If the stock price decreases, the short call position will make a profit in the amount

43

of the premium. If the stock price increases, the short position will lose by the amount of the increase less the amount of the premium.

The figure shows the profits/losses for the seller of a three-month Nifty 1250 call option. As the spot Nifty rises, the call option is in-the-money and the writer starts making losses. If upon expiration, Nifty closes above the strike of 1250, the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the Nifty-close and the strike price. The loss that can be incurred by the writer of the option is potentially unlimited, whereas the maximum profit is limited to the extent of the up-front option premium of Rs.86.60 charged by him.

6.3.4 Short Put: A trader who believes that a stock's price will increase can sell the right to purchase the stock at a fixed price. This trade is generally considered inappropriate for a small investor. If the stock price increases, the short put position will make a profit in the amount of the premium. If the stock price

44

decreases, the short position will lose by the amount of the decrease less the amount of the premium.

The figure shows the profits/losses for the seller of a three-month Nifty 1250 put option. As the spot Nifty falls, the put option is in-the-money and the writer starts making losses. If upon expiration, Nifty closes below the strike of 1250, the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the strike price and Nifty-close. The loss that can be incurred by the writer of the option is a maximum extent of the strike price( Since the worst that can happen is that the asset price can fall to zero) whereas the maximum profit is limited to the extent of the up-front option premium of Rs.61.70 charged by him.

6.4 Introduction to Option Strategies Combining any of the four basic kinds of option trades (possibly with different exercise prices) and the two basic kinds of stock trades (long and short) allows a

45

variety of options strategies. Simple strategies usually combine only a few trades, while more complicated strategies can combine several. 1. Covered Call: Long the stock, short a call. This has essentially the same payoff as a short put. 2. Straddle: Long a call and long a put with the same exercise prices (a long straddle), or short a call and short a put with the same exercise prices (a short straddle). 3. Strangle: Long a call and long a put with different exercise prices (a long strangle), or short a call and short a put with different exercise prices (a short strangle). 4. Bull Spread: Long a call with a low exercise price and short a call with a higher exercise price, or long a put with a low exercise price and short a put with a higher exercise price. 5. Bear Spread : Short a call with a low exercise price and long a call with a higher exercise price, or short a put with a low exercise price and long a put with a higher exercise price. 6. Butterfly: Butterflies require trading options with 3 different exercise prices. Assume exercise prices X1 < X2 < X3 and that (X1 + X3)/2 = X2 Long butterfly - long 1 call with exercise price X1, short 2 calls with exercise price X2, and long 1 call with exercise price X3. Alternatively, long 1 put with exercise price X1, short 2 puts with exercise price X2, and long 1 put with exercise price X3. Short butterfly - short 1 call with exercise price X1, long 2 calls with exercise price X2, and short 1 call with exercise price X3. Alternatively, short 1 put with exercise price X1, long 2 puts with exercise price X2, and short 1 put with exercise price X3.

6.5 Black Scholes Option Model Black Scholes Model has been widely used but it is a complex option pricing model. It is based on concept of “risk less hedge”. Investor buys stock & simultaneously sells a call option on that stock. If stock’s price rises, investor earns profit but holder of

46

option will exercise it; that exercise will cost investor money. If stock price falls, investor will lose on his investment in stock but gain from option (which will expire worthless if stock price falls). Black Scholes model helps to set up so that investor ends up with risk less position - no matter what stock does, investor’s portfolio remains constant. Risk less investment yields risk less rate; if return > risk free rate, arbitrageurs will buy this risk less position & in process push rate of return down.

Black Scholes Model: Given price of stock, its potential volatility, option’s exercise price, life of option & risk-free rate, there is but one price for the option if it is to meet the equilibrium condition -- that a portfolio consisting of stock & call option will earn risk free rate. The assumptions of the Black-Scholes Option Pricing Model 1. The stock underlying the call option provides no dividends during the call option’s life. 2. There are no transactions costs for the sale/purchase of either the stock or the option. 3. kRF is known and constant during the option’s life. 4. Security buyers may borrow any fraction of the purchase price at the shortterm risk-free rate. 5. No penalty for short selling and sellers receive immediately full cash proceeds at today’s price. 6. Call option can be exercised only on its expiration date (“European”). 7. Security trading takes place in continuous time, and stock prices move randomly in continuous time. The three equations that make up the OPM are: V = P[N(d1)] - Xe -kRFt[N(d2)]. d1 = ln (P/X) + [kRF + (2/2)]t t d2 = d1 -  t. Terms in Black-Scholes equation V = current value of call option P = current price of underlying stock

47

N (dio) = probability that a deviation < di will occur in a standard normal distribution. Thus N (d1) & N (d2) represent area under a standard normal distribution function. X = exercise, or strike price of option e = 2.7183 kRF = risk free rate t = time until option expires (option period) ln (P/X) = natural logarithm of P/X 2 = variance of rate of return on the stock

What is the value of the following call option according to the OPM? Assume: P = $27; X = $25; kRF = 6%; t = 0.5 years: 2 = 0.11 V = $27[N(d1)] - $25e-(0.06)(0.5)[N(d2)]. ln($27/$25) + [(0.06 + 0.11/2)](0.5) d1 = (0.3317)(0.7071)

= (.07696 + .0575)/.2345 =0.5736. d2 = d1 - (0.3317)(0.7071) = d1 - 0.2345 = 0.5736 - 0.2345 = 0.3391. N(d1) = N(0.5736) = 0.5000 + 0.2168 = 0.7168. N(d2) = N(0.3391) = 0.5000 + 0.1327 = 0.6327.

V = $27(0.7168) - $25e-0.03(0.6327) = $19.3536 - $25(0.97045)(0.6327) = $4.0036.

The impact of the following Para-meters have on a call option’s value

48

 Current stock price: Call option value increases as the current stock price increases.  Exercise price (“Strike” price): As the exercise (strike) price increases, a call option’s value decreases.  Option period: As the expiration date is lengthened, a call option’s value increases (more chance of becoming in the money.)  Risk-free rate: Call option’s value tends to increase as kRF increases (reduces the PV of the exercise price).  Stock return variance (“volatility”): Option value increases with variance of the underlying stock (more chance of becoming in the money).  Premium (price pay) depends on:  strike (exercise) price market price (market - strike) = intrinsic value (intrinsic value = economic value of exercising immediately)  time until expiration = time value  short term interest rates  volatility  anticipated cash payments on the underlying (div.)

Option Pricing

  Factors       Current price of underlying Strike price Time to expiration of option Expected price volatility Short-term interest rate Anticipated cash payments (dividends)

Effect of an increase of the factor on Call Price + + + + Put Price + + + +

7. Interest Rate Derivatives:

49

7.1 Introduction An interest rate derivate is a derivative security where the underlying asset is the right to pay or receive a (usually notional) amount of money at a given interest rate. Interest rate derivatives are the largest derivatives market in the world. Market observers estimate that $60 trillion dollars by notional value of interest rate derivatives contract had been exchanged by May 2004. According to the International Swaps and Derivatives Association, 80% of the world's top 500 companies at April 2003 used interest rate derivatives to control their cash flow. This compares with 75% for foreign exchange options, 25% for commodity options and 10% for equity options. The various interest rate futures contracts traded on exchanges worldwide provide an array of portfolio hedging and cross-hedging mechanisms for financial instruments such as mortgages or high-grade corporate bonds. A long hedge correlates to falling interest rates, while a short hedge would be used for risk management when rising interest rates are anticipated. For example, the manager of a bond portfolio who foresees rising interest rates could hedge by selling T-Bond futures. As interest rates raise, the price of the T-Bond contract falls, thus, short selling the appropriate number of T-Bond contracts vis-à-vis the value of the bond portfolio would provide a hedge against the de-valued portfolio. Similarly, a long-hedge can be used to by a fund manager to lock in the price he/she will pay to add Treasury Bonds to the portfolio: 7.2 Points of Interest: What Determines Interest Rates? Interest rates can significantly influence people's behaviour. When rates decline, homeowners rush to buy new homes and refinance old mortgages; automobile buyers scramble to buy new cars; the stock market soars, and people tend to feel more optimistic about the future.

But even though individuals respond to changes in rates, they may not fully understand what interest rates represent, or how different rates relate to each other. Why, for example, do interest rates increase or decrease? And in a period of changing rates, why are certain rates higher, while others are lower?

50

An interest rate is a price, and like any other price, it relates to a transaction or the transfer of a good or service between a buyer and a seller. This special type of transaction is a loan or credit transaction, involving a supplier of surplus funds, i.e., a lender or saver, and a demander of surplus funds, i.e., a borrower.

7.2.1 Supply and Demand As with any other price in our market economy, interest rates are determined by the forces of supply and demand, in this case, the supply of and demand for credit. If the supply of credit from lenders rises relative to the demand from borrowers, the price (interest rate) will tend to fall as lenders compete to find use for their funds. If the demand rises relative to the supply, the interest rate will tend to rise as borrowers compete for increasingly scarce funds.

7.2.2 Expected Inflation Inflation reduces the purchasing power of money. Each percentage point increase in inflation represents approximately a 1 percent decrease in the quantity of real goods and services that can be purchased with a given number of dollars in the future. As a result, lenders, seeking to protect their purchasing power, add the expected rate of inflation to the interest rate they demand. Borrowers are willing to pay this higher rate because they expect inflation to enable them to repay the loan with cheaper dollars. If lenders expect, for example, an eight percent inflation rate for the coming year and otherwise desire a four percent return on their loan, they would likely charge borrowers 12 percent, the so-called nominal interest rate (an eight percent inflation premium plus a four percent "real" rate). 7.2.3 Economic conditions: All businesses, governmental bodies, and households that borrow funds affect the demand for credit. This demand tends to vary with

51

general economic conditions. When economic activity is expanding and the outlook appears favourable, consumers demand substantial amounts of credit to finance homes, automobiles, and other major items, as well as to increase current consumption. With this positive outlook, they expect higher incomes and as a result are generally more willing to take on future obligations. Businesses are also optimistic and seek funds to finance the additional production, plants, and equipment needed to supply this increased consumer demand. All of this makes for a relative scarcity of funds, due to increased demand. On the other hand, when sales are sluggish and the future looks grim, consumers and businesses tend to reduce their major purchases, and lenders, concerned about the repayment ability of prospective borrowers, become reluctant to lend. As a result, both the supply and demand for credit may fall. Unless they both fall by the same amount, interest rates are affected.

7.2.4 Federal Reserve Actions: As we have seen, the Fed acts to influence the availability of money and credit by adjusting the level and/or price of bank reserves. The Fed affects reserves in three ways: by setting reserve requirements that banks must hold, as we discussed earlier; by buying and selling government securities (usually U.S. Treasury bonds) in open market operations; and by setting the "discount rate," which affects the price of reserves banks borrow from the Fed through the "discount window." 7.2.5 Fiscal Policy: Federal, state and local governments, through their fiscal policy actions of taxation and spending, can affect either the supply of or the demand for credit. If a governmental unit spends less than it takes in from taxes and other sources of revenue, as many have in recent years, it runs a budget surplus, meaning the government has savings. As we have seen, savings are the source of the supply of credit. On the other hand, if a governmental unit spends more than it takes in, it runs a budget deficit, and must borrow to make up the difference. The borrowing increases the demand for credit, contributing to higher interest rates in general.

7.3 Interest Rate Predictions

52

General economic conditions, for example, cause all interest rates to move in the same direction over time. Other factors vary for different kinds of credit transactions, causing their interest rates to differ at any one time. Some of the most important of these factors are: 1. Different levels and kinds of risk  default risk  liquidity risk  maturity risk Different rights granted to borrowers and lenders
2.

 Coupon and zero-coupon bonds  Convertible bonds.  Call provisions


Put provision Different tax considerations

3.

7.4 Forward rate agreement (FRA) Let us assume that you have agreed to a loan with a floating interest rate. If the general level of interest rates rose, you would normally be exposed to a higher interest burden. But the purchase of a forward rate agreement (FRA) offers protection: if money market rates rise, the FRA pays you the difference between the interest rate fixed in the FRA and the prevailing market interest rate You can protect your investment income against falling interest rates by selling the FRA. If interest rates fell below the agreed threshold, FRA will compensate you for the reduced return Let us assume that you have taken out a two-year loan with a bank for EUR 5 million, with interest payments linked to the six-month EURIBOR. The interest rate fixed for the six-month period starting today is 4.0% p.a. The future development of the sixmonth EURIBOR is uncertain today, which exposes you to risk. For that reason, you

53

buy a FRA, with a six-month hedging period, starting in six months' time (a so-called 6x12 FRA) at a rate of 5.5%. If, for example, over the next six months the six-month EURIBOR were to rise to 6.5%, without this contract you would be subject to 1.0% higher interest for this interest period. Thanks to the FRA, which compensate you for these additional costs, leaving your interest expense at 5.5% plus your loan margin. Contrary to your expectations: in this case, your interest income will fall short of the anticipated level. You can offset this risk by purchasing a floor. If, on the fixing day for your floor contract, the prevailing EURIBOR rate is lower than the agreed floor rate, you will be compensated to the extent of this differential. When you buy a floor you pay only the option premium, with no subsequent costs incurred.

54

8. Interest rate options
8.1 Hedging Pre-Issue Pricing Risk for Fixed-Rate Debt Many companies today are considering the issuance of fixed-rate debt to lock in costeffective funding and strengthen their capital base. Interest rates, however, don't always cooperate. Fortunately, there are a number of hedging tools available which can reduce the impact of interest rate fluctuations on prospective debt issues or private placements during the structuring and marketing period before pricing. The Challenge Companies planning to issue fixed-rate debt are exposed to the risk of Treasury rate movements until the new issue is priced. Even the briefest waiting period can significantly increase exposure. To address this challenge, issuers can choose from a variety of off balance sheet risk management techniques to synthetically hedge the yield on the Treasury security on which the debt will be priced. For Example Consider a company that decides today to borrow $100mm for 10 years, with the proposed issue to be priced in six weeks. The company does not want to speculate on the direction of interest rates, and seeks to reduce its exposure until the issue is priced. Until the debt is priced, the company faces exposure to changes in the underlying Treasury rate; and un hedged interest rate exposure can translate into real money. For example, on a $100 million 10-year Treasury with a current yield of 6.56%, the present value of a one basis point change in rates is $72,000! As you can see in the table below, the cost impact of even a small change in rates can be extremely large - higher if rates go up, lower if rates fall. If in markets of even average volatility, intraday rate movements alone can be as much as 15 basis points up or down, consider how much is at risk over the typical 1 to 3 month pre-issue period.

55

Change in Treasury Rate (in basis points 0 10 20 30 40 50

Present Value of Interest Cost on $100 million Notional $0 $720,000 $1,440,000 $2,160,000 $2,880,000 $3,600,000

8.2 Hedging Solutions 8.2.1 Caps-Hedging against rising interest rate You plan to take out a loan, taking advantage of what are presently very attractive interest rates. Despite the fact that you expect interest rates to rise, you still wish to participate in the event of falling rates. The solution for this is a cap. As the buyer of a cap you hedge against the risk of rising money market rates. If, on the agreed fixing day for your cap, the prevailing market interest rate, generally EURIBOR, exceeds the maximum interest rate agreed in the cap contract, cap will pay you the difference between the prevailing market rate and the agreed cap limit for the current interest period, based on the underlying notional amount. The particular advantage of this hedging method is that you continue to benefit without restrictions from falling money market rates Example let us assume that you intend to carry out some modernisation measures in your company. As you do not wish to unnecessarily commit liquid funds, you decide to take out an investment loan of EUR 1 million. A cap creates a ceiling on floating rate interest costs. When market rates move above the cap rate, the seller pays the purchaser the difference. A company borrowing on a floating rate basis when 3 month LIBOR is 6% might purchase a 7% cap, for example, to protect against a rate rise above that level. If rates subsequently rise to 9%, the company receives a 2% cap

56

payment to compensate for the rise in market rates. The cap ensures that the borrower's interest rate costs will never exceed the cap rate. 8.2.2 Floors-Hedging against falling interest rate When investing liquid funds, an attractive return is a key criterion for your decision. However, if money market rates decline this would, in practice, represent an actual shortfall in revenue for your company. As a result, you could be missing out on returns which you may have relied upon in your planning. You can avoid the resulting uncertainty by buying what is known as a floor. A floor is an agreement on a minimum interest rate – basically an option on a minimum interest rate. This protects you against the risk of falling interest rates for a period of up to ten years. If interest rates go up, you will benefit from this rise without restriction. Investments with a variable rate of interest – such as Floating-Rate Notes – are a common instrument to benefit from rising money market rates. However, interest rates might fall – A floor is the mirror image of a cap. When market rates fall below the floor rate, the seller pays the difference. A 6% floor triggers a payment to the purchaser whenever market rates drop below 6%. Asset managers buy floors to guarantee a minimum return on floating rate assets. They sell floors to generate incrementally higher returns. Debt managers buy floors to protect against opportunity losses on fixed rate debt when rates fall. They may sell floors as a component of a hedge strategy involving other derivative instruments. 8.2.3 Treasury collars (the combination of buying a Treasury cap and selling a Treasury floor) can be used to hedge current rates within a targeted range. The cap protects against increases in interest rates. The sale of the floor, which eliminates the benefit from a decline in rates below the floor rate, reduces the cost of the hedge. A Treasury collar can be structured at no upfront cost by setting the cap and floor rates such that the premium received for the floor entirely offsets the premium due for the cap.

57

Combining Caps and Floors to Create Collars A collar is created by purchasing a cap or floor and selling the other. The premium due for the cap (floor) is partially offset by the premium received for the floor (cap), making the collar an effective way to hedge rate risk at low cost. In return the hedger gives up the potential benefit of favourable rate movements outside the band defined by the collar. A borrower who purchases an 8% cap and sells a 6% floor guarantees a 6-8% base rate on a floating rate loan. An investor in floating rate CD's might do exactly the opposite, buying a 6% floor and financing it with the sale of an 8% cap. A costless collar is created when the cap and floor levels are set so that the premiums exactly offset each other. Caps, floors and collars are a simple but very effective way to control risk and manage hedge costs. The option characteristics of caps and floors offer unique opportunities to minimize borrowing costs or achieve higher investment returns

8.3 Hedging A Large Debt Issue For large debt issues companies frequently set Treasury locks in increments, minimizing the odds of locking-in at a temporary market high point. Hedging onethird to one-half of the principal amount of a proposed debt issue at a time eliminates interest rate risk on a significant portion of the debt and produces a "dollar cost averaged" lock rate.

8.4 Options on interest rate futures A call option buyer, for example, is bullish. That is, he or she believes the price of the underlying futures contract will rise. If prices do rise, the call option buyer has three courses of action available. The first is to exercise the option and acquire the underlying futures contract at the strike price. The second is to offset the long call position with a sale and realize a profit. The third, and least acceptable, is to let the option expire worthless and forfeit the unrealized profit. The seller of the call option expects futures prices to remain relatively stable or to decline modestly. If prices remain stable, the receipt of the option premium enhances

58

the rate of return on a covered position. If prices decline, selling the call against a long futures position enables the writer to use the premium as a cushion to provide downside protection to the extent of the premium received. For instance, if T-bond futures were purchased at 80-00 and a call option with an 80 strike price was sold for 2-00, T-bond futures could decline to the 78-00 level before there would be a net loss in the position (excluding, of course, margin and commission requirements). However, should T-bond futures rise to 82-00, the call option seller forfeits the opportunity for profit because the buyer would likely exercise the call against him and acquire a futures position at 80-00 (the strike price). The perspectives of the put buyer and put seller are completely different. The buyer of the put option believes prices for the underlying futures contract will decline. For example, if a T-bond put option with a strike price of 82 is purchased for 2-00, while T-bond futures also are at 82-00, the put option will be profitable for the purchaser to exercise if T-bond futures decline below 80-00. In many instances, puts will be purchased in conjunction with a long cash or long Tbond futures position for "insurance" purposes. For instance, if an institution is long T-bond futures at 82-00 and a T-bond put option with an 82 strike is purchased for 200, the futures contract could, theoretically, fall to zero and the put option holder could exercise the option for the 82 strike price, assuming the option had not yet expired. The seller of put options on fixed-income securities believes interest rates will stay at present levels or decline. In selling the put option, the writer, of course, receives income. However, if interest rates rise, the buyer of the put option can require the writer to take delivery of the underlying instrument at a price greater than that in the new market environment. Since an option is a wasting asset, an open position must be closed or exercised, otherwise the option expires worthless. The chart below illustrates what happens to the buyer and the seller after an option is exercised.

59

8.5 FUTURES POSITIONS AFTER OPTION EXERCISE Call option Buyer assumes Long T-bond/note futures position Seller assumes Short T-bond/note futures position Put option Short T-bond/note futures position Long T-bond/note futures position

8.6 Trading Example: Hedging with Options on CME Interest Rate Futures Whenever CME Eurodollar futures can be used to lock in a rate, options on futures can be substituted to guarantee a rate floor or ceiling. As an alternative to a long futures position, which determines a forward investment return for an asset, the purchase of a call option can be substituted. The call gives the right to buy the futures contract at a stated price, providing a floor for a return on the asset while preserving the opportunity for a potential profit. On the other hand, instead of taking a short futures position to predetermine a liability rate, buying a put option can provide protection. The put gives the right to sell the futures at a stated price, providing a ceiling for the liability rate, while preserving the opportunity for a lower cost of funds. The effective floor or ceiling rate provided by the option is determined by its strike price and the premium paid. The “strike yield” (simply 100 minus the option strike price) is adjusted to reflect the cost of the option. For example, suppose the following prices were observed: Contract Jun CME Eurodollar futures Jun 96.00-strike call Jun 96.50-strike call Jun 96.00-strike put Jun 95.50-strike put Price/Premium 96.02 0.30 0.11 0.28 0.11 Delta 1.00 0.51 0.25 0.49 0.24

Under these conditions, the user of the futures contract could expect to lock in a target LIBOR of 3.98 percent (100.00 -96.02) - an asset return if long or a liability cost if short. Subject to basis risk, this yield would be locked in regardless of whether market rates rise or fall over the hedge period. Using the 96.00-strike call to hedge a floating rate investment, a hedger could guarantee a minimum return of 4.00 percent for a cost of 30 basis points. In other

60

words, the realized minimum return would be 3.70 percent as a worst case (4.00 .30). If the rate falls below 4.00 percent, futures prices would rise and the call option would increase in value. The lower investment rate on the asset would be supplemented by the profit on the call to ensure a minimum net return of 3.70 percent.

On the other hand, if the rate rises above 4.00 percent, the option would be worthless at expiration, and the investor would simply lose the cost of the option and receive the higher market rate on the asset. Using the 96.50-strike call, the investment hedger would establish a minimum return of 3.39 percent (100.00 - 96.50 -.11). Why would someone use the 96.50-strike call rather than the 96.00-strike call, when the latter offers a higher minimum return? The question involves an important trade off consideration. While it is true that the 96.00-strike call provides a more attractive worst-case scenario, it does so for a larger upfront cost. The purchaser of the 96.00-strike call pays $750 for this protection ($25 x 30 basis points), while the cost of the 96.50-strike call is only $275 ($25 x 11 basis points). To hedge floating rate liabilities, put options present a similar set of choices. A short futures contract can establish a forward rate of 3.98 percent. The 96.00-strike put can provide a ceiling rate of 4.28 percent (100.00 - 96.00 + .28) for the premium of $700 ($25 x 28 basis points); and the 95.50-strike put can provide a 4.61 percent (100.00 95.50 + .11) ceiling rate for the price of $275 ($25 x 11 basis points).

61

9. Currency Options
9.1 Introduction Suppose a United Kingdom manufacturing firm is expecting to be paid $100,000 for a piece of engineering equipment to be delivered in 90 days. If the exchange rate goes down over the next 90 days the UK firm will lose money, but if the rate goes up then the UK firm will make a profit. The UK firm can purchase an option (the right to sell part or all of their expected income for pounds sterling at a given rate near today's rate) to mitigate their risk of exchange rate fluctuation over the 90 days. Conversely another party may wish to have the reverse option for a similar reason. A market maker will buy and sell these options with the aim of making a profit while not incurring too much risk. In finance, a foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. For example a USD/GBP FX option might be specified by a contract allowing the purchaser to exchange £1,000,000 into $2,000,000 on December 31st. In this case the pre-agreed exchange rate, or strike price, is 2USD/GBP or 0.5GBP/USD and the notional is £1,000,000. This type of contract may be called either a dollar call or a sterling put depending on the market convention. If the dollar is stronger than 0.5GBP/USD come December 31st (say at 0.55GBP/USD) then the option will be exercised, making a profit of (2 - 1/0.55)*1,000,000 = $181,818 or £100,000. 9.2 Hedging with Options While forwards and futures are the most effective instruments used to minimize the volatility of an exposed foreign currency transaction, they may not be appropriate for all types of foreign exchange risk management. Their biggest limitation is the fact that they do not provide the opportunity to benefit from favourable foreign exchange movements. One can argue that unless a company is engaged in the currency speculation business, foreign exchange gains should be a secondary concern, although a counter argument is that managers should care only about downside risk since 62

nobody will penalize them for making too much money. Another limitation of forwards and futures is that they may not match the contingent nature of some foreign currency transactions. If, for example, a firm enters into a short futures position to hedge an anticipated inflow that fails to materialize, there will be no gains to offset futures losses if the exchange rate appreciates. Currency options give the holder the right, but not the obligation, to buy or sell a fixed amount of foreign currency at a specified price. 'American' options are exercisable at any time prior to the expiration date, while 'European' options are exercisable only on the expiration date. Most currency options have 'American' exercise features. Call options give the holder the right to buy foreign currency, while put options give the holder the right to sell foreign currency. Call options make money when the exchange rate rises above the exercise price (allowing the holder to buy foreign currency at a lower rate), while put options make money when the exchange rate falls below the exercise price (allowing the holder to sell foreign currency at a higher rate). If the exchange rate doesn't reach a level at which the option makes money prior to expiration, it expires worthless – unlike forwards and futures, the holder of an option does not have an obligation to buy or sell if it is not advantageous to do so.
Numerical Example

To demonstrate the benefits of hedging, consider a firm with a US$1 million receivable due in 90 days. At the prevailing exchange rate of 0.6800 USD/CAD, the receivable is worth $1,470,588. However, for every basis point the Canadian dollar appreciates within the next three months, the receivable loses $2,150 in value. In order to offset any potential losses in the value of the US dollar receivable, the firm could use Canadian dollar futures to hedge its exposure. Each Canadian dollar futures contract is worth $100,000, and every basis point change in the futures price (quoted in US dollars) is equal to US$10. Using options rather than futures, management would like to minimize its downside risk in the event that the Canadian dollar appreciates, yet at the same time benefit from any depreciation that may occur within the next three months. To hedge its downside risk, the firm would buy three month Canadian dollar call options, which would give them the right to buy Canadian dollars at a specified price at any time

63

prior to the expiration date. While the firm can specify what price it wants to lock in, the most common strategy is to buy calls with a strike price at or very close to the prevailing exchange rate ('at-the-money' options). Because Canadian dollar options cover a face value of $100,000, the firm would need to buy 15 call options to cover its US$1 million exposure (US$1 million = $1,470,588). The premium paid for these options would be around US$0.80 per $1,000, or $17,647.06. In 90 days, the call option will have some value if the Canadian dollar has appreciated (since it allows the holder to buy Canadian dollars at a more favourable rate). Even if the prevailing exchange rate is less than the strike price, the option may still have some residual value based on the remaining time to expiration and the volatility in the underlying currency. For strike prices that are well above the prevailing exchange rate, the probability of making money on the option becomes so low that the option value is effectively zero. Table given below outlines the payoff structure of the option hedge. As before, the un hedged position can lose up to $62,000 if the exchange rate appreciates to 0.7100 USD/CAD. The third column represents the hypothetical prices of a Canadian dollar call option with a strike price of 0.6800 USD/CAD for each spot rate. These option prices are based on an assumed annual interest rate of 5% and exchange rate volatility of 7%, and the option is assumed to have one week to expiration. If the exchange rate remains at 0.6800 USD/CAD, each option is worth about US$0.30, reflecting the time value remaining in the option. For spot rates above 0.6800 USD/CAD, the option value increases to reflect both the time value remaining in the option and the intrinsic value of the option if exercised immediately. If the exchange rate falls, then the option loses its value, but since the holder simply doesn't exercise when this happens, the maximum loss is the premium paid when the option was purchased.

64

Spot Rate USD/CAD

Un hedged Receivable

Gain/Loss Cash

Option Price

Gain/Loss Option

Hedged Receivable

0.6500 0.6525 0.6550 0.6575 0.6600 0.6625 0.6650 0.6675 0.6700 0.6725 0.6750 0.6775 0.6800 0.6825 0.6850 0.6875 0.6900 0.6925 0.6950 0.6975 0.7000 0.7025 0.7050 0.7075 0.7100

1538462 1532567 1526718 1520913 1515152 1509434 1503759 1498127 1492537 1486989 1481482 1476015 1470588 1465202 1459854 1454546 1449275 1444043 1438849 1433692 1428571 1423488 1418440 1413428 1408451

+67873 +61979 +56129 +50324 +44563 +38846 +33171 +27539 +21949 +16401 +10893 +5427 0 -5387 -10734 -16048 -21313 -26545 -31739 -36896 -42012 -47101 -52149 -57161 -62138

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.01 0.02 0.05 0.10 0.18 0.30 0.45 0.64 0.85 1.08 1.32 1.57 1.82 2.07 2.32 2.57 2.82 3.07

-17647 -17647 -17647 -17646 -17641 -17625 -17576 -17445 -17144 -16531 -15427 -13656 -11102 -7749 -3692 +900 +5840 +10970 +16179 +21403 +26611 +31788 +36931 +42039 +47110

1520815 1514920 1509071 1497511 1491809 1486184 1480682 1475393 1470458 1466055 1462358 1459487 1457453 1456162 1455446 1455116 1455014 1455014 1455028 1455095 1455182 1455276 1455371 1455466 1455561

65

10. Swaps
10.1 Introduction: In finance a swap is a derivative, where two counterparties exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The cash flows are calculated over a notional principal amount. Swaps are often used to hedge certain risks, for instance interest rate risk. Another use is speculation. Swaps are Over-the-counter (OTC) derivatives. This means that they are negotiated outside exchanges. They cannot be bought and sold like securities or futures contracts, but are all unique. As each swap is a unique contract, the only way to get out of it is by either mutually agreeing to tear it up, or by reassigning the swap to a third party. This latter option is only possible with the consent of the counterparty. The Bank for International Settlements (BIS) publishes statistics on the notional amounts outstanding in the OTC Derivatives market. At the end of 2004, this was USD 248.288 trillion (that is, USD 248,288 billion, or six times World GDP). The majority of this (USD 147.4 trillion) were interest rate swaps. These split by currency Usually, at least one of the legs has a rate that is variable. It can depend on a reference rate, the total return of a swap, an economic statistic, etc. The most important criterion is that it comes from an independent third party, to avoid any conflict of interest. For instance, LIBOR is set by the British Bankers Association, an independent trade body. 10.2 Interest Rate Swap Interest Rate swaps are the most common type of swap. They typically exchange fixed rate payments against floating rate payments. Exceptions exist, such as floatingto-floating swaps (known as basis swaps). 10.3 Manage interest rate risk with a solution tailored to match a specific risk profile Among the most popular of derivative instruments, interest rate swaps are used by corporations, government entities, and financial institutions to manage interest rate risk.

66

Swaps can be applied to a wide range of hedging needs and can be easily tailored to match a specific risk profile. Their simplicity and flexibility have made them the workhorse of the risk manager's toolbox. A swap is an agreement to exchange interest payments in a single currency for a stated time period. Note that only interest payments are exchanged, not principal. Swap terms are customized to meet the user's specific risk management objectives. Terms include starting and ending dates, settlement frequency, the notional amount on which swap payments are based, and reference rates on which swap payments are determined. Reference rates are published rates such as LIBOR or benchmark Treasuries, or customized indexes crafted to meet the client's needs. 10.4 Why Use Swaps? Treasurers use swaps to hedge against rising interest rates and to reduce borrowing costs. Among other applications, swaps give financial managers the ability to: Convert floating rate debt to fixed or fixed rate to floating rate


Lock in an attractive interest rate in advance of a future debt issue


Position fixed rate liabilities in anticipation of a decline in interest rates


Arbitrage debt price differentials in the capital markets


Financial institutions, pension managers and insurers use swaps to balance asset and liability positions without leveraging up the balance sheet and to lock-in higher investment returns for a given risk level. 10.5 Interest Rate Swaps An IRS is an exchange between two parties of interest rate obligations (payments of interest) or receipts (investment income) in the same currency on an agreed amount of notional principal for an agreed period of time. The most common type of interest rate swaps are the “plain vanilla” IRS. Currently, these are the only kind of swaps that are allowed by the RBI in India. Dealings in ‘Exotics’ or advanced interest rate swaps have not been permitted by the RBI. In a plain vanilla swap, one party agrees to pay

67

to the other party cash flows equal to the interest at a predetermined fixed rate on a notional principal for a number of years In exchange, the party receiving the fixed rate agrees to pay the other party cash flows equal to interest at a floating rate on the same notional principal for the same period of time. Moreover, only the difference in the interest payments is paid/received; the principal is used only to calculate the interest amounts and is never exchanged. An example will help understand this better: Consider a swap agreement between two parties, A and B. The swap was initiated on July 1, 2001. Here, A agrees to pay the 3-month NSE-MIBOR rate on a notional principal of Rs. 100 million, while B pays a fixed 12.15% rate on the same principal, for tenure of 1 year. We assume that payments are to be exchanged every three months and the 12.15% Interest rate is to be compounded quarterly. This swap can be depicted diagrammatically as shown below:

An interest rate swap is entered to transform the nature of an existing liability or an asset. A swap can be used to transform a floating rate loan into a fixed rate loan, or vice versa. To understand this, consider that in the above example; A had borrowed a 3 yr, 1 crore loan at 12%. This means that following the swap, it will: (a) Pay 12% to the lender, (b) Receive 12.15% from B (c) Pay 3 month MIBOR Thus, A’s 12% fixed loan is transformed into a floating rate loan of MIBOR – 0.15%. Similarly, if B had borrowed at MIBOR + 1.50%, it can transform this loan to a fixed rate loan @ 13.65% (12.15 + 1.50). Following figure summarizes this transaction.

68

10.6 An IRS can also be used to transform assets. Example A fixed-rate earning bond can be transformed into variable rate earning asset and vice versa. In the above example, it could be that A had a bond earning MIBOR+0.5% and B a bond earning 12.5% interest compounded quarterly. The swap would then result in A receiving a fixed income of 12.65% and B receiving a variable income of MIBOR+0.35%. This can be shown diagrammatically as follows:

Sometimes, a bank or financial intermediary is involved in the swap. It charges a commission for this. The two parties often do not even know who the other party is. For them, the intermediary is the counter-party. For example, if a financial institution charging 20 basis points were acting as intermediary, the swap would look as follows:

10.7 Swaps for a comparative advantage Comparative advantages between two firms arise out of differences in credit rating, market preferences and exposure. Example: Say, Firm A with high credit rating can borrow at a fixed rate of 12% and at a floating rate of MIBOR + 20 bps. Another firm B with a lower credit rating can borrow at a fixed rate of 14 % and a floating rate of MIBOR + 150 bps.

Firm ‘A’ has an absolute advantage over firm ‘B’ in both fixed and floating rates. Firm ‘B’ pays 200 bps more than firm A in the fixed rate borrowing and only 120 bps

69

more than ‘A’ in the floating rate borrowing. So, firm ‘B’ has a comparative advantage in borrowing floating rate funds. Now, Firm ‘A’ wishes to borrow at floating rates and becomes the floating rate payer in the swap arrangement. However, A actually borrows fixed rate funds in the cash market. It is the interest rate obligations on this fixed rate funds, which are swapped. At the same time, B wishes to borrow at a fixed rate, and thus will actually borrow from the market at the floating rate. Then, both the parties will exchange their underlying interest rate exposures with each other to gain from the swap. The calculation of the gain from the swap is shown below: The gain to firm A, because it borrows in the fixed rate segment is: 14% - 12% = 200 bps. And, the loss because firm B borrows in the floating rate segment is: (MIBOR + 20 bps) – (MIBOR + 120 bps) = 130 bps. Thus, the net gain in the swap = 200 – 120 = 70 bps. The firms can divide this gain equally. Firm B can pay fixed at 12.15% to firm A and receive a floating rate of MIBOR as illustrated below:

Effective cost for firm A = 12% + (MIBOR – 12) = MIBOR - 15 bps This results into a net gain of ((MIBOR + 20) - (MIBOR - 15)) i.e., a gain of 35 bps. Effective cost for firm B = (MIBOR + 150) + (12.15% - MIBOR) = 13.65% This results into a gain of (14% - 13.65%) i.e., a gain of 35 bps. Thus, both the parties gain from entering into a swap agreement.

70

As we have seen, firms can use IRS to transform assets and liabilities. But then, why don’t firms take the desired form of loan or asset (fixed or floating) in the first place? Ricardo’s comparative advantage theory explains this behaviour to some extent. Continuing with the same example, let us assume that A’s credit rating is better than B’s, and ‘A and B’ can raise loans for fixed and floating rates as given below:

Here, we see that though firm A can borrow cheaply compared to firm B in both the markets, the difference in rates available is not the same. Firm B has a comparative advantage in the floating rate market because it pays only 1.30% higher here, compared to the 2% difference in the fixed rate market. So, firm B will borrow at a floating rate, and firm A at fixed rate. After the swap deal, the cost of the floating rate loan to firm A will be MIBOR0.15%, a clean gain of 35 basis points. Similarly, firm B also gains 35 basis points, because the cost of its loan will be 13.35% only, after the swap. Thus, both parties gain from the swap, as shown below:

In a perfect market, however, the spread between fixed and floating rates offered should vanish due to IRS. This is not seen in reality, and spreads continue to persist. So, the credit ratings of the firms are not the only criteria by which lenders judge firms, and the comparative advantage theory continues to hold.

10.8 Swaps for Reducing the Cost of Borrowing With the introduction of rupee derivatives, the Indian corporate can attempt to reduce their cost of borrowing and thereby add value. A typical Indian case would be a corporate with a high fixed rate obligation.

71

MIPL, an AAA rated corporate, 3 years back had raised 4-year funds at a fixed rate of 18.5%. Today a 364-day T-bill is yielding 10.25%, as the interest rates have come down. The 3-month MIBOR is quoting at 10%. Fixed to floating 1 year swaps are trading at 50 bps over the 364-day T- bill vs. 6month MIBOR. The treasurer is of the view that the average MIBOR shall remain below 18.5% for the next one year. The firm can thus benefit by entering into an interest rate fixed for floating swap, whereby it makes floating payments at MIBOR and receives fixed payments at 50 bps over a 364-day treasury yield i.e. 10.25 + 0.50 = 10.75 %.

The effective cost for MIPL = 18.50 + MIBOR - 10.75 = 7.75 + MIBOR At the present 3m MIBOR is 10%, the effective cost is = 10 + 7.75 = 17.75% The gain for the firm is (18.5 - 17.75) = 0.75 % The risks involved for the firm are:  Default/credit risk of party B: Since the counterparty is a bank, this risk is much lower than would arise in the normal case of lending to corporate. This risk involves losses to the extent of the interest rate differential between fixed and floating rate payments.  The firm is faced with the risk that the MIBOR goes beyond 10.75%. Any rise beyond 10.75% will raise the cost of funds for the firm. Therefore it is very essential that the firm hold a well-suggested view that MIBOR shall remain below 10.75%. This will require continuous monitoring. How does the bank benefit out of this transaction? The bank either goes for another swap to offset this obligation and in the process earn a spread. The bank may also use this swap as an opportunity to hedge its own floating liability. The bank may also leave this position uncovered if it is of the view that MIBOR shall rise beyond 10.75%.

72

10.9 Currency Swaps: A currency swap is a foreign exchange agreement between two parties to exchange a given amount of one currency for another and, after a specified period of time, to give back the original amounts swapped. There is usually an exchange at maturity (optional at start). Exchange at maturity is at the spot rate. The given are of some of the examples as how cash flow take place.

Currency Swap Cash Flows: 7% USD fixed v 6-mth £ LIBOR Date 01/06/00 01/12/00 01/06/01 03/12/01 03/06/02 Floating Rate Payments 100 (6-mth LIBOR) (6-mth LIBOR) (6-mth LIBOR) (6-mth LIBOR + £ 100) 6-mth £ LIBOR [act/365] 7% fixed [ann, act/act] Fixed Rate Receipts (USD 170) USD 11.90 USD 11.90 + USD 170

Swap c/p

Swap c/p

Cross Currency Basis Swap: 6-mth DEM LIBOR v 6-mth USD LIBOR
Date 01/06/00 01/12/00 01/06/01 03/12/01 03/06/02 Floating Rate Payments 100 (6-mth USD LIBOR) (6-mth USD LIBOR) (6-mth USD LIBOR) (6-mth USD LIBOR + USD 100)
6-mth USD LIBOR [act/360]
Swap 6-mth DEM LIBOR Swap

Floating Rate Receipts (DEM 170) 6-mth DEM LIBOR 6-mth DEM LIBOR 6-mth DEM LIBOR 6-mth DEM LIBOR + DEM 170

73

10.10 A plain vanilla foreign currency swap has just been arranged between parties ABC and XYZ. ABC has agreed to pay dollars based on LIBOR, while XYZ will pay British pounds at a fixed rate of 7 percent. The current exchange rate is £1= $1.65. The notional principal is £100 million = $165 million. The tenor of the swap is seven years, and the swap has annual payments paid in arrears. The following table shows the periodic cash outflows only for each party at each relevant period of the swap. (Ignore the exchange of principal.)

Year 0 1 2 3 4 5 6 7

LIBOR (%) XYZ Sterling Pay Outflows ABC Dollar Pay Outflows 6.5800 5.870 £7,000,000 6.745 £7,000,000 6.550 £7,000,000 6.100 £7,000,000 6.800 £7,000,000 6.350 £7,000,000 6.450 £7,000,000 0.0635*$165,000,000=$10,477,500 0.0680*$165,000,000=$11,220,000 0.0610*$165,000,000=$10,065,000 0.0655*$165,000,000=$10,807,500 0.06745*$165,000,000=$11,129,250 0.0587*$165,000,000=$9,685,500 0 0 0.0658*$165,000,000=10,857,000

10.11 Swaption Hedge against adverse movements in interest rates and exchange rates Swaptions are options on swaps. Like swaps, they offer protection against adverse movements in interest rates and exchange rates, and are frequently used to minimize financing or hedging costs. Combined with other instruments, swaptions are often used to solve more complex risk management challenges. Interest rate and Currency swaptions give the holder the right, but not the obligation, to enter into or cancel a swap agreement at a future date. The buyer may purchase either the right to receive a fixed rate in the underlying swap or to pay the fixed rate. There are three styles of Swaptions. Each style reflects a different timeframe in which the option can be exercised. American Swaption, in which the owner is allowed to enter the swap on any day that falls within a range of two dates. 74

Bermudan Swaption, in which the owner is allowed to enter the swap on a sequence of dates. European Swaption, in which the owner is allowed to enter the swap on one specified date.

75

11. Research Design
Purpose of This Study/Project: The purpose of this study is to determine & justify the usefulness of derivatives in banks and firms where the risk can reduce and increased according to there needs. At the same time to focus on the few of the regulation changes which the respondents are expecting in India so that it helps them.

Objective of This Study/Project:

The main objectives of this study are: 1. To assess risk appetite of respondents. 2. To analyze the derivative products used by them to mitigate the risks. 3. To know about the regulation changes which want to take place in India to improve the liquidity in the bond market. 4. How exporters and importers will hedge their currency risk exposure and to know about the reasons why the currency risk is the most unhedged risk in India.

Methodology:

The data complied can be classified as 1. Primary Data: Questioner was sent to many people through e-mail finding the address from the news paper and mutual fund website. 2. Secondary Data: This data was collected & complied from various websites & magazines.

76

11.1 Questionnaire
Dear Sir/Madam,

I am a student studying MBA in Christ College Institute of Management, Bangalore. As part of my curriculum I am undertaking a dissertation on “Study on Forex and Debt Market Derivatives” under the guidance of Prof. Chandrashekar CKT, Director CCIM. We assure you that all information provided by you will be kept confidential and used for academic purpose only.

Thanking you, Ramakrishna N, CCIM, Bangalore

RESPONDENT PROFILE
1. Gender: Male O Female O

2. Type of Firm or Company Name: …………………………………………………. 3. Designation: ………………………………………………….. 4. Experience (in years) 1-5 O 15-20 O

5-10 O >20 O

10-15 O

77

1. Have your Bank or Corporate has hedged the interest through Interest rate futures in foreign country exchanges O Interest rate options in foreign country exchanges O Interest rate swaps O Forward Agreement O 2. Have you come across any counterparty default when you entered forward agreements to hedge the interest rate? Yes O No O 3. Why do there is very thin trade in Interest rate futures in India? Particulars Lack Of Participants allowed Lack of liquidity High margins Standardised contract Lack of proper pricing Mark to market is cash settled Lack of underlying papers 4. CCIL proposal to settlement of Rupee Derivative Products [Interest Rate Swaps (IRS) & Forward Rate Agreements (FRA)] on a guaranteed basis has increased the number of contracts. Strongly agree…………………………………………….…Strongly disagree. 5. Which hedging strategy do your Bank/Firm uses to overcome the interest rate risk Market Value Naïve Model O Conversion Factor Model O Business Point Model O Regression Model O Price Sensitivity Model O Others (specify)___________________________________________ O Strongly Agree Agree Neither Agree Nor Disagree Disagree Strongly Disagree

78

6. How do your Bank/Firm reduce the Duration of the Portfolio/ Balance Sheet Shortening/Lengthening of the investments O Receive fixed/Pay fixed Swaps O Hedging Assets and Liabilities individually O Immunize through Planning Period Case O Through Options O 7. What do you think the favourable reasons for the more volumes in Forward market than in Futures market? Extremely Favourable 5 4 3 2 1 Extremely Unfavourable

5 Tailored to individual needs No mark to market Convenient market place Self regulating No security deposit

4

3

2

1

8.

Pricing of Options create Arbitrage opportunity but due to transaction cost this arbitrage disappears Strongly Agree Agree Neither Agree nor Disagree Disagree Strongly Disagree

9. If you trade in options to what extent do you analyse these variables Much Greater Extent Delta Theta Vega RHO Gamma Some What Greater Extent To Certain Extent Neutral

79

10. How many basis points do you expect above the term structure of interest rate when you lend. (Because term structure don’t consider the given below) <25 bps Tax Status Default Risk Put Option Liquidity Risk 25-50 bps 50-75 bps 75-100 bps >100 bps

11. Do you think Option Adjusted Spread will accommodate all the above risks Strongly Agree Agree Neither Agree nor Disagree Disagree Strongly Disagree

12. If you plan to lend or borrow 6 months down the line Would you wait for 6 months and then invest at that rate, which prevail in market. Will you go for Caplet? Will you go for Floorlet? Will you choose Collar? 13. Rank the factors given below which motivates for entering into Swaps _____Customized features of swaps which is not available in Futures/Options _____Raising the finance at lower cost through swaps _____Reduced transaction cost _____Lower hedging cost _____Avoiding costly regulations _____Maintaining privacy _____Efficient managers who can use swaps effectively

14. Compare to Interest rate swaps Currency swaps are Superior About the same _____ _____ _____ _____ 1 2 3 4

Inferior _____ 5

80

15. To what extent the given below factors are important in pricing the swaps High Slope of Term Interest Rate Structure Creditworthiness of Counterparty Risk Exposure to Swap portfolio 16. For the given below risks which derivative products do you use Shift the BidAsk spread Default Risk Basis Risk Mismatch Risk Interest Rate Risk Interest rate Futures/Options Credit Default Immunize the Swap Duration Moderate Low

17. Rank the top 5 in given below swaps as per your preference to use Type of Swaps Amortizing Swap Accreting Swap Roller Coaster Swap Off Market Swap Forward Swap Extension Swap Rank Type of Swaps Basis Swap Yield Curve Swap Constant maturity Swap Rate Differential Swap Seasonal Swap Corridor Swap Rank

18. Compare to Interest Rate Future/Options Swaps are Superior _____ 1 About the same _____ 3 Inferior _____ 5

_____ 2

_____ 4

19. To over come the mismatch risk Swap Dealers enter into Interest rate Futures/Options which has created more liquidity in the bond markets. Strongly Agree Agree Neither Agree nor Disagree Disagree Strongly Disagree

81

20. What do you think the favourableness of investors preference to purchase Structured Notes(SN) Extremely Favourable 5 4 3 2 5 SN available in small quantities Less credit evaluation and credit risk More marketable and liquidity Pay off pattern is good Yield curve is Upward/Downward sloping 21. What do you think the favourableness of issuers preference to issue Structured Notes(SN) Extremely Favourable 5 4 3 2 5 Reduce in Financing cost Market imperfection Operationally efficient firm 1 Extremely Unfavourable 4 3 2 1 1 Extremely Unfavourable 4 3 2 1

22. Rank the given below according to your preference. Particulars Interest Swaps Currency Swaps Flexibility Credit Exposure Pricing Arbitrage

23. Interest rate futures are traded very thinly in India. Interest rate options are not started. What steps should RBI take to improve the liquidity in bond market. Please give your suggestion. _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________

82

1. Do you or your firm/bank trade in foreign currency Yes No O O 2. Which Arbitrage do you more come across with Geographical Arbitrage O Cross Rate Arbitrage O 3. What do you think the favourable reasons for the more volumes in Forward market than in Futures market? Extremely Favourable 5 4 3 2 1 Extremely Unfavourable

5 Tailored to individual needs No mark to market Convenient market place Self regulating No security deposit

4

3

2

1

4. Rank the Exchange Rate System as you prefer to trade _____Freely Floating O _____Managed Float or Dirty Float O _____Pegged Exchange Rate System O _____Joint Float O 5. Which Derivative product you prefer to hedge for the given risk Transaction Exposure _________________________________________ O Translation Exposure O _________________________________________

6. Pricing of Options create Arbitrage opportunity but due to transaction cost this arbitrage disappears Strongly Agree Agree Neither Agree nor Disagree Disagree Strongly Disagree

83

7. To what extent do you think given below is important in determining the exchange rate? Most Important 7 6 5 4 3 2 1 Unimportant 7 Interest Rate Parity Purchase Power Parity Demand and Supply Balance of Payment GDP Current Account Deficit Fiscal Deficit 6 5 4 3 2 1

8. Compare to Interest rate swaps Currency swaps are Superior About the same _____ _____ _____ 1 2 3

_____ 4

Inferior _____ 5

9. Rank the factors given below which motivates for entering into Swaps _____Customized features of swaps which is not available in Futures/Options _____Raising the finance at lower cost through swaps _____Reduced transaction cost _____Lower hedging cost _____Avoiding costly regulations _____Maintaining privacy _____Efficient managers who can use swaps effectively

10. Compare to Currency Future/Options Swaps is Superior _____ 1 About the same _____ 3 Inferior _____ 5

_____ 2

_____ 4

84

11. To what extent given below factors are important in pricing the currency swaps High Slope of Term Interest Rate Structure Creditworthiness of Counterparty Risk Exposure to Swap portfolio Moderate Low

12. Rank the given below according to your preference. Particulars Interest Swaps Currency Swaps 13. Do you think FDI’s and FII’s should be allowed to hedge Yes No If yes, do you think inflows from FDI and FII will increase Strongly Agree Agree Neither Agree nor Disagree Disagree Strongly Disagree Flexibility Credit Exposure Pricing Arbitrage

14. Currency risk is the most unhedged risk in India. To what extent given below reasons will contribute for this Most Highest Oil companies and Public sector undertakings are not allowed to hedge Lack of proper risk management among importers/exporters Restrictions on booking and cancellation of exports/imports Exorbitant transaction charges, charged by Banks Lack of expertise among the corporation about risk management Banks need to educate their clients about Forex risk and Derivatives Highest Moderate Lowest

85

15. What steps should be taken to improve the currency trading in India using Derivatives _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________

86

12. ANALYSIS AND INTERPRETATION
1. Have your Bank or Corporate has hedged the interest through
Ways in which Int rate risk is Hedged by banks & Corporates
70 60 50 Pe rce ntage 40 30 20 10 0 0 Interest rate futures 0 Interest rate options Series1 Interest Forward rate swaps Agreement 32 68

M ode s of He dging

Figure 1 depicts the ways in which Banks/Firms have hedged there interest rates. When the respondents were asked about how they hedge 60% respondents replied they use IRS where as 32% use FRA where as not even a single respondent used Interest rate futures and options. 2. Have you come across any counterparty default when you entered forward agreements to hedge the interest rate?

Counterparty Risk Faced By Banks

13%

87%

Yes

No

Figure 2 depicts the counterparty risk faced by banks/firms When respondents were asked about do they come across any counterparty risk 87% said no, where as 13% said yes.

87

3. Why do there is very thin trade in Interest rate futures in India?

Reasons for thin trade in Indian Interest rate futures market
22 12 30 16 20 16 32 46

Lack of underlying papers

Mark to market is cash settled

4 2 6 6

Lack of proper pricing 0 Standardised contract

12

76

Strongly Disagree Disagree

14 28 14 20 24 26 16 26 18 14

Neither Agree Nor Disagree Agree Strongly Agree

High margins 0 0 Lack of liquidity 4 0

12

84

Lack Of Participants allowed

6 10

20 40 60

64 80 100

0

20

Perentage

Figure 3 depicts the reasons for the thin trade in the Indian Interest rate futures market.

88

4. CCIL proposal to settlement of Rupee Derivative Products [Interest Rate Swaps (IRS) & Forward Rate Agreements (FRA)] on a guaranteed basis has increased the number of contracts. Strongly agree…………………………………………….…Strongly disagree.
Settlement Of IRS And FRA By CCIL Has increased the number of contracts

Strongly Disagree 0 Disagree Neither Agree Nor Disagree Agree Strongly Agree 0 10 20 30 Percentage 40 50 4 12 28 56 60

Figure 4 depicts that number of contracts has been increased due to the CCIL’s proposal to settle FRA and IRS. 5. Which hedging strategy do your Bank/Firm uses to overcome the interest rate risk

Hedging Strategies Used By Banks And Corporates
Others Strategies Price Sensitivity Model Regression Model Business Point Model Conversion Factor Model Market Value Naïve Model 0 5 10 15 Percentage 20 25 8 16 28 30 16 4 28

Figure 5 depicts the different strategy used by the Banks and Corporate to Hedge the interest rate risk.

89

6. How do your Bank/Firm reduce the Duration of the Portfolio/ Balance Sheet

Various Methods Used By The Bank/Firm For Reducing The Duration
60 50 40 30 20 10 0 56 Percentage

32 12 0 Receive fixed/Pay fixed Swaps Immunize through Planning Period Case Shortening/Lengthe ning of the investments Hedging Assets and Liabilities individually 0 Through Options

Figure 6 depicts the various methods used by the Banks and Corporate to reduce the duration of Portfolio/Balance Sheet 7. What do you think the favourable reasons for the more volumes in Forward market than in Futures market? Favourable Reasons for More Volumes In Forwards Than Futures 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

1 2 3 4 5 Tailored to individual needs No mark to market Convenient market place Self regulating No security deposit

Figure 7 depicts the favourable reasons given by respondents to enter with forwards than futures.

90

8. Pricing of Options create Arbitrage opportunity but due to transaction cost this arbitrage disappears

Pricing Of Options Creat Arbitrage But Due To Transaction Cost It Disappears
72 80 70 60 50 Percentage 40 30 20 10 0

16 4 4 4

Strongly Agree Agree

Neither Disagree Strongly Agree Disagree Nor Disagree

Figure 8 depicts that most of the respondents strongly agrees with arbitrage opportunity exist with option pricing but due to the transaction cost this disappears. 9. If you trade in options to what extent do you analyse these variables
Extent Of Analysis Of Variables While Trading In Options 1 2 Gamma 5 17 4 9 RHO 7 5 0 1 Vega 3 21 4 3 Theta 6 12 1 2 Delta 5 17
Variables Number Of Respondents

Much Greater Extent To Certain Extent

Some What Greater Extent Neutral

Figure 9 Depicts the various variables the respondents look at while trading in Option.

91

10. How many basis points do you expect above the term structure of interest rate when you lend. (Because term structure don’t consider the given below)
Expectation of Int Rate Above Term Structure
Number Of Respondents 16 14 12 10 8 6 4 2 0 <25 bps 25-50 bps 50-75 bps 75-100 bps >100 bps Interest In Basis Points Tax Status Default Risk Call Option Liquidity Risk 5 3 3 8 4 0 0 0 0 7 7 14

13 11 7

6

6 4 1 1

Figure 10 depicts the basis points which the respondent expects above the term structure of interest rate because it does not accommodate tax status, default risk, call option and liquidity risk. 11. Do you think Option Adjusted Spread will accommodate all the above risks?

Do Option Adjusted Spread Will Accomadate Risks which Term Structure Doesnot Consider

Disagree 4% Neither Agree Nor Disagree 16%

Strongly Disagree 0%

Agree 24%

Strongly Agree 56%

Figure 11 depicts that 56% of the respondents strongly agreed that option adjusted spread will accommodate the risks which term structure does not consider.

92

12. If you plan to lend or borrow 6 months down the line

To Lend/Borrow 6 months down the line

Collar 20%

Wait for 6 months 20%

Floorlet 24%

Caplet 36%

Figure 12 depicts the responses given by respondents when they asked about if they would like to lend and borrow 6 months down the line. 13. Rank the factors given below which motivates for entering into Swaps

Ranks Given For Different Features For Entering Into Swaps
12
7 6 5 4 3 2 1

0 2
0

4 4

2 5

1 4 3

4 5 4 3 6

2

2 4

2 3

3 3 3 3

Ranks

5 3 6 5
5

2

4

3

5

Number Of Respondents Customized features Raising finance at lower cost Reduced transaction cost Lower hedging cost Avoiding costly regulations Maintaining privacy Efficient managers who can use swaps effectively

Figure 13 depicts the various features which forces the respondents to enter into swaps.

4 2 3

10

6 3 3 3

2 3 6
15

5 1 4

20

2 7 0

4
25 30

93

14. Compare to Interest rate swaps Currency swaps are

Compare To Interest Rate Swaps Currency Swaps
60 50 Percentage 40 30 20 10 0 Superior About the same Inferior 12 16 12 4 56

Figure 14 depicts 56% of respondents responded that there is no such a difference between Interest rate swaps and currency swaps. 15. To what extent the given below factors are important in pricing the swaps

Extent Of Given Factors Important In Pricing The Swaps
Number Of Respondents 30 25 20 15 10 5 0 High Slope of Term Interest Rate Structure Risk Exposure to Swap portfolio Moderate Extent Of Importance Creditworthiness of Counterparty Low 5 0 17 14 5 0 6 3 25

Figure 15 depicts the factors which influences pricing the swaps.

94

16. For the given below risks which derivative products do you use
Derivative products Used To Reduce The Given Risk 25
Number Of Respondents 21 20 15 15 10 5 1 0 Shift the Bid-Ask Interest rate Credit Default spread Futures/Options Swap Derivative Products Default Risk Basis Risk Mismatch Risk Immunize the Duration 0 1 8 7 4 0 0 0 0 3 7 17 16

Interest Rate Risk

Figure 16 depicts the various derivative products used by the banks and corporate to hedge the risks like default risk, basis risk, mismatch risk and interest rate risk. 17. Compare to Interest Rate Future/Options Swaps is

Compare To Interest Rate Futures/Options Swaps Are
50 40 30 Percentage 20 10 0 Superior About the same 24 20 8 0 Inferior 48

Figure 17 depicts most of the respondents agree that swaps are superior to interest rate futures and options.

95

18. To over come the mismatch risk Swap Dealers enter into Interest rate Futures/Options which has created more liquidity in the bond markets.
Increased Liquidity In Bond Market Due To Swap Dealers Hedge Mismatch Risk
Strongly Disagree Disagree Neither Agree Nor Disagree Agree Strongly Agree 0 10 20 20 24 30 Percentage 40 50 60 0 4 52

Figure 18 depicts most of the respondents neither agrees nor disagree for the statement that due to the mismatch risk, swap dealers enter into Interest rate futures and options which has created more liquidity in bond markets.

19. What do you think the favourableness of investors preference to purchase Structured Notes(SN) Extremely Favourable 5 4 3 2 1 Extremely Unfavourable

Nu mber Of Respondents

Favourableness of investors preference to purchase Structured Notes(SN)
20 18 16 14 12 10 8 6 4 2 0 18 15 12 6 3 10 SN available in small quantities 8 7 6 3 1 Less credit evaluation and credit risk More marketable and liquidity 8 6 6 54 4 1 Pay off pattern is good 0 5 2 00 Yield curve is Upward/Downward sloping

4

5

4

3

2

1

Figure 19 depicts the favourable reasons for the investor’s preference to purchase structured notes.

96

20. What do you think the favourableness of issuers preference to issue Structured Notes(SN)

Favourableness of issuers preference to issue Structured Notes
1 2 3 4 5 0 5

Reduce in Financing cost

Figure 20 depicts the favourable reasons for the issuers to issue structured notes.

21. Rank the given below according to your preference for Interest Rate Swaps

Number Of Respondents

Figure 21 depicts the features available in the interest rate swaps which the respondents ranked according to there preference.

1

3 3 4

2

18 16 14 12 10 8 6 4 2 0

2

Ranks For Features Of Int Rate Swaps
17

10 8 7 6 7 7

1

7 4 5 15

10

Number Of Respondents Market imperfection Operationally efficient firm

2 Ranks

3 6 7 6
15 20

7
25 30

10 6 2 0 3 4

Flexibility Credit Exposure 5 5 Pricing 4 3 3 Arbitrage

97

22. Rank the given below according to your preference for Currency Swaps

Ranks For Features Of Currency Swaps
16 14 12 10 8 6 4 2 0 Number Of Respondents 15

10 7 8 6 8 7

9 4 2 5 6 4 2 3 4

Flexibility Credit Exposure Pricing Arbitrage

1

2 Ranks

3

4

Figure 22 depicts the features available in the currency swaps which the respondents ranked according to there preference. 23. Do you or your firm/bank trade in foreign currency?

The Banks/Firms Trade In Foreign Exchnage
120 100 Percentage 80 60 40 20 0 Yes Response No

Figure 23 depicts that 100% respondent banks and firms trade in foreign exchange.

98

24. Which Arbitrage do you more come across with

Arbitrage Opportunity The Banks/Firms Come Across

Geographical Arbitrage 36% Cross Rate Arbitrage 64%

Figure 24 depicts the various type of arbitrage opportunity the bank/firms come across when they trade in foreign currency.

25. Rank the Exchange Rate System as you prefer to trade
Exchange Rate System The Respondents Like

Joint Float 12% Pegged Exchange Rate System 4% Managed Float or Dirty Float 36%

Freely Floating 48%

Figure 25 depicts the exchange rate systems which the respondents liked. Most of the respondents that is 48%liked to be the floating rate where as others had different opinion.

99

26. To what extent do you think given below is important in determining the exchange rate?
Factors Important In Determining Exchange Rate
90 80 70 Percentage 60 50 40 30 20 10 0 7 6 5 4 Importance Interest Rate Parity Balance of Payment Fiscal Deficit Purchase Power Parity GDP Demand and Supply Current Account Deficit 3 2 1 00 24 78 64 56 48 38 26 26 24 26 24 24 22 18 16 16 1414 14 12 14 14 12 12 12 8 8 6 6 8 44 202 2 0 0 0 0 0000 00 2

Figure 26 depicts the factors which are important in determining the exchange rate. 27. Do you think FDI’s and FII’s should be allowed to hedge
Does FDI's And FII's Should Be Aloowed To Hedge In India

No 24%

Yes 76%

Yes

No

Figure 27 depicts 76% of respondents voted for allowing the FDI’s and FII’s should be allowed to hedge there foreign exchange in India.

100

28. If yes, do you think inflows from FDI and FII will increase

Does FII's And FDI's Inflow Will Increase If They Allowed To Hedge
90 80 70 60 50 40 30 20 10 0 85

Percentage

12

3 Neither Agree Nor Disagree

0 Disagree

0 Strongly Disagree

Strongly Agree

Agree

Figure 28 depicts that 85% of the respondents strongly agreed that if FII’s and FDI’s are allowed to hedge there foreign exchange the inflows will increase. 29. Currency risk is the most unhedged risk in India. To what extent given below reasons will contribute for this

Reasons for Currency risk is the most unhedged risk in India
80 70 60 50 40 30 20 10 0 76 58 48 32 20 24 4 Most Highest Highest 16 4 0 12 6

Percentage

Moderate

Lowest

Oil companies and Public sector undertakings are not allowed to hedge Lack of proper risk management among importers/exporters Restrictions on booking and cancellation of exports/imports

101

Reasons for Currency risk is the most unhedged risk in India
90 80 70 60 50 40 30 20 10 0 82 58 32 34 20 16 14 10 12 4 18 8 6 Lowest 0 34

Percentage

52

Most Highest

Highest

Moderate

Restrictions on booking and cancellation of exports/imports Exorbitant transaction charges, charged by Banks Lack of expertise among the corporation about risk management Banks need to educate their clients about Forex risk and Derivatives

Figure 29a and 29b depicts the various reasons for the currency risk which is most un hedged risk in India.

102

13. FINDINGS
 In India most of the banks and firms hedge there interest rate risk either through Interest rate swaps or forward agreements.  Nearly 87% of the respondents said that they never come across counterparty risk. Once if they come across the party who has not full filled the contract name will be revealed in market. This means then onwards no one will enter contract with him. For this reason no one likes to default.  Most of the respondents strongly agreed that the main reasons for very thin trade in interest rate futures in India is lack of underlying paper, lack of liquidity, lack of participants allowed, Standardised contract, high margins.. Where as most of them disagreed that the following reasons contributing towards thin trade, that is mark to market is cash settled, and lack of proper pricing.  Nearly 80% of the respondents felt that due to CCIL’s proposal to settle the Interest rate swaps and Forward rate agreements has increased the volumes in the market.  28% of the respondents use Market Value Naïve Model, 28% use Price Sensitivity Model 16% of respondents use Regression Model and 16% Conversion Model where as only 8% used Business point model as hedging strategy to overcome interest rate risk.  56% 0f Bank/Firm reduce the Duration of the Portfolio/ Balance Sheet by Receive fixed/Pay fixed, 32% through Immunizing Planning period case, 12% through hedging assets and liabilities individually where as no one used the options and shortening and lengthening of investments.  More volumes in forwards than futures because forwards are tailored to individual need, no mark to market, convenient market place.  72% and 16% strongly agreed and agreed respectively that pricing of options create arbitrage opportunity but due to the transaction charges it disappears.  21, 17, 17, 12 and 5 respondents responded that they analyse the Vega, Delta, Gamma, Theta and RHO respectively to much greater extent when they trade in options.  Most of the respondents expect 25-50 basis points for call option, 50-75 basis points for liquidity risk, 75-100 basis points for default risk and 50-75 basis

103

points for tax status above the term structure of interest rate when they lend. (Because term structure don’t consider the given below)  56% and 24% respondents strongly agreed and agreed respectively that option adjusted spread will accommodate all the above risks.  If the respondents expect some cash flow in 6 months down the line to invest the strategy used to invest is 36% responded that they will go for caplet, 24% floorlet, 20% collar where as 20% responded that they will wait for 6 months and then invest.  56% respondents claimed that compare to the interest rate swaps currency swaps are about the same where as 28% claimed that they are superior.  High importance given while pricing swaps is the slope of term structure interest rates and risk exposure of swap portfolio where as moderate importance is taken in terms of counterparty risk.  72% of respondents claimed that compare to Interest rate futures and options swaps are superior where as 20% claimed that it is about the same.  52% of respondents neither agreed nor disagreed the statement that to over come the mismatch risk Swap Dealers enter into Interest rate Futures/Options which has created more liquidity in the bond markets. Where as 24% and 20% strongly agreed and agreed for this.  Most of the respondents felt the following factors are extremely favourableness to invest in structured note. Those factors are 1. Structured notes available in small quantities. 2. Less credit evaluation and credit risk. 3. More marketable and liquidity. 4. Payoff pattern is good. 5. Yield curve is upward and down ward sloping.  Most of the respondents felt that the following factors are extremely favourableness for the issuer to issue structured notes. 1. Reduce in finance cost 2. Market imperfection 3. Operationally efficient firm.

104

 Most of the respondents ranked high for flexibility in interest rate swaps and currency swaps where as arbitrage, credit exposure and pricing were ranked respectively after flexibility.  64% of respondents said that cross rate arbitrage is high where as 36% of respondents said geographical arbitrage is high.  48% responded in favour of free floating exchange rate, 36% towards managed float, 12% joint float where as only 4% favoured pegged exchange rate system.  Most of the respondents felt that demand and supply will play a major role in determining exchange rate.  76% agreed to allow FDI and FII to hedge their currency risk in India.  Most of the respondents strongly agreed that if FII and FDI are allowed to hedge the inflows will increase.  Currency risk is the most unhedged risk in India and the reasons for this is 1. Oil companies and Public sector undertakings are not allowed to hedge 2. Lack of proper risk management among importers/exporters 3. Restrictions on booking and cancellation of exports/imports 4. Exorbitant transaction charges, charged by Banks 5. Lack of expertise among the corporation about risk management 6. Banks need to educate their clients about Forex risk and Derivatives

105

14. CONCLUSION
 Derivatives help in discovery of future as well as current prices.  The derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them.  Derivatives markets help increase savings and investment in the long run. Transfer of risk enables market participants to expand their volume of activity.  Interest rate futures and options are playing a major role in mitigating the unexpected risk where as in India it is not happening.  Liquidity in the Indian Bond market is very less.  There is a little liquidity in the bond market this is due to the statutory requirement that primary dealers want to trade in the bond market to certain amount of transactions in a year.  Liquidity in the bond market can be increased by Interest rate futures and options. The SEBI or RBI need to set up a committee and make a thorough study on this and should come out with new rules and guidelines.  Even now the interest rate futures are available in the market it is restricted to only primary dealers. Only once in the life time after introduction of interest rate futures it is traded and that is in 2003. Then onwards not even a single contract is traded.  The recent decision taken by RBI to allow intra day short selling in bond market is a good move but it will not create much liquidity in the market.  Interest rate futures are not traded even after introduction and I think there is no use of introducing interest rate options in the market.  At the same time it is not only the rules and guidelines which are affecting the liquidity in the bond market but the risk appetite of the investors.  In India most of the investors don’t like to take risk where has in many countries the investors prefer for junk bonds due to the high returns.  Issuance of structured notes in India is very less. With the help of swaps the issuer can reduce the finance cost and the return to the investor is high because of the payoff pattern is very good.  When it comes to corporate bonds it is even worse.

106

 Most of the corporate are raising the debt from foreign countries at less rate compare to the India interest rates. In the year 2005 India Inc has raise around 75,000 crores from overseas through FCCB, ADR and GDR.  Interest rate swaps are better than futures and options. Due to the CCIL proposal to settle the IRS through it the number of contracts is increased.  In 1992 when Indian government accepted for Liberalisation, Privatisation and Globalisation the then finance minister Man Mohan Singh and Present Prime Minister took a right decision saved the country from huge depreciation of currency. He allowed only current account convertibility and put a break on capital account convertibility. Many of the countries like Indonesia who allowed full convertibility is suffering. Now 1 dollar is equal to some thousand of the Indonesian currency.  Most of the people accepted the decision and asked a question that when the India is going to have full currency convertibility then Man Mohan Singh gave three conditions and if three are satisfied then India can allow currency into fully convertibility. Those conditions are: o Inflation of the country should be less than 5%. o Fiscal deficit should be less than 5%. o India should have a Forex reserve of $200 bn.  Now the companies who are earning foreign exchange are allowed to invest 200% net worth of the company and every individual is allowed to invest $25,000 in other countries.  All the above are good measures but in India the most unhedged risk is currency risk. The reasons for this are mentioned in findings. To overcome this problem the following steps need to be taken. 1. Oil companies and Public sector undertakings should be allowed to hedge 2. There should be proper risk management among importers/exporters 3. Restrictions on booking and cancellation of exports/imports should be removed. 4. Exorbitant transaction charges, charged by Banks should be removed. The loss incurred by the bank in purchasing and selling of dollars on behalf of exporters and importers are bear upon small exporters and importers. 5. Lack of expertise among the corporation about risk management 6. Banks need to educate their clients about Forex risk and Derivatives. 107

 At the same time RBI has put unreasonable restriction on FII’s and FDI’s to hedge the currency risk in India. This should be removed.  Because of this the FII’s and FDI’s will hedge the currency risk in other countries like Hong Kong, Dubai and Singapore. This type of hedging is called Non Deliverable Forwards.  Hong Kong dealers have got more confidence in Indian rupee and now Indian rupee is fully convertible in Hong Kong. As other countries are doing this why not India should allow foreign currency risk to hedge.

108

15. Bibliography
http://www.derivativesindia.com http://www.derivatives-r-us.com http://www.igidr.ac.in/~ajayshah http://www.mof.nic http://www.nseindia.com http://www.sebi.gov.in http://www.rediff/money/derivatives http://www.rbi.org http://www..com
http://www.eurexchange.com http://www.hkfe.com http://www.liffe.com http://www.simex.com http://www.cbot.com http://www.cboe.com

109


								
To top