overview definitions & benchmarks overnight indexed swaps uses & opportunities linkages...
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OverviewOverview
Definitions & BenchmarksDefinitions & Benchmarks
Overnight Indexed SwapsOvernight Indexed Swaps
Uses & OpportunitiesUses & Opportunities
Linkages between marketsLinkages between markets
Interest Rate- market viewsInterest Rate- market views
IRS- DefinitionIRS- Definition
Exchange of cash flows (Risks)Exchange of cash flows (Risks)•Notional PrincipalNotional Principal•Prescribed datesPrescribed dates•Prescribed computation methodPrescribed computation method
FIXED and FLOATING rates of interest. FIXED and FLOATING rates of interest. •Floating based on a market benchmark. Floating based on a market benchmark.
IRS- Floating BenchmarksIRS- Floating Benchmarks
Independent & TransparentIndependent & Transparent
Dependable (Past & Future)Dependable (Past & Future)
ExamplesExamples–Overnight MIBOR (Mumbai Inter-Bank Offer Rate)Overnight MIBOR (Mumbai Inter-Bank Offer Rate)–Commercial Paper RatesCommercial Paper Rates–Prime Lending RatesPrime Lending Rates–T-Bill Yields (14 , 91, 182 and 365 days )T-Bill Yields (14 , 91, 182 and 365 days )–Forex Swap Rates (Premia)Forex Swap Rates (Premia)
Daily MIBOR linked IRS = OIS
IRS- Floating BenchmarksIRS- Floating Benchmarks
PLRBank Specific2-way Quotes not available
T-Bill YieldsDaily Quotes not availableCut-off yields not independent
Forex Swap RatesPossible- non MMkt.No source at present
CP RatesBenchmark not availableCorporate Specific
Overnight Indexed Swap (OIS)Overnight Indexed Swap (OIS)
Floating leg based on MIBORFloating leg based on MIBOR•Daily overnight rate referenceDaily overnight rate reference•Compounded daily/ accrued over holidaysCompounded daily/ accrued over holidays•NSE/ Reuters (26-32 bank’s average)NSE/ Reuters (26-32 bank’s average)
Other market conventionsOther market conventions•Pre-defined notional principal. Pre-defined notional principal. •Normal FRA / IRS terminologyNormal FRA / IRS terminology
–Pay/ buy an OIS = pay fixed receive floatingPay/ buy an OIS = pay fixed receive floating–Receive/ sell an OIS = receive fixed pay floatingReceive/ sell an OIS = receive fixed pay floating
Overnight Indexed Swap (OIS)Overnight Indexed Swap (OIS)
Corporate Citibank
FIXED CASH FLOW- Cfix
FLOATING CASH FLOW- Cfloat
Fixed Coupon is calculated as follows -
Cfix = P x Rfix x d basis
Cfix = Fixed Coupon P = Notional PrincipalRfix = Agreed Fixed Interest Rated = Length of Coupon Period in daysbasis = Applicable day basis (e.g. 365)
OIS - MechanicsOIS - Mechanics
Floating Coupon is calculated as follows -
Cfloat = P x Rfloat x d basis
Cfloat = Floating Coupon P = Notional principalRfloat = Compounded Floating Interest Rate (see next slide)
d = Length of Coupon Period in daysbasis = Applicable day basis (e.g. 365)
OIS - MechanicsOIS - Mechanics
Floating Rate is calculated as follows -
d business
Rfloat = ( [ 1 + ri x d i ] - 1 ) basis i=1 basis d total
Rfloat = Floating Rater i = MIBOR Rate for the ith business day d i = Number of days the ith MIBOR rate appliesd business = Number of business days in the coupon periodd total = Total no. of calendar days in the coupon periodbasis = Applicable day basis (e.g. 365)
OIS - MechanicsOIS - Mechanics
IRS- RBI GuidelinesIRS- RBI Guidelines
FRA/ IRS allowed for hedging rupee balance FRA/ IRS allowed for hedging rupee balance sheet exposures.sheet exposures.
Banks to exercise due diligenceBanks to exercise due diligence•Certificates that transaction for hedging balance Certificates that transaction for hedging balance sheet exposures (w.r.t. size and tenor)sheet exposures (w.r.t. size and tenor)
IRS- BenefitsIRS- Benefits
‘‘Essentially divorces liquidity management Essentially divorces liquidity management from interest rate risk management.’from interest rate risk management.’
Simple to useSimple to use
Minimal credit riskMinimal credit risk
No ballooning of balance sheetNo ballooning of balance sheet
IRS- OpportunitiesIRS- Opportunities
Better interest rate risk managementBetter interest rate risk management•Diversification of riskDiversification of risk• Implement interest rate viewsImplement interest rate views
Access to cheaper fundingAccess to cheaper funding•Comparative AdvantagesComparative Advantages
Good Cash/ Liquidity Management ToolGood Cash/ Liquidity Management Tool•Monthly collections vs quarterly interest paymentsMonthly collections vs quarterly interest payments
IRS- StructuresIRS- Structures
Hedge increases- go fixedHedge increases- go fixed•Hardening rates: Fix future CP issue/ rollover costsHardening rates: Fix future CP issue/ rollover costs•Convert floating WCDL into fixed rateConvert floating WCDL into fixed rate
Reduce costs- go floatingReduce costs- go floating•Softening rates: Raise term funds but pay MIBORSoftening rates: Raise term funds but pay MIBOR•Receive fixed against existing fixed rate loansReceive fixed against existing fixed rate loans
Example I - Comparative AdvantageExample I - Comparative Advantage
Funding at lower MIBOR spreads than beforeFunding at lower MIBOR spreads than before
AAA issues 1yr fixed at AAA issues 1yr fixed at 11.10%11.10%
OIS OIS AAA receives Fixed AAA receives Fixed 10.00%10.00%
AAA pays AAA pays MIBORMIBOR
Net impact is 1 year funds @ MIBOR + 110BPsNet impact is 1 year funds @ MIBOR + 110BPs
Example II - Lending at CallExample II - Lending at Call
Placement of deposits at call-linked ratesPlacement of deposits at call-linked rates
ABC buys 180 day T-BillsABC buys 180 day T-Bills 9.8%9.8%
OISOIS ABC pays fixedABC pays fixed 9.5%9.5%
ABC receives ABC receives MIBORMIBOR
Net impact is 180 day return @ MIBOR + 30BPsNet impact is 180 day return @ MIBOR + 30BPs
Has effectively lent in the call marketHas effectively lent in the call market
Example III - Hedging future CP RatesExample III - Hedging future CP Rates
Locking in future funding costsLocking in future funding costs
ABC has Rs.100mio CP maturing in 3 monthsABC has Rs.100mio CP maturing in 3 months
FRA FRA (or IRS) for 3v6 at 10.8%(or IRS) for 3v6 at 10.8%
Unwind FRA at time of rolloverUnwind FRA at time of rollover
Net impact is CP funding rate @ 10.8%Net impact is CP funding rate @ 10.8%
Profit/ loss on unwind will offset rate receivedProfit/ loss on unwind will offset rate received
IRS- Current scenarioIRS- Current scenario
Flurry of OIS deals on Day 1Flurry of OIS deals on Day 1
Corporates - Main receivers of fixed ratesCorporates - Main receivers of fixed rates
Limited inter-bank dealsLimited inter-bank deals• ISDA documentationISDA documentation•Not represented fully by all foreign banks & PDsNot represented fully by all foreign banks & PDs•Absence of nationalised banksAbsence of nationalised banks
IRS- Future ScenarioIRS- Future Scenario
More volumes More volumes
Longer tenorsLonger tenors
Other new benchmarksOther new benchmarks•MIBOR, but not overnight basedMIBOR, but not overnight based•Other index basedOther index based
Banks end up being “Payers of fixed rates” Banks end up being “Payers of fixed rates”
Keen interest by nationalised banksKeen interest by nationalised banks
IRS- IssuesIRS- Issues
Illiquidity in the secondary corporate bonds Illiquidity in the secondary corporate bonds
T Bill reference rate yet to evolve despite T Bill reference rate yet to evolve despite existence of a T Bill auction calendarexistence of a T Bill auction calendar
Expected time for development of a term money Expected time for development of a term money marketmarket
Accounting/tax for IRS/FRAs (Hedge vs MTM)Accounting/tax for IRS/FRAs (Hedge vs MTM)
Basis riskBasis risk
Linkages between marketsLinkages between markets
Call Money vs Forward PremiumCall Money vs Forward Premium•Arbitrage potentialArbitrage potential• Immediate response across curveImmediate response across curve
IRS vs CCY swaps (Premia) vs T-BillsIRS vs CCY swaps (Premia) vs T-Bills•Accessible by the main banksAccessible by the main banks•Different considerationsDifferent considerations•Other markets more liquid/ less bid-offerOther markets more liquid/ less bid-offer
Linkages between marketsLinkages between markets
Tenor $LIBOR
Fwd.Premia
SwapCurve
IRSCurve
T- BillYield
6 mth 5.90 4.90 10.80 9.50 9.70
12 mth 6.10 5.00 11.10 10.0 10.2
Call Money rate was 10.12 (as on Aug 16’99)
Linkage between marketsLinkage between markets
IRS = Call - 62 bpsIRS = Call - 62 bps•Reflecting 6 month expectationsReflecting 6 month expectations
T Bill = IRS + 20bpsT Bill = IRS + 20bps•Reflecting funding riskReflecting funding risk
Swap = Tbill + 110bpsSwap = Tbill + 110bps•Swap= Libor + PremiumSwap= Libor + Premium•Reflecting short term reactionReflecting short term reaction
IRS cannot be more than SwapIRS cannot be more than Swap
Continuing discontinuitiesContinuing discontinuities
High bid-offer spreads in IRSHigh bid-offer spreads in IRS• Lack of efficiency Lack of efficiency •Fewer aggressive banks/ Docs/ Credit issuesFewer aggressive banks/ Docs/ Credit issues•Logistical/ internal limitationsLogistical/ internal limitations
Cash vs. IRS Cash vs. IRS • Liquidity fears (50bps)Liquidity fears (50bps)•LAF- guarantees liquidity, start made (like FED)LAF- guarantees liquidity, start made (like FED)
Continuing discontinuitiesContinuing discontinuities
TBIlls vs FwdsTBIlls vs Fwds•FCNR USD funds with few banksFCNR USD funds with few banks•surplus INR other bankssurplus INR other banks•Switching difficult from both sidesSwitching difficult from both sides•Difficult to short GOI securities- 1wayDifficult to short GOI securities- 1way•15% rule for longer tenors15% rule for longer tenors•Short end is relatively integratedShort end is relatively integrated
Interest Rates - so far Interest Rates - so far
• Shocks in Jan/ Aug’98Shocks in Jan/ Aug’98• Interest rates lower across the board in 1999Interest rates lower across the board in 1999• Successfully survived a major event risk- KargilSuccessfully survived a major event risk- Kargil• Historically low inflationHistorically low inflation• Increasing liquidity, longer tenors in bondsIncreasing liquidity, longer tenors in bonds
RBI approachRBI approach• Openness - e.g. Feedback on PolicyOpenness - e.g. Feedback on Policy• IRS- hedging mechanismIRS- hedging mechanism• Public statements on objectivesPublic statements on objectives• Corridor of interest rates.Corridor of interest rates.
Interest Rate- TrendsInterest Rate- Trends
1%
3%
5%
7%
9%
11%
13%
15%
17%
J-9
6
O-9
6
J-9
7
A-9
7
J-9
7
O-9
7
J-9
8
A-9
8
J-9
8
O-9
8
J-9
9
A-9
9
1mth
3mth
6mth
12mth
24mth
60mth
Interest rates - SovereignInterest rates - Sovereign
Surplus liquidity, low inflationSurplus liquidity, low inflation
BanksBanks• Evaporating fears of liquidity crisisEvaporating fears of liquidity crisis
–shocks still there (12/08)shocks still there (12/08)• Surplus SLR due to lack of alternativesSurplus SLR due to lack of alternatives
GovernmentGovernment• FY99-00 Govt. net borrowing target (78% done)FY99-00 Govt. net borrowing target (78% done)• Long tenor based rally - high durationLong tenor based rally - high duration• Oct. Credit policy, higher fiscal needs- KashmirOct. Credit policy, higher fiscal needs- Kashmir
Interest rates- CorporateInterest rates- Corporate
Limited Supply, growing demandLimited Supply, growing demand
Mutual FundsMutual Funds•Tax anomaly driving the industryTax anomaly driving the industry•Flush with liquidity - funds seek yields Flush with liquidity - funds seek yields
Compression in Corporate spread over GOICompression in Corporate spread over GOI•Compression to shift to longer tenor/ Tier II namesCompression to shift to longer tenor/ Tier II names
Trend to reverse (Q3’00) after a few shocksTrend to reverse (Q3’00) after a few shocks•Spike in GOI yields/ Ill-liquidity/ Credit deteriorationSpike in GOI yields/ Ill-liquidity/ Credit deterioration
Interest rates - prognosis Interest rates - prognosis
Likely to trend lowerLikely to trend lower• Inflation yet to hit bottom(Nov)Inflation yet to hit bottom(Nov)•Higher Real yieldsHigher Real yields•No signs of credit pickupNo signs of credit pickup
Expansionary Credit policyExpansionary Credit policy•Bank rate/ Repo/ CRR cut; Deposit rates/ PLR stickyBank rate/ Repo/ CRR cut; Deposit rates/ PLR sticky•Accommodate govt. borrowing targetsAccommodate govt. borrowing targets
No $/ INR shocks/ Political uncertaintiesNo $/ INR shocks/ Political uncertainties
Rupee Interest Rate Derivatives and CitibankRupee Interest Rate Derivatives and Citibank
Trading expertise. Experienced teamTrading expertise. Experienced team
Ability to offer low bid-offer quotesAbility to offer low bid-offer quotes
Risk management systems in placeRisk management systems in place
Exposure to IRS products in Emerging MarketsExposure to IRS products in Emerging Markets
Huge corporate reach- Can match requirementsHuge corporate reach- Can match requirements
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