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 9.7012 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-96

O-9

6

J-97

A-9

7

J-97

O-9

7

J-98

A-9

8

J-98

O-9

8

J-99

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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DisclaimerDisclaimer