CASE 8
Maybank
Maybank: Gap Risk Management – FRA & Eurodollar
Situation: It's November 11, 2003.
• A client wants a loan in 6 months (May 11, 2004) from USD 200 M at
6-mo LIBOR + spread (37.5 bps).
That is, in May 11, 2004: Maybank lends at 6-mo LIBOR + 37.5 bps.
6-mo LIBOR + 37.5 bps
Today = Nov 11
6 months = May 11
12 months
Today: 6-mo LIBOR = 2.625%; spread: 0.375%
=> 3% (or 1.5123% for the 184 day period)
Maybank does not know 6-mo LIBOR in 6 months.
=> Risk: The bank takes a deposit now (say, a 12-mo deposit at 2.63%)
that can be used to fund the loan in 6 months, 6-mo LIBOR goes down.
Maybank: Gap Risk Management – FRA & Eurodollar
• Eurodeposits are available to fund the future 6-mo loan:
6MO 2.52 - 2.56 (Long ED: Deposit at 2.52% for 6-mo)
12MO 2.60 - 2.63 (Short ED: Get funding at 2.63% for 12 months)
A future 6-mo net funding position at:
f = [(1+.0263*365/360)/(1+.0252*181/360) – 1]*360/184 = 2.7039%
(≈ 1.35% for a 6-mo period).
Note: If in May 11 6-mo LIBOR (+37.5 bps) > f => loan profitable.
Maybank: Gap Risk Management – FRA & Eurodollar
• Hedging alternatives: Short FRA and Short ED
Lock a future interest rate, f. Then, if in 6 months, 6-mo LIBOR < f, the
short side wins.
• Short: FRA 6x12 at 2.74% (184 days)
Set f at (1+.0274*(184/360)) -1 = 1.4004%
• Short ED strip (6-mo and 9-mo):
6-mo Eurodollar at 2.5625% (92 days)
+
9-mo Eurodollar at 2.59375% (92 days)
Set f at (1+.025625*(92/360))*(1+.0259375*(92/360)) – 1 = 1.322%
ED sets a lower funding cost, lower than the implied by the Eurodeposit
strip.
Maybank: Gap Risk Management – Stack Hedge
Given that dates are fixed (and there are no intermediate payments) a
stack –i.e., shorting 2 3-mo ED contracts to cover a 6-mo exposure- is
not a good alternative.
Maybank: Gap Risk Management – Swaps & Cap
(1) A fixed-for-flexible swap can be used in 6-mo (in the last slide we
calculate a current quote). But, not now, since there are no cash flows!
A eurodollar put option (right to go short a Eurodollar) with a 6-mo
maturity is a better solution.
Note: A swaption –i.e., an option giving the holder the right to enter into
an underlying fixed-for-flexible swap- can be used.
(2) A cap can be used to limit exposure.
Maybank: Gap Risk Management – 6-mo Cap at 2.5%
Steps to calculate cost of Cap at 2.5%.
(1) Calculate implied forward rate (done before): f = 2.7039%
Note: The option expires in 6 months, but does not settle until the end of
the 12-month period, which is one year from today (Nov 11, 2004).
(2) Discount rate on the option is 2.630%. The discount factor is
[1 + .0263 x (365/360)] = 1.026665
(3) Calculate volatility for the future 6-mo rate. Set v=.15
(4) Calculate Call Value (C) for X=2.5% and f =2.7039% .
d1: 0.795242 => N(d1): 0.786764
d2: 0.689613 => N(d2): 0.754781
Call = 0.23417
Amount Paid = (0.23417/100) x (184/360) x USD 200 M = USD 0.239M
Maybank: Gap Risk Management – 6-mo Swap Rate
(1) Swap is for 6 months, n=2.
f6,12
= [(1+.025625*(92/360))*(1+.0259375*(92/360))](360/184) – 1 =
= 0.026029694 (money market basis).
(2) Convert this money market rate to its effective equivalent stated on
an annual bond basis.
FRE6,12 = 0.026029694 x (365/360) = 0.026391218.
(3) Coupon payments are s.a. , k=2. Restate this effective annual rate on
an equivalent quarterly bond basis.
SC = [(1 + 0.026391218)1/2 - 1] x 2 = 0.026219354 (quarterly bond
basis)
=> The swap coupon mid-rate is 0.026219354 %.