Overview
Definitions & Benchmarks
Overnight Indexed Swaps
Uses & Opportunities
Linkages between markets
Interest Rate- market views
IRS- Definition
Exchange of cash flows (Risks)
•Notional Principal
•Prescribed dates
•Prescribed computation method
FIXED and FLOATING rates of interest.
•Floating based on a market benchmark.
IRS- Floating Benchmarks
Independent & Transparent
Dependable (Past & Future)
Examples
–Overnight MIBOR (Mumbai Inter-Bank Offer Rate)
–Commercial Paper Rates
–Prime Lending Rates
–T-Bill Yields (14 , 91, 182 and 365 days )
–Forex Swap Rates (Premia)
IRS- Floating Benchmarks
CP Rates
Benchmark not available
Corporate Specific
PLR
Bank Specific
2-way Quotes not available
T-Bill Yields
Daily Quotes not available
Cut-off yields not independent
Forex Swap Rates
Possible- non MMkt.
No source at present
Daily MIBOR linked IRS = OIS
Overnight Indexed Swap (OIS)
Floating leg based on MIBOR
•Daily overnight rate reference
•Compounded daily/ accrued over holidays
•NSE/ Reuters (26-32 bank’s average)
Other market conventions
•Pre-defined notional principal.
•Normal FRA / IRS terminology
–Pay/ buy an OIS = pay fixed receive floating
–Receive/ sell an OIS = receive fixed pay floating
Overnight Indexed Swap (OIS)
FIXED CASH
FLOW- Cfix
Corporate
Citibank
FLOATING CASH
FLOW- Cfloat
OIS - Mechanics
Fixed Coupon is calculated as follows Cfix = P x Rfix x
Cfix
P
Rfix
d
basis
=
=
=
=
=
d
basis
Fixed Coupon
Notional Principal
Agreed Fixed Interest Rate
Length of Coupon Period in days
Applicable day basis (e.g. 365)
OIS - Mechanics
Floating Coupon is calculated as follows -
Cfloat = P x Rfloat x d
basis
Cfloat
P
Rfloat
d
basis
= Floating Coupon
= Notional principal
= Compounded Floating Interest Rate (see next slide)
= Length of Coupon Period in days
= Applicable day basis (e.g. 365)
OIS - Mechanics
Floating Rate is calculated as follows d business
Rfloat = ( [ 1 + ri x d i ] - 1 ) basis
i=1
basis
d total
Rfloat
ri
di
d business
d total
basis
=
=
=
=
=
=
Floating Rate
MIBOR Rate for the ith business day
Number of days the ith MIBOR rate applies
Number of business days in the coupon period
Total no. of calendar days in the coupon period
Applicable day basis (e.g. 365)
IRS- RBI Guidelines
FRA/ IRS allowed for hedging rupee balance
sheet exposures.
Banks to exercise due diligence
•Certificates that transaction for hedging balance
sheet exposures (w.r.t. size and tenor)
IRS- Benefits
‘Essentially divorces liquidity management
from interest rate risk management.’
Simple to use
Minimal credit risk
No ballooning of balance sheet
IRS- Opportunities
Better interest rate risk management
•Diversification of risk
•Implement interest rate views
Access to cheaper funding
•Comparative Advantages
Good Cash/ Liquidity Management Tool
•Monthly collections vs quarterly interest payments
IRS- Structures
Hedge increases- go fixed
•Hardening rates: Fix future CP issue/ rollover costs
•Convert floating WCDL into fixed rate
Reduce costs- go floating
•Softening rates: Raise term funds but pay MIBOR
•Receive fixed against existing fixed rate loans
Example I - Comparative Advantage
Funding at lower MIBOR spreads than before
AAA issues 1yr fixed at
11.10%
OIS AAA receives Fixed
10.00%
AAA pays
MIBOR
Net impact is 1 year funds @ MIBOR + 110BPs
Example II - Lending at Call
Placement of deposits at call-linked rates
ABC buys 180 day T-Bills
9.8%
OIS ABC pays fixed
9.5%
ABC receives
MIBOR
Net impact is 180 day return @ MIBOR + 30BPs
Has effectively lent in the call market
Example III - Hedging future CP Rates
Locking in future funding costs
ABC has Rs.100mio CP maturing in 3 months
FRA (or IRS) for 3v6 at 10.8%
Unwind FRA at time of rollover
Net impact is CP funding rate @ 10.8%
Profit/ loss on unwind will offset rate received
IRS- Current scenario
Flurry of OIS deals on Day 1
Corporates - Main receivers of fixed rates
Limited inter-bank deals
•ISDA documentation
•Not represented fully by all foreign banks & PDs
•Absence of nationalised banks
IRS- Future Scenario
More volumes
Longer tenors
Other new benchmarks
•MIBOR, but not overnight based
•Other index based
Banks end up being “Payers of fixed rates”
Keen interest by nationalised banks
IRS- Issues
Illiquidity in the secondary corporate bonds
T Bill reference rate yet to evolve despite
existence of a T Bill auction calendar
Expected time for development of a term money
market
Accounting/tax for IRS/FRAs (Hedge vs MTM)
Basis risk
Linkages between markets
Call Money vs Forward Premium
•Arbitrage potential
•Immediate response across curve
IRS vs CCY swaps (Premia) vs T-Bills
•Accessible by the main banks
•Different considerations
•Other markets more liquid/ less bid-offer
Linkages between markets
Tenor
6 mth
12 mth
$
Fwd.
LIBOR Premia
5.90
4.90
6.10
5.00
Swap
Curve
10.80
IRS
Curve
9.50
T- Bill
Yield
9.70
11.10
10.0
10.2
Call Money rate was 10.12 (as on Aug 16’99)
Linkage between markets
IRS = Call - 62 bps
•Reflecting 6 month expectations
T Bill = IRS + 20bps
•Reflecting funding risk
Swap = Tbill + 110bps
•Swap= Libor + Premium
•Reflecting short term reaction
IRS cannot be more than Swap
Continuing discontinuities
High bid-offer spreads in IRS
•Lack of efficiency
•Fewer aggressive banks/ Docs/ Credit issues
•Logistical/ internal limitations
Cash vs. IRS
•Liquidity fears (50bps)
•LAF- guarantees liquidity, start made (like FED)
Continuing discontinuities
TBIlls vs Fwds
•FCNR USD funds with few banks
•surplus INR other banks
•Switching difficult from both sides
•Difficult to short GOI securities- 1way
•15% rule for longer tenors
•Short end is relatively integrated
Interest Rates - so far
•Shocks in Jan/ Aug’98
•Interest rates lower across the board in 1999
•Successfully survived a major event risk- Kargil
•Historically low inflation
•Increasing liquidity, longer tenors in bonds
RBI approach
•Openness - e.g. Feedback on Policy
•IRS- hedging mechanism
•Public statements on objectives
•Corridor of interest rates.
Interest Rate- Trends
17%
15%
1mth
13%
3mth
11%
6mth
9%
12mth
7%
24mth
5%
60mth
3%
A-99
J-99
O-98
J-98
A-98
J-98
O-97
J-97
A-97
J-97
O-96
J-96
1%
Interest rates - Sovereign
Surplus liquidity, low inflation
Banks
•Evaporating fears of liquidity crisis
–shocks still there (12/08)
•Surplus SLR due to lack of alternatives
Government
•FY99-00 Govt. net borrowing target (78% done)
•Long tenor based rally - high duration
•Oct. Credit policy, higher fiscal needs- Kashmir
Interest rates- Corporate
Limited Supply, growing demand
Mutual Funds
•Tax anomaly driving the industry
•Flush with liquidity - funds seek yields
Compression in Corporate spread over GOI
•Compression to shift to longer tenor/ Tier II names
Trend to reverse (Q3’00) after a few shocks
•Spike in GOI yields/ Ill-liquidity/ Credit deterioration
Interest rates - prognosis
Likely to trend lower
•Inflation yet to hit bottom(Nov)
•Higher Real yields
•No signs of credit pickup
Expansionary Credit policy
•Bank rate/ Repo/ CRR cut; Deposit rates/ PLR sticky
•Accommodate govt. borrowing targets
No $/ INR shocks/ Political uncertainties
Rupee Interest Rate Derivatives and Citibank
Trading expertise. Experienced team
Ability to offer low bid-offer quotes
Risk management systems in place
Exposure to IRS products in Emerging Markets
Huge corporate reach- Can match requirements
Disclaimer
•Although the information contained herein is believed to be reliable,
Citibank makes no representation as to the accuracy or completeness of
any information contained herein or otherwise provided by Citibank.
•The ultimate decision to proceed with any transaction rests solely with
the customer. Citibank N.A. is not acting as your advisor. Therefore,
prior to entering into any proposed transaction, you should determine
the economic risks and merits, as well as the legal, tax and accounting
characterizations and consequences of the transaction, and that you are
able to assume these RISKS.
•The contents of this presentation are proprietary in nature, and may
not disseminated in whole or in part without Citibank's written
consent.