Pmatik Jagati

INTEREST RATE RISK MANAGEMENT

1 FRA
2 Interestmate futures

3 Interestrate options 4 cap Floom Collam

n interest rate swaps

5 Cheapest to Deliver Interest rate futures

6 Swaption

1 FRA

suppose Priatik Jagati wants to Bonnow I 1000000 after 6months for a period

of 3months but he is afraid of interestrate rising often 6 months

Here He can enter into FRA contract today itself to Borrow E 1000000
after 6 months Say 8.59
i e 6 9 FRA 8.5 contracted rate

After 6months Interest rate turns out to be 12

Real Borrowing mom Bank FRA contract 46 9 FRA 8.51.7

Borrow 1000000 at actual Bonnow F 1000000 FRA 8.5 Interestoff 21250

rate of 121 Don7mm After 6months settle FRAby investing at commentmates

Interestoff 1000000 129 Invest 1000000 124 Interest1 f 30000

30000
any Gain on FRA settlement 9mm 8750
mins
1 Effective Interest Amount 30000 8750 21250 ptu
8495
Effective Interest rate 21250 100 2 1257 nm com
1000000
8.57 D a
 7

How to calculate theoretical FRA

E9 6m Libor 10 D a 10 6112 57 1.05

am Libor 12 pin 12 91,2 91 1 09

6 9 FRA 100 380957 mths

3.8095 15.2381 P.a

Note 6months Libom 6 9FRA 9may Libon

1 100
1 05 1 038095 1.09 1.05 5
Sneha is 9 es cam
Prette 57 105Com 00i.esroast 8th 1 09 9m
1 7 1 9.7
1 6 9FRA FRA after 6 months for 3 months Period
2 8 10 FRA 9 FRA after 10 months for 2 months period
3 2 5 FRA 1 FRA often 2 months for 5 month Period

E9 6mLibor 121 pie 61 1.06

12mLibom lhf.ph 147 1 14

1 6 12FRA 08 100 7.547 6m 15.094 f P.a

1.0

OH 6 12FRA 1.07547 7.5471 6m 15.0947Pa

6pm 12FRA
100
1 06
1.06 7.5471

I
On 1.14 12m
 Ef 2 412
months Libon 2 2 3331 1 00333
6 months Libon 5 5 6 12 2 51 1 025
i 2 6FRA 1.025 1 00337 100 2.1598 f hmu
1.00333
648f Pra
OH 2 6FRA 1 025 1021598 2 15987 hm 6481 p.a
g on
1025 100

3
mar 3 8Borrow 1003 2.15981

8m
invest 0m 1.025 dm

Arbitrage in FRA

3mLibon 121 8mlibon 181 Quoted 3 8 FRA 131 14

ASIA
Sol 3mLibory 12 3 12 3 1.03 common

8mLibon 18 8 12 121 1 12

I Theoretically 3 8FRA 1 1.08737 20 97 f D a

8.13ft

Since Quoted 3 8 FRA is cheaper than theoretical we should Bonnow 3 8FRA

BOMMOW
3m Libor 3 8FRA 1 1 03 105833 1.09008 outflow
Invest 7 8m Libon 1 1 12 1.12 Inflow
i Gain 03 Pen Borrowed

ME

FDABorrow
 Amount megd after 6months bom a period of 3months 60cm

Quoted 6 9 FRA 9.30 9 30 3 12 2 3251 3m

i We should Bonnow 6XGFRA 23251 ba 3m
Case I 9 ftp.e.ie 241 3mi Case I 8.8 it 2.2113m
Bonnow 460cm 9.31 3112 1.395cm detblow Borrow 460cm 9.31 31,4 1.395cm detblow

Invest 460cm 9.61 3127 1 44on Inflow Invest 460cm ftp.x3p 1.32cnInblow
Gain 9m 450000 Loss 9m 750000

Finalsettlement16m 45,98 439453 Finalsettlement16m 759 733855

1 9m Rate 4 51 9.5 3112 11251 1101125

6mRate 51 5 6112 2 57 1 025

i 3 6FRA 1.025 1 0136 1 36 3mm 136 5.447 f a

proping

2 6m libon 51 2157 1 025

12m Libory 6.57 6.51 1 065

I 6 12 FRA 1.065 110390 3 90 16months 7 ftp.a

p.az
 3.3751

But Quoted 6 12FRA it 657 61751 which is cheaper Hence Bonnow

BOMMON 6m 6 12FRA 1 1.025 103375 1 0595Goufflow

Invest 12m 1 1065 1.065 Sthblowy

i GainPen Bonnowed 0054 Arbitrate Gain

Explanation

1 Bonnow 1 for 6months and enter into FRA to borrow 6.757 dom further 6months
Amt Payable i e outflow after 12 month 1 1 025 1 03375 1.0595 outflow

2 Invest 1 for 12month directly 6.57 1 1 065 1 065 Inflow

Gain den Borrowed 0054

loan 5.251

a Profit to fm Fincomp 5.5 5251 257 25 Basis Points

b Settlement Amount 9months

BOMMON 6 9 FRA 100 5.25 90360 9 1.3125Cm outflow
Invest 100 5.57 90360 1 375Cm Inflow

Gain 9month 625000

D v of Gain i e settlement ant 4 59 9 176 9545 616522

 1 1126
1 1836

it 929h Lyme Yield 4 21 ph Comp Annually 10425 1.08576

Byns Yield 4 48f pea Comp Annually 4.04487 1.1405

i 2 3 FRA 1.1405 1.0504 ie 5.04 t.p.ee

1 08576

ABCUA 2 3FRA 6 10638 ie 6.381Pa

Ii
4.51 Allow to Lapse 5.51 Exercise
Interest to Bank outflow 4507 4100 4 51.7 5.5cm 4100 5.5 7
Payofffromoption Inflow 46cm 4100 15.5 504

Premium cost outflow 10 CM 10cm

4100cm 0.1 7 4 60cm 5.14cm
 FRA

IF Intimate thins outtobe 4.51 If intimate fans out to be 6157

ROMMOW FRA 450m
5941 6127 1 485 m Ronnow FRA 450m 5941 6127 1 485 m
Invest Actual450m 9 51 61127 1 125m Invest Actual450m 6.57 x 61127 1.625m

less 4114417 Gain 0.564 f 140000

83689

Borrowingcostto Bank Actual Borrowingcostto Bank actual

50mF 451 6 12 112506m 50mF 6.57 6 12 E 162500ftblow

Total cost E 1485000 Total cost E 1485000

1485000
Eff Matt 1485000 100
1,2 5.941Pa Eff Matt 100
12 51941Pa
5000000 50000000
 Interest Mate Futures
t 50m
Amount
of Futures to short for Perfect Hedging 9mm floom

lot size 50000 E

i No contracts ᵗ 1000 0 00 2000 contracts

of
t 50000

Interestmate 5.851 Price 100 5.85 94.157

affmaid
Abid ofmaterising of Price falling
Tonnow Tell futures

CASEA 4.57 100 45 95.5 CASE B 651 700 6 5 93 5

sell 3mFutures 2000 50000 9415 312 Sell 3mFutures 2000 50000 9415 312
2000 50000 95.5 312 2000 50000 93.5 3112
BuyspotFutures BuyspotFutures
3
loss 2000 5000 1.351 312 Gain 2000 5000 X 651 12
Futuresettlement e 337500 outflow futureself e 162500 Inflow

Actual Bcost to Bank 450me bon6m Actual Bcost to Bank 150m forany
41507 451 61127 E 1125000 outflow t50m 6.57 61127 E 1625000 outflow

Total cost f 1462500 Total cost f 1462500

1 Effectivemate 1462500
100 12 Pa 1 Effectivemate 1462500
100 1 Pa
5000000 50000000

5.851 5.851
Interest Rate Options

it is a night but not an obligation and acts as insurance by allowing business

to protect themselves against adverse interest movements whileallowingthem to
benefit from favourable movements

Important types Interest rate options are

of
Ii Capoptions Right Ñ ive difference in interest cost on notional Principal

it market interest rates rises above stipulated cap mate

Buyer of cap option pays premium to the seller in return for cap might
E9
2 year Interest mate cap of Notional Principal 10m 6mLibon Cap 5
Agreement date is 15ᵗʰjanuary 2001 Reset dates 15th 15th
july january
Note The first period
ofcap agreement is excluded as it is known on DateofAgreement
Resetdates Libor onResetdates Paymentdates Days Gain on settlement

15July01 5.51 15Jan2002 18h 10m 5.5 5 f 18465 25205

15Jan 02 4.61 15July2002 181 Capoption lapses

15July02 15Jan 2003 184 18

5.41 10m 15.4
511 5 20164

il Floomoption Protects Buyer ofthe bloom fromlossess advising boom decrease in

interest rates

E9 Suppose All info Same as above cap option example

except that Buyer
purchased floom option instead
of cap option i e right to receive difference if
market interestrates decreases below stipulated FloomMate

Resetdates Libor onResetdates Paymentdates Days Gain on settlement

15July01 5.51 15Jan2002 184 Floom lapses

1
15Jan 02 4 61 15July2002 181 10M 5 46 19836
 15July02 5.41 15Jan 2003 184 Floom lapses

iii InterestRate collame it is a combination

of lap floom
ThePurchaser
of a Collar buys a cap and simultaneously sells a floom

Premium on cap option 15m 1 t 150000 total

Premium for every reset dates 150000 150000 40861

4halbyeamsp.ci 347871
ICAI

Reset Period Additional Interestdueto CapExercised Premium Off Net receipt

34139
15m 14 6112 75000 40861

61639
15mF 1 51 6 12 2102500 40861

3 15Mt 21 6 12 150000 40861 109139

 PAST PAPER MAY 2022

lap Floor
I capx Moono revonimott
Capx Floor
55 capx room Fom 254 18,4
6284
cart room
188954
Capx Front 50m 75.7 x 1
5

Effective
RESETE LIBOR DAYS Hightest InterestPaymenttoBank12 51 What thhoff interestmates
Payment
Resettable
4 5 f
1
311218 Ft 181 30.6.19 50m 757 5
1859589 1859589

1
30.06.19 81 184 31.12.19 50m 8.57
5 2142466 X X 2142466

1
3112 19 61 182 30.6.20 50m 657 4 1616120 X X 1616120

30.0620 4751 184 31.12.20 50m 5.251 1319672 62842 1382514

31 1220 4251 181 30.6.21 50m 4757 1 5 1177740 185959 1363699

30.06.2 5.251 184 31.12.21 507 5751 1 1449315 X X 1449315

5
1096Days 9813703

Average Annual Effective Intimate 9813703 100

50000000

6.54 Prn
Interest Rate Swaps

Pay fixedrate 51 every 6months

for 5years on nominal amount

Fixed Rate Payer Floating Rate Payer

Receive floatingmate equivalent to LIBOR

MIBOR PLR onnotional Amount
E9 PlainVanillaSwap

Suppose Priatik
Tagati deliver that interest rates mayRise in future He may
speculate and make money through Plain vanilla swap it interest rate actually

moves according to his belief

Ii Interest rate may rise Ñ ÉÑiie Pay Fixed Receive variable

Iii is a a fall in a Pay variable Receive fixed

Tanner
Now

Say Pyatik Jagati entered into swap to ray fixed

5
every 6months on notional
amount of 1000000 and receivevariable equivalent to Libon
501

41000000
I outflow fixed every 6month 51 50000

1ˢᵗ6months LIBOR 61 Inflow 60000 NetSettlementGain360000 500007 10000

2ⁿᵈGmonths LIBOR 5.54 Inflow 55000 a 455000 50000 5000

2nd6month LIBOR 4 Inflow 40000 is loss 440000 50000 10000

4th6months LIBOR 84 7 Inflow 80000 a i Gain480000 50000 30000

E9 Desire floating
Preatik tagati want to Borrow I 500000 at floating interestrates since
he believes that interest rates may go down in future
Floating rates L t 3.75

fixed Math 11 5 Borrow fixed outflow field

SwapBankQuotes FixedHe Floating 9 A L t 251

Outflow Fixed 11 51
Pratik tagati Lender
Inflow
fixed
9

Moon
a SwapBank
x.gg there is extrasaving
Net outflow L 2175 of due to
11151 91 L t 257 swapping

Pratik tagati want to Borrow I 500000 at fixed interest rates since

he believes that interest rates may go up in future

Floating rates L t 3.75 Against the desire

fixed math 13
SwapBankQuotes FixedHe Floating 9 A L t 251

Otow Floatine 43757

Priatik tagat and
Inflow
Floating
It 251

7 blowpipe
SwapBank
gy
swapping is advisable
not cost dueto benefitof
I 3 75 L rs 9 12.51
 7
Eg 4To convert Fixed rate loan into floating on vice versa
suppose 2years Ago Profile Jagat Borrowed 1000000 101 fixed rate
bon a period of 7 years He now believes that interest rate will go down
in Futureand therefore want to convert fixed mate into Floating rates

Swaps 20 30Basic Points over 5yearl Treasury yield a s LIBOR Treasuryrate

9.201 9301 gy
407

Swaps fixed rate 9 20 19 30 1 floating Libor

outflow fixed 10
Pratia Japan henden
Inolow
fixed 9
2

Glow Swap Bank

ago

Net Cost 10 9.2 t I 0 81 floating date

tooooo 81 x 8,60

500000761 x

901

in Semi Annual fixed payment 500000 8f 13 0 20000

iil floating rate payment if Libor is

6f 500000 61 1860 15083

iii fixedmate Payen would Pay to floating mate Payer Net 20000 15083
 Overnight IndexSwap Dailycompounding
4917

Floatingleg

opening Notional Amt Interest closing Balance

The 100000000 1 100021233
100000000 7751 365 21233
wed 100021233 1
100021233 8.151 365 22334 100043567

then 100043567 100043567 8.121 4765 22256 100065823

1
Ai 100065823 100065823 7.951 365 21795 100087618

100087618 100087618 7.98 2365 43764 100131382

Affsan
1
mon 100131382 100131382 8.154 365 22358 100153740

i Interest on Floating leg 100153740 100000000 153740 Inflow

i Interest on Fixed Payment 153740 317 153423

i Fixed rate ofInterest 153423 100 P.a

100000000
345

8
 Currency swap

I B

154 10 1
61 6

at 91
811 1711 157

Aine Bine fat dectice

1 Int OfftoBank in Yen Borrowing 1 Int.offtobankin Boymowin

514ten2400000ox57 YA 1200000 fen 10 4200000 10 7 A 20000

2 ReceiptfmomBinfen 61 ls 11 2 Paidtoainfen

6 44en2400000xbf.YM
An 7 1440000 ten24000000 6 144000dam

240000Yen
i NetBenefit in ten B A 1 Receiptfrom Aint 97
i NetBenefit in 24 007 12009 w
200000 9 4 B 18000

Int Paid to in 9 Netloss in 20000 18000 AB 2000

2000009 9 7 18000 ten 20008 1207 ten240000ft.pro

mu
NetCost 4180009 2000 1600015 NetCost ten1440000 Ya240000 for 1680000
netcost.int 2 00 1007 8 metcostinf.lk8800100 71
RTPMTP

113wants to Borrow at Fixed rate whereas Zaki wants to borrow at floating

Since there is a potential gain if IB borrows at floatingmate and Zaki borrows at

Fixed mate and then they can enterinto swap with each other
Potential Gain 2 BPLR 2.57 BPLR 5 225 0254Commission

GBPLR 4 5 BPLR 2.75 0 251

1.54 shared Equally by Zaki IBY

Effective Bcost will be

IB 21 751 1 257
Zaki BPCR 2.59 757 BPLR 1 757

Explaination IB ZAKI

Int Off to Bank BPLRt 5 2 251

Zaki to try BPLRT 5 BPLR 5

Commission
1251 125
Intozaki Bbify 1.125 1 125
1 251 BPLR 1751
cheapest to Delivery Bonds CTD

CTI Bond is the least expensive Bond in the basket of deliverable bonds

it is determined
by difference between cost of acquiring the bonds for delivery

and the Price received by delivering the acquired bonds Thisdifference gives Profit

or loss totheseller of futures

Profitofseller of Futures FutureSettlement Price Quoted spot price

Conversion factor of Deliverable Bond

Conversion Factor
Alldeliverable bonds have different maturities and couponmates To make them Comparable
toeach other RBI introduced conversion factor Conversion factor isbeing published by
NSE

Suppose 42 Sold some 7 interest rate futures underlying

Notional 7.57 coupon
Bonds Theexchange provides following eligible securities that can be delivered
Futuresettlement Price 1000
Future settlementPrice Buying Price
Security Conversionfactor conversion factor quotedprice Gain on settlement

7.96 401 2023 1 037 1037 1037.40 0 40

6.55 901 2025 906 906 926.40 20.40

6.80 901 2029 9195 919 5 877 50 42

6.85901 2026 9643 964.3 972.30 8
844 901 2027 1 1734 1173.4 1146.30 27.10
885401 2028 1 2428 1242.8 1201 70 41.10

I cheapest to deliver Bond is 680 907 2026 which yield may benefit

Inflow SettlementPrice Conversionfactor outflow quoted Price

Swaptions hoption on interest rate swap Premium costincurred

it gives the holder the right but not obligation to enterinto interest rate swap
at a specific date in future at particular fixed rate and bon specific term
Two types

I Fixed rate Payer Sneaption 4CALL SWAPTION

Right to Pay fixed leg and receive floating leg No obligation
relief thatfloating rate will goup

ii Fixed mateReceiven Swaption 4PUT SWAPTIONY No obligation

to Receive fixed
Right leg and Pay floating leg

4 1674
5m liben 10 10 4,2 1104107
f
9m lion 124 1249112 91 1 of y
5 9 AA
fL 1044
ken

2m I 121 211 It 02
8mi 157 101 1 10

USFRA 2 I 1107843 7.8431 6m

PreatiFgati