Rupee Int Rest Swap City Bank

8/3/2019 Rupee Int Rest Swap City Bank

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Overview

Definitions & Benchmarks

Overnight Indexed SwapsUses & 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)



Daily MIBOR linked IRS = OIS

IRS- Floating Benchmarks

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

CP Rates

Benchmark not available

Corporate Specific



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)

Corporate Citibank

FIXED CASHFLOW- Cfix

FLOATING CASHFLOW- Cfloat



Fixed Coupon is calculated as follows -

Cfix = P x Rfix x d

basis

Cfix = Fixed Coupon

P = Notional Principal

Rfix = Agreed Fixed Interest Rated = Length of Coupon Period in days

basis = Applicable day basis (e.g. 365)

OIS - 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 days


OIS - Mechanics



Floating Rate is calculated as follows -

d business

Rfloat = ( [ 1 + ri x d i ] - 1 ) basisi=1 basis d total

Rfloat = Floating Rate

r i = MIBOR Rate for the ith business day

d i = Number of days the ith MIBOR rate applies

d business = Number of business days in the coupon period

d total = Total no. of calendar days in the coupon period


OIS - Mechanics



IRS- RBI Guidelines

FRA/ IRS allowed for hedging rupee balancesheet 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 managementfrom 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 despiteexistence of a T Bill auction calendar

Expected time for development of a term moneymarket

Accounting/tax for IRS/FRAs (Hedge vs MTM)

Basis risk




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




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 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

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 - 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 namesTrend 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



•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.

Disclaimer

Rupee Int Rest Swap City Bank

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