IRRM REVISION NOTES

Ef As Per IRP Theory

3m Int rate 10 10 3 12 2.51 1 025
3m Antmate 18 18 3 12 4.5 1.045

i Forward Premium 1 045 1.025 100 1.9512 f eff 3m

1 025
1.9512 12
3
7.8048 P.a

i Forward discount 1.045 1.025 100 1.91389 ebb 3m

1 045
1.9138 1213
7.6552 f P.a

Alternatively

Forward Premium Intrate Factor 1.045 1.019512

Intimate Factor 1.025

1 9512 eff 3m

Forward Rate Agreement

Eg
3m Libor 10 f 10 3112 2.5 1.025
6m Libom 11 11 6112 5.5 1.055

1 3 6 FRA 6mLI6OM 1 055 1 0293

3mLibor 1.025
 FRA
6m antrate E 10 5 1 05
12m9nFMate E 12 124 1 12

Detailed

195 5 6667 eff 6m

FRA 1 100

[Link] FRA 13.33 P.a

I
1 12m 41 12 117
1.12

Pratik 1 1112 OH 1 121 of 1 1.12

Pankaj 1 1.05 1.0667 0M 1 57 6.667 1 12

Shortcut
6m9nF 10 5 1.05
12m At 12 12 21.12

6 12FRA 12m 1112 1.06667 6.6679 eff 6months

6m 1105
13.33 f Pia

E9 5m Libor 4.5 4.5 5 2 1.875 1101875

8m Libon 4.95 495 8 12 3.31 1 033

5 8 FRA 8M LibOM 1.033 1 013988

5m Libon 1101875
1.3988 eff 3months
5.595 P.a
Arbitrage in FRA SASTA
BOMMW

3mLibor 12 8mLibor 18 Quoted 3 8 FRA 13 15

BOMMON

501 3mLibor 12 3 12 3 1.03

8mLibon 18 8 12 12 1.12

i Theoretically 3 8FRA 1 08738 8.378 965M

9mm
1,1 8.738 145
20.97
833
5 12 5
14
But Quoted 3 8 FRA is 13 14 which is cheaper
i We should Borrow at 3 8 FRA at 14
i e Borrow at 3MLibon 3 8 FRA
i.e Invest at 8m Libor
In Short
Since Quoted 3 8 FRA is cheaper than theoretical we should Bonnow 3 8FRA
Bonnow 3m Libor 3 8FRA 1 1 03 1.05833 1.09008 outflow
Invest 1 8m Libon 1 1 12 1.12 Inflow
Bommowed
Gain 03 Per
nounded
of
89
6mantmate 15 7.51 1 075

10m at mate 18 a 15.1 1.15

Quoted 6 10 FRA 22 23 menerga

cal Theoretical 6 10 FRA and Arbitrage Gain

Theoretical 6 10 FRA 1 15 1 06976 6 976 eff hm

1,075 20.93 P.a
 7.3331

But quoted 6610 FRA is 221.1231 Which is costlier

i We Should Invest in 6 10 FRA 6mL Invest

ROMMOW 10m Libor 1 1'15 2 1 15

Invest 6mLibor 6 10FRA ex 1.075 1.07333 1.1538

ArbitrageGain 0038 Pen Borrowing

Hedging in 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 lit 12 ii 7

Real Bornowing mom Bank FRA contract 46 9 FRA 8.51.7

Bonnow 1000000 at actual Bonnow F 1000000 FRA 8.5 Interestoff 21250
rate of 12 on7mm After 6months settle FRAby investing at commentmates

Interestoff 1000000 121 312 Invest 1000000 124 Interest1 f 30000

30000 49ᵗʰmonth Gain on FRA 19ᵗʰmonth 8750
I Final Settlement Amount 87 8495

Effective Interest Cost 30000 8750 21250

Effective Interest rate 21250 100 8.5
1000000
Real Bornowing from Bank FRA contract 6 9 FRA 8.5.17
Borrow 1000000 at actual 21250
BorrowF 1000000 FRA 8.5 Interestoff

rate of 7 Gon1mm After 6months settle FRAby investing at commentmates

Interestoff 1000000 7 31,2 Invest 1000000 7 Interest Inflow 17500

17500 Loss on FRA 9ᵗʰmonth 3750
I Final Settlement Amount 3750 a 3685
1 0975

Effective Interest cost 17500 3750 21250

Effective Interest rate 21250 100 12 8.5
3
1000000

I Due to FRA Contract Interest cost effectively locked of 8.51 even if market
interest rate changes

Point to Note

6mLibon 8.1 8 61m hy 1.04

tomtibon 9 9 1 2 7.5 1.075
lym lifom 9 1 09

Lym Libom 91 1 09 one 1 9 97 1 1881

By Libor 4 48 4.0448 1.1405

E1 Interest Rate option Continued Below

Bank Guarantees 5.04 P.a interest Premium Cost 0.1

Case I Interest turns out 4.5
option lapses Eff Cost 451 0.1 4.61

Case II Interest turns out 5.5

0.1 5 14
option Exercises Eff Cost 5.04
 Interest Rate Futures
Interest rate Futures are quoted in Price instead of Mates
E9 IRF 5 100 5 45
11 3.51 100 3.5 96.5
1 5 851 100 5.85 94 15
Heme
if Interest rates rises Price falls fire Inverse relationship

For Borrowing afraid of interest mates mising which means

we are

we are afraid of IRF Price falling

IRF is quoted in Price and we are afraid of Price falling Therefore
we should sell Interest mate Futures

Referring 922 from Question Bank

Borrow e 50m after 3months for a period of 6 months 43 9 Futures
3month Futures available instead 94 15
of 6months
i Amount to short on Perfect Hedging f som f 100m

lot size 50000

i No 18 2000 contracts
of contracts 0

Futures short 2000 Contracts 50000 94 15

Case I Rate turns out 4 51 After 3 months case I Rate turns out 6.54 After 3 months

Sell Futures 2000 50000 94.15 3m Sell Futures 2000 50000 94.15 3m
Buy 11 2000 50000 95.5 13m Buy 11 2000 50000 93 5 13m
1055 2000 50000 1.351 3 12 Gain 2000 50000 65 3 in

337500 162500

Font 6 Actual Bonn Cost Font 6.5 6

Actual Bonn Cost 4.51 12 12
1125000 1625000

Overall Cost 1125000 337500 1462500 Overall Cost 1625000 162500 1462500
146 5 12 146 5 12
lost 1 100 6 5.851 lost 1 100 6 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 15ᵗʰjuly 15ᵗʰjanuary
Note The biristPeriod
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 fromlosses arising from 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

15Jan 02 4.61 157442002 181 1 19836

10m 5 46 5
15July02 5.41 15Jan 2003 184 Floom lapses
 iii InterestRate Collant It is a combination of cap Floom
thePurchaser of a Collar buys a cap and simultaneously sells a Floom

Floating Rate Borrower Pays Premium and Buys capoption

1 Investor 11 11 Floom option
in

Note Referring 9.357

Suppose Premium on cap option 15m 1 E 150000 total
Discount mate 7 4 Halfyearly meset dates strikemate 8

Premium for every reset dates 150000 150000 40838

4 halfyearsP.v 3 673
07
[Link] mini
Strike mate 8
Libon Reset Period Additional Interestdueto CapExercised Premium Off Net receipt
94 I 15m K X 1 76 12 75000 40838 34162
9 51 2 15Mt 1 51 6 12 2112500 40838 71662
10 3 15Mt X 2 16 12 150000 40838 109162

PAST PAPER

FLOOM
Payoff
18 62842
1815
Capx Floor 50m 251 6
capx moon
capx room
50m X 185959
capx room 75 1,81
capx moon

apx room
 Effective
DAYS
RESEES LIBOR Phthent InterestPaymenttoBank at 51 Kloft Flyoff Interestmates
Paymentdate

Reradde
L 5

311218 7 181 30.6.19 50m 757 1515 1859589 x x 1859589

1
30.06.19 8 184 311219 50m 8.57
5 2142466 x x 2142466

3112 19 6 182 30.6.20 50mx657 1 4 1616120 X X 1616120

300620 4751 184 31.12.20 50m 628429 1382514

5.251 18 1319672

31 1220 4251 181 30.6.21 50m 1859598

5757 18 1177740 1363699

30.06.21
5.25.1 184 31.12.21 507 5751 1815 1449315 X X 1449315

1096Days 9813703

Average Annual Effective Intimate 9813703 100

365
50000000 1096

6.54 Pra
Interest Rate Swaps
Pay fixedmate 5 every 6monty
for 5years on nominal amount

Fixed Rate Payer Floating Rate Payers

Receive floatingmate equivalent to LIBOR

MIBOR PLR onnotional Amount

Eg PlainVanillaSwap
Suppose Protile
Tagati belives that interest mates may rise in future He may
speculate and make money through Plain vanilla swap if interest rate actually

moves according to his belief

1 Interest rate may rise Fitine Pay Fixed Receive variable

Iii is a a Fall a a Pay variable Receive fixed
tenner
Now 5 effective 6months
SayPratik Jagati entered into swap to pay fixed 5 every 6months on notional
amount of 1000000 and receivevariable equivalent to Libon

So
11000000
I outflow fixed every 6monte 5 7 50000

1ˢᵗ6months LIBOR 6 Inflow 60000 NetSettlement Gain460000 50000 10000

2ⁿᵈ6months YBOR 5.5.1 Inflow 55000 a 55000 50000 5000

2nd6months LIBOR 4 Inflow 40000 loss 440000 50000 10000

4th6months LIBOR 8 7 Inflow 80000 a 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 Fixedv6 Floating 9 A L t 251

Pay Fixed 11.5

Pratik tagati Lender
Receive
Fixed
9

Variable SwapBank
[Link] there is extrasaving
Net outflow L of 11 due to
11151 91 L 257 2.751 swapping

Pratik tagati want to Borrow I 500000 at fixed interestrates since

he believes that interest rates may go up in future

Floating rates Lt 3.751 Against the desire

fixed math 13
SwapBankQuotes FixedHe Floating 9 A L t 251

PM Floating 375
Priatik renden
tagat Receive
Floating
L
f 254

Pay SwapBank
fixed g
swappingis advisable
dueto benefitof
L t 375 25 9 12 5 1 157
Net Cost L
 7
Eg 4To convert fixed rate loan into floating on vice versa
suppose 2years Ago Prettile
Jagat Borrowed 1000000 10 fixed rate
bon a period of 7 years He now believes that interest rate will go down
in Futureand therefore wants to convert fixed mate into Floating rates

Swaps 20 30Basic Points over 5years Treasury yield is s LIBOR Treasuryrate

9.20 9.30 910
4017 2030BPovenIyaTyieldFi
swaps fixed rate 9 20 19 30.1 floating Libor vs
LIBOR Elodie

2030BPoven9
atblow fixed 10 9.20 9.30 fixed
Pratia Japan Lender
Inolow clear
biped
9.2

detblow
Ligon Swap Bank
Netcost 10 9.2 L L 0.8 floatingmate

Overnight Index Swap Daily compounding

Fixed Pay Floating receive

155ns
Into
satism

153740 153423 1573423

100000000
100
1 99
81 Pia
 Floatingleg

opening Notional Amount Interest Closing Balance

1
The 100000000 100000000 7751 365 21233 100021233

wed 1
100021233 100021233 8.151 365 22334 100043567

then 100043567 100043567 8.121 1365 22256 100065823

Ani 100065823 100065823 7.951 1365 21795 100087618

Catsun 100087618
2days
100087618 7.98 365 43764 100131382 Compoundin
1
mon 100131382 100131382 8.154 365 22358 100153740

Interest on Floating leg 100153740 100000000 153740 Inflow

1 Interest on Fixed Payment 153740 317 153423

i Fixed rate ofInterest 153423 100 365 p.a

100000000 7
8 Pra

canneren swap In 0

Against the Desire Desire

Desire Against the Desire

Desire 9 8 171 Against Desire 5 10 157

A 5 outflow to Bank Yen B 10 outflow to Bank 7

6 Inflow from B ten 6 outflow to A very
9 outflow to B 7 91 Inflow from A 7
Net 81 outflow to A Net FY outflow to B
 Aine Bine Yen
1 Int OfftoBank in ten Boynowing 1 Int OfftoBank in Boynowing

5 44924000000 57.7 A 200000 yen 10 4200000 101.7 A 20000

2 ReceiptfromB inten 6 5 1 2 Paid to 7 inten 64

1440000Ten Yen1440000
Sten2400000 64 B Yen24000000 64 dufflow
i NetBenefit in Fen B A 240000Yen
1 ReceiptfromAin 91
29 07
18000
i NetBenefit in 120 0 200000
say B
1

Int Paid to in 9 2000

netlossin 20000 18000 AB
4200000 9 4 18000 ten 2000 120 [Link]
ow
Netcost 418000 2000 16000 Netcost Yen1440000 Ya240000 per 1680000

netcost int 2
800 1004 8 netcost
int 120 80 100
71

Swaptions option on interest rate swap Premium cost incurred

it gives the holden the night but not obligation to enterinto interestrate swap
at a specific date in future at particular fixed rate and for specific term

Two types Benefitif rate increases

I Fixed rate Payery Swaption CALL SWAPTION

Right to Pay fixed leg and receive floating leg No obligation

Benefit if rate decreases

ii Fixed makeReceiven Swaption PUT SWAPTIONY No obligation
to Receive fixed
Right leg and Pay floating leg
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 in
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

conflation Gain on settlement
Security factor conversion factor quotedprice

7.96 401 2023 1 037 1037 1037.40 0 40

655 901 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
8.85401 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