INTEREST RATE RISK MANAGEMENT
INTEREST RATE FRA OF LOAN INTEREST RATE FRA OF INVESTMENT
Interest Rate FRA Interest Rate FRA
2 v 5 FRA at 4% - 6% 2 v 5 FRA at 4% - 6%
Market KIBOR 8% 4% Market KIBOR 3% 5%
Locked KIBOR 6% 6% Locked KIBOR 4% 4%
Compensation receivable (Market KIBOR is more than Compensation receivable (Market KIBOR less than Locked
locked KIBOR) 2% KIBOR) 1%
Compensation payable (Market KIBOR is lower than locked KIBOR) 2% Compensation payable (Market KIBOR more than locked 1%
Net outcome on the date of loan Rs. Rs. Net outcome on the date of investment Rs. Rs.
Actual interest payment at market rate Actual interest income at market rate
(Market KIBOR + Credit Spread = Actual interest rate (Market KIBOR - Credit Spread = Actual interest income rate
p.a. x amount of loan x loan duration/12 x x cost p.a. x amoun of investment x inventsment duration/12 x x income
Compensation (receivable)/compensation payable Compensation receivable/compensation (payable)
(Compensation rate x amount of loan x loan (Compensation rate x amount of investment x investment
duration/12) (x) x duration/12) x (x)
Total interest cost x x Cost Total interest income x x income
Effective interest rate Effective interest rate
(Interest cost after hedging/loan x 100 x 12/loan (Interest income after hedging/Investment x 100 x 12/investment
duration) x% p.a. x% p.a. duration) x% p.a. x% p.a.
INTEREST RATE GUARANTEE OF LOAN INTEREST RATE GUARANTEE OF INVESTMENT
Interest Rate Guarantee /OTC interest rate option Interest Rate Guarantee /OTC interest rate option
Non-binding agreement to lock interest rate of loan. Premium cost is paid and compensation Non-binding agreement to lock interest rate of investment.
is receivable not payable. Premium cost is paid and compensation is
receivable but not payable.
Market KIBOR 8% 4%
Locked KIBOR 6% 6%
Market KIBOR 3% 5%
Compensation receivable (Market KIBOR is more than
locked KIBOR) 2%
Locked KIBOR 4% 4%
Compensation payable (not applicable) 0%
Compensation receivable (Market KIBOR less than Locked 1%
Net outcome on the date of loan Rs. Rs. Compensation payable (Not applicable) 0%
Actual interest payment at market rate Net outcome on the date of investment Rs. Rs.
(Market KIBOR + Credit Spread = Actual interest rate Actual interest income at market rate
p.a. x amoun of loan x loan duration/12 x x cost (Market KIBOR - Credit Spread = Actual interest income rate
Compensation (receivable) p.a. x amoun of investment x inventsment duration/12 x x income
(Compensation rate x amount of loan x loan Compensation receivable/compensation (payable)
duration/12) (x) -- income (Compensation rate x amount of investment x investment
Premium cost duration/12) x 0
(Premium rate % x amount of loan x loan
duration/12) (x) (x) cost
= Total interest cost x x Cost Total interest
Effective income
interest rate x x income
Effective interest rate (Interest income after hedging/Investment x 100 x 12/investment x% p.a. x% p.a.
(Interest cost after hedging/loan x 100 x 12/loan
duration) x% p.a. x% p.a.
INTEREST RATE FUTURE OF LOAN INTEREST RATE FUTURE OF INVESTMENT
iii) Short term Interest rate Futures iii) Short term Interest rate Futures
Standardised interest rate forward contract. Standardised interest rate forward contract.
Forward vs futures : Non-standardised but future is standardise contract Forward vs futures : Non-standardised but future is
Step 1) Hedge construction (1st March) Now Step 1) Hedge construction (1st March) Now
Company will open position in future market by SELLING 20 future contract for Company will open position in future market by BUYING 20 future contract for
March/June/Sep/Dec expiry date ( immediately following to the date of loan) at a future price March/June/Sep/Dec expiry date ( immediately following to the date of loan) at a future price of
of 95.00 (according to expiry date). Company will deposit initial margin of Rs. xxxxx. 95.00 (according to expiry date). Company will deposit initial margin of Rs. xxxxx.
Note: No of future contracts = (Amount of loan ÷ Contract Size) x Loan duration ÷ Contract duration)
Note: Expiry date: Immediately next to the date of borrowing
Note: Future price : select as per expiry date
Step 2) Close
Company the position
will close position ininfuture
future market
market by(Date of future
BUY 20 loan) 1st July for
contract Step 2) Close the position in future market (Date of loan)
March/June/Sep./Dec. expiry date at a future price of 93.43. Company will earn gain in future Company will close position in future market by BUY 20 future contract for March/June/Sep./Dec.
market of Rs. Xxxx expiry date at a future price of 93.43. Company will earn gain in future market of Rs. Xxxx
(W1) Closing future price 1-Mar 1st (W1) Closing future price 1-Mar 1st July
Date Date of
Now of loan Now loan
Future price 95 93.43 Future price 95 93.43
Spot rate (100%- Current KIBOR 6%) 94 (100% - 7%) 93 Spot rate (100%- Current KIBOR 6%) 94 (100% - 93
Basis (%) 1 0.43 Basis (%) 1 0.43
Outstanding Basis = (1/7 month x 3 months) = 0.43 Outstanding Basis = (1/7 month x 3 months) = 0.43
Note Silent or basis will move to zero on evenly basis in each month. Note Silent or basis will move to zero on evenly basis in each
(W2) Gain/loss of future (W2) Gain/loss of future
Sell future price 95.00 Sell future price 93.43
Less Buy future price (93.43) Less Buy future price -95
Gain per contract 1.57 % Loss per
(%) contract
x number of contracts x contract size x future contract (1.57) %
Gain (%) x number of contracts x contract size x future contract duration/12 duration/12
Step 3) Net Outcome on date of loan Rs. Rs. Step 3: Net outcome on the date of investment Rs. Rs.
Actual interest payment at market rate Actual interest income at market rate
(Market KIBOR + Credit Spread = Actual interest rate (Market KIBOR - Credit Spread = Actual interest income rate
p.a. x amoun of loan x loan duration/12 x x cost p.a. x amoun of investment x inventsment duration/12 x x income
Gain/loss in future market from step ii x (x) cost/(in Compensation receivable/compensation (payable)
Finance cost of margin (amount x interest rate x loan (Compensation rate x amount of investment x investment
duration/12) - if any x x cost duration/12) x 0
Interest cost x x Total interest income x x income
Effective interest rate
Effective interest rate (Interest cost after hedging/loan (Interest income after hedging/Investment x 100 x 12/investment
x 100 x 12/loan duration) x% p.a. x% p.a. duration) x% p.a. x% p.a.
OPTIONS ON INTEREST RATE FUTURE OF LOAN OPTIONS ON INTEREST RATE FUTURE ON INVESTMENT
iv) Options on interest rate futures iv) Options on interest rate futures
Step 1) Hedge construction (Today) Step 1) Hedge construction (Today)
Company will enter into 20 put option (sell futues) contracts for Mar./ June /Sep./Dec expiry Company will enter into 20 Call option (Buy futues) contracts for Mar./ June /Sep./Dec expiry
at a best exercise of 95.00. Company will pay premium cost of [Link]. at a best exercise of 95.00. Company will pay premium cost of [Link].
Note Best exercise price of put option for June expiry June Note Best exercise price of Call option for June expiry Implied June
premium Implied interest interest premium Total
Exercise price rate cost rate Total cost Exercise price income rate income
94.5 0.271 5.5 5.771 94.5 5.5 0.271 5.229
95 0.52 5 5.52 95 5 0.52 4.48
Note Premium cost Note Premium cost
Premium rate % x number of option contract x contract size x option contract duration/12 Premium rate % x number of option contract x contract size x option contract duration/12
0.52% x 20 contract x Rs. 200,000 x 3 month/12 0.271% x 20 contract x Rs. 200,000 x 3 month/12
Step 2) Close the position in future market (Date of loan) 1st July Step 2) Close the position in future market (Date of loan) 1st July
Company will close position in future market by buying 20 future contract for Company will close position in future market by Selling 20 future contract for
March/June/ Sep. /Dec. expiry date at a future price of 93.43. Company will earn gain in March/June/ Sep. /Dec. expiry date at a future price of 93.43. Company will earn gain in future
future market. market.
Sell future price 95.00 Sell future price 94.50
Less: Buy future price (93.43) Less: Buy future price (93.43)
Gain per contact 1.57 % Gain per contact 1.07 %
Gain (%) per contract x no of contract x contract size x contract duration/12 Gain (%) per contract x no of contract x contract size x contract duration/12
Note: Loss on option then ignore this options and don't close it. Note: Loss on option then ignore this options and don't close it.
Step 3) Net Outcome on date of loan Rs. Rs.
Actual interest payment at market rate Step 3: Net outcome on the date of investment Rs. Rs.
(Market KIBOR + Credit Spread = Actual interest rate
p.a. x amoun of loan x loan duration/12 x x cost Actual interest income at market rate
(Market KIBOR - Credit Spread = Actual interest income rate
Gain from option market from step ii x -- p.a. x amoun of investment x inventsment duration/12 x x income
Finance cost of margin
(amount x interest rate x loan duration/12) - if any x x cost Gain from options on interest rate future
x 0
= Interest cost after hedging x x
Effective interest rate (Interest cost after hedging/loan
x 100 x 12/loan duration) x% p.a. x% p.a. Total interest income x x income
Effective interest rate
(Interest income after hedging/Investment x 100 x 12/investment
duration) x% p.a. x% p.a.