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Derivatives
Session 5
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Foreign Currency Derivatives
Financial management of the MNE in the 21st century involvesfinancial derivatives.
These derivatives, so named because their values are derivedfrom underlying assets, are a powerful tool used in business
today.
These instruments can be used for two very distinctmanagement objectives:
Speculation use of derivative instruments to take a position in the
expectation of a profit
Hedging use of derivative instruments to reduce the risks associatedwith the everyday management of corporate cash flow
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The Nature of Derivatives
A derivative is an instrument whose value
depends on the values of other more basic
underlying variables called bases (underlying
asset, index, or reference rate), in acontractual manner
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The Nature of Derivatives
The underlying asset can be equity, forex,commodity or any other asset.
For example, wheat farmers may wish to sell
their harvest at a future date to eliminate therisk of a change in prices by that date. Such
a transaction is an example of a derivative.The price of this derivative is driven by the
spot price of wheat which is the underlying.
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Examples of Derivatives
Forward Contracts
Futures Contracts
Swaps Options
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The Players in a Derivative Market
The following three broad categories of participants
Hedgers
Speculators
Arbitrageurs
Some of the large trading losses in derivatives occurred
because individuals who had a mandate to hedge
risks switched to being speculators
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Why are they used?
To discover price
To hedge risks
To speculate (take a view on the future direction of
the market)
To lock in an arbitrage profit
To change the nature of a liability
To change the nature of an investment withoutincurring the costs of selling one portfolio and buying
another
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Derivatives in India
In the Indian context the Securities Contracts(Regulation) Act, 1956 (SC(R)A) defines
derivative to include
1. A security derived from a debt instrument, share,loan whether secured or unsecured, risk instrumentor contract for differences or any other form ofsecurity.
2. A contract which derives its value from the prices, orindex of prices, of underlying securities.
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Derivatives in India
Derivatives are securities under the SC(R)A
and hence the trading of derivatives is
governed by the regulatory framework under
the SC(R)A.
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Currency Forwards
A forward contract is an agreement between afirm and a commercial bank to exchange aspecified amount of a currency at a specified
exchange rate (called the forward rate) on aspecified date in the future.
Forward contracts are often valued at $1million or more, and are not normally used byconsumers or small firms.
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Currency Forwards
When MNCs anticipate a future need for or future
receipt of a foreign currency, they can set up forward
contracts to lock in the exchange rate.
The % by which the forward rate (F) exceeds thespot rate (S) at a given point in time is called the
forward premium (p).
F= S (1 +p)
Fexhibits a discount whenp < 0.
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Currency Forwards
Example S = $1.681/, 90-day F= $1.677/
annualizedp =FS 360S n
=1.677 1.681 360 =.95%
1.681 90
The forward premium (discount) usually reflects the
difference between the home and foreign interestrates, thus preventing arbitrage.
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Foreign Currency Futures
Aforeign currency futures contractis an alternativeto a forward contract that calls for future delivery ofa standard amount of foreign exchange at a fixedtime, place and price.
It is similar to futures contracts that exist forcommodities such as cattle, lumber, interest-bearingdeposits, gold, etc.
In the US, the most important market for foreigncurrency futures is the International MonetaryMarket (IMM), a division of the Chicago MercantileExchange.
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Currency Forwards
A swap transaction involves a spot transaction along
with a corresponding forward contract that will
reverse the spot transaction.
A non-deliverable forward contract (NDF) does notresult in an actual exchange of currencies. Instead,
one party makes a net payment to the other based
on a market exchange rate on the day of settlement.
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An NDF can effectively hedge future
foreign currency payments or receipts:
Forward Market
Expect need for 100MChilean pesos.Negotiate an NDF to buy
100M Chilean pesos onJul 1. Reference index(closing rate quoted byChiles central bank) =$.0020/peso.
April 1
Buy 100M Chileanpesos from market.
July 1
Index = $.0023/peso receive $30,000 frombank due to NDF.
Index = $.0018/peso pay $20,000 to bank.
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Currency Futures
Currency futures contracts specify a standardvolume of a particular currency to beexchanged on a specific settlement date.
They are used by MNCs to hedge theircurrency positions, and by speculators whohope to capitalize on their expectations ofexchange rate movements.
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Currency Futures
The contracts can be traded by firms or individuals
through brokers on the trading floor of an exchange
(e.g. Chicago Mercantile Exchange), automated
trading systems (e.g. GLOBEX), or the over-the-counter market.
Brokers who fulfill orders to buy or sell futures
contracts typically charge a commission.
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Foreign Currency Futures
Contract specifications are established by the exchange onwhich futures are traded.
Major features that are standardized are:
Contract size
Method of stating exchange rates
Maturity date
Last trading day
Collateral and maintenance margins
Settlement
Commissions
Use of a clearinghouse as a counterparty
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Foreign Currency Futures
Foreign currency futures contracts differ from forwardcontracts in a number of important ways:
Futures are standardized in terms of size while forwards can becustomized
Futures have fixed maturities while forwards can have anymaturity (both typically have maturities of one year or less)
Trading on futures occurs on organized exchanges whileforwards are traded between individuals and banks
Futures have an initial margin that is market to market on a daily
basis while only a bank relationship is needed for a forward Futures are rarely delivered upon (settled) while forwards are
normally delivered upon (settled)
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Delivery date Customized Standardized
Participants Banks, brokers, Banks, brokers,MNCs. Public MNCs. Qualified
speculation not public speculationencouraged. encouraged.
Security Compensating Small security
deposit bank balances or deposit required.credit lines needed.
Clearing Handled by Handled byoperation individual banks exchange
& brokers. clearinghouse.
Daily settlementsto market rices.
ompar son o e orwar u uresMarkets
Forward Markets Futures Markets
Contract size Customized Standardized
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An Option is.
A contract where the buyer has the right, but not theobligation to
- Buy/Sell- Specified quantity of a currency
- At a specified price (strike price)- By a particular date (expiry date)
For this right, the buyer pays the seller(writer) of theoption an upfront fee (called option premium)
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Forwards Options Forwards most common & and popular derivative
instrument for hedging forex exposures.
Offers best protection against adverse exchangerate movements BUT carries risk of opportunity lossin the event of favorable movements.
An Option offers the protection of a forward contractbut without its commitment.
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Options v/s Forwards
Options give the buyer aright but no obligation.
Good instrument to hedge
adverse price moves &avoiding opportunity loss.
Upfront premium
Can choose the strikeprice
Forwards are fixed pricecontracts wherein thebuyer/seller is obligated tothe price
Opportunity loss
No upfront premium
Cannot choose the price
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Option Terminologies
Cal l Opt ion:
Gives the holder the right but not the obligation to BUY an
underlying at a fixed price from the writer of the option.
Put Opt ion :
Gives the holder the right but not the obligation to SELL
an underlying at a fixed price to the writer of the option
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Two types of option
American Option
May be exercised at any time during the life of a contract.
European Option.
May be exercised only at maturity or expiry date.
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Options - specif ications
Strike Price or Exercise priceThe fixed price at which the option holder has theright to buy or sell the underlying currency.
Expiry DateThe last day on which the option may be exercised.
Life or Exercise Period
The period of time during which the option holderenjoys the purchased option contracts.
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Advantage of Option over Forwards
Forward Contract
On April 01, importer A buys USD forward at 43.75 with anexpiry date May 31.
Currency Option
Same day, importer B buys a USD call option, with a strike
price of 44.00 at same expiry on 31st May and pays apremium of 15 paisa. His worst effective rate is now 44.15.
On May 31
USD/INR trades at 43.50. Importer A buys Dollars at 43.75.Importer B can ignore the option and buy USD at thecurrent market rate of 43.50.
His net cost now works out to 43.50+0.15 = 43.65.
O ti l
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Options example USD imports - due 31st May
Company buys an USD call option with a strike price of43.70 when spot rate is 43.60.
2 business days before the expiry date, the company has to
decide whether or not to exercise the option.
So on 29th May at the specified cut-off time, if spot USD isover 43.70, the company will exercise the option and buyUSD at 43.70
However, if spot rate is less than 43.70, then the companycan let the option lapse and instead fix the spot rate for thetransaction on 29th May.
O ti l
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Options example USD exports - due 31st May
Company buys an USD put option with a strike price of43.70 when spot rate is 43.60.
2 business days before the expiry date, the company has to
decide whether or not exercise the option.
So on 29th May at the specified cut-off time, if spot USD isbelow 43.70, the company will exercise the option and SellUSD at 43.70
However, if spot rate is morethan 43.70, then the companycan let the option lapse and instead fix the spot rate for thetransaction on 29th May.
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Risk / Prof i t Prof i le
Buyer Seller
Profit Unlimited Premium
Risk Premium Unlimited
O i ik i
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Option str ike pr iceIn the money (ITM) The option is In the Money when the Strike Price is
favourable to the option holder(buyer) than the currentforward rate.
Eg: USD put option with strike 43.80 current fwd rate 43.75option in the money
Out of the money (OTM) The option is Out of the Money when the Strike Price is
unfavourable to the option holder(/buyer) than the currentforward rate.
Eg: USD call option with strike 43.90 current fwd rate 43.75
option out of the moneyAt the money (ATM) The option is At the Money when the Strike Price is equal to
the current forward rate.
O ti F d & O P iti
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Option, Forwards & Open Position
A call option will outperform a forward contract when spot
rate at maturity plus option premium is less than theforward rate.
A put option will outperform a forward contract when spotrate at maturity less the option premium is greater than
the forward rate.
As to unhedged positions, a call option will be better thanan unhedged position only if the strike price plus premiumis less than the spot at maturity.
Likewise, a put option will be better than an unhedgedposition only if the strike price less the option premium isgreater than the spot at maturity.
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Price of an Option
Can the Option buyer have the cake & eat it too?
Not really - since the option seller charges the buyer an
upfront premium payable in cash.
And the upfront premium can be as high as 1% or even moredepending on the strike price and the maturity period.
Wh O ti P i ?
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Why Option Premium?
An option buyer never loses money with reference to thestrike price but may make or save money.
The option seller is in an opposite position he can havewindfall losses.
Based on the probability distribution of spot prices at
maturity, there is an expected gain or profit to the buyer.
This is charged as upfront premium.
Option seller always incurs a loss, while he hedges his
short option position using mathematical hedgingtechniques
The loss is recovered by way of the upfront premium.
O ti i Q t ti
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Option premium - Quotations
Points of the second currency/terms currency
or
Premiums are quoted as a flat percentage of the basecurrency Principal amount
Example:USD/INR put 1m $USD/INR strike price = 43.90Premium quoted as 0.33 INR
Or 0.33*1,000,000 = 3,30,000 INR330,000 INR = 7,569 $ (330,000/43.60 spot)7,569 $ is 0.75% of 1m $ principal
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Factors determining Premium value
Volatility
Strike Price
Life or Exercise Period
Interest Rates - domestic & foreign
Current Market Rate
V l tilit hi t i / i l i d
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Volatilityhistor ic v/s implied Volatility is defined as the standard deviation over the
mean on the returns on prices.
Historic volatility is the volatility calculated using a set ofhistorical data (usually the set of data corresponds to theperiod of the option).
Implied volatility is the market expectation of futurevolatility.
Traders in the option market quote the option premium,which is then used as an input in the Black & Scholesoption pricing formula to calculate the implied volatility.
Research has proved that option trading affects thevolatility of the underlying market, causing a reduction inmost cases.
Change in premium with change in volati l i ty
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0
0.005
0.01
0.015
0.02
0.025
1 2 3 4 5 6 7 8 9 10
X axis - Volatility in %
Y axis - Option Premium
s
Change in premium with change in volati l i ty
St ik P i D i
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Str ike Price Dynamics
The option premium can be quite high for ATM options.
Is there a way to reduce the premium ?
There is one golden rule. You cant get anything in themarket for free.
So to reduce the premium, you have to give up someprotection.
To reduce the premium, you have to raise the strike priceand consider buying an OTM option thereby giving up
some protection. The more OTM the option is, the lowerwill be the premium. Conversely, the more ITM an optionis, the higher will be the premium.
St ik P i
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Str ike Pr ice
The more otm the option is, the lower will be the
premium. Conversely, the more itm an option is, thehigher will be the premium. For eg: USD/INR Spot =43.50
It is seen that the reduction in premium is less than theprotection sacrificed.
Strike Price Premium Fall in Protection
Premium Sacrificed
43.90 0.450
43.80 0.400 0.050 0.10
43.70 0.354 0.046 0.10
43.60 0.311 0.043 0.10
43.50 0.273 0.038 0.10
6 month Dollar Put
Choosing the r ight str ike pr ice
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USD/INR spot = 43.50; 6 months ATM = 43.86
Worst case rate = 43.35
You have USD exports
Fix the worst case rate (WCR)
Bearish on Rupee
You buy an OTM Put with lowest strike so that the strike minuspremium is above WCR
Strike = 43.70 Premium = 0.35 WCR = Strike - Premium = 43.35
Bullish on Rupee
You buy ATM USD Put
Strike = 43.86 Premium = 0.41, WCR= Strike - Premium = 43.45,which is more than 43.35 (WCR)
Choosing the r ight str ike pr ice
Comparison between Str ike Price & WCR Pay off Profi le
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43.2000
43.3000
43.4000
43.5000
43.6000
43.7000
Strike 43.70
Strike 43.86
Strike 43.70 43.35 43.35 43.51 43.67
Strike 43.86 43.45 43.45 43.45 43.61
43.54 43.70 43.86 44.02
Strike 43.70 --> premium 0. 35 --> WCR 43.35 --> If bearish on Rupee.
Strike 43.86 --> premium 0.41--> WCR 43.45 --> If bullish on Rupee.
X axis - Spot at maturityY axis - Effective rate
Comparison between Str ike Price & WCR Pay off Profi le
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Option Strategies
Long USD Call Option
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Long USD Call Option
Profit
LossArea
Loss
Cost of Premium
Strike Price
Break-even price
ProfitUnlimited
Price of underlying(USD/INR)43.90
43.90+0.45= 44.35
Short USD Call Option
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Short USD Call Option
Strike Price
Break-evenprice
Price of underlyingUSD/INR
LossUnlimited
PremiumIncome orProfit
Profit
Loss
43.90
43.90+0.45= 44.35
Long USD Put Option
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Long USD Put Option
Strike Price
Break-evenprice
Price of underlyingUSD/INR
Profitunlimited
Loss
Cost ofPremium
43.90 - 0.45= 43.45
43.90
Short USD Put Option
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Short USD Put Option
Strike Price
Break-evenprice
Price of underlying
Profit
Loss
PremiumIncome orProfit
LossUnlimited
43.90
43.90 - 0.45= 43.45
I ndian Scenar io
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I ndian Scenar io
In the pre-liberalization era, the insular economicenvironment felt no scope for the derivative market todevelop.
Indian corporate depended on term lending institutions fortheir project financing & commercial banks for working
Capital. Forward contract was the only derivative product to hedge
financial risk.
Post-liberalization India saw developments in the
instrument forward contract.
Corporate was allowed to cancel & rebook forwardcontracts.
Why Rupee options?
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Why Rupee options?
Rupee options would enable an Indian corporate to hedge
against downside risk on FC/INR while retaining the upside,by paying a premium upfront better competitiveness.
Hedge against uncertainty of cash flows due to NONLINEAR payoff of option for eg. Indian company bidding
for an international contract bid quote in Dollars but cost inRupees Risk of USD/INR falling till the contract is awarded forwards will bind the company even if the overseascontract not allotted Option contract will freeze the liabilityonly to the option premium paid upfront.
Attract more forex investment due to availability of anothermechanism for hedging forex risk.
R ti h ?
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Rupee options why now?
RBIs earlier concerns
Poor risk management skills at banks, who would beselling options to customers
Options market may impact the spot rupee
Current considerations Increasing volatility in the rupee makes it difficult for
corporates to manage risk Exchange rate policy appears looser; strong reserves
provides comfort Option use is getting more commonplace
Iss es in pricing
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Issues in pricing
Different banks will use different pricing models, although
FEDAI is already polling banks for implied volatility, whichwill be available on their web-site
Spread between theoretical price and quoted price can bequite high
Need to shop around
Your Portfolio
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Your Portfolio
USD/INR Spot 43.50
6 month fwd rate 43.86
You are an importer
Worst Case Rate (WCR) 44.40
6 month USD/INR volatility 3% / 3.5%
Diff based on Risk free rate 1.65%
Low Cost Option Strategies
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Low Cost Option Strategies
An option buyer can reduce his premium cost by selling
another option. The combination can reduce the cost asthe premium received on the option sold could eitherpartially or fully offset the cost of option bought.
Different Strategies:
1. Range Forward
2. Participating Forward
3. Seagull
4. Leveraged forward
Zero Cost Range Forward (RF)
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Zero Cost Range Forward (RF)
Range Forward - involves buying an out of the money
call/put option with the worst case rate as the strike priceand selling an out of the money put/call option with such astrike price (best case rate) that the net premium is zero
If price at maturity is beyond the wcr the bought option will
be exercised
If the price at maturity is beyond bcr the sold option will beexercised
If price at maturity is between the wcr & bcr you buy orsell at spot
Although entry is painless, exit could be painful
Range Forward
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g
43.00
43.20
43.40
43.60
43.80
44.00
44.20
44.40
44.60
43.00
43.10
43.20
43.30
43.40
43.50
43.60
43.70
43.80
43.90
44.00
44.10
44.20
44.30
44.40
44.50
44.60
44.70
44.80
spot at maturity
NeteffectiveRate
Buy USD Call at 44.40, Sell USD Put at 43.50
Participating Forward (PF)
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Participating Forward (PF)
Participating forward - involves buying an out of themoney call/ put option with the worst case rate as thestrike price and selling an in the money put/call option fora reduced amount and with the same strike price so thatthe net premium is zero
In effect there is a synthetic OTM forward contract for theamount of the ITM option sold and a free OTM option for
the balance amount
Participating Forward
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g
42.60
42.80
43.00
43.20
43.40
43.60
43.80
44.00
44.20
44.40
44.60
42.70
42.90
43.10
43.30
43.50
43.70
43.90
44.10
44.30
44.50
44.70
Spot at Maturity
NetE
ffective
rate
Buy USD Call at 44.40, Sell USD Put at 44.40 for 31% of Call amount
Seagull (S)
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Seagull (S) Involves buying an out of the money call/put option (A) and selling an
out of the money put/call option (B) & also selling a far-of-the-moneycall/put option (C ) so that the net premium of the whole portfolio iszero
If price at maturity is between the strikes of (A) and (C), only (A) willbe exercised
If the price at maturity is beyond the strike of (B), only (B) will be
exercised
If the price at maturity is beyond the strike of (C), both (A) and (C) willbe exercised.
If price at maturity is between the strikes of (A) & (B) you buy or sell at
spot
This a a variant of the range forward as a far-out-of-the-money call/putis sold with the range forward to improve the best case rate or thestrike of (B).
Seagull
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g
42.5
43
43.5
44
44.5
45
42.70
42.90
43.10
43.30
43.50
43.70
43.90
44.10
44.30
44.50
44.70
44.90
45.10
Spot at Maturity
NetE
ffectiverate
Buy USD Call at 44.40, Sell USD Put at 43.25, Sell USD Call at 44.80
Leveraged Forward (PF)
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Leveraged Forward (PF)
Leveraged forward - involves buying an in the money call/put option and selling an out of the money put/call optionfor an increased amount and with the same strike price sothat the net premium is zero
In effect there is a synthetic in the money forward contractfor the full amt with a leveraged loss beyond the syntheticITM forward rate (strike price).
Leveraged Forward
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43.20
43.40
43.60
43.80
44.00
44.20
44.40
43.00
43.10
43.20
43.30
43.40
43.50
43.60
43.70
43.80
43.90
44.00
44.10
44.20
44.30
44.40
44.50
Spot at Maturity
NetE
ffectiveRate
Buy USD Call at 43.65, Sell USD Put at 43.65 for 200% of Call amount
Rupee Options Product specif ications
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Rupee OptionsProduct specif ications
Vanilla European options & combinations thereof at
introduction. This will continue till banks havesophisticated systems & risk management frameworks tohedge this new non-linear product.
Over the counter contracts.
Can be tailored to suit the corporates need.
FC-INR where foreign currency may be the ccy desiredby the corporate.
No minimum amt recommended by RBI.
Premium payable on spot basis.
Rupee Options Product specif ications..
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Rupee Options Product specif ications..
Settlement would be either by delivery on spot basis or
net cash settlement in Rupees on Spot basis, dependingon the FC-INR spot rate on maturity date. (specs will bespecified in the contract) RBI reference rate could be thereference rate for settlement.
Strike Price & Maturity could be tailored to suitcounterparties needs typical maturities are 1 week,2weeks, 1, 2, 3, 6, 9 & 12 months.
Exercise style: European.
Uses of Rupee options
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Uses of Rupee options
To hedge genuine FX exposures arising out of
trade/business (Banks may book transactions based onestimated exposure for uncertain amounts)
To hedge FC loans.
To hedge GDR after the issue price is finalised. Balance in EEFC accounts.
Special cases & contingent exposures.
Derived FX exposure viz FX exposure generated due to aasset/liability coupon &/or P+I swap.
One hedge for one exposure
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One hedge for one exposure
Only one hedge may be booked against a particularexposure for a given time period.
For eg Exporter with USD receivables after 6 months,
can sell a forward for 3 month & after 3 month square theforward & book an option for another 3 months.
But the exporter cannot book a forward & an option forthe same exposure at the same time.
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Hedging Rupee Options
Authorized dealers to be allowed to hedgeoptions by accessing the spot market.
Extent & frequency to be decided bydealers.
ADs to be allowed to hedge Greeks usingoptions.
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Clients as net receivers of premium
Earlier clients could not receive netpremium.
Now large corporates with aggressivetreasury operations have been allowed toreceive net premium as the market
matures. They can buy as well sell option contracts.
Barr ier options
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Barr ier options
These are two types of barriers in options:- Knock in barrier
- Knock out barrier
These can be single barrier or double barrieroptions
Barriers are American in nature
Main advantage is smaller upfront premiumcompared to Plain Vanilla option with same strike
price
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Barrier Options
A barrier option, also known as knock out option, isa type of financial option where the option toexercise depends on the underlying crossing orreaching a given barrier level.
Barrier options were created to provide theinsurance value of an option without charging asmuch premium.
For example, if you believe that US Dollar will go upthis year, but are willing to bet that it won't go above
Rs45, then you can buy the barrier and pay lesspremium than the vanilla option.
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Barrier Options
Barrier options are path-dependent exotics that aresimilar in some ways to ordinary options.
There are put and call, as well as European and
American varieties. But they become activated or, on the contrary, null
and void only if the underlying reaches a
predetermined level (barrier).
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In and Out
"In" options start their lives worthless and onlybecome active in the event a predetermined knock-in barrier price is breached.
"Out" options start their lives active and become null
and void in the event a certain knock-out barrierprice is breached.
In either case, if the option expires inactive, thenthere may be a cash rebate paid out.
This could be nothing, in which case the option endsup worthless, or it could be some fraction of thepremium.
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Four main types of barrier options
Up-and-out: spot price starts below the barrier level and hasto move up for the option to be knocked out.
Down-and-out: spot price starts above the barrier level andhas to move down for the option to become null and void.
Up-and-in: spot price starts below the barrier level and has tomove up for the option to become activated.
Down-and-in: spot price starts above the barrier level and hasto move down for the option to become activated.
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Barrier Options (Example)
A European call option may be written on anunderlying with spot price of $100, and a knockoutbarrier of $120.
This option behaves in every way like a vanilla
European call, except if the spot price ever movesabove $120, the option "knocks out" and thecontract is null and void.
Note that the option does not reactivate if the spot
price falls below $120 again. Once it is out, it's outfor good.
Knock out barr ier options
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Knock out barr ier options
Knock out options get knocked out (dead or cease toexist) only when the spot rate hits the specified
barrier or either of the two barriers.
There are two kinds of knock out barriers in India:
- Up and out knock out
- Down and out knock out
Knock in barr ier options
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Knock in barr ier options
Knock in options get knocked in (come alive)
only when the spot rate hits the specified barrier
or either of the two barriers.
There are two kinds of knock in barriers:
- Up and in knock in
- Down and in knock in
Knock out + Knock in options with same strike &
barriers equals plain vanilla option.
Euro import portfol io
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Euro import portfol io
You have Euro imports EUR/USD Spot 1.2870
Worst case rate 1.31
Time 6 months 6M Forward rate 1.2920
Volatility 9.5% / 10%
6M USD Libor2.99%
6M Euro Libor2.19%
Smart Forward (SF)
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Smart Forward (SF)
Zero cost exotic hedge
Plain out of the money option as long as a specified
in the money trigger is not hit
Option gets transformed into a out of the moneysynthetic forward contract if the trigger is hit
If the market view turns out to be wrong, there can be
an opportunity loss, and
The SMART FORWARD becomes a DUMB
BACKWARD
Smart Forward
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Smart Forward
1.14
1.16
1.18
1.2
1.22
1.24
1.26
1.28
1.3
1.32
1.2
1.21
1.22
1.23
1.24
1.25
1.26
1.27
1.28
1.29 1.
31.31
1.32
1.33
1.34
1.35
1.36
1.36
1.36
Spot at Maturity
NetEffec
tiveRate
Buy Euro Call at 1.31, Sell Euro Put at 1.31
with KI at 1.1925
Choice Forward (CF)
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Choice Forward (CF)
Zero cost exotic hedge
Involves buying an in-the-money option with two
knock out barriers.
Also simultaneously buying an out-of-money option
with the same two knock in barriers (A)
Also selling in-the-money option with same two
knock in barriers (B)
(A) & (B) put together constitute an out-of-money,
double knock-in, synthetic, forward contract
Choice Forward
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1.18
1.19
1.2
1.21
1.221.23
1.24
1.25
1.26
1.27
1.28
1.15
1.17
1.19
1.21
1.23
1.25
1.27
1.29
1.31
1.33
1.35
1.37
1.39
1.41
Spot at Maturity
NetEffec
tive
Rate
Buy Euro Call at 1.27 with KO at 1.38 & 1.20, Sell Euro Put at 1.31
with KI at 1.38 & 1.20, Buy Euro Call at 1.31 with KI at 1.38 and 1.20