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PRESENTATION

ON

RISK MANAGEMENT &

INTRODUCTION TODERIVATIVES

BY

B.Y.OLKAR 

Former Chief Executive, FEDAI

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RISK MANAGEMENT FRAMEWORK 

IDENTIFYING RISK. DEFINING RISK.

MEASURING OF RISK. MODELS SUCHAS ³VAR´.

MONITORING RISK.

CONTROLLING RISK.

PERFORMING EVALUATION.

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FEDAI Value at Risk (VaR) - Revised

Comparative Evaluation

Major Parameters Present Models Proposed (Revised)

Model

1. Confidence Level 97.5% 99.0%

2. Holding Period 3 days 3 days

3. Distribution Assumption Unconditional normality Empirical unconditionaldistribution of residuals.

4. Back Testing Not done by FEDAI Back Testing provided for 

5. Coverage of instruments/

maturities

USD/INR limited to three

maturities upto 6 months

Wider coverage - $/Rupee

Spot, Forwards upto 1 year 

& 10 major cross currency

 pairs.6. Computation of volatility Unconditional ± uses

Standard Deviation

EWMA ± (Exponential

Weighted Moving Average)

which implies more weight

as to recent data.

7. Based on volatility data for Latest 251 days data. Latest 500 days data.

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VaR Models

³VaR Model tells you how much you will lose on good days ± 

not on the one bad day´[Ethan Berman, CEO,

Risk Metrics Group set up, J P Morgan]

1. Many models do not account for liquidity risk ± (option pricing models created by brilliant minds at LTCM

assumed continuous markets).2. Assume that future will not be vastly different from

today. Assumptions are as good as the historical data fedinto them.

3. Take into account relatively short period, say 24 hours to3 days to determine their potential trading losses.

4. Focussed on two or three standard derivatives world ± system breaks down when many more events fall outsidethe two/three standard deviation.

5. More money lost than what models predicted.

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RISK MANAGEMENT

CONTROL MEASURES Internal inspection and audits.

Review of systems and procedures.

Monitoring compliance.

Risk education.

Comprehensive IT infrastructure for reduction of human errors.

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Role of Risk Management :

Disaster Strikes ! [cont.]

8. Hammersmith & Fulham counties [Disallowedswap activities] c/p loss $1.0 b.

9. Askin Capital Group (Askin) [Mortgage-backedsecurities] $600 m.

10. Deutsche Morgan Grenfell [Violation of valuation guidelines] $600 m.

11. Kidder Peabody (Jett) [Unauthorised trading]$350 m.

12. Salomon Brothers (Mozer) [Unauthorisedtrading] $290 m.

13. West Virginia (Lester) [Interest Ratespeculation] $280 m.

14. Allied Irish Banks/All First (J.Rusnak) $690 mn.

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SMALLER DISASTERS

1. Merrill Lynch (Rubin) [Unauthorised trading]$275 m.

2. Salomon Brothers [book-keeping errors] $200m.

3. Paine Webber [Misleading sale of partnerships]$200 m.

4. Mellon Bank [Securities lending: interest ratespeculation] $200 m.

5. Nolderhoffer Investments [Thailand, S&P puts]$100+m.

6. Salomon Brothers [Clerical error in programtrading] $100+m.

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SMALLER DISASTERS [cont.]

7. Procter & Gamble [Interest rate swap] $157 m.

8. First Cap. Strategists [Unauthorsied trading]

$128 m.

9. Natwest Markets [Interest rate swaps] $145 m.10. Porugal¶s central bank [Gold losses in Drexel

collapse] $100 m.

11. State of Wisconsin [Foreign interest rate

speculation] $95 m.

12. Gibson Greetings [Interest rate swap] $23 m.

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BAR ING BANK  FAILUR E

1. Baring Bank Established in 1762.2. Barings set up derivative business in

Singapore to deal on SIMEX on account

of customers.3. In 1992, Nick Leeson persuadedmanagement that he could generate ³Risk Free´ profit by arbitraging stock index

future µNIKKEI 225¶.4. Nick Leeson controlled dealing as well as

 backup.

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BAR ING BANK  FAILUR E (Cont.)

5. Shown profits by manipulating accounts.

6. Management did not understand and didnot control risk.

7. Head office kept remitting margin money.

8. Bank failed due to huge losses.

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Allied Irish Banks (AIB)Currency Fraud at its Baltimore Subsidiary

The Man : John Rusnak. (not a µstar trader¶).Attempted to recoup money he had lost on proprietary trading strategy.

Total losses stand around $690 mn. Wiping out 60%

of AIB¶s 2001 earnings and significantly depletingcapital.

Sold number of deep in-the-money options for high premium.

Arbitrage between FX options and spot & forwardmarkets: Buying options cheap and selling whenexpensive.

1997 ± incurred serious losses on forward deals

taking position on movement of JPY.

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Allied Irish Banks (AIB)Currency Fraud at its Baltimore Subsidiary [cont.]

Created fictitious options positions to hide losses.

First option involved receipt of large premium and second oneinvolved identical amount payment. But first would expire thesame day; the second after several weeks. How can the

 premium be same ? How no payouts on first option?

Exploited weaknesses in the controls.

Failure in back-office to obtain transaction confirmations.

Failure in back-office to check rates.

Manipulated VaR : (i) Bogus options appeared as µhedge¶, (ii)interferred directly with inputs into VaR calculation.

Senior Management in Dublin & Baltimore failed to pay enough

attention to All First¶s propritary trading.

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LTCM ± (Over-Leveraged Hedge Fund)

1. Founded in 1994. Managed by a dream team of  best brains in finance, including Nobel Lauretsand top investment bankers and former ViceChairman of Federal Reserve Board.

2. Being hedge fund, not regulated by SEC.

3. In 4 years built up assets close to $ 125 bn. ±  Capital base $ 4 bn.

4. Off-Balance Sheet business = Notional principal

amount over $ 1 trillion.5. Complex swaps, equity derivatives, total-returnswaps, index options, bets on take over targets.Single default by LTCM would trigger crossdefault on all trades.

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LTCM ± (Over-Leveraged Hedge Fund)

[cont.]

5. Return on Equity :

1995 .. 47%

1996 .. 45%

1997 .. 17%

Even planning to handing back $ 3 bn. of capital to investors.

6. Exposures (mainly by way of loan)

Chase .. $ 3.2 bn. (13%)*

Morgan .. $ 0.9 bn. (8%)

Bankers Trust .. $ 0.875 bn. (17%)

Lehman Bms .. $ 0.447 bn. (8%)

BOA .. $ 0.400 bn. (1%)

Merrill Lynch .. $ 1.40 bn.

JPM/Goldman Sachs .. Not Disclosed

(figures exclude potential losses on derivatives)

* Approximate % to tangible equity.

Total Bank Exposure (both on and off Balance Sheet) $ 200 bn.

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LTCM ± (Over-Leveraged Hedge Fund)

[cont.]

7. Investors lost 90% of their money in just twomonths.

8. Original prospectus = It would employ ³tons of 

leverage and have a lot of volatility in earnings´(Leverage was 40-60 to one)

9. Rescued by Banks in their own interest & by FED

to avoid systemic risk.

10. VAR Model failed to reveal the full inpact.

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SETTLEMENT RISK 

1. Settlement Risk : Risk of incorrectly funding or 

not receiving consideration.

2. Lesser understood and appreciated risk. Alsocalled as Herstatt Risk.

3. Herstatt Bank in Germany failed on 26 June 74.

Banking license was withdrawn after close of 

 banking hours. By then DEM payments werereceived locally irrevocably. Correspondent

 bank in N.Y. suspended payments in New York.

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BANK BORROWERS AT FLOATING AND

LENDS AT FIXED ± Possible Impact on Spread

[Amount = Say, US$ 100 Mn.]

HALF

YEAR 

Assured

6 Month

LIBOR 

Interest

Payments

USD Mn.

Interest

Receipts on

Loan at Fixed

Rate 8% p.a.

US

DMn.

Spread

(+) OR 

(-)

USD Mn.

1. 6.00 % 3.00 4.00 1 (+)

2. 5.50 % 2.75 4.00 1.25 (+)

3. 7.50 % 3.75 4.00 0.25 (+)4. 8.00 % 4.00 4.00 NIL

5. 9.00 % 4.50 4.00 0.50 (-)

6. 10.00 % 5.00 4.00 1.00 (-)

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INTER EST R ATE SWAP ± (PLAIN 

VANILLA SWAP)

SITUATION Amount say, US$ 100 Mn.

I. µA¶ is a Corporate

µA¶ has issued 3 year bond at Fixed Rate of 9%

µA¶ has lent funds at .. (LIBOR + 1%)

II. µB¶ is a Corporate with an exactly opposite situation i.e. hisincome is at Fixed Rate (9.25%) and payments are at aFloating Rate (LIBOR).

PR OBLEM

Mismatch in inflows and outflows in interest payments(Floating v/s. Fixed)

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INTER EST R ATE SWAP ± (PLAIN 

VANILLA SWAP) [cont.]

SOLUTION

INTER EST R ATE SWAP WHER E

1. A pays Floating to B

2. A receives Fixed from B

III. An intermedium perceives the needs of both the

parties and brings them together.

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INTEREST RATE SWAPS ± 

(Plain Vanilla) - Example

R ECEIVES (LIBOR + 1) R  ECEIVES FIXED 9.25%

Pays LIBOR to µB¶

Receives from µB¶

Fixed At 8.5% P.A.

PAYS 9% FIXED PAYS LIBOR 

A B

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INTEREST RATE SWAPS ± 

(Plain Vanilla) ± Example [cont.]R ESULT OF THE ARR ANGEMENT

A¶s Income (LIBOR + 1) + Fixed8

.5 B¶s Income 9.25% + LIBOR 

A¶s Payment = Fixed 9% + LIBOR B¶s Payment = LIBOR + 8.5%

I.E. LIBOR + 1 + 8.5% - 9% - LIBOR I.E. 9.25% + LIBOR ± LIBOR 

 ± 8.5%

 NET SPREAD = (0.5%) NET SPREAD = (0.75%)

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INTEREST RATE SWAP (IRS)

1. Only interest payments on Notional amount are exchanged. Theprincipal amount itself is NOT exchanged.

2. One party pays floating Rate, the other party pays a fixed rate

(Typical Coupon Swap). Floating Rate Indexes used are :

LIBOR (in most US$ Swaps ± about 75%), PR IME, CP Rate,FED Funds Rate, T-Bill Rate.

3. Notional Principal amount and maturity are specific.

4. SWAP R ATE i.e. fixed rate is quoted as spread over appropriatematurity current coupon. Treasury payments on floating Rate

side are usually (but not always) made flat, i.e. at selected Index

Rate without spread.

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Interest Rate Swap (IRS) [cont.]

Definition (IRS)

An Interest Rate Swap is a financial contract between

two parties exchanging or swapping a stream of interestpayments for a µnotional principal amount on multiple

occasions during s specified period. Such contracts

generally involve exchange of a µfixed to floating¶ or

µfloating to floating¶ rates of interest. Accordingly, on

each payment date ± that occurs during the swap period ± cash payments based on fixed/floating and floating

rates, are made by the parties to one another.

(RBI Guidelines)

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SWAP STRUCTURESA 1. BULLET SWAP (PLAIN VANILLA SWAP)

|________________ (Notional amount does not vary)

| |

| |

| |

|________________|_______ T

A 2. AMORTIZING SWAP

|___  Notional principal amount decreases (in

| |_____ regular or irregular increments) over the

| |____ life of the swap.

| |

| |___  

| |

|________________|_______ T

A = Notional Principal T = Time (No. of Year)

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SWAP STRUCTURES [cont.]A 3. ACCR ETING (APPR ECIATING) SWAP

| ____ (Opposite of [2])

| ___| |

| ____| |

| __| |

|__| |

|________________|________ T

A 4. R OLLER COASTER SWAP

| ___ (Combination of 2 & 3)

|___ | | ___|

| | | | | |

| | | |___| |

| |___| |

|________________|______ T

A = Notional Principal T = Time (No. of Year)

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X Y

INTEREST RATE SWAP

(Comparative Advantage)FIXED R ATE FLOATING R ATE

µX¶ can Borrow @ 8.60% LIBOR 

(Rating : µAAA¶)

µY¶ can Borrow @ 9.60% LIBOR + 0.50%

(Rating : µA¶)

FIXED R ATE FLOATING R ATE

BORR OWING BORR OWING

8.85%

SWAP

LIBOR 

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INTEREST RATE SWAP

(Comparative Advantage) [cont.]

µX¶ Receives : 8.85% and PAYS : 8.60% + LIBOR 

(Net Cost : LIBOR ± 0.25%)

µY¶ Receives : LIBOR and PAYS : 8.85% +

LIBOR + 0.50%

(Net Cost : 9.35%)

Both Save : 0.25%

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THE PRICING OF

INTEREST RATE SWAPSDealers quote LIBOR flat for a spread over US

treasury yield.

Example: 5-year swap quoted at 30-33, implying that

a pay-fixed side will pay 33-basis point over 5-year treasury yield.

Floating Rates LIBOR (per cent)

6 month 3.5

6 month 3.5625

12 month 3.6875

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THE PRICING OF INTEREST

RATE SWAPS [cont.]

--------------------------------------------------------Fixed Rates Spread (B.P.) Treasury Yield Swap Rate (%)

--------------------------------------------------------

2-year .18 - .21 4.09 4.27 ± 4.30

3-year .31 - .35 4.57 4.88 ± 4.92

5-year .30 - .33 5.50 5.80 ± 5.83

7-year .34 - .37 6.03 6.37 ± 6.40

10-year .35 - .38 6.53 6.88 ± 6.91

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OPTION - Definition

AN OPTION

GIVES THE HOLDER THE RIGHT

BUT NOT THE OBLIGATION

TO BUY OR SELL A SPECIFIC ASSET

AT A PREDETERMINED (SPECIFIC) PRICE AT A CERTAIN FUTURE DATE OR TIME.

THE BUYER (OR HOLDER) OF THE OPTIONPAYS PR EMIUM TO THE SELLER 

THE SELLER (OR WRITER) HAS THEOBLIGATION TO BUY OR SELL THE ASSETIF THE BUYER (HOLDER) OF THE OPTIONEXERCISES HIS RIGHT.

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OPTION - Terminology

Call/Put

Volatility

Strike Price

American/European

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OPTION ± Terminology [cont.]

Exercise Intrinsic Value

Time Value

Seller/Writer

Buyer/Holder

In the Money/At the Money/Out of the Money

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DEFINITIONA ³CALL´ IS THE R IGHT TO ³BUY´ THE UNDER LYING ASSET.

CALL BUYER  OR HOLDER BENEFITS FR OM INCR EASED

PR OFITS AS MAR KET PR ICES R ISE WITH THE POTENTIAL FOR UNLI

MIT

EDPR 

OFITS.

IFPR 

IC

ES

FALLTH

E LOSS

IS

LIM

IT

EDT

O

THE PR EMIUM PAID FOR THE OPTION.

CALL SELLER  OR WR ITER  KEEPS THE PR EMIUM AS PR OFITWHILE MAR KET PR ICES IN THE UNDER LYING R EMAIN STATICOR  DECLINE. IF PR ICES R ISE THEN THE POTENTIAL LOSSESAR E UNLIMITED.

SELL A CALL ± SHORT CALL

BUY A CALL ± LONG CALL

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DEFINITION [Cont.]A ³PUT´ IS THE R IGHT TO ³SELL´ THE UNDER LYING ASSET.

PUT SELLER  OR WR ITER  KEEPS THE PR EMIUM AS PR OFITWHILE MAR KET PR ICES IN THE UNDER LYING R EMAIN STATICO

R R IS

E.

IFPR 

IC

ES

FALLTH

ENTH

EP

OT

ENT

IAL LOSS

ES

AR 

E

UNLIMITED.

PUT BUYER OR HOLDER BENEFITS FR OM INCR EASED PR OFITSAS MAR KET PR ICES DECLINE WITH THE POTENTIAL FOR UNLIMITED PR OFITS. IF PR ICES R ISE THE LOSS IS LIMITED TO

THE PR EMIUM PAID FOR THE OPTION.

BUY A PUT ± LONG PUT

SELL A PUT ± SHORT PUT

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SOLD CALL

1.View : Price of underlying asset will decline (or remain unchanged). [If unchanged seller gains the

rime value].

2. Maximum possible gain is the premium received.

3. Maximum possible loss is unlimited, as there is no

limit to how the asset will rise (and hence theoption will be exercised against the call seller).

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SOLD PUT

1.View : Price of underlying asset willincrease (or remain unchanged).

2. Maximum possible gain is the premium.

3. Limit of potential loss is limited to how low

the price of the asset can fall.

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WHY OPTIONS ?

1. THEY GIVE PR OTECTION FR OM ADVERSE MOVEMENTS, BUT R ETAIN 

THE GAINS FR OM FAVOUR ABLE MOVEMENTS.

* AN IMPORTER OF MACHINER Y WHO HAS TO PAY JPY AFTER 2

MONTHS.

* AN EXPORTER, SELLING TEXTILES TO GERMANY, WHO HAS TO

R ECEIVE EUR O/DEM SOMETIME WITHIN THE NEXT 3 MONTHS.

2. FOR INSUR ANCE

* A CONTR ACTOR WHO IS BIDDING FOR A CONTR ACT IN EUR O,

WHER E THE R ESULTS WILL BE KNOWN SOMETIME IN THE NEXT

MONTH.

3. OTC OPTIONS AR E VER Y FLEXIBLE, AND CAN BE LOW-COST

4. CUSTOMERS WANT THEM

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Value of an Option

VALUE OF AN

OPTION = Intrinsic Value + Time Value

Intrinsic Value ± Difference between

Option Rate and Market Rate.

Time Value ± Time Left to Maturity

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PRICING AN OPTION

FACTORS INCLUDED IN PRICING

MODEL (BLACK & SCHOLES)

STRIKE PRICE

UNDERLYING PRICE

TIME TO EXPIRY

INTEREST RATE

VOLATILITY

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PR ICING AN OPTION:

An Intuitive Approach (Probability/Pay Out)

OPTION PRICES DEPEND ON THEPROBABILITY OF GIVEN CURRENCYMOVEMENTS AND THE PAYOFFS

THAT WILL OCCUR IF AND WHENTHOSE MOVEMENTS TAKE PLACE.

AN OPTION PRICE IS JUST THEPRESENT VALUE OF THE EXPECTEDPAYOUT.

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PR ICING AN OPTION:

An Intuitive Approach (Probability/Pay Out)

[cont.]

EXAMPLE* YOU AR E LOOKING TO DR ILL OIL FR OM A CERTAIN PIECE OF LAND YOU WOULD

LIKE TO BUY. THER E IS:

* 50% CHANCE OF FINDING SOMETHING WHEN Y OU DR ILL

* IF YOU DO FIND SOMETHING THER E IS:

* 30% CHANCE OF FINDING CR UDE YIELDING $500,000 PR OFIT.

* 40% CHANCE OF FINDING CR UDE AND GAS YIELDING $750,000 PR OFIT.

* 30% CHANCE OF FINDING HIGH GR ADE CR UDE YIELDING $1.5 MILLION PR OFIT.

* WHAT IS THE MAXIMUM YOU WOULD BUY IT FOR?

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KNOCK -OUT (DR OPOUT) OPTION

KNOCK -IN (DR OPIN) OPTION

European style currency Option.

Dropout level built into the Option.

If dropout level is breached at any time

during the life of the option, the contract isimmediately terminated.

If dropout level is not breached during thelifetime of the option, then the option will

 behave precisely the same manner on expiryas a normal European style option.

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EXAMPLE

The spot Pound Sterling/D

ollar is 1.6000

Customer buys European style currency option which gives him theright to buy Pound Sterling and sell USD at 1.6000 with 3 monthsmaturity.

Premium is say 1.72% of Sterling amount payable with two businessdays value from the contract date.

On Expiry

Spot Rate is above 1.6000. Will he exercise ?

Spot Rate is below 1.6000. Will he exercise ?

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EXAMPLE [Cont.]

With Drop Out FeatureDropout level is say 1.5600.

Premium is say 1.05% of Sterling amount

If at any time before expiry the rate falls below 1.5600, then thecontract lapses.

With Drop in Feature

Drop in level is say 1.5600

If the spot rate falls through 1.5600 during the lifetime of the optionand if, on expiry the option is ³in-the-money´ the option will be

exercised in precisely the same manner.

If on expiry, the spot rate is below 1.6000, then the option will be³out-of-the-money´ and will not be exercised.

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EXAMPLE

Customer purchases 3-month Sterling Call Dollar PutLook Back Option (Say for Sterling Pound 10 mn.)

Premium is say, 4.37% of the Sterling amount payable.

On expiry Pound Sterling/USD is 1.6350. Highest rateduring the 3 month period is 1.6500 and the lowest1.6100.

Q. 1. What it the strike rate of the Sterling CallLook Back 

Option?

Q.2. Will the customer exercise theO

ption?

E ample of Interest Rate ³CAP´

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Example of Interest Rate ³CAP´

(CAP is an Interest Rate Option)PER IOD 1 YEAR 

%

2 YEAR 

%

3 YEAR 

%

AVER AGE R ATE

LIBOR 

RATES

(AVERAGE)

6.5% 9.5% 11.0 9.00 p.a.

CAP

RATE 8.0 8.0 8.0 8.0

COST OF

PREMIUM FOR CAP

(ANNUALISED)

1.1875 1.1875 1.1875 1.1875

ALL IN

BORROWING COST 7.6875 9.1875 9.1875 8.6875

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Caps & Floor 

Cap ± the right to fix the borrowingrate.

Floor ± the right to fix the lendingrate.

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Forward Rate Agreement (FRA)

DefinitionA Forward Rate Agreement (FRA) is a

financial contract between two parties to

exchange interest payments for a µnotional

 principal¶ amount on settlement date, for a

specified period from start date to maturity

date.

[RBI Guidelines]

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Forward Rate Agreement (FR A) [cont.]FEATUR ES

traded in the OTC market

no standardisation of amount

in all convertible currencies

never any transaction of principal (notional principal only)

only interest differential is paid or received on the notional principal on thesettlement day

interests applied are LIBOR 

front-end discounted payment

no up-front fees, except the transaction costs

contract currency, amount, contract rate, settlement date are specified in advance

(3 x 6) ³Three Sixes´ : An interest rate for 3 months to start in 3 months from thedate of contract.

FRABBA MARKET QUOTES

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FRABBA MARKET QUOTES

(ILLUSTRATIVE)

USD FRAS JPY FRAS

1/4 6.19/15 1/7 6.53/49 1/4 2.45/42 1/7 2.62/58

2/5 6.30/26 2/8 6.68/64 2/5 2.57/54 2/8 2.71/67

3/6 6.56/52 3/9 6.91/87 3/6 2.68/65 3/9 2.81/77

4/7 6.74/70 4/10 7.10/06 4/7 2.76/73 4/10 2.91/87

5/8 6.94/90 5/11 7.26/22 5/8 2.82/79 5/11 3.00/97

6/9 7.14/10 6/12 7.43/39 6/9 2.92/89 6/12 3.10/07

F d R t A t (FRA)

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Forward Rate Agreement (FRA)Examples of Confirmations

PART 1

To be Used on the Agreement Date

F.R.A. CONTR ACT

AGR EEMENT DATE

CONFIRMATION NOTICE

TO :-

FR OM :-We are pleased to confirm the following Forward Rate Agreement (F.R.A.) made

between ourselves as per FR ABBA Recommended Terms and Conditions dated

«««. 1985. (Direct/Broker «««««««««««.).

CONTR ACT CURR ENCY & AMOUNT ««««««««.«««.««««...

FIXING DATE «««««««««.

SETTLEMENT DATE ««««««.. MATUR ITY DATE ««««.«««...

CONTR ACT PER IOD (DAYS) ««««««««««««««««««««.

CONTR ACT R ATE ««««.. % per annum on an actual over 360/365

days basis (as applicable)

Forward Rate Agreement (FRA)

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Forward Rate Agreement (FRA)

EXAMPLE [Cont.]

SELLER ¶S NAME «««««««««««««««««««««««««.

BUYER ¶S NAME «««««««««««««««««««««««««..NON-STANDAR D TERMS & CONDITIONS (IF ANY)

««««««««««

Any payment to be made to us under the F.R.A. hereby confirmed should becredited to our Account Number

«««««««««««««««««««« at««««««««««««««««««««««««««««««««.

PLEASE ADVISE BY TELEX, OR CABLE US IMMEDIATELY, SHOULD

THE PARTICULARS OF THIS CONFIRMATION NOT BE IN

ACCOR DANCE WITH YOUR UNDERSTANDING.

Either :- Or :-

SIGNED : ««««««««««. TESTED TELEX CONFO

FOR AND ON BEHALF OF

««««««««««««««...

ADVANTAGES OF FRA

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ADVANTAGES OF FRAA. HEDGE : BANK  CAN HEDGE ITS FUTUR E LENDING/ DEPOSIT

OPER ATIONS AND FIX FUTUR E R ATES IN A SIMPLE AND

EFFICIENT MANNER.

B. CR EDIT R ISK  : CR EDIT R ISK I N FR A IS NEGLIGIBLE AS THE

EXPOSUR E IS ONLY TO THE EXTENT OF INTER ESTVAR IATIONS.

C. FLEXIBILITY : AN OPPORTUNITY TO R EVERSE OR SQUAR E THE

POSITION BY MAKING OFFSETTING CONTR ACTS.

D. CR EDIT LIMITS : FR A DOES NOT TIE UP THE BORR OWINGLIMITS TO THE SAME EXTENT AS ACTUAL BORR OWING IN

VIEW OF LIMITED R ISK AS MENTIONED IN (B) ABOVE.

E. BALANCE SHEET : SINCE THER E IS NO EXCHANGE OF

PR INCIPAL AMOUNT, FR As AR E TR EATED AS OFF BALANCE

SHEET ITEMS AND HENCE DO NOT ATTR ACT R ESERVE

R EQUIR EMENTS.

F. SAVING ON FUNDING COST : A JUDICIOUS COMBINATION OF

FR A AND MAR KET BORR OWING CAN ENABLE A BORR OWER BANK  R EDUCE ITS FUNDING COST AS COMPAR ED TO THE

COST IN THE CASH MAR KET.

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THANK YOU