Financial Markets - Part 5 - Juillet 2014

Information about Financial Markets - Part 5 - Juillet 2014

Published on July 13, 2014

Author: Acadefi

Source: authorstream.com

Content

Structured Products: Structured Products Johann BARCHECHATH July 2014 Agenda : Agenda 1. Introduction What is a Structured Products Hedging vs Investment Why a second generation ? Customer Objectives 2. Hedging Solutions FX IR 3. Investment Solutions Touch Deposit Dual Currency And more … 1. Introduction: 1. Introduction Introduction : What are Structured Products ?: Introduction : What are Structured Products ? In finance, a structured product is generally a pre-packaged investment strategy based on derivatives. Derivatives: single security (forward, indices, …), basket of securities, options, debt issuances and/or foreign currencies, and to a lesser extent, swaps. Introduction : What are Structured Products ?: Introduction : What are Structured Products ? Structured products were created to meet specific needs. Combinations of derivatives and financial instruments create structures that have specific risk/return and/or cost savings profiles that may not be otherwise achievable in the marketplace. Introduction : Hedging vs Investment: Introduction : Hedging vs Investment Structured Hedging Structured solutions can be designed specifically to suit individual risk and return objectives . There exist a wide range of tailored structured strategies to compliment the treasury policy of companies regarding exposures with foreign exchange, interest rates, commodities, … Introduction : Hedging vs Investment: Introduction : Hedging vs Investment Structured Investment Structured investment products are customized financial instruments with fixed maturities , consisting of a fixed income part (bonds, note, …) which includes derivatives . They are typically composed of a bond that protects the principle and an option that depends on an underlying asset’s performance. All terms, however, can be tailored to suit an investor’s risk attitude and financial objectives. Introduction : Evolution: Introduction : Evolution Structured Products & Exotic Options OTC Options & Swaps Listed Futures & Options Forwards – CP – Repo - Warrants Underlying FX – FI – Equities – Commodities - … Introduction : Why a second generation ?: Introduction : Why a second generation ? Standard options sometimes are referred to as first-generation options and exotic options are referred to as second-generation options. Based on this logic, we refer to the structured products which incorporate the features of exotic derivatives as the second-generation structured products. Also this class of products may be distinguished due to the methodology required to price these products. No closed-form formula is available. We rely then on Monte Carlo techniques . Introduction : Evolution of Hedging Strategies: Introduction : Evolution of Hedging Strategies Simple Forward Par Forwards = strips Ratio Forwards Introducing leverage to improve forward hedging rates Boosted KO forward Adding a KO barrier on top to improve strike rates further. Accumulator and Fading structures KO forward style structures into daily fixing with monthly settlement style structures More Exotic KO Barriers with Path Dependence Target Redemption Forwards. Escalator forwards Lookback forwards Multichance barriers Introduction : Structured Products ≠ Complex: Introduction : Structured Products ≠ Complex Structuring is not synonymous to complexity. The Flexi Forward is a simple product allowing to shorten the maturity of forward as you want and for the amount you want. It was created to answer client’s needs (unknown date of delivery of goods covered by a Letter of Credit). The pricing is complex (3 factors) but the product is simple. Introduction : Customer Objectives: Introduction : Customer Objectives Is there a hedging or investment policy in place ? What are they allowed to deal ? Derivatives, KO, leverage, .. Capital at risk, all type of underlying, maturities, … ? Are they allowed to deal in Exotic Options ? How averse are we to paying for a risk management solution ? Do they need a minimum return for their investments ? Introduction : Customer Objectives: Introduction : Customer Objectives Do we need complete protection against any movements in price? If a degree of risk is tolerated, what is the balance between: The desire to obtain upside savings The desire to avoid downside risk What is your view of future market movements? Do we have a benchmark rate or price which must be achieved? Will decide if we will use “participation” or “beat-the-market“ strategies 2. Hedging Solutions: 2. Hedging Solutions Cylinder: | | 15 Cylinder A Zero Cost Cylinder protects you, as a seller of foreign currencies, against the depreciation of these currencies. Under certain circumstances, it gives you the chance to benefit from a better exchange rate than the reference forward rate. You can determine yourself the upper limit (i.e. your maximum exchange rate) while the bank will fix the lower limit. Cylinder: Cylinder Example: Buyer EUR/Seller USD If the spot rate at maturity is lower than the lower limit, you will have to sell USD at the level of the lower limit at 1.3600. Your exchange rate will be better than the reference forward rate, but less favorable than the spot rate at that moment. If the spot rate at maturity is in between the upper and the lower limit, you will transact at the spot rate at that moment. If the spot rate at maturity is higher than the upper limit, you have the right to sell USD at the level of the upper limit at 1.4200. Your exchange rate will be less favorable than the reference forward rate, but better than the spot rate at that moment. KI Forward: KI Forward Client seller of EUR vs USD Pro’s Full protection in case of lower EUR/USD Full benefit on the upside up to a prefixed level Zero cost, zero premium KI Forward: KI Forward Profits Spot K B KI Forward: KI Forward Seller of € : Below K you are fully protected at K Above K, is the EUR/USD Never trade at or above B, you benefit from the current market conditions, Deal at least once at or above B, you have to sell EUR ag USD at K. How to build it ? Buyer Put EUR / Call USD at K Seller Call EUR / Put USD at K with american barrier at B KI Forward: KI Forward Spot Spot 1.3310 1.2800 1.2800 1.3310 Exchange rate Participating Forward: 21 Participating Forward A Participating Forward protects you, as a seller of foreign currencies, against the depreciation of these currencies and gives you, at the same time, a chance to benefit from a better exchange rate than the reference forward rate. The participation degree indicates the percentage that you benefit from a favourable evolution of the spot rate at the expiry. The protection rate offers you protection against adverse spot rate movements: your exchange rate will always be better than or equal to the protection rate. Participating Forward: Participating Forward Example: Buyer EUR/Seller USD There are two possible scenarios at the expiry of the Participating Forward: The EUR/USD spot rate is equal to or lower than the protection rate: you will have to sell USD at 1.4700 for 25% (=100% - the participation degree) of the nominal amount and you sell the remaining 75% of the nominal amount at the more favourable spot rate at that moment. The EUR/USD spot rate quotes higher than the protection rate: you have the right to sell USD at 1.4700. Bonus Forward: 23 Bonus Forward A Bonus Forward protects you, as a seller of foreign currencies, against the depreciation of these currencies. As long as the spot rate remains within a predetermined range during the lifetime of the contract, the Bonus Forward will ensure you to benefit from an improved exchange rate in comparison to the reference forward rate. Otherwise you will receive the guaranteed exchange rate. Bonus Forward: Bonus Forward Example: Buyer EUR/Seller USD If the spot rate quotes outside of the range anytime during the lifetime of the contract, you sell USD at the guaranteed rate of 1.4200, which is less favourable than the reference forward rate. If the spot rate remains within the range during the lifetime of the contract and quotes between 1.2800 and 1.3800 at expiry, you have the right to sell USD at the spot rate, which means that you fully benefit from the USD appreciation. If the spot rate remains within the range during the lifetime of the contract and quotes between 1.3800 and 1.5200 at expiry, you have the right to sell USD at 1.3800 which is better than the reference forward rate. More …: 25 More … Leverage KO Accumulator Target … Interest Rate Swap: Interest Rate Swap An Interest Rate Swap (IRS) exchanges the variable reference interest rate of your loan for a fixed interest rate without having to modify your existing loan conditions. By doing so, you fix the interest rate for a longer period of time. The variable reference interest rate EURIBOR you receive from the IRS can be used to pay back the variable reference interest of your loan. Eventually you pay a fixed rate plus the credit margin of your loan. You are protected against an increase of the variable reference interest rate but you are not able to profit from a decrease. Interest Rate Swap: Interest Rate Swap Example Through this IRS you pay eventually a fixed rate + credit margin instead of a variable rate + credit margin. Cross Currency Swap: Cross Currency Swap A Cross Currency Swap is a very useful instrument to manage foreign exchange cash flows in your company. It is an agreement to exchange known future cash flows that are expressed in different currencies over a predetermined period of time. By entering into a Cross Currency Swap, you will, for example, be able to repay a foreign currency loan in your own currency, or, to invest in a foreign currency bond and transform all related cash or interest flows into your domestic currency. There is an exchange of the interest flows and of the notional amounts on the value date and the maturity date at the same foreign exchange rate. The floating interest rate modalities and interest flows during the swap are often based on Interbank Offered Rates (IBOR’s). Cross Currency Swap: Cross Currency Swap Example (1) On the value date, the notional amounts are exchanged at a fixed foreign exchange rate. (2) During the lifetime of swap, the interest flows are exchanged based on the respective notional amounts and currency. (3) At maturity, both notional amounts are exchanged again at the initial fixed foreign rate. Collar: Collar A Collar guarantees a maximum level (Cap) for the variable reference interest rate of your loan. The bank will pay you the extra interest each time the variable reference interest rate (e.g. EURIBOR) is fixed above the level of the Cap. The Collar however, will not allow you to take advantage of a variable reference interest rate below a pre-determined level (Floor). You will be required to pay us the extra interest each time the variable reference interest rate of your loan is fixed below the level of the Floor. A Collar enables variable rate borrowers to retain the advantages of their variable rate facility while providing the additional benefit of a maximum interest rate. Collar: Collar Example: Borrower The variable reference interest rate exceeds the Cap: the bank will pay you the difference between the Cap and the variable reference interest rate for that interest period. you will continue to pay back your loan as usual (including the credit margin). The variable reference interest rate is in between the Cap and the Floor: you will continue to pay back your loan as usual (including the credit margin). The variable reference interest rate is below the Floor: You will pay the bank the difference between the variable reference interest rate and the Floor for that interest period. You continue to pay back your loan as usual (including the credit margin). This example is a theoretical example which is given for illustration purposes only. It is not intended to give any indication on future results. At each fixing date of your variable rate loan, there are three possible scenarios: Participating Cap: Participating Cap A Participating Cap guarantees a maximum level (Participating Cap Strike) for the variable reference interest rate of your loan (e.g. LIBOR, EURIBOR) with the possibility to benefit partially from lower variable reference interest rates. You can fix the Participating Cap Strike according to your needs and you will be fully protected above this level. Consequently, the bank will determine the participation degree, i.e. the percentage of the variable reference interest rate decline below the Participating Cap Strike you will benefit from. The Participating Cap is separate from your loan but its dates and amounts should match those of your loan. Participating Cap: Participating Cap Example: Borrower At every fixing date of your variable rate loan, there are three possible scenarios: The variable reference interest rate exceeds the Participating Cap Strike: the bank will pay the difference between the Participating Cap Strike and the variable reference interest rate for that interest period. The variable reference interest rate is equal to the Participating Cap Strike: you will not need to make use ofthe product for that interest period. The variable reference interest rate is below the Participating Cap Strike: you will have to pay interest at the Participating Cap Strike level on 50% (= 100% - the participation degree) of the nominal amount for that interest period. Bermudan Swap: Bermudan Swap You have an existing loan with a variable interest rate maturing within 5 years? A Bermudan Swap exchanges the variable reference interest rate (e.g. EURIBOR) of your loan for a fixed rate (= Bermudan Swap rate) that is lower than a 5 year IRS rate at that moment. You pay for each interest rate period the Bermudan Swap rate and receive the variable reference rate from us. The bank is entitled to cancel the Bermudan Swap on every call date after an initial period. If that happens, you are back in your initial position. Bermudan Swap: Bermudan Swap Example: Borrower As long as the bank does not cancel the Bermudan Swap, you continue to receive the variable reference interest rate and to pay the Bermudan Swap rate which is lower than a 5-year long-term interest rate at that moment. As soon as the bank cancels the Bermudan Swap after an initial period, you are back in your original position i.e. paying a variable interest rate (+ credit margin). Inflation Swap: Inflation Swap Do you have revenue or cost streams on which inflation could have an negative impact? An Inflation Swap exchanges a variable reference inflation index for a fixed inflation rate, based on a nominal amount and for a predetermined period. By doing so, you will turn cash flows, which are affected by the real observed inflation, into fixed and predictable payment streams. However, you will no longer be able to benefit from a increase or decrease of the real observed inflation. Inflation Swap: Inflation Swap Example Company ABC lets an office building and receives rent on a monthly basis for a total annual amount of EUR 100.000. This rent is indexed on a yearly basis. At the same time, the company is paying back its mortgage loan for the building on a monthly basis for a total amount of EUR 105.000 fixed per year. The rental income is indexed according to following formula: Indexed amount = EUR 100.000 x Consumer Price Index period / Consumer Price Index base By using an Inflation Swap, Company ABC avoids a negative cash flow in the beginning of the transaction, and ensuring a constant and positive cash flow in the future. 3. Investment Solutions: 3. Investment Solutions Investment – Touch Deposit: Investment – Touch Deposit You anticipate that the market will reach a level within a pre-set time frame. You want to monetize this view without risking your capital. Investment – Touch Deposit: Investment – Touch Deposit Maturity : 3 mois Currency of deposit : EUR Nominal : 1 000 000 Underlying: €/$ Touch level : 1.30 Boosted Yield : 4.00% (Act/360) Spot : 1.35 Market yield : 3.00% Investment – Touch Deposit: Investment – Touch Deposit If the €/$ reach 1.30 then the yield of the deposit is 4% Otherwise it’s 0%. 0% Spot Yield 1.30 4% Investment – Touch Deposit: Investment – Touch Deposit How to built it ? A Deposit to guarantee the capital A Derivative to get the potential upside 100% Spot Yield 1.30 101% Investment – Touch Deposit: Investment – Touch Deposit How to built it ? How to get 100% in 3 month time ? Put aside today at the treasury desk : 100 / (1+3%/4) = 99.25 100% Spot Yield 1.30 101% Investment – Touch Deposit: Investment – Touch Deposit How to built it ? How to get 1% in 3 month time if we touch 1.30 ? Buy a One Touch digital which pays 1 € at 1.30 : Premium = 50%, then the cost is 0.50 €. 100% Spot Yield 1.30 101% Investment – Touch Deposit: Investment – Touch Deposit What we have ? We receive 100 from the client. We give 99.25 to the treasury. We give 0.50 to the option trader. We keep 0.25 has the margin. What are the risks / advantages for : The Treasury Desk ? The Option Trader ? The Client ? The Structurer ? Investment – Touch Deposit: Investment – Touch Deposit Variations … Guaranted yield One Touch Call No Touch Call No Touch Put European Digital Call European Digital Put Range Deposit DNT Deposit Investment – Dual Currency Deposit: Investment – Dual Currency Deposit A Dual Currency Deposit is a deposit which offers you an enhanced interest rate compared to a regular deposit. At maturity you will receive the nominal amount plus the enhanced interest (pro rata temporis) in EUR or in another currency. This will depend on the spot rate compared to a predetermined strike level at the maturity date. If you are paid back in another currency, it will be at the strike level rate. Investment – Dual Currency Deposit: Investment – Dual Currency Deposit Example If at the maturity date of 18/12, the EUR/USD spot rate is equal or lower than 1.3500, you will receive the nominal amount plus the enhanced annual interest rate of 9.5% (pro rata temporis) expressed in EUR. If at the maturity date of 18/12, the EURUSD spot rate is higher than 1.3500, you will receive the nominal amount plus the enhanced annual interest rate of 9.5% (pro rata temporis) expressed in USD converted at 1.3500. Investment – Dual Currency Deposit: Investment – Dual Currency Deposit Risks ? Market vision ? How to built it ? Dual Currency Deposit (DCD, DCOD, …) is a very popular product for Corporation and also for Private Banking. Structured Products: Structured Products Johann BARCHECHATH July 2014

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