Treasury Products Part I

Treasury Products

Toolbox

The market offers a broad range of products to either hedge any market related risk, like

interest rate risk foreign exchange risk foreign exchange risk credit risk liquidity risk

or speculate on market developments

Products

Products can be classified either by accounting standards Off-balance On-balance

impact on the balance sheet in terms of liquidity Liquidity neutral Liquidity effective

trading place Over the counter (OTC) Exchange Traded

Classification

On-balance: Assets (loans, securities) Liabilities (deposits, issues)

Off-balance: Derivatives (interest rate derivatives,

foreign exchange [FX] swaps, credit derivatives)

Classification

Liquidity Neutral: derivatives (interest rate swaps [IRS],

futures, options, credit default swaps [CDS]) [CDS])

Liquidity Effective: On-Balance Products Derivatives (FX swaps, cross-currency

swaps)

Classification

Over the counter (OTC): most on-balance products can be traded OTC tailormade derivatives are traded OTC

Exchange Traded: Futures Future Options Equities

Classification

There are two categories of Derivatives:

unconditional forward contracts (Futures, Swaps, Forwards)Forwards)

conditional forward contracts (Options)

Derivatives Overview

bedingte Termingeschfte unbedingte Termingeschfte

Derivative FinanzinstrumenteDerivatives

conditional forwards unconditional forwards

OptionenOptionen auf Futures

brsengehandelt

FX-OptionenZinsoptionen

(Caps, Floors, Collars)Optionen auf Swaps

OTC

Futures

brsengehandelt

ForwardsFRAsSwaps

OTC

conditional forwards unconditional forwards

Exchange traded Exchange traded

FuturesFutures Options

FX OptionsIR Options

(Caps, Floors, Collars)Swaptions

Underlyings: foreign exchange / interest rates / bonds / commodities/ equities / indices

Pricing

Arbitrage-free conecpt:

The fair market price is not based on future market expectation but on the assumption market expectation but on the assumption that there is no risk-free profit (arbitrage) achievable!

Pricing

There aint no such thing as a free lunch!

Terminology

Standardized tenors

Overnight (O/N): value date = trading date (T)maturity date = starting value + 1 working day (T+1)

Tom(orrow)/Next (T/N): value date = trading date + 1 working day (T+1)maturity date = starting value + 1 working day (T+2)

Spot/Next (S/N): value date = trading date + 2 working days (T+2)maturity date = starting value + 1 working day (T+3)

Spot/Week (S/W): value date = trading date + 2 working days (T+2)maturity date = starting value + 7 working days (T+9)

Other maturities (1, 2, 3...,12 months) are generally quoted out of Spot (T+2)

Basics Interst rate calculation

There are three ways to determine the number of days (D):

Actual : Counting the actual numbers of days that elapse. Term of interest: 1 March 31 March: 30 days Term of interest: 1 March 1 April: 31 days Term of interest: 1 March 1 April: 31 days

30: Each month counts as 30 days (remaining days in a month are subtracted). Term of interest: 1 March 31 March: 30 days Term of interest: 1 March 30 March: 29 days Term of interest: 1 March 1 April: 30 days

Basics Interst rate calculation

There are three ways to determine the number of days (D):

30E: Each month counts as 30 days (the 31st is treated as if it was the 30th; remaining days are subtracted). Term of interest: 1 March 31 March 29 days Term of interest: 1 March 31 March 29 days Term of interest: 1 March 30 March 29 days Term of interest: 1 March 1 April 30 days

Basics Interest rate calculation

There are three ways to determine the day basis (B)

360: Assuming that each year has 360 days 365: Assumption that each year has 365 days 365: Assumption that each year has 365 days Actual: The actual days per year are counted

(leap year 366 days, "normal" year 365 days)

Source: Treasurers Handbook, Enthofer/Haas, p.42

Source: Treasurers Handbook, Enthofer/Haas, p.42

Interest rate calculation

Interest rate calculation - Example

Bank A gives a 1-month deposit of Euro 5 million at 3 %. Start date of this credit is 1st October and end date is 1st November. The actual number of days for this period is 31. Basis of term calculation is 360 days per year.per year.

The absolute interest of this credit is:

Interest rate calculation - Example

You have lent GBP 10 million to a customer

At the maturity date (153days after value date) you receive an interest value date) you receive an interest payment of GBP 165.994,52

What was the interest rate?

%3,96

Average interest rate calculation

Average interest rate calculation -Example 2 January - 2 April (90 days) at 2.5 % 2 April - 2 July (91 days) at 2.75 % 2 July - 2 October (92 days) at 2.875 % 2 October - 2 January (92 days) at 3 % 2 October - 2 January (92 days) at 3 %

Average interest rate calculation -Example 2 January - 2 April (90 days) at 2.5 % 2 April - 2 July (91 days) at 2.75 % 2 July - 2 October (92 days) at 2.875 % 2 October - 2 January (92 days) at 3 % 2 October - 2 January (92 days) at 3 %

Compound (Effective) Interest

Compound (Effective) Interest -Example

2 January - 2 April (90 days) at 2.50 %2 April - 2 July (91 days) at 2.75 %2 July - 2 October (92 days) at 2.875 %2 October - 2 January (92 days) at 3.0%2 October - 2 January (92 days) at 3.0%

Compound (Effective) Interest -Example

2 January - 2 April (90 days) at 2.50 %2 April - 2 July (91 days) at 2.75 %2 July - 2 October (92 days) at 2.875 %2 October - 2 January (92 days) at 3.0%2 October - 2 January (92 days) at 3.0%

Future Value

Future Value

You take a deposit of EUR 1 Mio at a rate of 6 % p.a. for 92 days (Actual / 360). At the end of its term, the value of the deposit will be:

Future Value

You take a deposit of EUR 1 Mio at a rate of 6 % p.a. for 92 days (Actual / 360). At the end of its term, the value of the deposit will be:

Present Value

Present Value - Example

We know that the current yield of a US treasury bill is 0.50 %. The future value is 1,000,000 in 2 months (61 days). Calculate the present value of the T bill:the present value of the T bill:

999.153,49

Present Value - Example

We know that the current yield of a US treasury bill is 0.50 %. The future value is 1,000,000 in 2 months (61 days). Calculate the present value of the T bill:the present value of the T bill:

999.153,49

Present Value / Future Value

If you know the Present Value and the Future Value of an Investment you can calculate the implied interest rate (=yield):

Present Value / Future Value

You bought a Commercial Paper at a price of 99,1234%; Notional amount 1.000.000; tenor 91 days (Basis 360). The implied yield is?is?

Present Value / Future Value

You bought a Commercial Paper at a price of 99,1234%; Notional amount 1.000.000; tenor 91 days (Basis 360). The implied yield is?is?

3,4985%

Yield curve

There are four different types of yield curves:

a) Steep yield curve : ("normal) short-term interest rates are lower than long-term interest rates.rates.

b) Flat yield curve : interest rates for different terms are the same.

c) Inverse yield curve : short-term interest rates are higher than long-term interest rates.

d) Humped yield curve : at some point on the yield curve a non-linear hump exists

Yield curve

4,00%

5,00%

6,00%

0,00%

1,00%

2,00%

3,00%

4,00%

O/N 1y 2y 3y 4y 5y 6y 7y 8y 9y 10y

NORMAL

INVERSE

FLAT

HUMPED

Interpolation

In case you need to calculate a value on the yield curve between two given reference rates, you can use linear interpolation.

Interpolation

1 months 1,23% (31 days)3 months 1,76% (90 days)1 months ????? (46 days)

Interpolation

1 months 1,23% (31 days)3 months 1,76% (90 days)1 months 1,365% (46 days)

Forward rate

Situation: You need to take a 20mn loan in 2 months

time for 3 months You are afraid of rising interest rates You are afraid of rising interest rates You want to fix the rate already now

Your options?

Forward rate

Deposit given

Loan taken

Loan taken

Deposit given

Loan taken

Spot 2 months 5 months

Spot 2 months 5 months

Forward rate concept

3,00%

3,50%

4,00% YtM-Rate - Swap

6 M-Euribor/LIBOR Implied Forwardrates

1,00%

1,50%

2,00%

2,50%

3,00%

0,5 1 1,5 2 2,5 3 3,5 4 4,5 5

Forward rate - Example

yield curve: 1 Mo 4,00 % 2 Mo 4,00 % 3 Mo 5,00 %

FRA price:

? 1 / 4 3 Mo 5,00 % 4 Mo 5,00 % 5 Mo 5,00 % 6 Mo 5,00 % 9 Mo 4,50 % 12 Mo 4,00 %

? 3 / 6

? 6 / 12

Forward rate - Example

yield curve: 1 Mo 4,00 % 2 Mo 4,00 % 3 Mo 5,00 %

FRA price:

? 1 / 4 ~5,33 3 Mo 5,00 % 4 Mo 5,00 % 5 Mo 5,00 % 6 Mo 5,00 % 9 Mo 4,50 % 12 Mo 4,00 %

? 3 / 6 ~5,00

? 6 / 12 ~3,00

Forward rate calculation

Forward rate agreement - Example

Forward rate calculation for GBP, starting in 3 months for a term of 3 months

Interest rates GBP: 3 months = 7 % (91 days) 6 months = 7 % (183 days)6 months = 7 % (183 days)

Forward rate agreement - Example

Forward rate calculation for GBP, starting in 3 months for a term of 3 months

Interest rates GBP: 3 months = 7 % (91 days) 6 months = 7 % (183 days)6 months = 7 % (183 days)

Forward rate agreement (FRA)

Your bank is quoting you 2,17% - 2,19% for a 2 / 5 FRA.

To hedge your interest rate risk you areTo hedge your interest rate risk you are

buying 20mn at 2,19 %

Forward rate agreement (FRA)

2 months have passed and your 90 day Euro loan is going to be fixed at 3M EURIBOR.

3M EURIBOR Fixing: 2,47 %

What is happening with your FRA?

FRA Amount Due calculation

FRA Amount Due calculation

14.067,72

Money Market FuturesExamplehttps://www.theice.com/products/#/38527986/Three-Month-Euribor-Futures

Dezember 2015 Euribor Future, traded on ICE Futures EuropeContract specificationsNotional amount: 1.000.000Duration: 90 daysDuration: 90 daysValue date: 14.12.2015 ( = 3rd Wednesday in Dezember)

Last traded price of 99,995 implies an interest rate of 0,005 %If interest rate rises the price of the future falls (e.g. 0,50 % = 99,50) and vice versa.The smallest price change of 1 Tick (= 0,005) equals 12,5 (1mn x 0,005% x 90 / 360)

Futures

The strip

Price quotation Yield quotation

On actual market prices one could currently hedge the 3 month Euribor for Fixing Date 18.12.2017 at an interest rate of 0,195%!

Futures stripsavailable for major currencies

USD LIBOR Futures showingexpected increase in interest rates

Swiss LIBOR Futures trading above100 = negative interest rates!

YEN LIBOR Futures indicateunchanged low interest rates

Interest rate swaps (IRS)

Interest rate swaps (IRS) -Calculation

Basis swaps

Cross currency basis swaps