CASE 8 Maybank

Maybank: Gap Risk Management – FRA & Eurodollar Situation: It's November 11, 2003. • A client wants a loan in 6 months (May 11, 2004) from USD 200 M at 6-mo LIBOR + spread (37.5 bps). That is, in May 11, 2004: Maybank lends at 6-mo LIBOR + 37.5 bps. 6-mo LIBOR + 37.5 bps Today = Nov 11 6 months = May 11 12 months Today: 6-mo LIBOR = 2.625%; spread: 0.375% => 3% (or 1.5123% for the 184 day period) Maybank does not know 6-mo LIBOR in 6 months. => Risk: The bank takes a deposit now (say, a 12-mo deposit at 2.63%) that can be used to fund the loan in 6 months, 6-mo LIBOR goes down.

Maybank: Gap Risk Management – FRA & Eurodollar • Eurodeposits are available to fund the future 6-mo loan: 6MO 2.52 - 2.56 (Long ED: Deposit at 2.52% for 6-mo) 12MO 2.60 - 2.63 (Short ED: Get funding at 2.63% for 12 months) A future 6-mo net funding position at: f = [(1+.0263*365/360)/(1+.0252*181/360) – 1]*360/184 = 2.7039% (≈ 1.35% for a 6-mo period). Note: If in May 11 6-mo LIBOR (+37.5 bps) > f => loan profitable.

Maybank: Gap Risk Management – FRA & Eurodollar • Hedging alternatives: Short FRA and Short ED Lock a future interest rate, f. Then, if in 6 months, 6-mo LIBOR < f, the short side wins. • Short: FRA 6x12 at 2.74% (184 days) Set f at (1+.0274*(184/360)) -1 = 1.4004% • Short ED strip (6-mo and 9-mo): 6-mo Eurodollar at 2.5625% (92 days) + 9-mo Eurodollar at 2.59375% (92 days) Set f at (1+.025625*(92/360))*(1+.0259375*(92/360)) – 1 = 1.322% ED sets a lower funding cost, lower than the implied by the Eurodeposit strip.

Maybank: Gap Risk Management – Stack Hedge Given that dates are fixed (and there are no intermediate payments) a stack –i.e., shorting 2 3-mo ED contracts to cover a 6-mo exposure- is not a good alternative. Maybank: Gap Risk Management – Swaps & Cap (1) A fixed-for-flexible swap can be used in 6-mo (in the last slide we calculate a current quote). But, not now, since there are no cash flows! A eurodollar put option (right to go short a Eurodollar) with a 6-mo maturity is a better solution. Note: A swaption –i.e., an option giving the holder the right to enter into an underlying fixed-for-flexible swap- can be used. (2) A cap can be used to limit exposure.

Maybank: Gap Risk Management – 6-mo Cap at 2.5% Steps to calculate cost of Cap at 2.5%. (1) Calculate implied forward rate (done before): f = 2.7039% Note: The option expires in 6 months, but does not settle until the end of the 12-month period, which is one year from today (Nov 11, 2004). (2) Discount rate on the option is 2.630%. The discount factor is [1 + .0263 x (365/360)] = 1.026665 (3) Calculate volatility for the future 6-mo rate. Set v=.15 (4) Calculate Call Value (C) for X=2.5% and f =2.7039% . d1: 0.795242 => N(d1): 0.786764 d2: 0.689613 => N(d2): 0.754781 Call = 0.23417 Amount Paid = (0.23417/100) x (184/360) x USD 200 M = USD 0.239M

Maybank: Gap Risk Management – 6-mo Swap Rate (1) Swap is for 6 months, n=2. f6,12 = [(1+.025625*(92/360))*(1+.0259375*(92/360))](360/184) – 1 = = 0.026029694 (money market basis). (2) Convert this money market rate to its effective equivalent stated on an annual bond basis. FRE6,12 = 0.026029694 x (365/360) = 0.026391218. (3) Coupon payments are s.a. , k=2. Restate this effective annual rate on an equivalent quarterly bond basis. SC = [(1 + 0.026391218)1/2 - 1] x 2 = 0.026219354 (quarterly bond basis) => The swap coupon mid-rate is 0.026219354 %.