International Financial Services I Karel Bruna

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International Financial Services I Karel Bruna 5.-6. FRA and FX swaps International Financial Services I Karel Bruna

Main Business Problems (FRA and FX swaps) Strategy of management of single and multi-currency liquidity position in bank/MNC Main sources of risk involved in multi-currency cash flow FX swaps as the hedging instrument against FX FRA as the hedging instrument against interest rate risk

Main Characteristics of FRA Maturity: 1Mx3M, 3Mx6M, 6Mx9M, 9Mx12M, odd dates Price: bid/ask FRA rate Currencies: those with existed interbank money markets Amount: minimum defined by the market maker Purpose of trading: management of single-currency liquidity hedging of interest rate exposure

Forward Rate Agreement Pricing and quotation, cash settlement 1 + IRD,LONG(tLONG/360) 360 FRA rateBID = (---------------------------------- - 1) ------ 1 + IRL,SHORT(tSHORT/360) tFRA 1 + IRL,LONG(tLONG/360) 360 FRA rateASK = (--------------------------------- - 1) ------ 1 + IRD,SHORT(tSHORT/360) tFRA notional value(IR – FRA rate)(tFRA/360) cash settlement = ------------------------------------------------------ 1 + IR(tFRA/360)

Forward Rate Agreement Hedging against interest rate risk cash shortage situation - risk of future rise of interest rates in money market company buys FRA contract at FRA rateASK company obtains compensation payment in case SR > FRA rate company pays compensation payment in case SR < FRA rate cash excess situation – risk of future decline of interest rates in money market company sells FRA contract at FRA rateBID company obtains compensation payment in case SR < FRA rate company pays compensation payment in case SR > FRA rate

Main Characteristics of FX Swaps Maturity: short dates, 1M, 2M, 3M, 6M, 9M, 12M, odd dates Price: bid/ask forward (swap) points Currency pairs: as in case of forward contracts Amount: minimum defined by the market maker Purpose of trading: management of multi-currency liquidity hedging of FX exposure

Outright forwards vs. FX Swaps forward value date USD FRASK CZK FX swaps second leg value date USD SRMID+(-) swap pointsASK USD first leg value date CZK SRMID Bank Client Dealer 1 Dealer 2

FX Swaps FX Swap Transactions 1st Leg Value Date 2nd Leg Value Date Spot/forward Fixed Period spot 1, 2, 3, 6, and 12 months forward value date Broken (Odd) Dates any day between two fixed forward value dates Forward/forward 1, 2, 3 and 6 months forward value date 2, 3, 6, and 12 months forward value date Short Dates O/N Overnight today first business day after today T/N Tomorrow-next (Tom-next) second business day after today (spot value date) S/N Spot-next first business day after spot S/W Spot-1 week 1 week after spot