Treasury A Perspective into Markets and Dealing

The Business Issues Introduction to Derivatives The Markets Agenda

The USD/INR Price The Drivers Fiscal Policy Monetary Policy Trade Balance External Factors Correlations The Indicators Interest Rate Growth Rate Inflation Demand and Supply Offshore Interests (FII, NDF) Other Prices Value Propositions (REER, NEER) =44.20

Retails Oil Oil Seller Buys Oil at $60 per Barrel Gives INR Buy USD (at Spot Rate) Where are the risks? Receives INR

Where is Price Risk ….. Cost of Oil Imported - Day 1 Cost of Oil per barrel in INR $60 x = Rs Other Costs (refining etc) say Rs Total Cost Rs 2752 Replacement Cost – Day 30 Cost of Oil per Barrel ???? Exchange Rate of USD/INR ???? Crores Other costs assume fixed at Rs 100 Total Cost ????? The Price Risk is mitigated if the retail prices were totally linked with the Procurement Price – But reality is different…

The Reality is Procurement Price WTC Oil USD/INR Retail Price

The uncertainty over the ultimate costs leads to inefficient pricing especially in a competitive environment….. Cost of procurement is impacted by Price of Oil Price of USD If on Day 30 the price of Oil remains at $60 and the price of USD is and given that the retail price of Oil is not changed, OMC would lose How do we decide the the efficient pricing of oil for the consumer on Day 1? However, if the price of USD were to come down, OMC would gain

The Business Issue Introduction to Derivatives The Markets Agenda

Issues Business accruals in INR Procurement in USD Two factor pricing (Oil and USD) Inability to link Retail Pricing to Procurement Need Identified Minimize the impact of the Price Risk between retail and procurement Solution Use customized hedges to suit requirement Issues, Need and Solution

Effect Business accruals in INR Price Risk covered for the period of Forward Hedge Achieve more efficient pricing

Classical Interest Rate Parity Spot FX Forward FX Interest Rate 1 Currency 1 Currency 2 Interest Rate 2 Therefore the Hedging “Cost” is nothing else but the Interest Rate Differential between the two Currencies

Hedging – Some Issues When To Hedge Arrive at the Cost of Operations + Margins = Net Cost As and when levels are seen over the Net Cost View Based What period to hedge Hedge price risk for the period of resetting of Retail Prices

“ To my knowledge no model projecting movements in rates is superior to tossing a coin” Alan Greenspan Former Chairman Federal Reserve

USD/INR NYMEX OIL

The Business Issue Introduction to Derivatives The Markets Agenda

Financial instruments whose value is DERIVED from some other Underlying Asset Examples of Derivatives Futures and Forwards Swaps Options Types of Underlying Assets include: Equity Shares Interest Rates (including Government Bonds) Foreign Exchange Commodities

Buyer - acquires the Right but not the obligation Seller – sells the right but has the obligation Option is a contract where the Buyer buys the Right but not the Obligation….

46 FORWARD USD/INR USD/INR CALL ITM CALL ATM CALL OTM CALL Illustration

CALL PREMIUM 46 FORWARD USD/INR ITM CALL ATM CALL OTM CALL Premium Lower Premium Higher

Zero Cost Strategy BUY CALL SELL PUT Buy from the Bank Losses Limited Buy from the Market Unlimited Profit potential Exercise CALL Buy Exercise PUT Buy Sacrifice Profits Below 44.00

The Business Issue Introduction to Derivatives The Markets Agenda

The Interest Rates O/N Market –Usually in band of 5.25%-6.25% –System Liquidity Short Tenor –Up to 5 years –Banks and P.Ds Long Tenor –10 Years + –Insurance co. + Pension Funds

Global Interest Rates –US “number of rate increases…probably not be large..” – FOMC minutes. –UK BoE Cut policy rate in response to weakening economic activity. –Euro ECB hiking and may continue until inflation no longer exceeds target 2.0% (currently 2.3%) –Japan Mild deflation continues. (-0.3%)

Inflation – the Drivers Inflation Expectations Month End WPI Inflation Dec’054.40% Jan’064.78% Feb’065.09% Mar’064.96% Apr’064.16% May’064.42% Indian Inflation is OIL driven

Correlations High Correlation with Dollar movements in international markets.

Exchange Rate Rupee +ve –FII/FDI Inflows –External Commercial Borrowings –Service Exports Rupee –ve –Trade Deficit OIL

The Trade Flows Commodity Imports Oil is 32% of India’s commodity Imports. Growth in Oil imports = 43% Growth in import of machinery goods = 44% Overall, merchandise trade deficit Surpassed Invisibles surplus

The SBI advantage Largest in – Size, Network and Market Presence Total understanding of the PSU Environment Is the Business Partner in the growth of the Indian PSU Incorporated Has large pool of Expert Resources available for advice Preferred choice of major Corporates Transparent working Relationship based on Trust

Thank You