1. CASE 8
Maybank

2. 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 bps.
6-mo LIBOR bps
Today = Nov 11
6 months = May 11
12 months
Today: 6-mo LIBOR = 2.625%; spread: 0.375%
=> 3% (or % 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.

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

4. 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 ( *(184/360)) -1 = %
• Short ED strip (6-mo and 9-mo):
6-mo Eurodollar at % (92 days)
+ 9-mo Eurodollar at % (92 days)
Set f at ( *(92/360))*( *(92/360)) – 1 = 1.322%
ED sets a lower funding cost, lower than the implied by the Eurodeposit strip.

5. 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.

6. 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 = %
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
[ x (365/360)] =
(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: => N(d1):
d2: => N(d2):
Call =
Amount Paid = ( /100) x (184/360) x USD 200 M = USD 0.239M

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