15 mins reading planning

1. Identify FC payments/receipts currency and amount

2. Identify Hedge Date and Transaction Date
3. Hedging is Direct or Indirect (if FC payments/receipts currency and contract size currency is not
same, it will be indirect hedging)
4. Identify Hedge Strategy
a. Direct Hedging
i. FC Payments  Buy now Sell Later (Option: Call Option)
ii. FC Receipts  Sell now Buy Later (Option: Put Option)
b. Indirect Hedging
i. FC Payments  Sell now Buy Later (Option: Put Option)
ii. FC Receipts  Buy now Sell Later (Option: Call Option)

FRA
Borrow
Example 1
FRA = 9%
Spot interest rate = 11%

Loan interest = 11%

Receive against FRA = 2%

Example 2
FRA = 9%
Spot interest rate = 8%

Loan interest = 11%

Pay against FRA = 1%

Lender
Example 1
FRA = 5%
Spot interest rate = 4%

Deposit rate = 4%
Add: Receive against FRA = 1%

Example 2
FRA = 5%
Spot interest rate = 7%

Deposit rate = 7%
Less: Pay against FRA = -2%
 Indirect Hedging
FC Payments

Divide Case (indirect quote)

Pay more  Small rate
LC = €
FC = USD
Hedge Date
Transaction Date
Hedge Date Future Rate = USD 1.0894/ 1 €
Transaction Date Future Rate = USD 1.0699/ 1 €
Contract size = € 20,000
Spot rate on Transaction Date (Expected payment) = 1.0682
Spot rate on Transaction Date (Relevant for Gain/Loss on Future) = 1.0692/ 1 €

Hedge Strategy
Sell Now Buy Later

Hedge Setup
Choice of Contract = Contract expiring on/after transaction date (e.g. transaction date 1 June  June/July
contract)

No. of Contracts
(i) Convert FC payment in currency in which contract size is given or in LC using future rate at Hedge date
(e.g. USD 2.5m / USD 1.0894 = € 1,835,873)
(ii) No. of Contracts : LC converted amount / Contract size (e.g. € 1,835,873 / € 20,000 contract size = 92
contracts)

Gain/Loss on Futures
(+) Already sold on Hedge Date (No. of contracts X Contract size X FC Future rate on Hedge Date = FC amount)
(e.g. 92 contracts X € 20,000 X USD 1.0894 = USD 2,004,496)

(-) Buy Later on Transaction Date (No. of contracts X Contract size X FC Future rate on Transaction Date = FC
amount)
(e.g. 92 contracts X € 20,000 X USD 1.0699 = USD 1,968,616)

Convert FC Gain/Loss into local currency = FC Gain or Loss / Spot rate on Transaction Date (For Gain  Receive
less; For Loss  Pay more)
(e.g. Gain = USD 35,880 / USD 1.0692  Spot Rate on Transaction Date;  Receive less + Divide case  Higher
rate)
Gain/Loss on Spot (Yahan future ki dunya se bahir aagaye)
(-) Expected Payment on Transaction Date: (FC Payment / Spot rate on Transaction date (e.g. USD 2,000,000 / USD
1.0682 = € ).
(+) Could have been paid on Hedge Date (FC Payment / Spot rate on Hedge date)

Net Payment
Expected Payment on Transaction Date: (FC Payment / Spot rate on Transaction date (e.g. USD 2,000,000 / USD
1.0682 = € ).
Pay more + divide case = Small rate  Higher FC payment

Less/Add: (Gain) or Loss

Effective Rate
FC payment / Net Payment or vice versa (PKR / $, if rate quoted as PKR / 1 $)

Hedge Efficiency
Gain or Loss on Futures / Gain or Loss on Spot

Hedge is efficient if it falls within the range of 80% to 125%

FC Receipts

Divide Case
Receive Less  Big rate (for divide)
LC
FC
Hedge Date Future Rate
Transaction Date Future Rate
Contract size
Spot rate on Transaction Date (Expected receipts) (Receive less rate)
Spot rate on Transaction Date (Relevant for Gain/Loss on Future  Receive Less rate for Gain or Pay more rate for
Loss)

Hedge Strategy
Buy Now Sell Later

Hedge Setup
Choice of Contract = Contract expiring on/after transaction date

No. of Contracts
(i) Convert FC Receipts in currency in which contract size is given or in LC using future rate at Hedge date
(ii) No. of Contracts: LC converted amount / Contract size
Gain/Loss on Futures
(-) Already bought on Hedge Date (No. of contracts X Contract size X FC Future rate on Hedge Date = FC amount)

(+) Sell Later on Transaction Date (No. of contracts X Contract size X FC Future rate on Transaction Date = FC
amount)

Convert FC Gain/Loss into local currency = FC Gain or Loss / Spot rate on Transaction Date (For Gain  Receive
less; For Loss  Pay more)
(e.g. Gain = USD 35,880 / USD 1.0692  Spot Rate on Transaction Date;  Receive less + Divide case  Higher
rate)

Gain/Loss on Spot (Yahan future ki dunya se bahir aagaye)

(+) Actually bought on Transaction date: (FC Receipts / Spot rate on Transaction date)
(-) Could have been bought on Hedge Date (FC Receipts / Spot rate on Hedge date
= Gain/Loss on Spot

Net Receipts
Expected Receipts: (FC Receipts / Spot rate on Transaction date)
Receive Less + divide case = Big rate  Less FC receipts

Add/(Less): Gain or (Loss)

Effective Rate
FC receipts / Net Receipts or vice versa (PKR / $, if rate quoted as PKR / 1 $)

Hedge Efficiency
Gain or Loss on Futures / Gain or Loss on Spot

Hedge is efficient if it falls within the range of 80% to 125%

 Direct Hedging

FC Receipts
Divide Case
Receive Less  Big rate (for divide)
LC
FC
Hedge Date Future Rate
Transaction Date Future Rate
Contract size
Spot rate on Transaction Date (Expected Receipts) (Receive less rate)
Spot rate on Transaction Date (Relevant for Gain/Loss on Future  Receive Less rate for Gain or Pay more rate for
Loss)

Hedge Strategy
Sell Now Buy Later

Hedge Setup
Choice of Contract = Contract expiring on/after transaction date
No. of Contracts = FC Receipts / Contract size in FC.

Gain/Loss on Futures
(+) Already sold on Hedge Date (No. of contracts X Contract size X Future rate on Hedge Date = LC amount)
(Receive Less rate)

(-) Buy Later on Transaction Date (No. of contracts X Contract size X Future rate on Transaction Date = LC amount)
(Pay more rate)

Net Receipts
(+) Expected Receipts: (FC Receipts / Spot rate on Transaction date)
Receive Less + divide case = Big rate  Small FC receipts

Add/ (Less): Gain or (Loss) on Future

Gain/Loss on Spot (Yahan future ki dunya se bahir aagaye)

(+) Actually sold on Transaction date: (FC Receipts / Spot rate on Transaction date)
(-) Could have been sold on Hedge Date (FC Receipts / Spot rate on Hedge date)
= Gain/Loss on Spot

Effective Rate
FC receipts / Net Receipts or vice versa (PKR / $, if rate quoted as PKR / 1 $)
Hedge Efficiency
Gain or Loss on Futures / Gain or Loss on Spot
Hedge is efficient if it falls within the range of 80% to 125%

FC Payments
Divide Case (indirect quote)
Pay more  Small rate
LC
FC
Hedge Date
Transaction Date
Hedge Date Future Rate
Transaction Date Future Rate
Contract size
Spot rate on Transaction Date (Expected payment)
Spot rate on Transaction Date (Relevant for Gain/Loss on Future  Receive Less rate for Gain or Pay more rate for
Loss)

Hedge Strategy
Buy Now Sell Later

Hedge Setup
Choice of Contract = Contract expiring on/after transaction date
No. of Contracts = FC Receipts / Contract size in FC.

Gain/Loss on Futures
(-) Already bought on Hedge Date (No. of contracts X Contract size X Future rate on Hedge Date = LC amount) (Pay
more rate)

(+) Sell Later on Transaction Date (No. of contracts X Contract size X Future rate on Transaction Date = LC amount)
(Receive less rate)

Net Payments
(+) Expected Payments: (FC Receipts / Spot rate on Transaction date)
Pay more + divide case = Small rate  Big FC payments

Add/ (Less): Gain or (Loss) on Future

Gain/Loss on Spot (Yahan future ki dunya se bahir aagaye)
(-) Actually bought on Transaction date: (FC Receipts / Spot rate on Transaction date)
(+) Could have been bought on Hedge Date (FC Receipts / Spot rate on Hedge date)
= Gain/Loss on Spot

Effective Rate
Net Payment / FC Payments or vice versa (PKR / $)
Rate Quoted PKR / 1 $

Hedge Efficiency
Gain or Loss on Futures / Gain or Loss on Spot
Hedge is efficient if it falls within the range of 80% to 125%

Money Market
Chota Rate: Deposit Rate
Bada Rate: Borrowing Rate

FC Payment (FC Liability)  Create FC Asset

Deposit: FC Payment / (1+ FC Deposit rate X no. of months/12 months)
Covert: Pay more at spot on Hedge Date (Divide case: Small rate; Multiply case: Higher rate)
Borrow: LC Amount X (1+ LC Borrowing rate X no. of months/12 months)

Or vice versa (for receipts

 Interest Rate Futures

Borrow  Sell Now Buy Later

Identify Loan Amount
Hedge Date = Today or Future contract taken date
Transaction Date = Loan taken date
Settlement = Loan repayment date
Hedge Period
Loan Period
Contract Period

Hedge Strategy
Sell Now Buy Later

Hedge Setup
Choice of Contract = Future contract expire on/after Loan taken date
# of Contracts = (Loan amount / Contract size) X (Loan Period / Contract Period)

Gain/Loss on Futures
(+) Already sold on Hedge Date  Future Price (e.g. 91)
(-) Buy later on Transaction Date*  Future Price (e.g. 88.5)
Gain = 2.5%
Gain in Amount = No. of Contracts X Contract size X Future Gain% X Future Contract period/12months

*If Future price on transaction date is not given

Computation of Future Price on Loan taken (transaction date)
HD TD
Spot (ignore spread rate) (100-i) Given Given (Spot rate on HD +/- increase/decrease in rate on TD)
Basis + Bal. + Remaining Basis
Future Given Calculated

Remaining Basis = Basis (Bal. fig) X Remaining period/Total months

Remaining Period = Future contract expire date – Loan taken date
Total Period = Future contract expire date – Hedge period date

Note:
Interest Rate will be per annum. HD = Hedge Date; TD = Transaction Date
For Option: If only basis is given. Future price not possible to be calculated then
Total Basis = 44 and decrease 11 basis each month (total months 4, 2 months remaining)
Current Libor (spot) = 3.8% (increase in rate 0.5%)
Computation of Future Price on Loan taken (transaction date)
HD TD
Spot (ignore spread rate) (100-i) 96.2 95.7 (100-(3.8+0.5))
Basis (Less for borrow, Add for Lender) - 0.44 -0.22
Future 95.76 95.48
Gain/Loss on Spot
(-) Actual Interest: (Loan amount X Spot interest rate** on Transaction date X Loan Period/12 months)
(+) Interest could have been: (FC Loan amount X Spot interest rate* on Hedge date X Loan Period/12 months)
= Gain/(Loss)
*Libor + 2 = 9%
** Libor (7%) + 2% + increase in rate 0.5% = 9%

Hedge Efficiency: Gain or Loss on Future / Gain or Loss on spot

Net Cost
Actual interest (Loan amount X Spot interest rate on transaction date** X Loan Period/12 months)
Less/Add: (Gain)/Loss on Futures calculated above
= Net Finance Cost
** Libor (7%) + 2% + increase in rate 0.5% = 9.5%

Effective Interest Rate = Net Finance Cost / (FC Loan X Loan Period/12 months)

Interest Rate Options

Borrow  Put Option
Identify Loan Amount
Hedge Date = Today or Future contract taken date
Transaction Date = Loan taken date
Settlement Date = Loan repayment date
Hedge Period
Loan Period
Contract Period

Hedge Strategy
Put Option

Hedge Setup
Choice of Contract = Option contract expire on/after Loan taken date
# of Contracts = (Loan amount / Contract size) X (Loan Period / Contract Period)
Selection of Exercise Price
Exercise Price – Premium% = Net Amount
Select Highest Price

Gain on Option (if any)

Exercise Price
Future Price on Transaction Date. (100-i ki language future jaanta hai, spot nahin. Refer interest rate future for
Computation of future price on transaction date)
Whether option to be exercised (Yes/No)
EP > Future Price = Gain%
Gain in Amount = No. of Contracts X Contract size X Option Gain% X Option Contract period/12 months)

Gain/Loss on Spot
(-) Actual Interest: (FC Loan amount X Spot interest rate** on Transaction date X Loan Period)
(+) Interest could have been: (FC Loan amount X Spot interest rate* on Hedge date X Loan Period)
Gain/(Loss) in amount
*Libor (7%) + 2% = 9%
** Libor (7%) + 2% + increase in rate 0.5% = 9%

Hedge Efficiency: Gain or Loss on Future / Gain or Loss on spot

Net Cost
Actual interest (Loan amount X Spot interest rate on transaction date** X Loan Period/12 months)
Less: (Gain) on Options
Add: Premium (No. of contracts X Contract size X Premium% X Contract period/12 months)
= Net Finance Cost
** Libor (7%) + 2% + increase in rate 0.5% = 9%

Effective Interest Rate = Net Finance Cost / (Loan amount X Loan Period/12 months)

Summary
Future
Borrower  Sell Now Buy later (Put Option) (Select Highest Exercise Price)
Lender  Buy Now Sell later (Call Option) (Select Lowest Exercise Price)

Treatment of Premium

Payment (Pay more) Receipt (Receive Less)

Add Less Less Add

Divide
Multiply case case Multiply case Divide case