ACI/ FINANCIAL MARKETS

AND DEALING COURSE

FRAs & FOWARD

FORWARD
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 Forward points
•  

 Add (positive) points to the spot rate to get the forward

rate if quoted points indicate that bid points are is lower
than the offer points.
 subtract (negative) points from the spot rate to get the
forward rate if the quoted points indicate that bid points
are more than the offer points.

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 PREMIUM/ DISCOUNT
• Spot rate: GBP/USD 1.5235 1.5245
• 3 months points 30 25
• Forward outright 1.5205 1.5220
 Us$ is at premium to sterling (cable)
 Forward prices will always exhibit a larger bid-offer
spread than spot prices
 When base currency is at premium, the forward points
are added and vice versa
 High/low subtract the forward points (145-135)
 Low/high add the forward points (20-23)

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 Forward points
• forward points is the difference between the
outright forward rate and the current spot rate.
• given the following information calculate the
forward points:
 USD/ZAR 6.75/80
 USD 6 month (182 days) interest = 1.5%
 ZAR 6 month (182 days) interest rate 9%
 USD 360day and ZAR 365day convention.
 Use the borrowing method used earlier
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 PREMIUM/ DISCOUNT
 The swap rate or forward rate reflects the interest rate
differential between the two currencies. The change in
inflation rate will increase or decrease the number of
forward points (domestic rate increase or decrease)
 Negative points implies the base currency interest rates
is higher than the quote currency, hence base currency is
at discount and forward rate will be lower than the
current spot rate
 positive points implies the base currency interest rates is
lower than the quote currency, hence base currency is at
premium and forward rate will be greater than the
current spot rate
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 PREMIUM/ DISCOUNT
Premium is when the swap points are
positive » offer rate is higher than the bid
rate
Discount the swap points are in negative »
offer rate is lower than the bid rate

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 FORWARD- FORWARD
• A swap agreement created through the synthesis of two swaps
differing in duration for the purpose of fulfilling the specific
time-frame needs of an investor.
• Also referred to as a "forward start swap," "delayed start swap,"
and a "deferred start swap."
• Example: an investor wants to hedge a five-year duration
beginning one year from today, this investor enters into both a
one-year and six-year swap, creating the forward swap that meets
the needs of his or her portfolio.

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 Forward-Forward interest rate

• Borrower expects to borrow a loan 3 months from now for 6 months. He

wants to enters into 2 transactions (lend and borrow). Assume 3 month UGX

rate is 12.5% and 9 month UGX rate is 13.25%. Mark borrows UGX 10

million for 6 months and places it for 3 months in deposit terms.

• Mark has borrowed UGX 10 million and interest accrual starts in 3 months

time

• Mark has concluded two transactions – forward-forward

• 3month (91 days) and 9 months (272 days)

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 Forward-forward
•  
• Subst:-

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 Effective rate
•  Effective rate on the transaction

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 FORWARD - FORWARD
•  Mark borrows UGX 10 million for 9 months @ 13.25% and lends UGX 10
million for 3 months @ 12.5%, calculate the true yield.

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 Forward-Forward rate formula
•• Simple
  basic interest rate yield formula

• FRA agreement the buyer of FRA lends shorter term and borrows
longer term
• Shorter term (mv) = principal amount ()
• Longer term (mv) = maturity value ()
• %
 - forward rate; - longer rate; – longer days
 – shorter rate; – shorter days and – day base

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 Forward-Forward interest rate
•  

 Amount US$10m, borrowing rate 12% for 272 days and lending US$10m @
rate of 12% for 91 days. What is the 3 x 9 FRA rate?

 This period for 11.646% borrowing is a 3 X 9 “gap” borrowing for 6 months

starting in 3 months time.

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 Swap banks
• A swap bank is generic term describes a financial
institution that facilitates swaps between
counterparties. The swap bank can serve as either
a broker or a dealer
 A swap bank as a broker matches counterparties
but does not assume any risks of the swap
 S swap bank as a dealer, stands ready to accept
either side of a currency swap and then later lay
off their risk, or match it with a counterparty.

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 SWAPS
• Investors use swaps to hedge:
 Currency risk
 Credit risk
 Interest rate risk

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 Interest Rate Swaps
 Two parties – party and counterparty both exposed to
default risk, defaulting terminates the swap
 Arrangement – directly or indirectly (two swaps)
 A notional amount – basis for determination of the
cash flows
 Cash flows – fixed and floating cash flows
 Payment schedule- quarterly & net amounts (simple
interest formula applicable).
 Swap – party wishes to borrow for fixed rate and
counterparty wishes to borrow floating (changing
nature of their payments)
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 Interest Rate Swaps
• An instrument that allows the counterparty to exchange
one set of cash flows for another (floating to fixed)
 Financial institutions exchange risk (cash flows) on the
movement of interest risk
 Common derivatives and highly liquid (buy/sell market)
 Swap markets commonly talk in terms of fixed interest
rates
 Cissy quotes “6.45-6.36” in five year US dollars means
she is ready to pay 6.36 and receive at 6.45% in a five
year US dollar swap. Usually referred to as absolute
prices

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 Interest Rate Swaps
• A swap is set begin in two weeks time where party,
Aktion is to pay a fixed rate 7.19% per annum on
semi-annual basis (182days), and will receive the
floating rate: six- month LIBOR + 30bps from party
Brition. the notional principal is Us$ 35million. The
swap is for five years. Two weeks later the six-month
LIBOR is 6.45% per annum.
• Calculate the cash flows
• Explain the future payments related to this transaction
of 5 years.

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 Interest amount (Fixed interest
• The
  fixed rate is rate)
usually quoted on a semi-annual
bond equivalent yield basis, therefore the amount is
payable every six months

• The days convention takes on bond equivalent yield

basis 365 days in a year and the money market
equivalent yield basis 360 days in a year.

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 Interest amount (Floating interest rate)
• The
  fixed rate is usually quoted on a semi-annual
money market yield basis, therefore the first amount
is payable:

• ,375
• Other future payments will be determined every 6
months by the six- month LIBOR at that time

• $ 60,427.74 payable to party Brition by party Aktion

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 Interest amount (Floating interest rate)
• Aktion
  borrows $10m at floating:

• Aktion has a floating rate risk.

• The swap will take place only if Aktion wishes to
borrow capital for a FIXED RATE while Brition
wishes to borrow capital for a FLOATING RATE
(Aktion and Brition want to change the nature of their
payments)

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 Barclays Bank PLC London
1715 BARCLAYS BANK PLC LONDON 283 0909 TX 887841 BAST
SPOT 1 MTH 2MTHS 3MTHS 6MTHS 12MTHS

STG 1.5392/02 13/11 24/21 34/31 68/63 153/143

DEM 2.2321/52 55/48 108.99 157/147 304/289 588/558

CHF 1.8168/96 72.66 143/136 209/200 394/378 753/722

NLG 2.4996/29 65/59 128/119 189/179 364/347 691/661

FRF 7.6590/718 131/113 252/227 339/308 622/566 1219/1124

JPY 160.50/77 77/72 152/145 224/217 428/417 808/790

ITL 2375.4/9.4 67/82 147/168 223/248 416/463 754/832

BEF 45.88/98 13/9 24/19 34/29 65/55 127/108

ESP 187/96/25 37/47 79/93 118/135 220/243 399/444

XEU 1.2099/15 16/13 31/26 44/39 87/77 170/155
SOURCS: Reuters (courtesy Barclays Bank plc)

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 Value dates
• When calculating forwards dates with value date
shorter than spot, reverse the swap points and proceed
exactly as for a longer dated transaction.
Spot USD/DEM 1.4505 - 10

Overnight swap 1- ¾

Tom – next swap ½-¼ 1.4505 - 1.4510

+¼ +½
1.450525 1.45105

1- week swap 7 -5

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