Overview

Definitions & Benchmarks Overnight Indexed Swaps

Uses & Opportunities

Linkages between markets

Interest Rate- market views

IRS- Definition
Exchange of cash flows (Risks)
Notional Principal Prescribed dates Prescribed computation method

FIXED and FLOATING rates of interest.

Floating based on a market benchmark.

IRS- Floating Benchmarks

Independent & Transparent Dependable (Past & Future)

Examples
Overnight MIBOR (Mumbai Inter-Bank Offer Rate) Commercial Paper Rates Prime Lending Rates T-Bill Yields (14 , 91, 182 and 365 days ) Forex Swap Rates (Premia)

IRS- Floating Benchmarks

CP Rates Benchmark not available Corporate Specific T-Bill Yields Daily Quotes not available Cut-off yields not independent PLR Bank Specific 2-way Quotes not available Forex Swap Rates Possible- non MMkt. No source at present

Daily MIBOR linked IRS = OIS

Overnight Indexed Swap (OIS)

Floating leg based on MIBOR
Daily overnight rate reference Compounded daily/ accrued over holidays NSE/ Reuters (26-32 banks average)

Other market conventions

Pre-defined notional principal. Normal FRA / IRS terminology
Pay/ buy an OIS = pay fixed receive floating Receive/ sell an OIS = receive fixed pay floating

Overnight Indexed Swap (OIS)

FIXED CASH FLOW- Cfix

Corporate
FLOATING CASH FLOW- Cfloat

Citibank

OIS - Mechanics
Fixed Coupon is calculated as follows Cfix = P x Rfix x
Cfix P Rfix d basis = = = = =

d basis

Fixed Coupon Notional Principal Agreed Fixed Interest Rate Length of Coupon Period in days Applicable day basis (e.g. 365)

OIS - Mechanics
Floating Coupon is calculated as follows -

Cfloat = P x Rfloat x d basis

Cfloat P Rfloat d basis = Floating Coupon = Notional principal = Compounded Floating Interest Rate (see next slide) = Length of Coupon Period in days = Applicable day basis (e.g. 365)

OIS - Mechanics
Floating Rate is calculated as follows Rfloat = ( [ 1 + ri x d i ] - 1 ) basis i=1 basis d total
d business

Rfloat ri di d business d total basis

= = = = = =

Floating Rate MIBOR Rate for the ith business day Number of days the ith MIBOR rate applies Number of business days in the coupon period Total no. of calendar days in the coupon period Applicable day basis (e.g. 365)

IRS- RBI Guidelines

FRA/ IRS allowed for hedging rupee balance sheet exposures. Banks to exercise due diligence
Certificates that transaction for hedging balance sheet exposures (w.r.t. size and tenor)

IRS- Benefits
Essentially divorces liquidity management from interest rate risk management. Simple to use Minimal credit risk No ballooning of balance sheet

IRS- Opportunities
Better interest rate risk management
Diversification of risk Implement interest rate views

Access to cheaper funding

Comparative Advantages

Good Cash/ Liquidity Management Tool

Monthly collections vs quarterly interest payments

IRS- Structures
Hedge increases- go fixed
Hardening rates: Fix future CP issue/ rollover costs Convert floating WCDL into fixed rate

Reduce costs- go floating

Softening rates: Raise term funds but pay MIBOR Receive fixed against existing fixed rate loans

Example I - Comparative Advantage

Funding at lower MIBOR spreads than before AAA issues 1yr fixed at 11.10%

OIS AAA receives Fixed

AAA pays

10.00%
MIBOR

Net impact is 1 year funds @ MIBOR + 110BPs

Example II - Lending at Call

Placement of deposits at call-linked rates ABC buys 180 day T-Bills 9.8%

OIS ABC pays fixed

ABC receives

9.5%
MIBOR

Net impact is 180 day return @ MIBOR + 30BPs

Has effectively lent in the call market

Example III - Hedging future CP Rates

Locking in future funding costs ABC has Rs.100mio CP maturing in 3 months

FRA (or IRS) for 3v6 at 10.8%

Unwind FRA at time of rollover

Net impact is CP funding rate @ 10.8%

Profit/ loss on unwind will offset rate received

IRS- Current scenario

Flurry of OIS deals on Day 1 Corporates - Main receivers of fixed rates

Limited inter-bank deals

ISDA documentation Not represented fully by all foreign banks & PDs Absence of nationalised banks

IRS- Future Scenario

More volumes Longer tenors

Other new benchmarks

MIBOR, but not overnight based Other index based

Banks end up being Payers of fixed rates

Keen interest by nationalised banks

IRS- Issues
Illiquidity in the secondary corporate bonds T Bill reference rate yet to evolve despite existence of a T Bill auction calendar Expected time for development of a term money market

Accounting/tax for IRS/FRAs (Hedge vs MTM)

Basis risk

Linkages between markets

Call Money vs Forward Premium
Arbitrage potential Immediate response across curve

IRS vs CCY swaps (Premia) vs T-Bills

Accessible by the main banks Different considerations Other markets more liquid/ less bid-offer

Linkages between markets

Tenor 6 mth 12 mth $ Fwd. LIBOR Premia 5.90 4.90 6.10 5.00 Swap Curve 10.80 11.10 IRS Curve 9.50 10.0 T- Bill Yield 9.70 10.2

Call Money rate was 10.12 (as on Aug 1699)

Linkage between markets

IRS = Call - 62 bps
Reflecting 6 month expectations

T Bill = IRS + 20bps

Reflecting funding risk

Swap = Tbill + 110bps

Swap= Libor + Premium Reflecting short term reaction

IRS cannot be more than Swap

Continuing discontinuities
High bid-offer spreads in IRS
Lack of efficiency Fewer aggressive banks/ Docs/ Credit issues Logistical/ internal limitations

Cash vs. IRS

Liquidity fears (50bps) LAF- guarantees liquidity, start made (like FED)

Continuing discontinuities
TBIlls vs Fwds
FCNR USD funds with few banks surplus INR other banks Switching difficult from both sides Difficult to short GOI securities- 1way 15% rule for longer tenors Short end is relatively integrated

Interest Rates - so far

Shocks in Jan/ Aug98 Interest rates lower across the board in 1999 Successfully survived a major event risk- Kargil Historically low inflation Increasing liquidity, longer tenors in bonds

RBI approach
Openness - e.g. Feedback on Policy IRS- hedging mechanism Public statements on objectives Corridor of interest rates.

Interest Rate- Trends

17% 15% 13% 11% 9% 7% 5% 3% 1%

1mth 3mth 6mth 12mth 24mth 60mth

A-97

A-98

O-96

O-97

O-98

A-99

J-96

J-97

J-97

J-98

J-98

J-99

Interest rates - Sovereign

Surplus liquidity, low inflation Banks
Evaporating fears of liquidity crisis
shocks still there (12/08)

Surplus SLR due to lack of alternatives

Government
FY99-00 Govt. net borrowing target (78% done) Long tenor based rally - high duration Oct. Credit policy, higher fiscal needs- Kashmir

Interest rates- Corporate

Limited Supply, growing demand Mutual Funds
Tax anomaly driving the industry Flush with liquidity - funds seek yields

Compression in Corporate spread over GOI

Compression to shift to longer tenor/ Tier II names

Trend to reverse (Q300) after a few shocks

Spike in GOI yields/ Ill-liquidity/ Credit deterioration

Interest rates - prognosis

Likely to trend lower
Inflation yet to hit bottom(Nov) Higher Real yields No signs of credit pickup

Expansionary Credit policy

Bank rate/ Repo/ CRR cut; Deposit rates/ PLR sticky Accommodate govt. borrowing targets

No $/ INR shocks/ Political uncertainties

Rupee Interest Rate Derivatives and Citibank

Trading expertise. Experienced team Ability to offer low bid-offer quotes

Risk management systems in place

Exposure to IRS products in Emerging Markets

Huge corporate reach- Can match requirements

Disclaimer
Although the information contained herein is believed to be reliable, Citibank makes no representation as to the accuracy or completeness of any information contained herein or otherwise provided by Citibank. The ultimate decision to proceed with any transaction rests solely with the customer. Citibank N.A. is not acting as your advisor. Therefore, prior to entering into any proposed transaction, you should determine the economic risks and merits, as well as the legal, tax and accounting characterizations and consequences of the transaction, and that you are able to assume these RISKS. The contents of this presentation are proprietary in nature, and may not disseminated in whole or in part without Citibank's written consent.