2. REUTERS 3000 XTRA University of Hong Kong Trading Workshop David Lo Class 5 Treasury Workshop III Interest Rate Derivatives

3. REUTERS 3000 XTRA Agenda How to get the real-time and historical rates of FRA, IRS & Zero Coupon Rates How to use 3000Xtra for pricing FRA from deposit rates, futures or zero curve How to price IRS /Asset Swap from spot or historical zero coupon curve

4. REUTERS 3000 XTRA What is a FRA? (FRA = Forward Rate Agreement) An FRA (forward rate agreement) is a contract between two parties to lock in a forward interest rate, for a period, starting at a specific date in the future. For example, a 6 v 9 FRA is a contract that begins 6 months from now and ends after 9 months, i.e., lasts for 3 months. The two counterparties, one buyer and one seller, settle by cash payment at the start of the contract (in this example 6 months from now).

5. REUTERS 3000 XTRA Example : 6X9 FRA It begins in 6 months for a 3 month period To hedge the risk of rising rates, you can buy a 6X9 FRA to protect yourself from a rise in interest rate you expected to occur in 6 months time.

6. REUTERS 3000 XTRA Interest Rate Futures Cash Deposits Zero Coupon Curve FRA Pricing is via :

7. REUTERS 3000 XTRA FRA Pricing Model

8. REUTERS 3000 XTRA How to use the Model ? Choose Currency (eg. HKD, USD…..) (type in command line, or drop down box on top left) Choose FRAs from Deposit, Futures or Zero Coupon Who will trade the FRA? Ans : Money Dealer, Short-term IRD Desk...

9. REUTERS 3000 XTRA Benefits Automatic real-time update or you can input the value by yourself Use hyperlinks to access relevant quotes Able to calculate broken-dates by specific start and end dates Have choice of Normal or IMM dates Have choice of underlying instruments :deposit, futures or zero coupon

10. REUTERS 3000 XTRA What is an IRS? (IRS = Interest Rate Swap) Swap fixed rates with floating rates or vice versa It can cover interest rate exposure risk Plain Vanilla Swap – Fixed for Floating Alter the structure of cash flows into a desired format Quoted as fixed rate against standard floating rate (such as 3 month or 6 month LIBOR)

11. REUTERS 3000 XTRA Interest Rate Swap Two sides – receive & pay No principal exchange, just swapping interests flows Fixed interest - does not change throughout life of swap Floating interest - changes every pre determined period Spot Date1Y2Y3Y Fixed Interest payments Floating Interest payments

12. REUTERS 3000 XTRA Terminology 2 legs or sides Receive side or offer side - ( Lend Money  receive interest) Pay side or bid side - ( Borrow Money  pay interest) Notional  not exchanged in IRS - Lend Money and Borrow Money  net off - Credit risk is lower

13. REUTERS 3000 XTRA Quoting Conventions USD IRS - Annual Money against 3 month Libor Spot Date1Y2Y3Y Fixed Payments = Principal x Fixed Rate(%) x actual nos. days/360 Floating Payments = Principal x 3M Libor(%) x actual nos. days/360

14. REUTERS 3000 XTRA IRS as a Hedge Scenario - Corporate has an outstanding floating rate term loan with a remaining life of 3 years - Corporate feels that interest rates may rise in the future in tandem with economic recovery - Corporate wishes to lock the remaining life of the term loan into a Fixed Rate - Corporate seeks Bank for a strategy

15. REUTERS 3000 XTRA IRS as a Hedge CorporateBank Interest payments on outstanding loan 6 month Libor + 150bps IRS Corp receives 6 month Libor + 150bps Corp pays Fixed @ 4.875% To protect against rising interest rates

16. REUTERS 3000 XTRA Reference Code 0#IRS-HKDby institutions 0#IRS-HKD-BRKby broker 0#MARKETS

17. REUTERS 3000 XTRA Swaps (Swaps.kob) >Go to Model

18. REUTERS 3000 XTRA Benefits Data display model for different currencies Both institutions and broker contributions Clients can see all related instruments Eg. Swaptions, Basis Swap, ISDA FIXING, Treasury Swap Spread……. Display benchmark yield curve and zero curve Display related news

19. REUTERS 3000 XTRA IRS Pricing (Interest Rate Swap) >Go to Model

20. REUTERS 3000 XTRA Benefits It can calculate specific structure and conventions, including amortization Cash flow for the fixed and floating leg Client can choose Reuters zero curve or their own zero curve Use hyperlinks to access relevant quotes

21. REUTERS 3000 XTRA Asset Swaps (Asset Swap.xls)

22. REUTERS 3000 XTRA Purpose of the model Swapping a Fixed Asset for a Floating Asset (eg, 5 Years US Treasury for Libor) Achieve cheap funding Limited only to the same currency Client can choose Reuters zero curve or their own zero curve >Go to Model

23. REUTERS 3000 XTRA Zero Coupon Builder (ZeroBuilder.xls)

24. REUTERS 3000 XTRA Benefits It allows you to calculate a real-time zero coupon yield curve from deposits, futures, swap and bond rates. It can use either real-time update rates or input rates Save the setup for a curve and re-use it either in this worksheet or other model >Go to Model

25. REUTERS 3000 XTRA Parameters Deposits (D) You can enter deposits, but not pre-spot deposits (eg ON or TN) Futures (F) If you include futures, you must include the 3 month deposit rate in the preceding instrument codes. You may use any RICs, but best are continuation RICs or cm for contract month You must enter futures contracts in one strip, with no more than one contract missing from the strip. Interest Rate Swaps (S) In the Structure field enter the Adfin structure code to determine the nature of the cashflows (see Settings/Style Management/IRS Styles) Bonds (B) In the Structure field add the Adfin structure code to determine the nature of the cashflows (see Settings/Style Management/Bond Styles) Ins/Del buttons allow you to insert or delete rows in your instrument table (highlight the instrument to act on first)

26. REUTERS 3000 XTRA Q & A DAVID_HKU@YAHOO.COM