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RIIB

Topic: Credit Derivatives. RIIB. GROUP MEMBERS. Chirag Ranka 129 Raj Jain 128 Shekhar Mehta 107 Prathamesh Thakar 118 Vijeta Sharma 109 Vinayak Sukhatme 123. Credit derivative . What is credit? Lender Borrower Role of bank- extended credit. derivative.

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RIIB

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  1. Topic: Credit Derivatives RIIB

  2. GROUP MEMBERS • ChiragRanka 129 • Raj Jain 128 • Shekhar Mehta 107 • Prathamesh Thakar 118 • Vijeta Sharma 109 • VinayakSukhatme 123

  3. Credit derivative • What is credit? • Lender • Borrower • Role of bank- extended credit

  4. derivative • Underlying value of an asset • Forward contracts • Futures contracts • Option • swaps

  5. Options gives the buyer the right not the obligation to buy or sell a specified underlying at a set price on or before a specified date

  6. Difference Between Futures and Options

  7. Options • RIGHTS with the Buyer • OBLIGATION : SELLER • The Buyer EXERCISES his Rights to buy or sell an asset in future. The Buyer purchases is a RIGHT from the Seller • The Seller meets his OBLIGATIONS to sell or buy the asset in future

  8. 3 types of interest 1.Subsidized interest 2. Free market interest 3.Other types such as • Cost of fund interest (PLR) • Based Rate • Bench Marked Rate • Libor Rate

  9. Concept of bad loans • Depends on Trust of Depositor and investors • Financial system is based on trust. • NPA. • E.g. American Financial System

  10. Products offered in credit derivatives • (CLN) Credit Linked note • It’s a promissory note and it is negotiable. • A combination of a regular note (bond or deposit) and a credit-option. • Created through a SPV. • Can be issued by any bank, financial institution or NBFC.

  11. CLN Issued by ICICI – Subscribed by UCO Bank • The structure involves 150 Cr. loan portfolio of ICICI Bank through an SPV. The CLNs would be issued in 3 tranches - classes A, B and C. • Class A - CLN rated AAA issue size 80 Cr. • Class B - CLN rated AA issue size 65 Cr. • Class C - First loss position of 5 Cr.

  12. CLN Issued by ICICI – Subscribed by UCO Bank • Benefits to ICICI Bank • Can reduce exposure/ concentration on the particular corporate / industrial sector to which bank is overexposed. • Regulatory capital relief - The risk weighted exposure is reduced by the amount of funding received. The extent of assets collateralized by government securities is assigned a 0% risk weightage. First loss provision of 5 Cr. would attract a capital requirement with 100 % risk weight.

  13. CLN Issued by ICICI – Subscribed by UCO Bank • Pre-transaction regulatory capital requirement for ICICI would be CAR * risk weighted assets i.e. 9% x 100 % x 150 which is 13.5 Cr. • Post-transaction capital requirement will reduce to provision for first loss piece as the class A and B are fully funded and hence attract 0 % risk weight, i.e. 5 Cr. Thus, there is regulatory capital relief of 8.5 Cr. • Benefits to UCO • Can get synthetic exposure on good credits • Sectoral diversification

  14. Credit Default Swaps (CDS) • Premium is loaded in loan price itself. • Protecting the loan by giving guarantees in case it is defaulted. • Introduced in early 1990’s. • Effective tool for hedging. • E.g. London banks giving loan of $ 4bn to TATA.

  15. Credit Default Swap premium Contingent payment A buyer (A) pays a premium (single or periodic payments) to a seller (B) but if a credit event occurs the seller (B) will compensate the buyer. A - buyer B-Seller Reference asset

  16. Types of CDS • Binary swap • Basket CDS • Cancelable default swap (callable CDS or putable CDS) • Contingent CDS • Leveraged CDS

  17. Types of CDS • Binary swap • Pre-default valuation • Fixed amount • Basket CDS • Multi-name reference • Suited to protection buyers who have a better expectation about default frequencies

  18. Cancelable default swap • Callable CDS • Putable CDS • Contingent CDS • contingent event; e.g. default on another credit.

  19. Collateralized Debt Obligations (CDO) • Mortgage linked product • E.g. AIG bailout. • Asset liability mismatch • Create liquidity in balance sheet

  20. Types of CDO’s • A) Based on the underlying asset:Collateralized loan obligations (CLOs)Collateralized bond obligations (CBOs) Collateralized synthetic obligations (CSOs) Structured finance CDOs (SFCDOs) • B) Other types of CDOs Commercial Real Estate CDOs (CRE CDOs)Collateralized bond obligations (CBOs)Collateralized Insurance Obligations (CIOs) CDO-Squared

  21. Example of USA • Mortgage failure • Non eligible people got loan • No income /cannot pay • Ninja • Hence….resulted into Subprime crisis.

  22. Interest rate swaps • Only interest rate swaps • Only principal rate swaps • Currency swapsPrinciple only Swap (POS) Principle Interest Swap (PIS)

  23. (Forward Rate Agreement) FRA

  24. THANK YOU

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