A. Background and Definitions

• Futures Call Option:

• Futures Put Options:

• History of futures Options

B. Types of Contracts

D. Use of Futures Options

1. Loss Protection:

2. Liquidity:

3. Risk/Return:

4. Cash Flow:

5. Compound Hedging

3. LIBOR Flat:

5. Notional Principal:

6. Swap Bank:

7. Basis Point:

1. Plain Vanilla:

2. Fixed-for-Fixed Rate Swap:

3. Floating-for-Floating Rate Swap.

4. Circus Swaps:

5. Amortizing Currency Swaps:

• Exchange of principal is the norm
• Fixed-for-floating is the norm
• Three phases are involved: Initial exchange of principals, interest payments, re-exchange of principals.

B. Off Market Pricing

An example:

The swap bank's current Indication Pricing Schedule requires the bank to pay a fixed-rate of DM 6.975% sa (i.e. the midrate - 12.5bps) against six month LIBOR flat. However, the counterparty needs the swap bank to pay 9.5%DM.

NOTE: The swap bank's Indication Pricing Schedule shows that the 10 year midrate is 7.10DM and the 10 year midrate is 9.75%$.

Determine the exchange of cash flow from the client to the swap bank. The exchange rate at the time of the swap negotiation is 1.75 DM/$.

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INDICATION PRICING FOR DEUTSCHE MARK/DOLLAR SWAPS

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Maturity Midrate

3 years 6.48%sa

4 years 6.65%sa

5 years 6.78%sa

6 years 6.88%sa

7 years 6.96%sa

10 years 7.10%sa

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NOTE The rates above are midrates. To these rates, deduct 1/8% if the bank is paying

fixed rate. Add 1/8% if the bank is receiving fixed rate. All principal transactions are

assumed to be bullet transactions.

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C. Circus Swap Pricing

A combination of fixed-for-floating interest rate swap with a fixed-for floating currency swap where floating rates are LIBOR.

1. Forwards A custom-made contract Allows precise The contract

to buy or sell foreign hedging since are not liquid

exchange in the future at contracts are custom and use up

a pre-arranged exchange rate. made. available bank

lines-of-credit.

2. Futures A ready-made contract Low margin required Marketing

to buy or sell foreign easy access, liquid, and to market

exchange in the future allows smalls accounts causes cash

at a fixed exchange rate. to participate. flow

uncertainty

and requires a

high level of

expertise.

3. Options A contract that offers the Limits downside Complex

right to buy or sell foreign risk exposure while difficult to

exchange in the future at retaining upside understand

a fixed exchange rate. profit potential. and hard to

construct

hedges.

4. Swaps An agreement to exchange Versatile, allowing Expensive

one currency for another at easy hedging of documentation

specified dates and prices. complex exposures.

1. Borrowing and The borrowing Useful for long Costly to

Lending of domestic term needs or when manage and

currency, exchanging exchange traded maintain.

it into a foreign vehicles are thin. Also may be

currency and investing illegal in certain in the foreign country. regions.

2. Leading and Maintaining an equal Avoids unnecessary Costly to

Lagging amount of foreign ex- hedging costs. manage and

change assets and may not result in

liabilities by speeding up appropriate

or slowing down receivables matches.

or payables.

3. Matching Equating assests and liabilites Avoids unnecessary Appropriate

denominated in each currency. hedging costs. matches may

not be available.