T.4_BANKING AND FINANCIAL INSTITUTIONS (2017)Apunte Inglés
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BANKING AND FINANCIAL INSTITUTIONS
T-4. OFF BALANCE PRODUCTS
They are not asset or liabilities. Represent actual commitments which could result in a
future payment. Implicit risk for the bank. Additional services providing the customers
with daily operations (cash management systems, fx operations).
- Hedging: Use of derivatives to cover against interest rate, exchange rate or commodity prices fluctuations. Derivatives are financial products whose value depends on the evolution of an underlying asset. There are rights and obligations to trade. As far as you want more rights you have to face more obligations in exchange.
FX hedging allows coverage for exchange rate fluctuations. FX rates are highly volatile and this could result into gains or losses. FX hedging products try to protect companies’ balances from these fluctuations - FRAs. Forward rate agreement: OTC (over-the-counter) contract between parties that determines the rate of interest, or the currency exchange rate (ERA), to be paid or received on an obligation beginning at a future start date. Forward contracts are issued by banks and are personalized instruments. FRAs are used to hedge future interest or exchange rate exposure (ERAs – exchange rate agreement).
Es decir, fijamos un tipo de interés determinado y si los tipos suben, el banco paga la diferencia, mientras que si bajan, la empresa paga la diferencia. De esta forma, la empresa fija sus costes financieros, cubriéndose de una posible subida de los tipos de interés.
Spot prices mean today’s current price of the asset Forward prices mean future price we set for the asset by using a taylormade agreement between the bank and the customer 1 - - - Exchange rate agreement: Forward Foreign Exchange (FX) contracts. Agreement to exchange one currency for another. Exchange rate is fixed on the day of the contract.
Delivery takes place on a predermined date in the future. FX contracts also available to daily conversion between currencies (minimize difference between buy/sell positions).
Interest rate risk: Protecting the company against the evolution of interest rate (both in borrower or lender position). When borrowing, higher cost. When lending (savings), less profitability. Usual products: IRS, CAP, FLOOR, COLLAR, MORE COMPLEX PRODUCTS. Growing regulation to protect costumers when signing these contracts (MIFID).
Swap: Change from a floating interest rate to a fixed interest rate. When entering to the swap agreement, fixed rate is higher than existing rates.
Hedging implies moving from floating rates to fixed rates 2 - - - Cap: the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price. (hedging against interest rate increases). To set a maximum interest rate Floor: the buyer receives payments at the end of each period in which the interest rate is below the agreed strike price (hedging against interest rate decreases). To set a minimum interest rate.
Collar: Final combination of buying a CAP and selling a FLOOR. To set a maximum and a minimum. Out of the range you are in floating interest rate 3 ...