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Derivatives

Forward Rate Agreement (FRA)

Product characteristics

By way of a FRA (forward rate agreement), it is possible to secure as early as today an interest rate for a variable interest deposit or liability (such as a credit) that will only get started in the future. This agreement is independent of the basic deal – the deposit or the credit can even be in another bank.

The contracting parties will agree for the respective future period on a fixed rate of interest (FRA rate). We will compare this rate 2 days prior to the beginning of the period (on the so-called reference day) to the interest rate of the basic deal (reference rate). If the reference rate is higher than the FRA rate, the FRA Buyer will receive from the Seller a compensatory (netting) payment amounting to the difference between the interest rates. If the reference rate is lower, it is the FRA Buyer that makes the compensatory (netting) payment.

Interest swap (IRS)

Product characteristics

An interest swap is an agreement between two contracting parties in which one party undertakes to pay a variable (or fixed) interest rate agreed beforehand for an amount of funds agreed beforehand and a predetermined period of time. The other party simultaneously undertakes to pay the fixed (or variable) interest rate agreed beforehand for the same amount of funds and the same period of time.

The interest swap serves to hedge against the interest risk from the original deal (e.g. long-termed credit or purchase of bonds). The interest swap is just like the FRA independent of the basic deal, i.e. the original deal can be in another bank.

Cross currency swap - CCS

Product characteristics

A more general type of the interest swap is a cross currency swap. It is resorted to in a case where the original deal (such as the credit) that we want to hedge is in another than the local currency (e.g. in EUR). The cross currency swap is an agreement between two contracting parties about an exchange of future interest rates, however, unlike the classical interest swap, this agreement is about nominal amounts. This means that even the payments of interest are denominated in two different currencies wherefore not only interest payments but also the nominal amounts get exchanged.

Cap

Product characteristics

The cap enables to hedge against the interest risk by means of a guarantee of the maximum reference rate limit (such as the PRIBOR in case of a long-term credit). At the same time, however, it does not rule out the possibility of participating in the positive development of the interest rates (decrease of interest rates).

The cap is composed of several interest options, the so-called caplets. A caplet is in fact a call for the reference rate. If on the determined day (2 working days prior to the beginning of the given period) the reference rate is above the maximum determined limit, the so-called strike, the Buyer of the option will receive a compensatory payment amounting to the difference between the reference rate and the strike. By purchasing several caplets with the same strike at the same time an interest cap comes into existence. For this right, the Buyer must pay a certain price, the so-called „premium“.

Floor

Product characteristics

The floor is in fact the contrary of the cap and serves to hedge against the interest risk (protects from the decrease of interest rates in the future) by means of a guarantee of the minimum reference rate limit (such as the PRIBOR) in case of a long-term deposit. At the same time, however, it does not rule out the possibility of participating in the positive development of the interest rates (increase of interest rates).

The floor is composed of several interest options, the so-called floorlets. A floorlet is in fact a put for the reference rate. If on the determined day (2 working days prior to the beginning of the given period) the reference rate is below the minimum determined limit, the so-called strike, the Buyer of the option will receive a compensatory payment amounting to the difference between strike and the reference rate. By purchasing several floorlets with the same strike at the same time an interest floor comes into existence. However, the Buyer must pay for this right a certain price, the so-called „premium“.

More details can be found in the Dealing Manual available from our contact persons.