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Foreign Exchange Markets

Managing RiskN ovember 28th 2006


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Agenda

! FX Markets Snapshot

! Currency Exchange Rates and Volatilities

! Managing FX Risk

! Nature and Magnitude! FX Risk Policy

! Technology

! Tools/ Products


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Global FX Markets A Snapshot

! $2 trillion (approx.) average daily turnover, the largest in the world, equivalentto $300 /day per person on this planet

! Decentralized - over the counter market

! Market is highly concentrated

! 88% in major currency pairs

US Dollar; Yen; Euro; Sterling; Swiss Franc; Canadian Dollar; Australian

Dollar

! About 89% of the transactions involve US Dollar followed by Euro(37%) ,Yen(20%) and Pound (17%)

! 95% of the market is trading for profit

Source : http://about.reuters.com/investors/events/presentations.aspBIS Triennial Survey 2004

FX Marke t s : H igh ly Concen t r a ted


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Global FX market trends

Dealer-to-Customer FX Traded Electronically

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Inter-Dealer 2004 Inter-Dealer 2007 Dealer-to-Client 2004 Dealer-to-Client 2007

Electronic Volume Voice Volume

% Share of Spot FX by Segment 1995-2007

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

1995 1998 2001 2004 2007

I nterbank Fi nancial I ns titut ion s Non -Finan ci al I ns titut ions

Source: BIS, December 2004 (adjusted for local and cross-border double-counting) Source: BIS, December 2004 and Reuters

$16.1

$13.4

[$5.40]

0

2

4

6

8

10

12

14

16

18

2002 2004 2005

$inBillions

$1,271.80

$149.70

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

1997 1998 1999 2000 2001 2002 2003 2004 2005

#offunds

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

AssetsinBillio

ns

Hedge Fund & CTA AUM ($ Billions) # of Hedge Funds

Hedge Fund Growth (AUM; # of Funds) FX Assets Under Management in ParkerFX Index

Source: The Barclay Group; The Hennessee Group

Source: Parker FX Index (refers to AUM in 60 or so FX only funds measured by the Parker Index.)

Source : http://about.reuters.com/investors/events/presentations.asp


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Market Participants

! Traders/Brokers: High risk tolerance, short term involvement.Speculators.

! Corporations: Lower risk tolerance, long term involvement. Activehedgers.

! Investment Funds: Lower risk tolerance, long term involvement.

! Banks: Market makers. Supply money to players in market.

! Governments (through central banks): Market disruptors. Long termenables of economic goals.

Mul t i t u de o f Par t i cipan t s : Mark e t i s Pr im a ry OTC


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USD Index and Rate Movement

Daily QUSFFTARGET=, Q=USD 1/6/2004 - 12/5/2006 (GMT)

USD Index

Fed Funds Target Rate

USD dips following the April G7 meet - the communiqu highlighted

the role of a weaker dollar in the global adjustment process

USD under pressure due to structural factors

Price

.12

1

1.5

2

2.5

3

3.5

4

4.5

5

Price

.12

68

72

76

80

84

88

92

96

100

F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D

Q1 2004 Q2 2004 Q3 2004 Q4 2004 Q1 2005 Q2 2005 Q3 2005 Q4 2005 Q1 2006 Q2 2006 Q3 2006 Q4 2006

Mul t ip le d r iver s o f Exch ange Rat e Movem ent s


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EUR/ USD Rate & Volatility

Daily QEUR= 10/17/2003 - 12/4/2006 (GM T)Price

USD

.1234

1.1

1.15

1.2

1.25

1.3

1.35

ValueUSD

.1234

6

9

12

15

N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D

Q4 03 Q1 04 Q2 04 Q3 04 Q4 04 Q1 05 Q2 05 Q3 05 Q4 05 Q1 06 Q2 06 Q3 06 Q4 06


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USD/ JPY Rate & Volatility

Daily QJPY= 10/17/2003 - 12/4/2006 (GMT)Price

USD

.12

104

108

112

116

Value

USD

.12

4

8

12

16

N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D

Q4 03 Q1 04 Q2 04 Q3 04 Q4 04 Q1 05 Q2 05 Q3 05 Q4 05 Q1 06 Q2 06 Q3 06 Q4 06


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USD/ IN R Rate and Volatility

Daily QINR=IN 9/22/2003 - 1/9/2007 (GM T)Price

.123

44

45

46

Value

.123

0

3

6

9

O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J

Q4 03 Q1 04 Q2 04 Q3 04 Q4 04 Q1 05 Q2 05 Q3 05 Q4 05 Q1 06 Q2 06 Q3 06 Q4 06

I nc reased Vo la t i l i t y i n Nov 2 00 6 du e to RBI I n t e rven t ion


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Market Risks A Corporate Perspective

! Exchange Rate Risk : Adverse Currency movements foropen positions

! Interest rate Risk : Maturity / Maturity pattern mismatch

! Liquidity Risk

! Commodity Risk

Mul t ip le r i sks need t o b e m anaged


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FX Risk Management The Process

Set up FXManagement

Policy

Monitor FX Risk

CorporateObjectives

Measureperformance


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Corporate Objectives

! What is the Financial Philosophy and Policy of theorganization?

! Will treasury be a cost centre or a profit centre ?

! How would treasury be evaluated ?

Cor por a t e Ob jec t ives : The b ase o f R isk Managem ent


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Establish FX Risk Policy

!Clearly stated FX risk management objectives

!Definition and grouping (transactional , translational and economic) of the exposures

!Authorized FX products

!Established limits

!Defined FX Risk Performance Measures

! Reporting / MIS

!Approved by senior management / Board of Directors

Wel l de f i ned p rocedu r es and s t r uc tu r es


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Risk Management

! Open Position / Gap Limits

Overall limit that is further subdivided by

! Currencies of dealing

! Intraday and Overnight Dealing

! Products

! Individual Dealers

! Stop Loss Limits These can again be subdivided by the cuts listedabove

! VaR Limits

Lim i t s in L ine w i th t he R isk appe t i t e o f t he Organ iza t ion


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Technology! Requirement of Different Systems , integrated with one another

! Dealing Modules for Deal entry / Pricing

! Back Office Modules for settlement , validation and Accounting

! Risk Management Modules for Limits, VaR , Profit Monitoring and Reporting

! Systems should be tightly integrated to the companys core systems and be able toreconcile data with it

! System scalability and customizability for new model additions

! Controls and Security

!Defined Process Flows

! Audit trails

! Access Rights

W or ld Class t echn o logy enab l ing be t t e r r i sk m anagem en t


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Risk Management Products

!Knock Out Range Accruals!Target Redemption (TARN)

!Quanto Swaps

!POS with option protection

!Knock Out POS

!Caps & Floors

!Range Accruals & Accumulators

!POS with Range Accrual

!Cross Currency Swaps

!Callable Swaps

!Swaption

!Constant Maturity Swap

!Forwards

!Principal Only Swaps (POS)

High RiskMitigation

High Carry

Bullet Riskmanagement

Staggered RiskManagement

Pr odu cts spec i f i c t o Cust om er r isk m anagem ent needs


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FX Forwards & Options

! FX Forwards

! Obligation to buy/sell a currency

! Equivalently Offset movement in the underlying exposure

!FX Options! Right but no obligation to buy/sell

! Allow profit potential (limited & unlimited)

! Premium cost known upfront

Purchased OptionsAllow gains to accrue on the underlying exposure while limiting losses

Combination Structures

! Allow hedgers to reduce cost, usually structured to have initial net zero cost

! Allow hedgers to tailor the risk-reward profile of a hedging strategy to suit a view

! Profit and loss characteristics depend on respective combination

Structured Options may be preferred to forwards especially during high volatility environment toallow higher cost-benefit returns


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Cross Currency Swaps

A Cross Currency Swap is

! A contractual agreement between two parties

! To exchange a series of coupon and principal cash flows at regular intervals

! In different currencies

! Over a pre-specified period

! On a certain notional principal amount according to a prearranged formula

! Coupon Swaps

To convert the interest component of an INR liability to a FCY liability or vice versa

! Principal only Swap

To convert the principal portion of a liability from one currency to another currency

! Currency SwapTo convert the principal and interest component of a Liability from one currency toanother currency


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Cross Currency Swap Variants (Non INR)

! Libor-in-Arrears Swap:

The floating rate for a specific period is determined at the end of that periodrather than at the beginning of a period for a normal swap

! Range Accrual Swap:

Accrual on the floating leg occurs only if the floating rate benchmark is setwithin a predetermined range

! Callable Swap( regulatory issues)

Any swap which allows one counterparty to terminate the swap before itsmaturity

! Quanto Swap( regulatory issues)An interest rate swap in which the notional principal and the benchmark onthe floating leg are in different currencies


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Risk Management Structures

! Flexible Principal only Swap! Cover the Interest rate differential risk

! Fix the Spot rate within the next few months to allow benefit in rupee appreciation /depreciation

! Suitable when you want to fix the forward premium but expect the spot rate to movefavorably in medium term

! Swaps with embedded FC/Re Currency Options

! Standard swaps with currency options to provide protection on the currency risk

! Reduce the risk on the swap without taking away the potential benefit to a great extent

!USD Range Accruals! Accrual on the floating leg occurs only if the floating rate benchmark is set within a

predetermined range

! Better rate than a plain USD IRS

! Expect rates to move by a certain amount but not beyond certain levels


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! Knock out POS

! The POS knocks out if a certain level is seen and client gets carry in a shortertenure.

! Underlying is freed prematurely, thus client has option to enter a new structure

! Target Redemption (TARN) (Option)

! Structure is a strip of options and after a certain predetermined profit thestructure gets Knocked out, thus protecting the client from any future losses.

! Underlying gets freed prematurely, thus client has the option to enter a newstructure

!

Range Accrual KO POS! Combination of the Knock out POS and Range accrual POS.

! In case a predetermined level is seen client gets a carry. However if the level is notseen, client still gets a carry for the duration underlying remains in a range


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! Caps and Floors

! Used to hedge the floating leg of a currency swap, by capping themaximum amount payable by the company

! Hedges against an adverse movement in the rates markets by payingpremium across the tenor of the swap

! Swaption (regulatory issue)

! This is an option on a swap rate. At maturity of the swaption,customer has an option to enter a swap deal at a predetermined rateor the existing rate at that time

!

Other exotic structures! Snowball

! Ratchet

! Cliquet


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! Constant maturity swaps

! In CMS swaps the customer hedges himself against the slope of theinterest rate curve e.g. USD CMS 5-2

! Good hedging strategy if the company has opposite position acrossthe tenors

! One sided-accumulators

! For clients having a frequent payments, accumulators can provide agood hedging as clients benefit from adverse market movements andaccrue amount every day.


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Scenarios and Solutions

Customer has USD 5 Mm LC Imports in 90 days! Buy USD/INR forward! Buy USD Call / Sell USD Put! Any other ?

Customer has USD 5 Mm Liability payable in 5 years! Buy Series of USD/INR forwards (MIFOR vs USD IRS)!

POS! Currency Swap! Any other ?

Customer has CHF 5 Mm Liability in 2 years! Sell USD/CHF Forward and POS in USD/INR (effectively CHF/INR

POS)! Any other ?


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THANK YOU


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APPENDIX


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Dealing Trends

Conversational dealing

FX electronic matchingBank Bank

FX tradingportals

FX tradingportals

Inter-dealerbroker

PrimeBrokerageBank branch /

regional bank

Hedge fund /other financial

FX tradingportals

Corporate

Inter-dealer market

Dealer to customer market

Source : http://about.reuters.com/investors/events/presentations.asp

Many Many r e la t ionsh ip b e tw een Par t i c ipan t s


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Structure , Segregation & Mandates

! Experience and Expertise of authorized personnel

! Trading mandates for authorized personnel

! Limitation on out of hours trading

! Segregation of Duties and Functions

! Front office : Sales and Trading

! Mid Office : Risk Management and Closure

! Back office : Operations

! Code of Conduct for authorized personnel

! Active Senior Management involvement in Foreign Exchange Risk Management

Clear de l inea t ion o f respons ib ly


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FX Risk Monitoring & Reporting

!What to report?

!Transactions

!Positions / Gaps

!Exceptions

!Frequency of reporting (daily / weekly / monthly etc. )

Depending on the nature of the report and the people to whom it is to be reported

! People

!Who to report?

!Whom to report?

!Reporting Mechanism & Format Mails / System Updation / Meetings

Righ t i n fo rm a t i on t o t he r i gh t peop le at t h e r i gh t t im e


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Currency Movements

POUND / USD & EURO/USDPOUND / USD & EURO/USD Yen / USD

INR /USD INR / EURO

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