CHAPTER SEVEN Using Financial Futures, Options, Swaps, and Other Hedging Tools in Asset-Liability Management.
The purpose of this chapter is to examine how financial futures, option, and swap contracts, as well as selected other asset-liability management techniques can be employed to help reduce a bank’s potential exposure to loss as market conditions change. We will also discover how swap contracts and other hedging tools can generate additional revenues for banks by providing risk-hedging services to their customers.
An Agreement Between a Buyer and a Seller Which Calls for the Delivery of a Particular Financial Asset at a Set Price at Some Future Date
To Shift the Risk of Interest Rate Fluctuations from Risk-Averse Investors to Speculators
Financial Exchange (FINEX)
New York Futures Exchange (NYFE)
Marche a Terme International De France (MATIF)
Singapore Exchange LTD. (SGX)
Chicago Mercantile Exchange (CME)
London International Financial Futures Exchange (LIFFE)
Sydney Futures Exchange
Toronto Futures Exchange (TFE)The World’s Leading Futures and Option Exchanges
Cash-Market Price (or Interest Rate) Less the Futures-Market Price (or Interest Rate)
= Return Earned in the Cash Market
+/- Profit or Loss from Futures Trading
It Grants the Holder of the option the Right but Not the Obligation to Buy or Sell Specific Financial Instruments at an Agreed Upon Price.
A Contract Between Two Parties to Exchange Interest Payments in an Effort to Save Money and Hedge Against Interest-Rate Risk
The Swap Parties Only Swap the Net Difference Between the Interest Payments. This Reduces the Potential Damage if One Party Defaults on its Obligation
An Agreement Between Two Parties, Each Owing Funds to Other Contractors Denominated in Different Currencies, to Exchange the Needed Currencies with Each Other and Honor Their Respective Contracts.
Protects the Holder from Rising Interest Rates. For an Up Front Fee Borrowers are Assured Their Loan Rate Will Not Rise Above the Cap Rate
A Contract Setting the Lowest Interest Rate a Borrower is Allowed to Pay on a Flexible-Rate Loan
A Contract Setting the Maximum and Minimum Interest Rates That May Be Assessed on a Flexible-Rate Loan. It Combines an Interest Rate Cap and Floor into One Contract.