instruments in interest-rate, currency and ... - Volksbank AG

instruments in interest-rate, currency and ... - Volksbank AG

Group Treasury at Volksbank AG (VBAG): Your professional partnerfor managing interest-rate, currency and commodities risksThe volatile markets in recent years show that hedging treasury risks is a key component of operationalrisk management for SMEs and major clients fit for the capital market. Banks must provide high qualityadvisory and consulting services to keep pace with constantly changing conditions on the financialmarkets. Professional management of interest-rate, currency and commodity risks can greatly enhance acompany's value.Our specialists, who have extensive product knowledge and many years of experience, work with ourclients to develop custom hedging strategies. When used properly, products can reduce financing costsand enhance investment strategies. The aim is to eliminate market price risks that cannot be forecast asfar as possible.VBAG's Group Treasury relies on a holistic advisory approach meant to develop personal and innovativesolutions. In addition to a wide range of services, fundamental and methodical expertise, combined withmany years of experience on the capital markets, are among our core competencies.We have developed this publication to provide our clients with more information on these products. Itoffers an overview of our diverse instruments for interest-rate, currency and commodities management– along with examples of application."Inspiring Clients“ – we know our clients andwant to inspire them – this is our commitment!Martin FuchsbauerMember of the Managing Boardof Volksbank AGFranz SchleiferHead of Group Treasury Division,Volksbank AG3

4>> Active interest rate management secures returns „and optimises a company's financial assets.“

The decision between hedging and positioning, i.e. between a hedged interest situation and a deli be ratelyassumed interest-rate risk, is also an expression of the philosophy of a company’s treasury department:nThe argument in favour of employing a hedging strategy is that management can concentrate all its attentionon managing the performance-oriented cash flows, market trends and the company strategy, becausethere is no further need to manage positioning decisions.nA pure hedging strategy, however, may also result in competitive disadvantages, if competitors engage inactive interest-rate management and manage to reduce their interest expense by means of their positioningdecisions. The positioning, i.e. an active stance towards the interest-rate risk, therefore forms an importantstep in turning the financial area into a profit centre.INTEREST-RATE CURVESThe interest-rate structure curve and the interest payment curve it implies form a basis for decisions regardinginterest-rate management.nThe interest-rate structure curve is the graphic representation of the correlation of interest rates – in thecase of instruments with equal credit risk – dependent on the term to maturity. Interest-rate structurecurves reflect the anticipative attitude of the most active professional market players.nThe most important conclusion to be taken from the interest-rate structure curve is how the impliedinterest payment curve is derived. It is the future interest rate expected by the market, i.e. by theprofessional players in the market. This implied future interest rate and thus the implied interest paymentcurve can be calculated on the basis of the interest structure curve.Which forward rate is used for the decision is dependent upon the respective situation.ExampleWhen comparing a floating interest loan (6 month EURIBOR) with a fixed interest-rate loan, therespective 6 month forward rates are relevant. Therefore, the 2-/2 1 /2 year forward interest rateexplains market expectations with regard to the level of the 6 month rate in 2 years.If after 12 months, however, a decision has to be made on a 5-year fixed interest financing, its interestrate can either be hedged today through a forward swap or financed in 12 months at the current rate.The “1+5” annual rate tells how much – according to the expectation of the market – the rate will bein 12 months for a 5 year swap.6

The following formula enables us to establish at any time from two positions of the interest structure curve animplied forward interest rate, which constitutes one position of the implied forward interest-rate curve.This formula calculates for periods longer than one year.ZP t =(1 + ZP N ) N 1/t-1FP t = forward interest-rate period tZP n = zero interest rate for period nZP N = zero interest rate for period NN = long term to maturityn = short term to maturityt = N-n(1 + ZP n ) n 1/1Example2-year market rate: 4.75% (30/360), zero interest rate: 4.776%3-year market rate: 4.80% (30/360), zero interest rate: 4.815%(1 + 0.04815) 3Annuity in 2 years = -1 = 4.698% (30/360)(1 + 0.04776) 2The interest structure curve indicates a market expectation of 4.698% for the rate for anannuity over 2 years.The implied forward interest rate is an important decision-making criterion because it constitutes the basis forall tools of interest-rate management. But: interest-rate hedging only means protection against fluctuations inthe actual interest rate compared with interest as a result of the interest-rate structure curve. There is noprotection against a development of interest rates as shown by the forward interest-rate curve.Possible interest structure curvesFlat interest structure curve7

FORWARD RATE AGREEMENTSINTEREST-RATE SWAPWhat is an interest-rate swap?An interest-rate swap (IRS) is an agreement between two parties to swap payments of interest in the samecurrency over a determined period (e.g. fixed rate against floating rate). The agreement is based on a fixedprincipal amount (nominal amount) which is not however swapped. In a swap, the floating interest rate isusually linked to a reference rate, e.g. to the EURIBOR or LIBOR.The interest-rate swap can be used to modify the interest-rate characteristics of balance sheet items withoutmodifying the underlying balance sheet items. This is advantageous, especially if restructuring balance sheetitems for interest-rate reasons in the conventional way would result in the extension of the balance sheet andthe modification of balance sheet ratios or in additional costs.Determinants of an interest-rate swapn Currency and nominal amountn Time to maturity: between 6 months and 30 yearsn Fixed rate of interest: market rate at the timeinterest calculated quarterly, half-yearly or annually in arrears,on the basis of 30/360 or act/360n Floating interest rate: Reference rate (EURIBOR, LIBOR, …)roll over dates: 3 or 6 monthsinterest calculated on basis of roll over deadlines quarterlyor half yearly in arrears, based on act/360ApplicationsOn the liabilities side:nFor hedging a floating debt risk when expecting rates to increase.By swapping from a variable to fixed interest rate, the interest expenses are fixed and form a fixed basisfor calculations.nFor reducing borrowing costs by exchanging a long term fixed interest-rate agreement into a variableamount, with rates expected to remain stable or to decrease.On the assets side:nMaking use of an expected interest-rate increase by swapping fixed interest investments into a floating one.10

ExamplesExample 1: Liabilities side – from floating to fixed rate (floating against fixed)When financing using a floating interest-rate loan (roll over loan = R/O loan), liability may increase whenmarket rates increase, without income on the assets side increasing at an equal rate. This risk can be avoidedwith a swap changing the floating rate into a fixed rate. This creates a firm basis for calculation of interestexpenses over the term of the swap.For this swap the company pays Volksbank AG (VBAG) a fixed interest rate and in return receives a variablerate. The company uses this variable rate to make the EURIBOR payments on the R/O loan. As both variableinterest-payment-flowsbalance on the roll over dates, this transaction results in a fixed amount of the interestfor the R/O loan: with a fixed rate of interest resulting from swap plus margin resulting from the R/O loan.Transaction in course:A company pays EURIBOR + 100 BP under an R/O loan.Interest-rate swap:A company receives EURIBOR ± 0 BP from VBAG.The company pays VBAG a fixed rate of interest.Result:The company pays a fixed interest rate + 100 BP.VBAGEURIBORFixed interest rateCompanyEURIBOR + 100 BP11

Example 2: Liabilities side – from fixed to floating rate (floating against fixed)A company was able to obtain an attractive long term fixed interest-rate loan; not expecting the interest rateto rise and not in need of further fixed interest funds, the company can change over to a floating rate. A swapis entered into where VBAG pays the company a fixed rate for servicing the loan. In exchange, thecompany pays a variable EURIBOR rate of interest.Existing transaction: A company pays a fixed interest rate (e.g. 6%).Interest-rate swap: VBAG gives company a fixed interest rate (e.g. 5%).Company pays EURIBOR ± 0 BP to VBAGResult:Company pays EURIBOR ± difference between fixed interest rates.(here: EURIBOR + 100 BP)VBAGEURIBORfixed interest rate (5%)Companyfixed interest rate (6%)Termination of an interest-rate swapis possible at any time by means of aBack-to-back transaction: a back-to-back swap is entered into at current market conditions, over theremaining term of the original swap. The payee of the fixed rate of interest in the original swap becomes payerof the fixed rate in the back-to-back transaction. The interest position of the original transaction is thereforefully compensated.Cash-out: Premature termination of the agreement is exercised, balancing the reciprocal interest amountsreceivable via a counter account based on the current terms and conditions of the swap (to cover the lossfrom re-investment).12

Swap structuresOver the last few years, swap structures have been refined and developed further in order to hedge cash flowsresulting from investment projects or financial investments to the best possible extent. The following structuresdominate the market:In a swap with final maturity the nominal amounts remain thesame over the term of the swap.The amortizing swap is used in particular for hedging amortisingloan facilities.In a forward swap (also known as a delayed start swap, fixeddate swap) a future requirement for financing / investment can behedged already in advance against the interest-rate risk.13

In the step-up swap, the nominal amounts keep increasing overthe term of the agreement. This swap structure is especiallysuited for hedging the interest rate of major investment projectsto be realised progressively over a period of several years.In the case of an extendable swap, one of the parties has anoption to extend the swap beyond the original term at the sameterms and conditions.In a callable swap, one party has the option to terminate the swapprematurely.EONIA SWAPWhat is an EONIA swap?A further type of interest-rate swap is the EONIA Swap (EONIA = Euro OverNight Index Average). Thisenables liquidity within the call money sector to be controlled. Possible terms to maturity start out at one weekand enable users to either exclude volatility of the short call money rates when raising capital or making use ofit for investments. The EONIA rate is the average rate for call money for interbank transactions calculated bythe European Central Bank since 4 January 1999 based on actual transactions using the act/360 interestcalculation method. Calculation is carried out in arrears, taking into account the compound interest effectthrough the effective interest formula.14

Determinants of an EONIA swapn Nominal amountn Time to maturity: between 1 week and 2 yearsn Fixed rate of interest: EURIBOR rate as applicable, day count act/360n Reference interest rate: EONIA (Euro Overnight Index Average)The EONIA rate is calculated using the following formula:R = floating EONIA rate to be determined taking compound interest effects into accountt 1 = starting date of the EONIA swapt e = the maturity of the EONIA swapr i = interest rate for call money (per cent divided by 100)T i = number of days to which r i applies (normally 1 day, except for weekends and EUR-holiday)T = term of the EONIA swap in daysApplicationsOn the liabilities side:nThe EONIA swap enables users to vary linked interest rates and thus to minimise the risk of fluctuatingcall money rates.On the assets side:nAn EONIA swap enables users to make use of an inverse interest-rate structure and achieve better resultswhen investing short to medium term liquidity surplus funds.ExampleAssets side, inverse interest-rate structure, a one week EONIA swap is entered intoA company has short term liquidity available of EUR 10 million, which is currently invested based on theone week EURIBOR rate of 10 BP. In order to benefit from the inverse interest structure in the moneymarket, an EONIA swap is entered into, enabling the company, in spite of having invested the funds for aweek to benefit from the market’s higher call money rates.15

Transaction in course:A company is paid 10 BP (e.g. 4%) for investment using the 1 weekEURIBOR rate.EONIA swap:The company pays VBAG 4.1% interest over a week (= 1 week fixed rate).The company however receives for the same term to maturity and thesame principal the interest rate of 4.7245% (= average EONIA rate).Calculation EONIA rate: *)1 st day 4.172 nd day 4.153 rd day 4.124 th day 4.125 th – 7 th day 4.08Basically, the company pays interest amounting EUR 7,972.22, and obtains interestof EUR 8,002.36 from the swap. In actual fact, only the difference will be paid out,i.e. the company is paid EUR 30.14 by the swap partner.Result:The company receives the difference between the 1 week fixed rateand the average EONIA rate.VBAG1 week fixed rateaverage EONIA rateCompany1 week EURIBOR – 10 BP*) calculation of the average EONIA rate:16

CROSS CURRENCY SWAPWhat is a cross currency swap?A cross currency swap is a special form of interest-rate swap. It is an instrument of interest-rate and currencymanagement whereby the focus is once again on the swap of different interest payments.The first difference between the two flows of interest payments running in opposite directions is theirdenomination in different currencies. Moreover, the principal amounts are usually swapped at the beginningand at the end of the agreement; however, these principal amounts are in differing currencies. Interest paymentobligations of the swap partners resulting from possible underlying transactions are not affected. As in the caseof interest-rate swaps, only the payments between the parties involved are regulated.A cross currency swap can be illustrated in three steps:nStep 1: Swap of principal amounts upon entering into the transactionUpon entering into the transaction, principal amounts in the underlying currencies are swapped,usually at the current spot rate.Party 1principal currency Ix spot rate =principal currency IIParty 2An actual swap of the principals among the parties is not mandatory. What is, however, decisive is to fix therate of exchange because this is the only way to determine interest payments and the re-exchange ratio of the principalamounts. As a rule, the swap takes place in the vicinity of the current spot rate, with rates rounded up or down –to smooth out the principal amounts.nStep 2: Interest-rate swap before maturityInterest on the respective principal amounts received is swapped before maturity.Party 1principal currency Ix interest-rate currency Iprincipal currency IIx interest-rate currency IIParty 217

nStep 3: Re-exchange of the principal amounts upon maturityUpon maturity, principals are re-exchanged on the basis of the original rate of exchange (par forward basis).Party 1principal currency Ix par forward rate =principal currency IIParty 2When re-exchanging the principals, it is decisive to maintain the original spot rate (par forward rate). The parforward rate becomes possible because the difference in interest existing between the two currencies is balancedout by the interest payments made in the meantime.Note:If the principal amounts are converted instead of being swapped at the beginning of the term of the swap therestill is a currency risk because of the conversion which is also required upon maturity of the swap.Determinants of a cross currency swapn Currency and nominal amountn Exchange rates of the swap currenciesn Term: between 6 months and 30 yearsn Fixed rate of interest: current market interest rateinterest calculated every three, six or twelve months in arrears on thebasis 30/360 or act/360n Floating rate of interest: reference rate of interest (EURIBOR, LIBOR, …)roll over dates: 3 or 6 monthsinterest calculated according to the roll over dates every 3 or 6 monthsin arrears on the basis act/360ApplicationsCross currency swaps are used for foreign currency management both on the assets as well as on the liabilitiesside. They enable users to lock in the achieved foreign exchange gains or to take advantage of expected trendsin exchange rates. Items that result in interest payments are particularly suitable for this purpose. On the assetsside, for example, this is the case for loans and advances owed to the group and securities. On the liabilities side,this is the case for the corresponding medium- to long-term, zero interest or floating interest issues and loans.Termination of a cross currency swapis possible at any time through a back-to-back transaction or cash-out (just as in the case of the interest-rate swap).18

Typical cross currency swapsnIn the case of the fixed-fixed currency swap, fixed interest payments are paid and received indifferent currencies.nIn the case of the floating-floating currency swap (basis swap) floating rate interest is paid and received onprincipal amounts in two different currencies.nCombined cross currency swaps are able to swap fixed and variable interest payments in twodifferent currencies.ExampleLiabilities side – from the floating rate EUR loan into a JPY fixed interest loan (EUR floating against JPY fixed)A good example for a ”basic loan” is a floating interest-rate loan (roll over loan) in the local currency (EUR),because the best terms and conditions are usually available in this instance, offers can be directly compared on acredit margin basis using the EURIBOR and restructuring with a swap or a hedge with cap (cf. chapter interestrateoptions) is easy to arrange. With a cross currency swap, swapping the floating EUR rate of interest to a fixedrate of interest in a foreign currency, a fixed interest loan is created in the chosen low interest-rate currency. Therisk of the floating rate of interest is thus hedged. The foreign exchange risk can be limited better by being ableto terminate it at any time (by terminating the swap and valuation at the market conditions prevailing at thatparticular time).For this cross currency swap, the company gets a floating EUR rate and pays a JPY fixed interest rate to VBAG.With this variable rate, the company services the EURIBOR payments resulting from the R/O loan.As both variable interest payment flows balance out on the roll over dates, this transaction results in a foreigncurrency loan with a fixed interest rate over the full term of the swap.”Basic financing“: a company pays EURIBOR + 100 BP on an R/O EUR loan.Cross currency swap: The company receives EURIBOR +100 BP from VBAG. The company pays VBAG a JPY fixedinterest rate (about 100 BP above current market level).Foreign currency: Instead of the initial exchange and the final exchange, Group Treasury executed both conversions(initial and final). The JPY nominal amount is sold in the market at the beginning of the cross currency swap, withthis initial rate being crucial for the success of the foreign currency financing, and should occur when the foreigncurrency (JPY) is standing as high as possible against the local currency (EUR). The foreign currency amountreceivable by VBAG from company is also subject to this initial rate. In the event that the JPY/Euro rate drops (i.e.EUR/JPY rises), the foreign exchange gain can be realised by terminating the swap or hedge (forward exchangetransaction).Result: The company pays a JPY fixed interest rate.19

Initial exchange, to be replaced by conversion at initial rateFinal exchange, to be replaced by conversion and settlement against initial rate ofexchange – exchange risk!FORWARD RATE AGREEMENT (FRA)What is an FRA?A Forward Rate Agreement (FRA) is an agreement between two parties in which the rate of interest is fixedfor a future period and for a nominal amount agreed upon. The FRA does not include an agreement aboutthe exchange of capital.For the usual terms to maturity, FRAs are usually quoted for both sides, i.e. a buying side (purchase of a FRA)and a selling side (sale of an FRA) are specified. When quoting an FRA, two figures are given in addition to theinterest rate (e.g. 3 x 9, i.e. 3 against 9 months FRA) in order to determine the periods. The first figure refersto the period between the date of the agreement and the fixing of the interest rate (lead period + interestperiod).A 3 x 9 FRA thus has a three months’ lead period and a 9 months’ total term to maturity; the interest periodis 6 months (total term less lead period).Partial periods of the 3 x 9 FRA:total term until maturity 9 monthsLead period3 monthsDeal is finalisedInterest-rate period hedged6 monthsInterest-rate comparison and settlement20

On the assets side:nHedging the interest rate of planned investments: If a company expects a future excess ofliquidity and considers current interest rates to be attractive, it is already possible to fix such interest ratesfor a future period now.nHedging the interest rate of existing investments: Existing investments can be hedged againstthe risk of decreasing interest rates by selling FRAs.Termination of an FRAis possible at any time through a back to back transaction.QUANTO SWAPWhat is a quanto swap?The quanto swap is a way of reducing interest charges on financing – by benefiting from foreign interest rates– without reducing the foreign exchange risk.The quanto interest payments are based on a foreign interest curve without foreign exchange risk. The onlyrisk is that customer’s interest payments based on a foreign rate of interest might be higher than EURIBORinterest payments.ApplicationsA company wants to reduce the future borrowing cost of a conventional loan. This is possible only if (a) theborrower assumes a risk based on his specific expectation on future interest-rate differentials and (b) hisexpectations are confirmed by the market situation in the future.At the outset, the company has a floating rate euro loan (e.g. 3M EURIBOR loan).The company assumes that the difference between the 3M EURIBOR and the 3M CHF LIBOR will eithercontinue to exist at the same rate in the future as it is today or that this interest-rate differential (3M EURinterest minus 3M CHF interest) will increase. The company therefore enters into a euro quanto swap, inaddition to the existing floating euro loan.22

3M EURIBOR Loan3M EURIBORCompany3M EURIBORVBAG(3M CHFLIBOR + Spread)in EURHow it worksIn a euro quanto swap based on the CHF LIBOR, two euro floating rate interest payments are swapped. Thespread on the 3M CHF LIBOR agreed for the euro quanto swap remains unchanged during the term untilmaturity. All interest payments are made in EUR, so there is no foreign exchange risk. The bundle consistingof a floating rate euro loan plus euro quanto swap results in a floating euro loan for the company. Every quarterof a year, the company applies the 3M CHF LIBOR rate applicable at the particular time to his EUR principalin order to calculate the interest payable in EUR.RiskAs far as the market price trend of a euro quanto swap is concerned, the payer of the euro quanto interestpayments (3M CHF LIBOR + spread) is subject to a risk of the difference between the 3M EUR and the 3MCHF LIBOR rates narrowing.QuotationBasically, no fee is charged for a euro quanto swap, due to the fact that the spread on the 3M CHF LIBORagreed upon entering the swap is unchanged.TypesAs alternatives to the type described above, other euro quanto swaps are also possible upon request (euroquanto swap based on USD LIBOR etc.).Termination of a quanto swapis possible at any time by means of a back-to-back transaction or cash-out (just as in the case of the interestrateswap).23

CONSTANT MATURITY SWAP (CMS)DescriptionThe constant maturity swap (CMS) is a particular form of interest-rate swap where at least one swap partnerpays a variable flow of funds which is periodically adjusted against a longer term reference rate (e.g. 3 yearswap rate).If a company expects the interest curve to flatten in a way that is not anticipated by the market, he can enterinto a position in a “pay CMS – receive EURIBOR interest-rate swap”, for this purpose the underlying term tomaturity of the CMS rate can be chosen to correspond with precise expectations.This results in profit opportunities for the payer of the CMS interest rate in the event that the swap rates asthey materialise in the future (a) range on average below today’s future rates for the respective fixing datesand/or (b) increase less than expected by the market at the time the swap is entered into.ApplicationsAt the outset, the company has a floating rate euro loan (e.g. a 6M EURIBOR loan). In the present example,VBAG pays the 6M EURIBOR each half-year, while the borrower pays 80% of the 3 year EUR swap rate eachhalf-year.6M EURIBOR Loan6M EURIBORCompany6M EURIBORCMSpaymentVBAGQuotation: Agreement on a premium or discount on the underlying constant maturity swap (CMS) rate orfixing of a percentage factor.RiskExamplesDepending on the form of the CMS – either “pay CMS – receive EURIBOR” or “pay EURIBOR – receiveCMS”, a flattening or an increase in steepness of the interest curve can result in opportunities or risks.nnnConstant maturity swap for borrowersConstant maturity swap with zero cost cap for borrowersConstant maturity swap for investors24

INTEREST OPTIONSCAPWhat is a cap?A cap is an agreement of an upper limitation of the interest rate related to an underlying principal amount. If,for this purpose, the reference rate (e.g. EURIBOR or LIBOR) exceeds the maximum interest rate fixed bythe agreement (strike price), the seller (writer) pays the difference between the cap and the reference rateof interest to the purchaser of the cap. Settlement is the same as for FRAs.For the buyer, caps thus constitute a hedge against rising interest rates; whilst, however, simultaneouslyoffering the possibility of benefiting from a lower or decreasing level of market interest rates at the shortend of the interest curve.The important thing is how to design the cap premium, which is normally payable as a non-recurrent fee uponentering into the agreement. At the company’s request, it is possible to pay the premium at regular intervals,e.g. every six months.Determinants of a capn Currency and nominal amountn Term: between 2 and 10 yearsn Strike price: cap leveln Reference rate of interest: EURIBOR, LIBOR, ...n Roll over dates: dates when strike price and reference rate of interest are compared,usually 3,6,9 or 12 monthsn Premium: usually a non-current premium at the beginning of the contract period,expressed as a percentage of the underlying principal amountIt is easy to derive rules of thumb from the determinants in order to provide buyers with hints on the capprice trend:nnnnThe longer the term to maturity, the higher the cap premium.The higher the cap, the lower the cap premium.The more the difference between cap and implied market interest-rate level, the lower the cappremium.The more the interest-rate fluctuations expected (volatility), the higher the cap premium.25

Hedging profile: capApplicationsnBy agreeing on a cap, it is possible to limit the upper end of the interest-rate risk of floating interestloans. At the same time, the option remains to realise savings of interest expenses resulting from lower ordecreasing rates (asymmetrical risk profile).nAs opposed to a swap, caps may result in hedging interest rates also when no forecast is available on thefuture trend of interest rates. This is a result of the asymmetrical nature of caps: hedging against rising rates– with advantages when rates decrease.nA cap contract is entered into separately from the underlying transaction (e.g. a loan), meaning that thistool can also be used for loans already in existence.ExampleA company raises a EUR 10 m roll over loan with final maturity, with a 5 year term based on the6 month EURIBOR rate + 100 BP and decides that it never wants to pay more than 6.00% in the future. To ensurethis, it must buy a cap with a strike price of 5.00% (his 6.00% cap minus 1.00% margin from the R/O loan).For a 5 year cap against 6MO EUR-R/O at a strike price of 5.00% (6.00% – 1.00%), Group Treasury offers a priceof 125 BP, for example. This non-recurrent premium is payable upon entering into the contract.On the interest payment date, the strike price is compared with the current EURIBOR rate:Company pays VBAG resultVBAG pays for theEURIBOR Strike price from the R/O loan company company4.50 5.00 5.50 – 5.505.00 5.00 6.00 – 6.005.50 5.00 6.50 0.50 6.0026

Termination of a capis possible at any time through a back-to-back transaction or cash-out.Special cap structuresChooser capThe chooser cap is – just as a traditional cap – an agreement on a particular cap related to the 3 or6 month EURIBOR rate. Unlike a traditional cap, only part of the future interest periods is hedged in the formof individual caplets (= partial periods of a cap). The buyer decides before maturity whether the hedge will beutilised or not in the respective interest period. What is the advantage? The expense of the hedge is significantlyless, because not all future interest periods are hedged. The buyer has a “flexible” hedge over the term tomaturity, i.e. he can decide on exercising the option at each roll over date (useful in case the cap is exceededby a narrow margin).ExampleA company raises a EUR 10 m roll over loan with final maturity, 5 year term based on the 3 months EURIBOR rate+ 100 BP and decides that it never wants to pay more than 6% in the future. With a chooser cap and strike price of5.00% (6.00% minus 1.00%) the company acquires the right to be paid the difference between the respectivecurrent 3 month EURIBOR rate and 5.00% for a certain number of floating interest periods.The chooser cap:Term to maturity: 5 years (= 19 future interest periods)Of which company hedges a) 10 caplets b) 5 caplets of his choiceStrike price: 5.00%Interest indicator: 3M EURIBORThe underlying assumption regarding the rate of interest :The company expects, within the 5 year term, the 3 month EURIBOR not to exceed the 6% interest-rate capchosena) more often than ten times, b) clearly more often than 5 times.The risk:3 month EURIBOR exceeds 5.00% more often than a) 10 times or b) 5 times.The advantage:The buyer of the chooser cap has the right to benefit from the interest-rate cap a) ten times or b) five times. This means it ishis choice when to use the chooser cap over the term of validity. This makes control of the interest-rate risk position moreflexible. A margin remains to allow a reaction in the event of an unexpected interest-rate development. A conventional cap forthe structure as described would have cost for example 1.6% of the nominal amount, i.e. a premium of EUR 160,000 forEUR 10 million, the chooser cap alternatives as presented would cost, however a) for 10 caplets 1.15%, i.e. EUR 115,000 orb) for 5 caplets 0.85%, i.e. EUR 85,000.27

Participating capThe participating cap constitutes a particular cap structure, where the cap buyer hedges the risk of a rise ininterest rates free of charge and participates to a certain extent of the contract value in the decreasing interestrate. Assuming a 50% participation means that 50% of the nominal amount is charged interest with the strikeprice selected and 50% with the current floating rate, but not exceeding the strike price.ExampleA company raises a EUR 10 m roll over loan with final maturity, 5 year term based on 3 months EURIBOR +100 BP.For the complete amount of the loan a maximum interest rate of 6% is to be hedged, 50% of the capital is tobenefit from falling interest rates. The company therefore enters into the following participating cap with a strikeprice 5.00% (6.00% minus 1.00%).The participating cap:Term to maturity: 5 yearsStrike price: 5.00%Rate of participation: 50%Interest indicator: 3M EURIBORThe underlying expected interest rate:The company expects that the 3M EURIBOR will sharply decrease over the term to maturity of the loan; however isaware that this expectation is very uncertain.The risk:The 3 month EURIBOR rate does not decrease, the company finances at strike price (5.00%) plus 1.00% over thecomplete term to maturity.The advantage:The hedge is free of charge. A maximum 6.00% interest rate is hedged. However, the loan is subject to 50% of adecrease in interest rates. The result is to be illustrated in the following chart:Company pays VBAG ResultVBAG pays for theEURIBOR Strike Price from the R/O loan company company7.00 5.00 8.00 2.00 6.006.00 5.00 7.00 1.00 6.005.00 5.00 6.00 – 6.00Company pays Company pays ResultVBAG VBAG from the for theEURIBOR Strike Price from the R/O loan participating cap company4.00 5.00 5.00 0.50 5.503.00 5.00 4.00 1.00 5.002.00 5.00 3.00 1.50 4.5028

FLOORWhat is a floor?The complement to the cap is a floor, i.e. an agreement on a bottom interest-rate limit. If for this purpose thereference rate (e.g. EURIBOR or LIBOR) falls short of the minimum interest rate fixed by the agreement(strike price), the seller (writer) pays the purchaser of the floor the difference between floor and referencerate of interest.A check will be performed on each roll over date as to whether the respective current EURIBOR falls short ofthe agreed interest floor. If this is the case, the option writer will pay a compensation sum at the end of theinterest period for the amount of the difference between the floor and EURIBOR.Details and technical handling of floors are the same as those of caps. The market, however, is not quite asliquid as the cap market.Determinants of a floorn Currency and nominal amountn Term to maturity: between 2 and 10 yearsn Strike price: amount of the floorn Reference rate: EURIBOR, LIBOR, ...n Roll-over dates: dates when strike price and reference interest rate are compared;3, 6, 9 or 12 monthsn Premium: non-current premium at the beginning of time to maturity of the contract,expressed in per cent of the underlying nominal amount or annualised overthe aggregate term until maturityHedging profile: floor29

ApplicationsnA floor can be used for hedging asset items with a floating interest rate against possible decreases in therate and against the risk of a decrease of the return on investment.nA floor secures a minimum return at the level of the floor strike price (less the premium paid).ExampleA company places an amount of EUR 10 m with final maturity, 5 year term based on the 6 month EURIBOR -25 BPand decides that it never wants to receive less than 4.00% in the future. To ensure this, it must buy a floor with astrike price of 4.25% (its 4.00% floor plus 0.25% margin from the amount placed).For a 5 year floor against 6MO EUR-R/O at a strike price of 4.25% (4.00% + 0.25%), Group Treasury offers a priceof 50 BP, for example. This non-recurrent premium is payable upon entering into the contract.On the interest payment date, the strike price is compared with the current EURIBOR rate:Bank pays VBAG Resultto company pays for theEURIBOR Strike price on the amount placed company company4.50 4.25 4.25 – 4.254.25 4.25 4.00 – 4.004.00 4.25 3.75 0.25 4.00Termination of a flooris possible at any time through a back-to-back transaction or cash-out.30

COLLARWhat is a collar?A collar is the purchase of a cap and is fixed simultaneously with the sale of a floor. The interest-rate risk ishedged by a cap, at the same time as a floor is fixed. The objective of a collar is to reduce the cost of a cap. Bypurchasing a collar, however, the company can benefit from a possibly decreasing interest rate only until thefloor is reached.A special type of collar is the zero cost collar, i.e. a cap where no option premium is payable at the beginningof the contract because the proceeds from the sale of the floor are equivalent to the cost of purchasing a cap.Determinants of a collarn Currency and nominal amountn Term to maturity: between 2 and 10 yearsn Strike price: amount of the cap or floorn Reference rate: EURIBOR, LIBOR, ...n Roll-over dates: dates when strike price and reference rate are compared;3, 6, 9 or 12 monthsn Premium: non-current premium at the beginning of the term of the contract, defined inpercent of the underlying nominal amount or annualised over the totalHedging profile: collarTermination of collaris possible at any time through a back-to-back transaction or cash-out.31

SWAPTIONWhat is a swaption?Against the payment of an option premium a swaption gives an option buyer the right to execute, at adetermined point in time, a swap specified relating to its term and interest rate.Swaptions on the one hand enable the party to pay a fixed interest rate (purchase of a payer swaption), e.g.for hedging liabilities against rising interest rates.On the other hand, the swaption enables the party to get a fixed interest rate (purchase of a receiver swaption),e.g. for hedging assets against falling interest rates.Determinants of a swaptionn Currency and nominal amountn Term to maturity: between 2 and 10 yearsn Term of the option: between 1 day and 10 yearsn Strike price: fixed interest rate of the underlying interest swapn Option premium: depending on market situation and strike priceApplicationsnTo hedge project financing operations, for example in connection with bids submitted for a tenderinvitation. This enables the party to offer the financing for an offer of goods and/or services simultaneouslywithout incurring an interest-rate risk in the event of them failing to be awarded the contract. In addition,the swaption may not have lost value in the event of the loss of the contract. Depending on what happenedon the market, the value of the swaption can even exceed the price originally paid. Swaptions are alsofrequently used for hedging interest expense in the case of finance for planned acquisitions.nTo hedge planned finance operations. If, for example, a EUR loan is due in 12 months, the borrower canhedge the risk of rising interest rates for the subsequent issuance by means of a swaption.On the exercise date, for example, the purchaser of the payer swaption has two choices:– Market interest rates of a swap are higher than the strike price of the swaption – the option will beexercised. The party takes over the swap and thus secures an interest rate below current market rates atthe level of the strike price.– Market interest rates fall short of the swap underlying the swaption – the party will not exercise the optionand will finance at current market conditions.– The actual cost of the loan comprises of the total of the cost of the finance plus the premium for theannualised option.32

Termination of a swaptionis possible at any time through a back-to-back transaction or cash-out.ExampleThe situation at the outset• Invitation to tender: offer submitted today, award possible in 6 months• In case of an award, finance will be required for an amount of EUR 5 m over 10 years• Repayments on borrowing: linear• Floating rate finance at EURIBOR plus 1.00% possible at any time• At an interest rate exceeding 6.00% the project becomes unprofitable• Interest rates are expected to rise, therefore hedge by means of a fixed interest rateGroup Treasury’s swaption proposalPurchase of a payer swaption with 5.00% strike priceTerm of the option:6 monthTerm of the swap:10 yearsOption premium:non-recurrent 0.85% of the nominal amount or 0.20% calculated as loanpremium per yearThe hedge: In case of award fixed interest finance at 6.00%.The cost of the swaption hedge must be added.The profit opportunity:In case of rising interest rates exit possible at a profit.The risk:In case of no award and falling interest rates the risk is limited to the optionpremium paid.The advantage:In the case of a contract being awarded, the cost of the financing is fixed with the swap rate (5.00%) plus the loanmargin resulting from the floating finance (plus the cost of the hedge). In the case of the contract not being awarded,the risk is limited with the option premium paid (0.85% of the nominal amount). In the event that interest rates rise,it is even possible to sell the payer swaption bought for the hedge at a profit. In the case that the swap is taken over,it serves to hedge the interest rate and can be terminated at any time at the market interest rate offered at that time.Active interest-rate management is thus possible across the full term of the financing.33

34>> Hedging foreign exchange risks „provides security in volatile markets.“

CURRENCY MANAGEMENTA large part of global trade occurs in capriciously fluctuating currency markets. In times of globalisation andmarket internationalisation, it has become absolutely necessary to keep an eye on exchange rates.Particularly in turbulent times, it is crucial to hedge against foreign currency price fluctuations in order toprevent price losses from offsetting foreign transaction gains. Even minor price fluctuations can strongly affectoperating results.Whether concluding a business transaction with foreign suppliers, or shifting or raising capital in foreign currency,all such transactions are generally subject to currency risk.In addition to classic hedging of foreign currency risks, however, currency management can also mean aconscious exposure to risks unrelated to ordinary operations in order to realise price gains via currency volatility.Although there were really only two possibilities of hedging the inherent transaction price risk until the beginningof the 90s – foreign exchange spots and the forward exchange transactions – today, foreign exchange optionsand numerous related structuring opportunities offer a wide range of hedging strategies to choose from.The area of foreign exchange options has passed through a revolutionary phase over the course of the lastfew years. The possibilities for implementation appear limitless. New products are developed almost on a dailybasis that – adorned with promising names – offer customers new ways of hedging that are free of risk andexpense in some cases.The names and manner of illustrating the individual products are manifold and often confusing. Names such asButterfly, Condor, Ratio Spread, or Digital Option only partially suggest the structure of the hedging variant.However, these options and option structures all have one thing in common: As complicated as they maysound, all of these options are basically combinations of the three underlying transaction types: spots, forwardexchanges, and option contracts.Many of these “strategies” are short-term and only intended for special market and portfolio situations. But afew of them have managed to become standard instruments. They will be described below.35

FOREIGN EXCHANGE SPOTS ANDFORWARD EXCHANGE TRANSACTIONSWhat is a foreign exchange spot?The most simple and uncomplicated transaction related to currency risk management is the foreign exchange spot.Companies which have receivables or payables denoted in foreign currencies as a result of their foreign tradingactivities can convert foreign currency debits and credits into their book currency via foreign exchange spots.Spot transactions are traded on the spot exchange market. This market determines the exchange rates of the freelyconvertible currencies among one another. Trading occurs around the clock; the rates change continuously andquickly. The exchange rate movements result in a continuous change in the amount of foreign currency receivablesand payables.In a standard spot transaction, one currency is exchanged for another. The exchange ratio is determined by thecurrent exchange rate. The counterparties are obligated to exchange the negotiated sums. The standard rule fordelivery and payment on the spot exchange market is two working days after the transaction is concluded (spotdate). That is the period required in order to be able to conduct payments and transactions around the world ina timely manner.Price range (spread) and calculation of cross-currency ratesDifferent prices are applied depending on the type of underlying transaction (purchase or sale of foreigncurrency).The bid price is the price at which the key currency can be sold.The ask price is the price at which the key currency can be purchased.The interbank spot price is the price at which the banks can trade among one another. Corporate and privatecustomers can also trade at the interbank rate plus/minus a certain margin.The key currency in the interbank market is the euro; however, so-called cross-rates (e.g. CHF/JPY) are alsoneeded. These are calculated using the chain method:The chain method is illustrated as a rule of three. The question of the unknown is the starting point. In themiddle, there is a vertical fraction bar. The value sought on the left side is the question; the counter currencyper unit is on the right side. Each subsequent element on the left begins with the same designation with whichthe element on the right in the previous line ended. The last element on the right must have the samedesignation as the first element on the left. Every member having the same value with the same designation leftand right is cancelled out of the equation. Finally, the calculation is made: The product of the members of theright side is divided by the product of the left side.36

ExampleSought:CHF/JPY-rate determined via the EURBase values:EUR/CHF = 1.6450 –> EUR 1 = CHF 1.6450EUR/JPY = 161.00 –> EUR 1 = JPY 161.00CHF/JPY = ? –> CHF 1 = JPY x (how many JPY correspond to 1 CHF)Chain method:JPY x CHF 1 How many JPY equal CHF 1 ifCHF 1.6450 EUR 1 CHF 1.6450 corresponds to EUR 1 andEUR 1 JPY 161.00 EUR 1 = JPY 161.00?The euro values cancel each other out in this chain method equation. The following equation remains:CHF/JPY = 161.00/1.6450 = 97.8723One problem is the calculation of the bid and ask prices, which must also be taken into account in the calculation ofthe cross-rate.What are limit orders?Limit orders are contracts to buy or sell a specific amount of foreign currency when a specific spot price isreached. The temporal validity of these orders can set as desired – either until they are cancelled (withoutspecifying a date) or for a specific period of time. The market observation period takes place around the clock.There are different types:Limit order: This is a contract to buy or sell an amount of foreign currency when a specific exchange rate targetis reached.Stop loss order: This contract serves to limit losses in currently existing positions. With the help of a stop lossorder, the potential loss of a position in the event of strong rate movements is limited in advance. Long positionsare settled by a sale when the target rate is reached and vice versa.Loop order: When a specific rate is reached, the original position is settled and a new position is simultaneouslyopened in the opposite direction.Take profit order: This contract serves the taking of profits in currently existing positions. With the help of thetake profit order, in the event of rate fluctuations profits from a position are realised when a specific target rateis reached.37

What is a forward exchange transaction?A forward exchange transaction is an agreement (obligation) to buy or sell a specific amount of foreigncurrency at a later date. When the agreement is made, the forward rate, the currency, the amount, and thesettlement date are established. The transaction is not settled until the negotiated date.Forward rates normally deviate from spot prices. The reason for this is not the assessment of what the futurespot price will be, but rather exclusively in the interest-rate difference of the currencies.Theoretically, the forward rate for a currency can be identical with the spot price. However, this would bepure chance. If the forward rate exceeds the spot price, one speaks of a forward premium (report, premium,surcharge), or otherwise, of a forward discount (deport, discount). The premiums or discounts for each dateare designated as swap rates.Spot price +/- premium/discount = forward rateDeterminants of a forward exchange transactionn Term: from 3 days to 2 yearsn Currencies: all freely convertible currenciesn Exchange rateApplicationsnFor exportersThe exporter can fix the price or rate to be applied when the foreign currency is expected to be receivedin advance by concluding a forward exchange transaction. Thus, the exporter is protected from the risk ofthe rate falling, from foreign currency devaluation, or appreciation of the euro.nFor importersThe conclusion of a forward exchange transaction offers the importer the possibility of a fixed calculationbasis and security from the risk that the price or rate will increase, a foreign currency will appreciate, or theeuro be devaluated.38

Termination of a forward exchange transactionis done via counter-transaction converted to the current forward rate.There are following possibilities when a forward exchange transaction expires:n Utilisation: Through receipt of payments in foreign currency, debits or credits to a foreigncurrency account, etc.n Prolongation: Forward exchange contracts can be extended to a later date when theyexpire. The forward rate is corrected by the amount of the difference betweenthe interest rates of both currencies for the extension period by applyingpremiums or discounts.n Settlement: At the expiry date, the forward exchange transaction is settled in exchangefor a spot transaction to be concluded at the same time (official or unofficialmarket transaction). Any positive or negative rate differences result in acredit or debit to the respective customer account.Calculation formula for forward exchange transactionsExampleLegendExampleD =Days 90FR = Forward rate Results of the calculation (98.827)Spot = Spot price 100r kc = Interest rate p.a. in decimals, key currency 5.00%r cc = Interest rate p.a. in decimals, counter currency 0.25%B kc = Calculation base for the key currency (360 or 365) 360B cc = Calculation base for the counter currency (360 or 365) 36039

FOREIGN EXCHANGE OPTIONWhat is a foreign exchange option?With the purchase of a foreign exchange option, the buyer acquires the right, but not the obligation, to buy(call option) or sell (put option) a specific amount of a foreign currency at a rate fixed when the transactionis concluded (base price or strike price).The buyer of an option pays the seller (writer of an option) an option premium for this freedom to choose.The amount of this premium depends onnnnnthe chosen strike price,the term,the volatility of the exchange rate, andthe spread in interest rates between the two currencies.The premium costs for the purchase of a foreign exchange option are always higher than the hedge costs of acomparable forward exchange transaction. The added costs of the foreign exchange option are the price paid toensure that there is still a chance of earning a profit despite rate hedging. If one chooses the current forward rateas the strike price of the option, then the additional costs correspond exactly to the amount of the premium.Compared to the forward exchange transaction, the foreign exchange option offers the advantage thatnthe buyer of an option can choose the strike price at the conclusion of the transaction, andnthe buyer of an option has the choice at the expiry date to exercise his right or – if the spot price isbetter for him – to let it expire.Determinants of a foreign exchange optionn Term: from 1 day to 5 yearsn Currencies: all freely convertible currenciesn Strike price: the exercise price of the optionn Option premium: in BIPS of the exchange rate or percent of the domestic currency dependingon the market situation and the strike pricen Barrier price: additional price specification with respect to an exotic option which makesan option contract valid or invalid40

Types of optionsPlain vanilla options:Options of the so-called first generation (call and put options).Exotic options:Options of the second, third, and fourth generation, which, in additionto the aforementioned determinants, are also characterised by additionalparameters such as barriers, triggers, or payouts defined in advance.An option can either be a European option, which can only be exercised on the expiry date, or an Americanoption, which can be exercised anytime during the entire term until the expiry date and is generally somewhatmore expensive.Risk parameters of optionsThrough changes in the fundamentals (spot price, term, swap rates, and volatility) the option premium alsochanges. These changes can be calculated with the following parameters.Delta: Expresses to what extent the price of the option changes if the spot price of the underlying currencypair changes. The largest risk of option price change is that the spot price will change.Gamma: Expresses the change in the delta in the event that the spot price changes and is thus anindication of the price sensitivity of the option.Vega: Is the measure for the change of the option premium in the event that the volatility changes.Theta: Shows the change in the option premium with respect to decreasing term length if all otherfundamental factors remain constant.Termination of a foreign exchange optionis possible at any time via counter-transaction.41

ApplicationsThe applications for foreign exchange options and structures for the importers and exporters are describedbelow.The importerThe exporterpurchases a foreign currency call option:Thus he acquires the right to buy a currency atthe strike price chosen by him (exercise price).He has the choice of exercising his right or – if thespot price is lower than the strike price – of lettingit expire. For this, he pays an option premium inEUR or foreign currency at the time the transactionis concluded.purchases a foreign currency put option:Thus, the exporter acquires the right to sella currency at the strike price chosen by him(exercise price). He has the choice of exercisinghis right or – if the spot price is higher than thestrike price – to let it expire. For this, he pays anoption premium in EUR or foreign currency atthe time the transaction is concluded.sells a foreign currency put option:The importer is obligated to buy a currencyfrom the bank at the agreed strike price. Thebank - and not the importer – can choosewhether to exercise the option. If the spot pricefalls below the strike price, the bank will sell thecurrency to the importer at the strike price. Ifthe spot price rises, the bank will not exerciseits option; i.e. the importer has an upwardlyopen unsecured price risk. The importersells a foreign currency call option:He hereby undertakes to sell a currency to thebank at the fixed strike price. The bank - andnot the exporter – can choose whether toexercise the option. If the spot price rises abovethe strike price, the bank will call the currencyfrom the exporter at the strike price. If the spotprice falls, the bank’s option will not be utilised;i.e. the exporter has a downwardly openunsecured price risk. The exporter receives the42

eceives the option premium credited to hisaccount at the time the option is concluded.option premium cred-ited to his account at thetime the option is concluded.OPTION STRUCTURES AND STRATEGIESThe combination of a varying number of options permits a wide variety of possible applications. On the onehand, one can compensate an existing foreign currency risk; on the other hand, there is also the possibility ofexposing oneself to currency risk in order to profit from certain market situations through the conscious useof options. The risk can also be variously structured with options and quite consciously controlled.Zero-cost strategies for hedging against price fluctuationsZero-cost strategies are a popular variant for hedging foreign currency risk. The hedging is accomplishedhere for the importer through the purchase of a foreign currency call option and the simultaneous sale of aforeign currency put option in order to cover the costs of the purchase of the call option. The exporter sellsthe call and buys the put. Thereby, neither premium expenses, nor premium gains are incurred.The cylinder option (risk reversal)The importer purchases a foreign currency call option and sells a foreign currency put option. This results in aprice range. The call hedges above this range. The put is utilised below this range, whereby potential price gainsare limited by the exercise price of the put.Principally: The hedging side is purchased and the financing side is sold.43

The structure for the importer:The structure for the exporter:Ratio-spread optionThis is also a zero-cost strategy that arises from the combination of the purchase/sale of call options and thesale/purchase of put options. Of course, the value amounts of both options vary here. The fundamental ideahereby is the hedging of a transaction and the specification of a sale price at which a potential future transactionor the total volume of a period can be settled. The concluded underlying prices can serve as the calculationbase for the year as a whole.There are two possibilities.Full hedging:The purchase of the entire amount on thehedging side; simultaneously, an even largeramount is sold on the risk side to finance theoption.Partial hedging:The purchase of a partial amount on the hedgingside and simultaneous sale of a larger amounton the risk side.44

Participating optionThe participating option is the reverse of the ratio-spread option. In this scenario, 100% of the hedgingamount and a smaller amount on the risk side are traded.Spread optionA spread option consists of 2 of the same options (2 calls or 2 puts) with different strikes, whereby oneoption is sold and the other is purchased. Call spreads and put spreads are thereby differentiated. Here aswell, a price range is created.Additional option strategiesStraddle and strangleStraddle and strangle are trading strategies that either focus on increasing volatility in the market (purchase)or a decrease in volatility (sale). Both cases involve the purchase of both a call and put option or the sale ofboth a call and put option. The difference between straddle and strangle is that the strike price of the call andput are the same in a straddle and different in a strangle.ExampleStraddle purchase:Purchase of call Strike 100 Premium 2Purchase of put Strike 100 Premium 2Total premium to be paid 4Strangle sale:Sale of call Strike 102 Premium 2Sale of put Strike 98 Premium 2Total premium received 4In this case a profit is made when the pricesmove strongly in one direction or the other.Here, the premium is earned as maximumprofit when the prices fluctuate between thestrike prices.45

Exotic optionsHere as well, new and ever more complex types of options are being created almost daily. The mostimportant, however, are:nnnnnnnnBarrier optionsStep payment optionsDigital optionsAverage rate options (Asian options)Compound optionKnock in forwardForward extra plusOutright switchBarrier optionsAs opposed to the standard options, these options have one or more price specifications – so-called barriersor triggers. Depending on the type of option, exotic options become valid or invalid when one or more triggerprices are reached. For this reason, these options are generally less expensive than standard options.All of the previously cited strategies are naturally not only feasible with plain vanilla options, but also with barrieroptions. With respect to strategies for hedging foreign currency risks, principally, the barrier should neverbe set on the hedging side.Single barriersKnock out/Reverse knock outThese options expire if the barrier price was traded once during the entire term. The difference between aknock out and a reverse knock out is that the barrier is set “in the money” in reverse knock outs; that is, theoption has an internal value if it is “knocked out”.46

ExamplePurchase call option strike 100 Barrier: KO 96.00 Purchase call option strike 100 Barrier: RKO 108The illustration on the right shows the clear increase in loss after reaching the barrier and the resultinginvalidation of the hedging transaction. In contrast, the knock out price in the illustration on the left is alwayswithin the profit zone of the underlying transaction and thus offers the possibility of reacting to the new situation.Knock in/Reverse knock-in optionsThese options become valid only after the barrier is reached during the term. If it is not reached, the optionhas no value.ExamplePurchase call option strike 100 barrier: KI 96.00 Purchase call option strike 100 RKI 10847

European and American barriersWith respect to barrier options, there is a difference between European and American barriers. The differenceis that the European barriers only apply on the last day, whereas the American barriers apply during the entireterm. The purchase of an option with a European barrier is therefore more expensive.Strategy: the “knock in forward”The importer purchases a foreign currency call option and sells a foreign currency put option; both optionshave the same exercise price, but the put has a reverse knock in. This is also a zero-cost variant of hedgingby which, however, the exercise price is somewhat above the comparable forward rate. But it offers additionalpotential for profit as long as the price never reaches the knock in price during the term, because the traderprofits from continually falling prices until the barrier is reached.ExampleThe forward rate on 3 months is 103Hedging with knock in forwardis possible at 104:Purchase of call Strike 104 Premium -2Sale of put Strike 104 RKI 98 Premium 2Total premium: 0Term: 3 monthsAt expiration date:Price > 104Hedged by purchase of call at 104Price < 104 and > 98free conversion in the marketPrice < 98Conversion at 104 via sale of putDouble barriersDouble knock in or double knock outThese options have two barriers and become valid or invalid when either of the trigger prices is reached.48

Step payment optionsAs with the conventional standard options, the step payment option offers full hedging against pricefluctuations. They are different from standard options in that no premium is paid when the transaction isconcluded. The premium is only payable in partial amounts when certain steps are reached. Where thesesteps lie and how many there are is determined when the purchase is concluded.A step payment option offers the purchaser the opportunity to receive the hedging benefit for less money ifnone or not all of the steps are reached.ExampleExpectation of increasing prices with hedging via purchase of call.Purchase call option strike 105Term 3 monthsPurchase step payment call optionStrike 105 term 3 monthsStandard call, price 150 basis points Step 1 103 70 basis pointsStep 2 102 70 basis pointsStep 3 101 70 basis pointsTotal210 basisIf the expectations of the buyer of the step payment option are confirmed and the prices rise immediately then hehas a 100% hedge at 105 without having to pay a premium for it. Not until the prices fall below 101 does this hedgingvariant become more expensive than the purchase of the traditional standard option.Digital optionWith a digital option, two currencies are notexchanged, but rather only payment of a fixedamount at execution – the so-called payout. Therisk here can also be calculated at the time of sale,since the loss in the event that the option goes “inthe money” is known in advance. On the purchaseside, the profits on the payout are limited.These options are predominantly implementedwhen no further foreign currency positions shouldbe entered to finance hedging, since only the payoutof a fixed sum is involved.49

Average rate optionWith this option, an average of prices during a specific period is calculated at specific intervals and comparedto a specified strike price. If the option is “in the money”, the difference on the amount of the option is paidout via cash settlement. This option is generally less expensive than the standard option.Compound optionThis is an option on an option. It gives the buyer the right to purchase an option at a price and time specifiedin advance. If the compound option ends “in the money” and is executed, a new option is created.Forward extra plusA forward extra plus is initially a full hedging transaction with an exercise price that is worse than thecomparable forward exchange rate. However, a barrier is also negotiated. When the barrier is reached, thehedge extinguishes and is replaced by a synthetic forward with a better exercise price. A synthetic forwardrepresents the risk profile and the obligation of a forward exchange transaction constructed with options. Thatis, after the trigger is reached, the fulfilment obligation exists at a more favourable level. The advantage of thishedging strategy is that, despite an existing security, positive price fluctuations can be taken advantage of up toa certain degree. With this variant, three barrier options, each with the same trigger level, are traded.Outright switchAn outright switch is shown as a forward deal and includes an obligation even at expiration. When thecontract is made, two forward rates are negotiated: A best case and a worst case rate. Additionally, a price rangeis negotiated within which the spot price can fluctuate during the term. If the outer edges of the price rangeare not touched during the term, the transaction is converted at expiration at the better price. In the worsecase – that is, if the outer edges of the price range are touched or crossed at even just one point – the worstcase price takes effect. The best case price lies above the normal forward exchange rate, whereas the worstcase price lies below it. This strategy can also be calculated on a zero-cost basis.50

Knock in / Knock out optionOne of the most frequent forms of exotic option strategies is the so-called KIKO (knock in / knock outoption). This option strategy is among the most popular, because it is particularly well-suited to generate apremium (sale via the customers). KIKOs are primarily concluded with a term of 1 to 12 months. They can betraded in all freely convertible currencies and are usually encountered in combination, e.g. EUR IRS withCHF-link (here, the customer is hedged by a fixed rate for his financing below market level and enters intoCHF-financing only in the so-called “worst case”).ExampleOptimisation of EUR-financing via KIKOThe customer sells a EUR/CHF put – KIKO with the following parameters:Strike: 1.6500, Knock out at 1.6600 and Knock in at 1.6200 for a 6-month term and immediatelyreceives a premium of 1.50%.Possible scenarios at expiry date:EUR/CHF trades for 6 months between 1.6200 and 1.6600: the option becomes invalid and thecustomer has earned a 1.50% premium.EUR/CHF trades during the 6 months once at 1.6600: the option immediately becomes invalidand the customer has earned 1.50% premium.EUR/CHF trades once at 1.6200 and– once at 1.660: the option becomes invalid.– at the end of the term over 1.6500: the option becomes invalid.– at the end of the term below 1.6500: the option is exercised, i.e. the customer switches hisEUR-financing to a CHF-financing and profits from the better CHF-financing interest rate.In each case, however, the customer earns the 1.50% premium.51

52>> Managing commodity price risks allows for more reliable „planning and helps companies keep their competitive edge.“

with regard to the fixing of prices of commodities, since storage costs, fixed interest rate costs andinsurance costs as a rule lead to commodities sold for future delivery being more expensive than thosesold on the spot market. One would therefore expect that the futures markets for commodities wouldalways be in a state of contango and that the forward price would be higher than the spot price. Thispositive difference would correspond to the interest expenses that would be necessary for the financingof the purchase.Unlike other financial assets, such as shares or bonds, commodities futures do not, however, commandregular interest earnings or dividends. A commodities producer knows, however, with a high degree ofcertainty how much a mine or an oil field can produce in a month, six months or two years, and thereforesells off part of this production for future delivery. Moreover, banks which grant loans to commoditiescompanies often demand that the production for coming years is sold either partially or fully on futuresmarkets in order to ensure that loan repayments are secured.Due to these conditions, forward prices can occur that are lower than the current spot prices. Abackwardation of the commodities markets is a very frequent phenomenon. For example, over the last20 years the copper market has spent approximately 50% of the time in a state of backwardation, andthe oil and sugar markets have even been in a state of backwardation for 59% of the time since 1987.Commodity management instrumentsVBAG’s Group Treasury division has expanded its range of products and is now also actively involved incommodity trading. Traded commodities will soon be offered on an over the counter (OTC) basis in thisbroad area of activity.This means that no market-traded commodities products (such as futures) are available at the moment. Inaddition to precious metals, the commodities described hereafter from the base metals and energy sectors canalso be traded.nBase metals (product specifications)For all individual products in the base metal group both commodities futures trades as well as “plain vanilla”options are offered. Generally, the products from this commodities sector are not settled by physicaldelivery, but are fulfilled by means of equalisation payments in the form of a “cash settlement“.Base metal commodity trades in international trade are carried out using average prices. In order todetermine the relevant average price required for striking a hedge, the LME’s (London Metal Exchange)daily fixings are used. On the striking day an average price (simple weighted average) is formed fromthe daily fixed prices for the entire term. This price is compared with the forward price for a futures tradeor the strike price of an option on the due date. In the event that exploitation occurs from the option,the difference between the average price and the strike is balanced in favour of the purchaser of theoption. In futures trades an equalisation payment based on the difference between the originally agreedforward price and the fixed average price is always made, either in favour of or to the detriment of thecustomer.54

Product rangeBase metal futures trades * )Table 1Abbreviation Description QuotationAlu Aluminium EUR and USD(LME primary aluminium)Per metric tonCu Copper EUR and USD(Goods class A COMEX)Per metric tonNi Nickel EUR and USD(LME first class)Per metric tonSn Tin EUR and USD(LME)Per metric tonZn Zinc EUR and USD(LME special high grade)Per metric tonBase metal options * )Table 2Abbreviation Description QuotationAlu Aluminium EUR and USD(LME primary aluminium)Per metric tonCu Copper EUR and USD(Goods class A COMEX)Per metric tonNi Nickel EUR and USD(LME first class)Per metric tonSn Tin EUR and USD(LME)Per metric tonZn Zinc EUR and USD(LME special high grade)Per metric ton*) Group Treasury also offers hedging solutions for smaller volumes.nProduct specifications from the energy sectorFor energy sector products, futures trades and plain vanilla options are offered. As with base metals,transactions for these products are also only carried out on the proviso of there being a cash settlement.For energy sector commodities, other providers of prices apply for determining possible payments fromtransaction hedges. Futures trades are compared with the daily PLATT fixing (the official fixing by themarket maker is published by the PLATT agency) on the due date and balanced accordingly. Options areexercised in a very similar manner. The PLATT fixing for the striking date is consulted, in order todetermine whether exploitation has occurred or not. In the event of a strike, the difference between thestrike price and the fixing on the striking date is calculated accordingly in favour of the purchaser of theoption. In the case of futures trades there is once again always an equalisation payment based on thedifference between the originally agreed forward price and the fixed average price, either in favour of orto the detriment of the customer.55

Energy futures trades * )Table 3Abbreviation Description QuotationOil Brent Crude USD or EURper BarrelDiesel 1 ulsd 10 ppm cif fob barges USD or EURrotterdamper metric tonDiesel 2 ulsd 50 ppm cif USD or EURnorth west europeper metric tonHeating oil heating oil USD or EURper metric tonKerosene Jet kerosene fob barges USD or EURrotterdamper metric tonNatural gas Multi component product USD or EURper m 3Electricity power eex USD or EURper kilowatt hourEnergy options * )Table 4Abbreviation Description QuotationOil Brent Crude USD or EURper BarrelDiesel 1 ulsd 10 ppm cif fob barges USD or EURrotterdamper metric tonDiesel 2 ulsd 50 ppm cif USD or EURnorth west europeper metric tonHeating oil heating oil USD or EURper metric tonKerosene Jet kerosene fob barges USD or EURrotterdamper metric tonNatural gas Multi component product USD or EURper m 3Electricity power eex USD or EURper kilowatt hour*) Group Treasury also offers hedging solutions for smaller volumes.In order to secure commodities trades in the mid-term, various price changes can be effectively bridged by“hedging“. Relevant hedging instruments always manage the current price volatility with the aim of producingnot estimated prices, but fixed prices and contracts for commodities. As a result, the reliability of the strategicand operative planning and the cost control in the company is increased. This method is particularly suited forcommodities traded on the LME (London Metal Exchange) and can be individually applied. As the forwardprices for commodities are not determined by interest rate differences, they reflect the market expectation ofa possible future development in prices.56

58>> Methodical risk management is critical „in a rapidly changing financial arena.

RISK MANAGEMENTEvery company is forced to take risks whilst carrying out its business activities. The difference betweensuccess and failure often depends on correctly judging the risk involved in a single deal, transaction orbalance-sheet item – what risk can be taken, and to what extent? – and on the targeted risk managementbased upon this.The dynamic nature in which the world is developing is increasing the degree of uncertainty. Globalisationis creating new opportunities and risks. New technologies are accelerating business, whilst, however, alsoleading to ever quicker decision making and often to the radical transformation of organisational structuresand patterns of behaviour. The price of acquiring modern technology is often considerable, whilst itsworking life, on the other hand, is short due to the prevailing rapid speed of development. In addition,increasing concentrations of value and the dependency on highly developed and sensitive technical systemsincrease the company’s vulnerability. Strategic decisions and the results they lead to are therefore influencedby all kinds of risk. Such decisions force the management of companies to make decisions that were hithertothe domain of banks and insurers: those of methodical risk management.It is essential that the risk be identified on the one hand and then, inseparably related to this, quantified,in order to then be in a position to make the right decisions, realise business plans, and to evaluate theachieved results and secure the financial outcome for the company.The risks with which companies are confronted during day-to-day business are of a diverse nature.Sometimes it is at least possible to identify the risk, but then considerable problems are revealed duringthe quantification process. In the financial sector a methodology has existed for approximately a decade thathad previously proved successful for specialists, whereby risk can be quantified in a relatively simple manner.The development first started in 1994, when the controlling department of the international investmentbank, J.P. Morgan, began to summarise the bank’s total risk. It was used to bring interest rate risks, foreignexchange risks, stock risks and commodity risks down to a common denominator. The result was thesystem of “value at risk“. This concept lead to a single figure, which gave the investment bank’s controllingdivision information about how high the maximum loss from all positions per day would be with a certaindegree of probability.The concept of value at risk, which forms an estimate for the possible losses under normal marketconditions, has since developed into an internationally-used benchmark. The financial informationmentioned in the chapters on “Interest Rate Management” and “Currency Management” has pointed outa large selection of instruments that are required to control risk. The aim of this chapter is to explain riskanalysis and the quantification of risk, and to give indications about the associated risks for targetedmanagement of that risk.59

RISK ANALYSIS AND RISK BEARING ABILITY OF A COMPANYWhat is risk?The term risk is particularly common in the financial sector. The fact is, however, that there is no precisedefinition of risk. Risk is mainly associated with uncertainties and opportunities for loss as well as results thatdeviate from preconceived expectations. It remains open as to whether these risks have been entered intoconsciously or not.How much risk can a company enter into?Generally speaking, the risk bearing ability is the ability of the company to be able to sustain losses from risksentered into, without becoming insolvent. There are no precise figures for this, only basic approaches. One ofthese basic approaches states that the risk bearing ability should be relative to certain key figures for thecompany. In practice profit on ordinary activities, cash flow, EBITDA or level of own funds have served asindicators of this. Relationships between these values must be determined on an individual basis and aredependent on the company management’s disposition towards risk. Furthermore, operative risks, businessrisks and ratings risks must be taken into consideration.THE AIM OF RISK MANAGEMENTEfficient risk analysis increases the company management’s room to manoeuvre and the company’s risk bearingability. The aim of risk management is therefore to control existing risks and risks that may turn up in the futurein such a manner that the value of the company is increased because the risks have been decreased withoutinhibiting the yield opportunities, and ensuring that the risk position does not exceed the risk bearing ability.PHASES OF RISK MANAGEMENTIdentification of risks, sources of risksGenerally there are two types of risk:a) Internal risks/operative risksb) External risksOperative risks can only incur losses, never profits. Typical internal risks are events such as fires, explosions,water infiltration, staff accidents, damage to machinery, liability issues etc.External risks are the opposite of internal risks. Current and interest rate risks fall under this category. Theyare of a speculative nature and contain both elements of the chance to make a profit, as well as the danger ofmaking a loss. External risk, as a rule, is associated with all future-oriented business decisions and can thereforebe directly deduced from the company’s aims. In this instance, the risk of losses from external risks is of theutmost interest.60

How easily can this risk be eliminated? Does an exporter, who invoices in his domestic currency for the saleof his goods abroad, eliminate the external risk? The answer is no.The passive or indirect foreign currency risk still exists. In the event that his own currency rises against thecurrency used in the country he is exporting to, then the exporter’s goods become more expensive, and heis less able to compete. In actual fact the exporter relinquishes the risk and the management of the currencyfluctuation to his customer. However, the customer does not have to hedge against it; instead he can choosefrom offers from different currency areas.RISK QUANTIFICATION/VALUE AT RISKThe most well known key figure for risk is the value at risk (VaR). The result is always a single figure in the formof an absolute magnitude, which states how large the possible financial loss from assets can be before countermeasurescan take effect. The value at risk can relate to a single financial instrument, such as a single stock ora commodity, or to an entire portfolio of financial instruments. A VaR statement like “the possible loss couldbe EUR 2 million” would, however, not be very helpful. A limitation with reference to the time frame andprobability of the loss is also required.The complete value at risk statement would be: “With a probability of 99%, the maximum losssustained in the next 7 days will not exceed EUR 2 million.“For what period of time should the VaR be observed?This decision depends on how quickly counter-measures can become effective against the risk position. Thereis little sense in calculating the value at risk for an underlying for a single day, when it would take 5 days to balanceup a position. The value at risk analysis ought to always be applied to the periodof time that is necessary to resolve the position in question. For simple financial risks, such as foreign currencyrisks or stock portfolios, a holding period of one working day is generally reckoned with.Value at risk methods can also only measure quantifiable risks (e.g. financial risks like interest rate risks, foreigncurrency risks, commodity price risks), and not personal risks, political risks or operational risks. Thus, theactual challenge of risk management lies in also being able to evaluate these risks in the future using the VaRmethod.How is a value at risk statement formed?Let us take a look at the idea of the value at risk concept using a greatly simplified example. In thefollowing table, the fluctuations in value of a JPY credit portfolio over the last year are summarised.In order to give a clear overview, the fluctuations in value have been grouped into intervals and summarisedin terms of the frequencies of the individual ranges.61

JPY credit portfolio - period of observation 365 days (1 year)Daily change in EUR Days Days as percentage of total observation period+50.000 to +25.000 11 3.0%+25.000 to -0 169 46.30%0 to -25.000 175 47.95%-50.000 to -25.000 10 2.74%On 11 days, in the above example, the gain was between EUR 25,000 and EUR 50,000. For a large proportionof the period of observation, the gain or loss was between - EUR 25,000 and + EUR 25,000. Only on 10 daysin the year or 2.74% of the observation period was the loss greater than EUR 25,000.The assumption is now made that the past development is also representative for the future. Under thisassumption and from known data, the statement can therefore be deduced, that with a 97.26% probability theloss within 1 day will not be greater than EUR 25,000. After all, on 355 of 365 days, the loss from a single tradingday was less than EUR 25,000.The holding period of 1 day therefore emerges, as in the historical observation, the fluctuations in daily valueshave been observed for 365 days. If fluctuations in value had been observed on a weekly basis, then the valueat risk statement would apply for a week. This also reveals a problem with the historical simulation. In orderto obtain the same statement with the same degree of data integrity for a week, we would have required thehistorical data for the last 7 years. For a statement about how high the loss in a month would be, we wouldrequire data from the past 30 years.A degree of uncertainty always remains in value at risk statements (e.g. 100% - 97.26% = 2.74%). Thereforethe value at risk statements are frequently qualified with “under normal conditions”. If a value at risk is notgreater than EUR 25,000 for 97.26% of cases, what happens in the 2.74% of the cases that remain? Does theloss stand at EUR -25,500 or at EUR -1,000,000? Over the period of 1 year with 250 working days, thestatement also implies that on at least 7 working days the loss will be higher than the maximum expected lossof EUR 25,000.To answer this question, so-called “stress tests” are recommended, in which large historical fluctuations areentered into the equation.The “historical simulation“ works on the principle mentioned above regarding the measurement of value at risk.In the historical simulation, premises must be accepted that changes in risk factors (e.g. yields, interest rates andexchange rates) observed in the past are also relevant for the future. Put simply: What was the case in the past,will not change in the future. In very short holding periods e.g. of a single day, this assumption is unproblematicas a rule, and the volatility of the last 250 days can be viewed as being representative for another day. In thecase of longer holding periods or forecasts this statement becomes problematic.62

Monte Carlo simulation/Variance/covariance approachIf this premise is not acceptable, then it is necessary to resort to the Monte Carlo simulation or the variance/covariance approach (with assumed distribution). The Monte Carlo Simulation does not require any historical dataand works on only a few premises. However, this method is mathematically more demanding.The variance/covariance approach on the other hand has a considerable advantage over the historical simulation.Instead of long series of data containing historical observations, only two parameters - the mean value and thevolatility are required for the value at risk calculation. A requirement for using this model is a normal distributionof value fluctuations or returns of a stock or portfolio (normal Gaussian distribution or bell curve). The normaldistribution assumption is one of the basic premises for theoretical models for portfolios.The following parameters are required for the variance/covariance approach:nnnThe underlying’s current valueIts volatilityA factor which indicates the quality of the generated result (= the confidence level)The volatility factorWhat volatility is used for the calculation? For the holding period of one day, it is not necessarily essential toknow the daily volatility. The volatility can be statistically scaled up or down to fit the desired holding period.ExampleThe EUR/JPY volatility for a period of 1 year is assumed as being 15.0%.What is the volatility for a single working day?xd = Number of days for which the volatility should be calculated1Y = the annual volatility= The year is calculated as having 250 working daysVol p.a. Holding period Vol xd Price Possible loss15% 1 year 15.00% 100 15.0015% 1 day 0.95% 100 0.9515% 5 days 2.12% 100 2.1215% 10 days 3.00% 100 3.0015% 20 days 4.24% 100 4.2415% 30 days 5.20% 100 5.2063

However, we still do not have a statement regarding the quality, and thereby the reliability of this figure. Theso-called Z score represents this factor - the confidence level.The Z scoreThe Z score is a statistical measure, the quantile of probability, and provides information about the accuracy ofa statement. It results in statements along the lines of: “With X% probability the loss will not be greater thanY%.” The Z score can be calculated for any degree of probability. In Excel the formula is:z=standard deviation (figure in percent)Since we have ignored the Z score in the calculations, we can say z=1. The value 1 corresponds to a probabilityof 84.13% (see table below). The various probabilities are placed into the formula, and yield the scorescalculated in the table.Quality of the statement in % Z score66% 0.4125 a reliability of 66%70% 0.5244 a reliability of 70%75% 0.6745 a reliability of 75%80% 0.8416 a reliability of 80%85% 1.0364 a reliability of 85%84% 1.0000 a reliability of 84%90% 1.2816 a reliability of 90%95% 1.6449 a reliability of 95%99% 2.3263 a reliability of 99%For the example above, this means that the probability is only 84.13% that the loss from the analysed JPYcredit portfolio will not exceed 1.5% in a year.In order to reach a certainty of 90%, the formula must be completed using the Z score of 90% i.e. 1.2816.64

ExampleJPY creditCurrent price 100.00Annual volatility 15% (z=1)Price * Volatility * z = VaREUR/JPY price Volatility per year Possible lost per year in JPY100 15.00% 15.00There is an 84% probability that the loss from this JPY commitment will not be greater than 15% in one year.EUR/JPY price Volatility per year Z Possible lost per year100 15.00% 1.2816 19.224There is a 90% probability that the loss from this JPY commitment will not be greater than 19.22% in one year.CorrelationsWhat does a mixed portfolio consisting of several values look like?Credit portfolioCurrency Holding in % Volatility 30 days Z Possible lossJPY 33.3% 15% 1 5%CHF 33.3% 3% 1 1%USD 33.3% 11% 1 4%There is a probability of 84% that the total risk does not exceed 10%There is an 84% probability that the currency loss from the above credit portfolio will not exceed 10% with in thenext 30 days.65

This simple equation neglects the portfolio effect. If there are also stock holdings or commodities present, then thisfigure would assume an enormous scale. However, all kinds of financial instruments or currencies display a certaincorrelation towards one another. If the EUR falls in value against the JPY, does it also fall against the USD? Whateffect does this have on CHF interest rates?The correlation shows the connection between two financial instruments. In the event of their being a positivecorrelation between value A and value B, then synchronisation in the performance can be expected. A negativevalue hints at opposing performance.The correlation matrix below shows a negative correlation of the CHF against the JPY and the USD. If the EURfalls against the JPY, it should gain against the CHF and vice versa. If the EUR falls against the USD, then it also fallsagainst the JPY and rises against the CHF.Example for correlations to the EUR (observation period 250 working days)EUR/USD EUR/JPY EUR/CHF EUR/HUF EUR/PLN EUR/GBP EUR/CZKEUR/USD 100%EUR/JPY 60% 100%EUR/CHF -55% -13% 100%EUR/HUF 12% 9% -3% 100%EUR/PLN 40% 24% -17% 36% 100%EUR/GBP 44% 17% -13% 13% 32% 100%EUR/CZK 9% 12% 5% -16% 2% 2% 100%66

CALCULATION OF THE CORRELATED VALUE AT RISKAs already mentioned, in the first instance, the volatilities of the risk parameters to the home currency for acertain period of time are calculated.Step 1: Determining the market and value volatilities:Market volatilities per yearVolatilitiesUSDEUR/USD 11%EUR/CHF 3%EUR/JPY 15%Multiplication by the existing sum at risk gives the value volatility, the sum of which then gives the uncorrelatedVaR.Volatilities USD CHF JPY TotalAmount of credit in EUR 3,000,000.00 3,000,000.00 3,000,000.00 9,000,000.00Amount of credit in % 33% 33% 33% 100%Volatilities 11% 3% 15%Value volatility 330,000.00 90,000.00 450,000.00 VaR unkorrZ = 90% = 1.2816 422,911.76 115,339.57 576,697.86 1,114,949.19Value of volatility with 90% probabilityIn the second step, the correlations are determined.Step 2: Determination of correlations:Correlation to EUR EUR/USD EUR/CHF EUR/JPYEUR/USD 100%EUR/CHF -55% 100%EUR/JPY 60% -13% 100%67

The calculation of the correlated VaR is done using the following variance/covariance method formula.Calculation of the correlated value at risk:VaR p = Value at risk of the portfolioVaR n = Volatility values of the components of the portfolioC n = Correlation coefficients of the components of the portfolioValue vol USD 2 108,900,000,000.00Value vol CHF 2 8,100,000,000.00Var USD 2 202,500,000,000.002* Corr EURUSD/EURCHF* Value vol JPY* Value vol CHF 32,670,000,000.002* Corr EURJPY/EURUSD* Value vol JPY* Value vol USD 178,200,000,000.002* Corr EURCHF/EURJPY* Value vol USD* Value vol CHF 10,530,000,000.00Total 454,500,000,000.00Square root = VaR 674,166.15Z = 90% = 1.28155079437419 863,978.17VaR correlated 863,978.17The individual value volatilities are squared and connected to one another with the respective correlations.The sum of the risk factors is multiplied by the confidence level.The square root of the sum gives the correlated value at risk.The risk position improves enormously even in a simple credit portfolio when the correlations are taken intoconsideration. Finding the optimal portfolio is therefore only a question of optimising the portfolio.The volatilities and correlations of the major currencies can be found in Group Treasury’sMorning Mail.THE PATH TO AN OPTIMAL PORTFOLIOThe volatilities and correlations have been determined. We have also found an initial value for the value at riskof our portfolio.Next we want to improve this value by restructuring the portfolio. Based on the above data, a simple exampleshows: With a foreign currency portfolio that is equally distributed with each currency forming 1/3 of theportfolio, we have a VaR of EUR 879,493.12.68

The worst risk value would be on a 100% JPY financing, namely EUR 1,691,647.05.Total Volumes EUR 9.000.000,00 VaRJPY CHF USD33% 33% 33% 879,493.12100% 0% 0% 1,691,647.050% 100% 0% 422,911.760% 0% 100% 1,550,676.465% 75% 20% 467,924.0115% 85% 0% 277,510.4520% 40% 40% 802,705.1540% 40% 20% 782,061.0640% 20% 40% 1,045,230.19The final result of the VaR analysis would be:Currently the possible loss per day with a probability of 90% does not exceed EUR 858,993.78. This is 8.59% of thetotal credit portfolio. By restructuring the USD and JPY loans and stocking on CHF loans, the risk could be minimisedso that the statement reads:There is a 90% probability that the loss per day will not exceed more than EUR 277,510.The best distribution can be obtained, on the basis of the volatilities and correlations quoted in the example, if15% is financed in JPY and 85% in CHF.STRENGTHS AND WEAKNESSES OF THE MODELWith 90% probability the loss will not exceed a certain amount. A probability of 90%, however, meansthat a working year of 250 working days presupposes that on 25 days the loss will be higher than theamount assumed above of EUR 277,510.00. However, we do not know what the values beyond the 90%threshold are.The stress tests that have already been mentioned should also help to keep these situations under control. Asimple way of carrying out a stress test is to save the market data on eventful days (Asian crisis, stock marketcrash, catastrophes) and to use them in the actual portfolio, in order to see how it then reacts.The largest problem with “crash scenarios”, apart from the soaring rise in volatilities, is the divergence in theoriginally set correlations.All told, the VaR concept can be deployed without a great deal of effort, and offers the opportunity toevaluate the total risk of a portfolio, no matter how large. The system has proven itself and is generally used bybanks, investment banks, insurance companies etc. to control risk. Provided that the necessary degree ofattention and caution is displayed, a VaR examination offers every company the possibility to use risk managementto take advantage of the opportunities present in the market.69

GLOSSARYACT/ACT The day count convention of calculating accrued interest. Annual calculation based on the actual numberof days (normal year 365, leap year 366 days).ACT/360 Actual number of days/360. Day count convention of calculating accrued interest. The year is assumed tohave 360 days.AMERICAN OPTION The buyer can exercise an option at any time within a pre-determined period of time afterthe purchase of the option. Opposite: European option.ANNUALISED PREMIUM The premium is spread out over several years according to actuarial principles.ARBITRAGE Exploiting regional or international price/rate differences of the same financial instruments (e.g. securities,foreign exchange, banknotes) whereby these instruments are bought on the market that has the lowest prices/rates andsold again on the market with the highest prices/rates. Arbitrage can also take advantage of differences in interest ratesto increase profits (interest arbitrage).ASSET-SIDE MANAGEMENT Management of asset-side balance-sheet items, i.e. to reduce the interest-rate risk.ASYMMETRICAL RISK DISTRIBUTION When purchasing an option, the potential loss is limited to the amountof the option premium but the potential gain is unlimited. Vice versa when the option is sold, i.e. the risk is distributedasymmetrically (e.g. with interest options such as caps and floors). Opposite: Symmetrical risk distribution.AVERAGE RATE OPTION With this option an average of the rates is calculated at certain points in time during acertain period of time and then compared to a given strike price.BACKWARDATION Term used in commodity futures markets. In this case today’s spot price is higher than theforward price.BARRIER Additional specification for exotic options. Results in the premature deactivation (knock out) or in theactivation (knock in) of an option.BARRIER OPTION European call or put option that is either activated or deactivated when the spot price/rate(barrier) is reached that was determined when the option was purchased. Accordingly, one differentiates betweenknock-in and knock-out options.BASIS RATE SWAP Special type of interest-rate swap in which two variable streams of interest payments areexchanged.BID PRICE/RATE The price/rate at which foreign currencies, securities etc. are purchased from banks. From thecustomer’s point of view, the bid price/rate is equivalent to the selling price/rate. Opposite: Offered price/rate.BIP Point of the last decimal place in a foreign exchange rate.BOND BASIS Interest calculation based on the 30/360 or act/act conventions.BP basis point; 1 bp = 0.01 percentage points.71

CALL OPTION Is the right to buy that is related to a defined underlying instrument. Opposite: Put option.CAP Contractual agreement about the upper interest-rate limit for a specific amount of capital against payment of a oneofffee (cap premium). Opposite: floor.CAPLET Portion of a cap referring to a variable interest-rate period.CASH OUT Premature termination of a forward rate agreement or an interest-rate options contract whereby theclaims are mutually offset based on current market prices.CASH SETTLEMENT In this case, there is no purchase/sale of the underlying instrument when an option is exercised.Instead, the differential amount between the agreed price (strike price) and the current market value (market price) ofthe underlying is determined and paid out.CHOOSER CAP Contractual agreement on a rate ceiling for a specific amount of capital in return for payment of aone-off fee (cap premium); the choice is limited to a certain number of interest periods.COLLAR The simultaneous purchase of a cap and the sale of a floor. The goal of this instrument is to secure a certainfluctuation range of the interest rates within a certain set maximum and minimum.COMPOUND OPTION An option on an option.CONFIDENCE LEVEL Confidence interval In the value at risk concept, the confidence level denotes the probabilitywith which a potential loss will lie within a certain interval which is shown as the value at risk. See value at risk.CONSTANT MATURITY SWAP CMS. A special form of interest-rate swap where at least one swap partner paysa variable swap rate with a constant maturity that is periodically reset (e.g. semi-annual adjustment to the 3-year swaprate). The second swap partner, on the other hand, can pay either a variable rate (e.g. 6-month EURIBOR) or a fixedrate.CONTANGO Term used in commodity futures markets. In this case today’s spot price is lower than the forward price.CONVERSION The exchange of one currency into another.CORRELATION Measures the degree to which two or more underlyings move, as a reaction to a predeterminedevent, in the same direction. Correlations are indicated on a scale of minus one to plus one. It the prices of twoinvestments move continuously in the same direction they are perfectly correlated and have a grade of plus one on thescale or minus one if the opposite happens.CREDIT FORWARD A bank makes an agreement with a company to provide a loan at a later date at an interestrate that is agreed upon in advance. Such a structure holds two risks for the bank, the credit risk and the interest raterisk.CURRENCY SWAP Agreement between two contracting parties to exchange capital and interest payments over aspecific period in different currencies.CYLINDER OPTION With this option strategy, for example, an importer buys a foreign currency call option andsells a foreign currency put option. This gives him a certain range, above which he is protected by the call option. If therate drops below this range, the put option will be exercised, limiting possible gains to the strike price of the put.72

DELTA The delta refers to how much the price of the option changes when the spot rate of the underlying currencypair changes.DERIVATIVE Derivative instrument. A financial instrument that is not shown on the balance sheet and is thereforenot an asset but rather is derived from an asset. Its valuation is mainly based on the price/.ate, price/rate volatility andprice/rate expectations of the underlying instrument (such as shares, bonds, foreign currencies, and indices). The mostcommon derivatives are swaps, options and futures.DIGITAL OPTION In the context of interest-rate and currency management, a digital option (or binary option) iswhen a fixed amount, the so-called payout, is paid instead of exchanging the two currencies.DOUBLE BARRIERS Options with two additional trigger prices/rates.EONIA Euro Over Night Index Average. Since 4 January 1999, the European Central Bank has computed this averagerate based on effective transactions in the interbank market. It is calculated according to the act/360 day count convention.The calculation is done at the end of the day and takes the effect of compound interest into consideration by using theeffective interest-rate formula.EURIBOR European Interbank Offered Rate. Officially published mean interest rate at which the banks in the EUlend each other money.EUROPEAN OPTION The buyer can only exercise this option on an agreed expiry date. Opposite: Americanoption.EXERCISE PRICE The price at which the underlying instrument (e.g. a share, currency, index) can be purchased (inthe case of a call) or sold (in the case of a put).EXOTIC OPTION Options of the second and following generations that are characterised not only by theirdeterminants, but also by additional parameters such as barriers and payouts.FINANCIAL FUTURE Collective term for a standardised futures contract that is traded on the stock exchange.FIXED INTEREST RATE Interest rate for debt instruments (credit, loans, bonds) that cannot be changed during afixed period of time (until maturity or during part of the term – the fixed interest period).FLOOR Contractual agreement on the lowest rate of interest payable for a predetermined amount of capital in returnfor the payment of a one-off fee (the floor premium). Opposite: cap.FOREIGN EXCHANGE FUTURE Agreement (obligation) to buy or sell a particular foreign currency amount ata later point in time. Any rate fluctuations that occur in the meantime are disregarded. The exchange rate agreed uponis the one used on the agreed day of exchange.FOREIGN EXCHANGE OPTION In purchasing a foreign exchange option, the buyer acquires the right, but notthe obligation, to buy (call option) or to sell (put option) a certain amount of foreign currency at a rate of exchangeagreed at the time of the transaction (the base or strike price).FORWARD EXTRA PLUS See exotic options.FORWARD RATE AGREEMENT FRA. Agreement between two contracting parties in which the interest rate isfixed for a future period in time and for an agreed nominal amount (no capital is exchanged).73

FORWARD/FORWARD See credit forward.FRA Forward Rate Agreement.FUTURE Listed contract standardised with regard to amount, quality and date of delivery in which an item traded inthe money, capital, precious metals or foreign exchange markets is to be delivered or purchased at the price/ratedetermined by the stock exchange. Frequently, in such contracts (for example, on the basis of share indices), a marginpayment is paid in order to meet the existing commitment (instead of a physical delivery or purchase of securities).FUTURES MARKET In the futures market, a deal is concluded for a later point in time, whereby the conditions arelaid down when the deal is contracted (e.g. exchange of foreign currency in six months at a future exchange rate that isfixed today or the purchase of securities with payment and delivery at a later date).FX Abbreviation for foreign exchange. Exchange of one (foreign) currency into another (usually a country currency).GAMMA Change in the delta when the spot price/rate changes. Used to measure how price-sensitive the option is.GREEK VARIABLES These variables are used to express how sensitively an option price reacts to the change in acertain influencing factor. They include delta, gamma and theta.HEDGING Procedure by which an existing risk item is neutralised by a countervailing transaction.HEDGING INSTRUMENTS General term for financial instruments that are used to minimise risk. Usuallyderivatives such as options and futures.IMPLIED INTEREST PAYMENT CURVE The interest-rate curve expected in future by the market, i.e. byprofessional market participants.INTERBANK RATE The interest rate that banks charge each other for short-term borrowings (e.g. EURIBOR). Itis published for overnight money, weekly money and maturities of one, two, three, six and twelve months.INTEREST CALCULATION BASIS Tells you how the days are counted to calculate the interest. This is doneeither by the actual-number-of-days convention (act/360) or under the assumption of a 30-day month (30/360). Whiletransactions on the money market are usually calculated act/360, bonds in Europe are calculated with 30/360. Thedifferent calculation bases affect returns in particular on shorter terms and should therefore be taken into considerationin every yield comparison.INTEREST CALCULATION METHOD This refers to the method used to define the number of days on whichthe calculation of interest is based (act/act, act/360), as well as information about how often it is calculated and fixed(monthly, quarterly, semi-annually, annually).INTEREST STRUCTURE CURVE Graphic representation of the correlation between interest rates depending onthe terms to which they relate.INTEREST-RATE AND CURRENCY MANAGEMENT INSTRUMENTS Derivative financial instrumentsthat are used to actively manage interest-rate and currency risks (such as interest-rate swaps, currency swaps, ForwardRate Agreements, floors, swaptions, foreign exchange options, etc.).INTEREST-RATE CURVE In the money market and capital market, the graphic representation of yields for variousterms is called the interest-rate curve. A “normal” interest rate curve rises on a diminishing scale from the left (moneymarket) to the right (capital market).74

INTEREST-RATE FUTURES In finance, these are futures contracts whose underlying securities are money marketpapers and capital market instruments. Interest-rate futures contracts contain the contractual agreement to take over(buy) or deliver (sell) an interest-rate instrument whose term and interest rate have been specified in the contract (e.g.Austrian Government bonds) at a pre-determined price at a later, standardised due date.INTEREST-RATE OPTION The right to receive or pay a specified rate of interest at a specified time.INTEREST-RATE RISK Risk of a reduction in revenue or an increase in costs and a loss in value resulting from achange in interest rates.INTEREST-RATE SWAP Agreement between two contracting parties to exchange interest payments in the samecurrency over a specified period (without movement of funds). The agreement specifies the term, the nominal amountand the rates of interest to be exchanged. The nominal amount is not exchanged but rather is used to calculate theinterest amounts. Types: Coupon swap: A fixed interest rate is exchanged for a variable one (e.g. LIBOR, EURIBOR).Basis rate swap: Two variable interest rates are exchanged, e.g. 3-month USD LIBOR against US-CP composite rate.INVERSE INTEREST-RATE STRUCTURE An inverse interest-rate structure occurs when long-term interestrates are below short-term interest rates in at least one portion of the interest-rate curve.IRS See Interest-Rate SwapISDA AGREEMENT A master agreement for OTC financial derivatives provided by the International Swaps andDerivatives Association. It comes in various versions and provides a contractual foundation for derivative financialinstrument transactions between two parties.KEY INTEREST RATES are used by the European Central Bank (ECB) to control the money supply. By loweringthe key interest rates commercial banks can borrow money from the central bank less expensively. Since 1 January1999 the ECB’s key interest rates have been the rate for the main refinancing operations, the deposit facility rate andthe marginal lending facility rate.KNOCK IN FORWARD Options strategy for hedging foreign currency deals.LIABILITY-SIDE MANAGEMENT Management of liability-side balance sheet items oriented towards profit andliquidity.LIBOR London Interbank Offered Rate. Interest rate at which banks are prepared to loan money to other banks.LIBOR is fixed for a large number of currencies. It serves as a reference rate for Floating Rate Notes, swaps, et al.MARKET RISK The danger of losses in value caused by unexpected changes in market prices/rates (interest rates,share prices, exchange rates, prices of goods) before the affected positions can be closed out or hedged.MID-RATE Arithmetic mean between various prices/rates, for example between the bid price/rate and the offeredprice/rate.MONEY MARKET Market mainly for trade among banks where money can be deposited or borrowed for termsranging from one day to twelve months. Benchmarks are the EURIBOR and the LIBOR.MONTE CARLO SIMULATION Statistical method for calculating the value at risk (VaR) where a large numberof portfolio valuations are carried out with randomly generated data. Additional methods: Variance/Covariance models,historical simulation.75

NOMINAL INTEREST RATE The nominal interest rate is the percentage of interest charged or paid on the nominalvalue of a debt instrument (e.g. loan, bond) at which the debt instrument bears interest.NORMAL DISTRIBUTION The normal distribution is a distribution model for “continuous probability distributions”.It was originally developed by Carl Friedrich Gauß (1777-1855) to describe measuring errors: the so-called Gaussianerror curve. The normal distribution assumes a symmetrical distribution form in the shape of a bell where the values ofthe probability variables are concentrated in the middle of the distribution and become less and less frequent the fartherthey are away from the middle. The normal distribution is the most important distribution model in statistics and isused for a wide range of purposes.OFFERED PRICE/RATE Price/rate at which a financial instrument is offered for sale. Opposite: Bid price/rate.OPTION PREMIUM The price of an option.OPTION PRICE Premium, option premium. A premium that must be paid to buy an option or a warrant. Thefollowing factors are considered when calculating the option price: The exercise or strike price, the spot price/rate ofthe underlying instrument, the term of the option, the risk-free interest rate, dividends paid on the underlying instrumentduring the term of the option.OPTION The right to purchase (call option) an underlying item (e.g. securities or foreign currency) from a contractingparty (option seller) or to sell (put option) it to such party (option writer) at a previously fixed price/rate at a particulartime or in the course of a particular period in time.OTC DERIVATIVES Over-the-counter financial instruments (derivatives) that are not standardised or listed on astock exchange but are traded directly between market participants – over the counter.OTC MARKET Over-the-counter market. A general term referring to the trade of securities off the exchange.OUTRIGHT SWITCH See exotic options.PARITY FORWARD RATE The original spot rate (with currency swaps).PARTICIPATING CAP This is a special cap structure that offers a cap buyer protection without having to pay shouldinterest rates rise, while retaining a portion of the contract value should interest rates fall.PARTICIPATING OPTION A strategy consisting of two options used to protect against a certain price risk. It offerstotal protection against an unfavourable price trend while allowing a certain level of participation in a favourable pricetrend.PAYER SWAPTION An option on a swap giving the holder the right to pay fixed interest.PAYOUT The amount to be paid out on digital options at the end of the term.PIP One thousandth of a cent, i.e. the fourth decimal place in foreign exchange quotations.PLAIN VANILLA OPTION Options of the so-called first generation (call options and put options). As opposedto the so-called exotic options.POSITIONING Trading. Deliberately entering into a risk position.PUT OPTION Securitises the right to sell in conjunction with a defined underlying instrument. Opposite: Call option.76

QUANTO SWAP A special form of interest-rate swap where, by taking advantage of the different interest-rate levelsof two currencies, one succeeds in reducing the price of the interest payable without taking on a currency risk.R/O LOAN Rollover loan, loan with variable interest.RATIO SPREAD OPTION A zero cost strategy based on a combination of buying/selling call options andselling/buying put options. However, in this case the amounts of the two options vary.RECEIVER SWAPTION An option on a swap giving the owner the right to receive fixed interest.REFERENCE INTEREST RATE Term applied to a defined interest rate which lenders and borrowers agree onregarding a contractually agreed lending rate which must be periodically reassessed to reflect the current marketconditions. The lending rate is based on a premium (margin), which has been fixed for the entire term of the contract,being charged over the defined reference interest rate in the form of percentage points. If the reference interest ratefalls (rises) the agreed interest rate shows a correlated reaction. Typical reference interest rates are, for example,EURIBOR, LIBOR and other interbank offered rates.ROLLOVER Regular interest rate readjustment for transactions with variable interest rates.ROLLOVER LOAN R/O Loan. Medium- to long-term loan with variable interest rate whereby the interest rate isusually readjusted every three, six or twelve months. The periodic interest rate readjustments are based on, for example,EURIBOR, LIBOR.SINGLE BARRIERS Exotic options with an additional trigger price/rate which acts as a knock-in or a knock-out.SPOT PRICE/RATE The market price/rate that is currently being charged on money, capital and foreign exchangemarkets.SPREAD Interest premium. Margin measured in basis points.STANDARD NORMAL DISTRIBUTION A normal distribution with a standard variance of 1 and a mean of 0is called a standard normal distribution.STEP PAYMENT OPTION Option is hedged by paying the premium in partial payments when certain predeterminedlevels are reached.STRIKE PRICE The price that is agreed on when the option contract is made. In the case of a cap, this is equivalentto an upper limit to the interest rate, in the case of a floor it is a lower limit.SWAP Exchange of payment streams.SWAP INTEREST RATE The interest rate for swaps that is published by the reference banks for the term inquestion (interest-rate swap). Serves as a reference interest rate for fixed interest loans.SWAPTION Gives the purchaser of an option, against payment of an option premium, the right to enter into a swapdefined in terms of maturity and level of interest at a given time.SYMMETRICAL RISK DISTRIBUTION In a forward rate agreement, the opportunity for profit and the risk ofloss are the same for both contracting parties (e.g. with interest-rate swaps).THETA represents the change in the value of an option as the time until maturity decreases where all other conditionsremain the same.77

TRADING Deliberately entering into a risk position.TRIGGER price/rate barrier. Additional specification for exotic options.VAR see value at risk.VALUE AT RISK VaR. Statistical measurement of risk frequently used to measure a portfolio’s market risk. The lossmade by a portfolio, measured in absolute units of money, that is not exceeded with a specific level of probability withina specific period of time. The probability is expressed as the confidence level and the period of time as the holding time.VALUE AT RISK CONCEPT see value at risk.VARIABLE LOAN WITH INTEREST-RATE CEILING Loan with interest that, at an agreed credit margin, islinked to a reference interest rate (e.g. EURIBOR).VARIANCE/COVARIANCE APPROACH With the variance/covariance approach, cash flows are evaluatedtaking volatilities and correlations into consideration.VEGA Is the benchmark for the change in the option premium when the volatility changes.VOLATILITY Indicates the change in interest rates or prices/rates over time, in mathematical terms the annualisedstandard deviation in interest rates and prices/rates.VOLATILITY RISK Volatility describes the range of fluctuation of the average values of interest rates or prices/rates.The greater the possible evaluation range of an investment instrument, the higher the volatility risk is.Z SCORE The quantile of probability. This is needed to make probability statements about a standard normaldistribution variable. It is the basis for calculating the confidence level. See confidence level.ZERO COST COLLAR A special kind of collar (simultaneous purchase of a cap and sale of a floor) where no optionpremium must be paid for the cap at the beginning of the contract because the profit from the sale of the floor is thesame amount as the cost of purchasing the cap.ZERO INTEREST RATE Zero interest rates and zero discount factors eliminate the reinvestment risk on interestpayments to be made in the meantime and therefore lead to economically correct results.78

TREASURY PRACTICESInternational interest rate practicesInterest rate calculation methods on the money market (under one year) and the capital market (over one year)Currency Interest rate calculation Interest rate calculationmethod money marketmethod capital marketAUD - Australian dollar act/360 act/365, quarterlyCAD - Canadian dollar act/360 act/360, semi-annualCHF - Swiss franc act/360 30/360, annualCZK - Czech koruna act/360 act/360, annualDKK - Danish kroner act/360 30/360, annualEUR - euro act/360 30/360, annualGBP - British pound act/365 act/365, annualHKD - Hong kong dollar act/365 act/365, quarterlyHUF - Hungarian forint act/360 act/365, annualIDR - Indonesian rupiah act/360 act/360, quarterlyISK - Icelandic krona act/360 act/360, annualJPY - Japanese yen act/360 act/365, semi-annualMXN - Mexican peso act/360 act/360, monthlyMYR - Malaysian ringgit act/365 act/365, quarterlyNOK - Norwegian krone act/360 30/360, annualNZD - New Zealand dollar act/360 act/365, semi-annualPLN - Polish zloty act/365 act/act, annualRUB - Russian rouble act/360 act/365, annualSEK - Swedish krona act/360 30/360 annualSGD - Singapore dollar act/365 act/365, semi-annualTHB - Thai baht act/365 act/365, semi-annualTRL - Turkish new lira act/360 act/360, annualUSD - US dollar act/360 act/360, annualZAR - South African rand act/365 act/365, quarterlyThese interest rate calculation methods are market standards, although differing rules can be agreed upon, andare common, in particular where there is a combination of instruments.Non standard practices often apply in the domestic market.80

International FX practices (key currency, base currency, cross calculations)The following rules have been established as international FX practices.1. The euro is always quoted as the key currency(e.g. EUR 1 = GBP X).2. The British pound is placed ahead of all other currencies (except EUR)(e.g. GBP 1 = AUD X).3. The Australian dollar and the New Zealand dollar are always listed first, unless listed against EUR or GBP.(e.g. AUD 1 = USD X).4. The USD is the key currency against all other currencies except in the US domestic market(e.g. USD 1 = CAD X).5. ”Cross Rates“, i.e. non-standard currency pairs are placed in any order against one another.The corresponding reverse rate can also be quoted upon request.

IMPRINTPublished by: Österreichische Volksbanken-AG, 1090 Vienna, Kolingasse 14 - 16, Tel. +43(0)50 4004-0, Fax +43(0)50 4004-3683Authors: Alfred Buder, Alexandra Lauffer-Köpplinger, Harald Klimt, Martin Mayer, Walter Riess, Gernot Rux, Claudia SchleissEditor: Andrea Rainsberger, Österreichische Volksbanken-AG, Marketing & Communications, 1090 Vienna, Kolingasse 14 – 16Graphic design and production: Dieter Achter, Österreichische Volksbanken-AG, Marketing & Communications, 1090 Vienna, Kolingasse 14 - 16September 2010May 2011

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