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

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