Risk Management Policy

For Corporate Treasury

 Contents

INTRODUCTION.........................................................................................................................................................3

OBJECTIVES...............................................................................................................................................................3

POLICY STATEMENT...............................................................................................................................................3

POLICY FRAMEWORK............................................................................................................................................4

IDENTIFICATION OF RISKS...................................................................................................................................5

EXCHANGE RATE RISK

..........................................................................................................................................................................................7
IDENTIFICATION OF EXPOSURE.............................................................................................................................7
MEASUREMENT OF EXPOSURE.............................................................................................................................7
MANAGEMENT OF EXPOSURE..............................................................................................................................8
VALUATION................................................................................................................................................10
INTEREST RATE RISK............................................................................................................................................11
IDENTIFICATION OF EXPOSURE...........................................................................................................................11
MEASUREMENT OF EXPOSURE...........................................................................................................................11
MANAGEMENT OF EXPOSURE............................................................................................................................15
VALUATION................................................................................................................................................17
COMMODITIES PRICE RISK................................................................................................................................18
IDENTIFICATION OF EXPOSURE...........................................................................................................................18
MEASUREMENT OF EXPOSURE...........................................................................................................................18
MANAGEMENT OF EXPOSURE............................................................................................................................18
VALUATION................................................................................................................................................21
LIQUIDITY RISK .....................................................................................................................................................21
IDENTIFICATION OF EXPOSURE...........................................................................................................................21
MEASUREMENT OF EXPOSURE...........................................................................................................................21
MANAGEMENT OF EXPOSURE............................................................................................................................22
VALUATION................................................................................................................................................24
CREDIT RISK............................................................................................................................................................26
IDENTIFICATION OF EXPOSURE...........................................................................................................................26
MEASUREMENT OF EXPOSURE...........................................................................................................................26
MANAGEMENT OF EXPOSURE............................................................................................................................27
OPERATIONAL RISK..............................................................................................................................................28
MEASUREMENT OF EXPOSURE...........................................................................................................................28
MANAGEMENT OF EXPOSURE............................................................................................................................29
STOP LOSS AND VALUE AT RISK.......................................................................................................................30
STOP LOSS LIMIT.........................................................................................................................................30
LIMIT STRUCTURE.........................................................................................................................................31
VALUE AT RISK LIMITS....................................................................................................................................33
SIMULATION APPROACHES................................................................................................................................34

REPORTING AND REVIEW...................................................................................................................................35

REPORTING................................................................................................................................................35

2
 MONITORING OF COMPLIANCE...........................................................................................................................36
ANNEXURE................................................................................................................................................................37
HEDGING INSTRUMENTS..................................................................................................................................37

Introduction

Any business is open to a number of risks, amongst them: movements in

competitors' prices, raw material prices, competitors’ cost of capital, foreign
exchange rates and interest rates are the most important.
These Risk Management Guidelines set the principles and practices to managing
risks due to movements in foreign exchange rates, interest rates and
commodity prices. The Group/Company is expected to formulate its Risk
Management Policy that conforms to these guidelines and takes into account
Unit-specific issues and circumstances. The Company Board should approve
such a Policy.

Objectives

The objective of the policy is to provide an overarching framework for managing

the risks associated with treasury functions. Specifically the policy aims to:

1. Identify, measure and effectively manage financial risk;

2. On the ‘operational’ side [cash flows arising from regular import and
export transactions and project related costs], minimize the impact of
adverse fluctuations in the foreign currency rates on the cash flows
subject to exchange risk exposure limits set;
3. On the ‘financing’ side [cash flows associated with foreign currency
debt servicing obligations, i.e. principal and interest payments], avoid
losses while servicing loans taken in foreign currency, which may arise
from adverse exchange rate movements away from the target exchange
rate;
4. Minimize the cost of gross debt (i.e. total borrowings), within prudent
risk parameters;
5. Minimize the impact of adverse interest rate movements through the
use of interest rate management tools;
6. Minimize price risk in commodity/raw material by hedging; and
7. Ensure professional interaction with financial markets.

In essence, the objective is to reduce, if not eliminate, any losses due to forex
and interest rate related transactions.

Policy Statement

The following principles underlie the Treasury Management Policy:

• Centralised market interaction but decentralized strategic decisions;

3
 • Identification and effective management of financial risks;
• Clear accountability;

Policy Framework

Establishing successful policy frameworks involves articulating objectives,

strategies and tactics and defining how performance will be measured. A
generic template is provided to ensure consistency in the application of the
policy. However, the policies need to be formulated on a case-by-case basis with
consideration of the nature, size and complexity of financial market activities,
particularly the quantitative limits.

In order to carry out its responsibilities, the Board of Directors in a Company

should approve strategies and policies with respect to risk management and
ensure that senior management takes the steps necessary to monitor and
control these risks consistent with the approved strategies and policies. The
board of directors should be informed regularly of the risk exposure of the
Company in order to assess the monitoring and controlling of such risk against
the board’s guidance on the levels of risk that are acceptable to the Company.

Senior management must ensure that the structure of the Company's business
and the level of risk it assumes are effectively managed, that appropriate
policies and procedures are established to control and limit these risks, and that
resources are available for evaluating and controlling risk.

Companies should clearly define the individuals and/or committees responsible

for managing risk and should ensure that there is adequate separation of duties
in key elements of the risk management process to avoid potential conflicts of
interest. The Company should have risk measurement, monitoring, and control
functions with clearly defined duties that are sufficiently independent from the
business decision-making and position-taking functions of the company and
which report risk exposures directly to senior management and the board of
directors. Larger Corporate should have a designated independent unit
responsible for the design and administration of the company’s risk
measurement, monitoring, and control functions.

The company’s risk policy should be applied on consolidated basis and, as

appropriate, at the level of individual affiliates, especially when recognizing
legal distinctions.

Products and activities that are new to the Company should undergo a careful
pre-acquisition review to ensure that the Company understands their risk
characteristics and can incorporate them into its risk management process.
Prior to introducing a new product, hedging, or position-taking strategy,
management should ensure that adequate operational procedures and risk
control systems are in place. The board or its appropriate delegated committee
should also approve major hedging or risk management initiatives in advance of

4
 their implementation. Proposals to undertake new instruments or new strategies
should contain these features:

• Description of the relevant product or strategy;

• Identification of the resources required to establish sound and effective
risk management of the product or activity;
• Analysis of the reasonableness of the proposed activities in relation to the
Company's overall financial condition and capital levels; and
• Procedures to measure, monitor, and control the risks of proposed
product.
Identification of Risks

• Interest Rate risk;

• Exchange Rate risk;
• Commodity Price risk;
• Credit risk;
• Liquidity risk;
• Operational risk

Interest rate risk

Interest rate risk arises as a result of fluctuations in interest rates and it is

usually defined as the risk that a corporates funding costs (or company's net
interest earnings) may be adversely affected by changes in market interest
rates. Interest rate risk is of very wide importance to an organisation as it
concerns the risk of overall financial performance being impaired as a result of
changes in interest rates. The size of the interest rate position(s), the volatility
of interest rates and the time period of the risk govern the magnitude of interest
rate risk.

Exchange Rate Risk

Foreign exchange transaction risk is the risk that the company’s cash flows will
be adversely affected by movements in exchange rates that will increase the
value of foreign currency payables, or will diminish the value of foreign currency
receivables.
Foreign exchange translation risk relates to the effect of currency movements
on the value of a company’s assets and liabilities denominated in foreign
currencies when those values are translated into the functional currency of the
company for accounting purposes.

For the purpose of this policy, Foreign Currency is defined as any currency that
is not the Unit’s functional currency. It is likely that in case of certain Units, the
local currency will be treated as foreign currency for purposes of applying this
policy.

Commodity Price Risk

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Commodity price risk arises due to uncertainty associated with the future ability
of an organization to buy and sell the necessary materials and finished products
respectively at a price within a range sustainable for the business model.

Credit Risk

Credit risk is defined as the risk of incurring a loss as a result of the default by a
counterparty that has:
• Issued, accepted or endorsed a security in which the company has
invested;
• Accepted a deposit from the company; and
• Entered into a hedging transaction with the company related to the
management of financial risks.
The purpose of establishing credit limits is to ensure that the company deals
with creditworthy counterparties and that counterparty concentration risk is
addressed.
Liquidity Risk

Liquidity risk is the potential that an organization cannot fund its operations or
convert assets into cash to meet commitments. Liquidity risk management is
associated with ensuring that there are sufficient funds available to meet the
company’s financial commitments in a timely manner. It is also associated with
planning for unforeseen events, which may curtail cash flows and cause
pressure on liquidity. The possible causes of a liquidity crisis include:
• Unplanned reduction in revenue
• Business disruption
• Unplanned capital expenditure
In case of treasury, liquidity risk would be the ability of the company to unwind
existing or proposed trades for treasury.

Operational Risk

Operational risk is the risk associated with employing inadequate internal

controls, systems, people, processes and procedures or from external events. It
constitutes the risk of financial loss due to mismanagement, error, fraud or
unauthorised use of instruments.

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 Exchange Rate Risk

Identification of Exposure

• Any Cash Flow involving foreign exchange should be reported to the

individuals and/or committees responsible for managing risk. The
concerned person is expected to maintain a running account of all foreign
exchange transactions on a daily basis.

• It is the responsibility of the individuals and/or committees to compile the

requisite information on exposures from all sections of the company.

Measurement of Exposure

Exposure

An Exposure can be defined as the condition, in relation to an incomplete

transaction (i.e. a transaction that has been initiated, committed or physically
completed but has not been fully settled) where the ultimate financial outcome
of the transaction upon the completion or settlement could be different from the
one currently prevalent, due to changes in certain external circumstances. A
Risk is the possibility that such a difference in outcome could be negative. In the
matter of forex, the exposure would involve inflow or outflow of funds in a
currency other than the functional currency. A Forex exposure would arise
when the flow of such funds is likely to take place at a future time, and there is
uncertainty about the effective rate of exchange between the functional
currency and the transaction currency.

Net Exposure

As Exports and Imports provide a natural hedge, provided the timing of the
related cash flows is identical, the inflows and outflows have to be netted-off to
arrive at the ‘net’ exposure. For instance, if Exports are USD 10 Million and
Imports are USD 9 Million, then the ‘net’ exposure to be considered is USD 1
Million.

For purposes of calculating Net Exposure, inflows and outflows have to be

matched based upon the expected dates of such flows. As it is very difficult to
estimate such exact dates of inflows and outflows, the said exercise of matching
inflows and outflows, should be done over a fortnight, assuming the foreign
exchange rate fluctuations within a fortnight is not significant enough to create
any serious risk on the company’s operations. However, if the company feels
that the fluctuations in the relevant exchange rate are significant even during a
fortnight, then the company needs to do such matching of exposures over
shorter periods, i.e., over a week. A significant fluctuation in this case may be in
the range of +/- X% of the Base Exchange rate.

7
Management of Exposure

Instruments for Hedging

To limit the exposure to changes in foreign exchange rates,

corporates/institutions employs techniques, commonly called hedging, which
include (Explained in Annexure):

• Spot;
• Forward;
• Futures;
• Option;
• Swaps;
• Combinations of the above;

Exposures Limits

This exercise aims to state where the company would like its exposures to
reach. Net Exposure mechanism is ideal while hedging decision has to be taken,
but based on market view, forecasts and the risk appetite of the company the
treasury manager can take a view on the gross exposure with appropriate
approval.

The exposures will be considered over a period of Z months, on a rolling basis.

This would be a continuous exercise, and therefore, at any point of time, the
exposure for the next Z months will be taken into consideration for hedging or
otherwise, decision making processes.

• The overall target for the Company / Group is to have the net exposure
limit of USD X Million or 100% of Net Exposure (whichever is lower);

• Exposure Limits can be increased to the levels mentioned below after

taking approval from the respective authorities.

Exposure limits Approving Authority

100% of Net Exposure (if it is greater than USD X Head of Group
mn)
Y% of (Gross Exposure – Net Exposure) + NE Any Whole-time
Director
Z% of (Gross Exposure – Net Exposure) + NE BOD

• Under no circumstances the absolute exposure can be more than USD

million. Therefore no authority can approve exposure limits where the
absolute amount exceeds USD million.

8
Deal size limit

The following levels of executive/ officers are authorized severally to deal in the
following contracts by way of a single deal:
(Rs mn.)
Head of the Head of the Whole time
Type Dealers
desk Group Director

Upto Spot

Forwards

Futures

Options

Swaps

Combinations

Deal done above the specified limit shall be approved by the next higher
authority having the requisite power to enter the deal of that size. In case the
deal size is beyond the limit permitted for the whole time director, the BOD shall
approve the same.

Portfolio Limit

The following levels of executive/ officers are authorized severally to take a

maximum net position upto the following amounts at any point of time:
(Rs mn.)
Head of the Head of the Whole time
Type Dealers
desk Group Director

Upto Spot

Forwards

Futures

Options

Swaps

9
 Combinations

Bucket-wise Limit

The following percentage (of the portfolio limit) can be taken as net position (for
each executive/officers) in the time periods at any point of time:
(%)
Upto 1 >1 - 2 >2 - 3 >3 - 4 >4 - 5
Type > 5 yrs
yr yrs yrs yrs yrs

Forwards

Futures

Options

Swaps
Combination
s

Valuation

Marking to market shall be done for any spot/ forward/ tom positions arising out
of the operations of the group.

Tom/Spot Positions
Any outstanding position arising out of tom/ spot transaction shall be considered
for MTM purpose. These shall be valued using the tom/ spot rate (FEDAI rates)
as quoted at the close of trading on the Reuters or any information service.

Forward Positions
The outstanding forward positions shall be valued using the forward rates as
quoted at the end of the day on the Reuters or any other information service. In
case the forward rates are not available for the exact maturity of the contract,
the two adjacent forward rates shall be interpolated and the MTM positions shall
be calculated using the interpolated forward rates (FEDAI rates).

Swap
Both the legs of the swaps shall be valued using the market rates as quoted at
the end of the day on the Reuters or any other information service. (FEDAI rates)

Currency options
Options shall be valued based on the strike price, volatility, residual tenor, spot
rate, and interest rates.

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 Interest Rate Risk

Identification of Exposure

• Any Cash Flow involving interest rate payable/receivable should be

reported to the individuals and/or committees responsible for managing
risk. The concerned person is expected to maintain a running account of
all interest rate transactions on a daily basis.

• It is the responsibility of the individuals and/or committees to compile the

requisite information on exposures from all sections of the company.

Measurement of Exposure

Exposure

A Company's interest rate risk measurement system should address all material
sources of interest rate risk including repricing, yield curve and basis risk
exposures. A number of techniques are available for measuring the interest rate
risk exposure of both earnings and economic value. Their complexity ranges
from simple calculations to static simulations using current holdings to highly
sophisticated dynamic modeling techniques that reflect potential future
business activities.

If the company has positions denominated in different currencies it would

expose it to interest rate risk in each of these currencies. Since yield curves vary
from currency to currency, the company would generally need to assess
exposures in each. If the multi-currency exposures are substantial, the risk
measurement process should include methods to aggregate the exposures in
different currencies using assumptions about the correlation between interest
rates in different currencies. The correlation assumptions to aggregate the risk
exposures should be periodically reviewed so as to ascertain their stability and
accuracy. The company should also evaluate what its potential risk exposure
would be in the event that such correlations break down.

Repricing schedules

The simplest techniques for measuring a Company's interest rate risk exposure
begin with a maturity/repricing schedule that distributes interest-sensitive
assets, liabilities, and Off Balance-Sheet positions into a certain number of
predefined “time bands” according to their maturity (if fixed-rate) or time
remaining to their next repricing (if floating-rate). These schedules can be used
to generate simple indicators of the interest rate risk sensitivity of both earnings
and economic value to changing interest rates.

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Gap analysis:
Simple maturity/repricing schedules can be used to assess the interest rate risk
of current earnings, and is typically referred to as gap analysis. To evaluate
earnings exposure, interest rate-sensitive liabilities in each time band are
subtracted from the corresponding interest rate-sensitive assets to produce a
repricing “gap” for that time band. This gap can be multiplied by an assumed
change in interest rates to yield an approximation of the change in net interest
expense/income that would result from such an interest rate movement. The
size of the interest rate movement used in the analysis can be based on a
variety of factors, including historical experience, simulation of potential future
interest rate movements, and the judgement of company’s management.

These simple gap calculations can be augmented by information on the average

coupon on assets and liabilities in each time band. This information can be used
to place the results of the gap calculations in context. For instance, information
on the average coupon rate could be used to calculate estimates of the level of
net interest expense/income arising from positions maturing or repricing within
a given time band, which would then provide a “scale” to assess the changes in
expense/income implied by the gap analysis.

Duration:
A maturity/repricing schedule can also be used to evaluate the effects of
changing interest rates on a company’s economic value by applying sensitivity
weights to each time band. Typically, such weights are based on estimates of
the duration of the assets and liabilities that fall into each time band. Duration is
a measure of the percentage change in the economic value of a position that
will occur given a small change in the level of interest rates. It reflects the
timing and size of cash flows that occur before the instrument's contractual
maturity. Generally, the longer the maturity or next repricing date of the
instrument and the smaller the payments that occur before maturity (e.g.
coupon payments), the higher the duration (in absolute value). Higher duration
implies that a given change in the level of interest rates will have a larger
impact on economic value.

Duration-based weights can be used in combination with a maturity/repricing

schedule to provide a rough approximation of the change in a company’s
economic value that would occur given a particular change in the level of
market interest rates. Specifically, an “average” duration is assumed for the
positions that fall into each time band. The average durations are then
multiplied by an assumed change in interest rates to construct a weight for each
time band. In some cases, different weights can be used for different positions
that fall within a time band, reflecting broad differences in the coupon rates and
maturities (for instance, one weight for assets, and another for liabilities). In
addition, different interest rate changes can be sometimes used for different
time bands, generally to reflect differences in the volatility of interest rates
along the yield curve. The weighted gaps are aggregated across time bands to
produce an estimate of the change in economic value of the company that
would result from the assumed changes in interest rates.

12
Alternatively, an institution could estimate the effect of changing market rates
by calculating the precise duration of each asset, liability, and Off Balance-Sheet
position and then deriving the net position for the company, rather than by
applying an estimated average duration weight to all positions in a given time
band. This would eliminate potential errors occurring when aggregating
positions/cash flows. As another variation, risk weights could also be designed
for each time band on the basis of actual percentage changes in market values
of hypothetical instruments that would result from a specific scenario of
changing market rates. That approach - which is sometimes referred to as
effective duration - would better capture the non-linearity of price movements
arising from significant changes in market interest rates and, thereby, would
avoid an important limitation of duration.

Standardized Framework: Example

This annex contains an example setting out the methodology and calculation
process in one version of a standardized framework. Other methodologies and
calculation processes could be equally applicable in this context, depending on
the circumstances of the company concerned.

Methodology: Positions on the company’s balance sheet would be slotted into

the maturity approach according to the following principles:

• All assets and liabilities and all Off Balance Sheet items that are sensitive
to changes in interest rates (including all interest rate derivatives) are
slotted into a maturity ladder comprising a number of time bands large
enough to capture the nature of interest rate risk. Separate maturity
ladders are to be used for each currency accounting for more than 5% of
either assets or liabilities.
• On-balance-sheet items are treated at book value.
• Fixed-rate instruments are allocated according to the residual term to
maturity and floating-rate instruments according to the residual term to
the next repricing date.
• Core deposits are slotted according to an assumed maturity of no longer
than five years.
• Derivatives are converted into positions in the relevant underlying. The
amounts considered are the principal amount of the underlying or of the
notional underlying. Futures and forward contracts, including forward rate
agreements (FRA), are treated as a combination of a long and a short
position. The maturity of a future or a FRA will be the period until delivery
or exercise of the contract, plus - where applicable - the life of the
underlying instrument. For example, a long position in a June three month
interest rate future (taken in April) is to be reported as a long position
with a maturity of five months and a short position with a maturity of two
months.
• Swaps are treated as two notional positions with relevant maturities. For
example, an interest rate swap under which a company is receiving
floating-rate interest and paying fixed-rate interest will be treated as a
long floating-rate position of maturity equivalent to the period until the
next interest fixing and a short fixed-rate position of maturity equivalent

13
 to the residual life of the swap. The separate legs of cross-currency swaps
are to be treated in the relevant maturity ladders for the currencies
concerned.
• Options are considered according to the delta equivalent amount of the
underlying or of the notional underlying.
Calculation process: The calculation process consists of five steps.

• The first step is to offset the longs and shorts in each time band, resulting
in a single short or long position in each time band.
• The second step is to weight these resulting short and long positions by a
factor that is designed to reflect the sensitivity of the positions in the
different time bands to an assumed change in interest rates. The set of
weighting factors for each time band is set out in Table 1 below. These
factors are based on an assumed parallel shift of 200 basis points
throughout the time spectrum, and on a proxy of modified duration of
positions situated at the middle of each time band and yielding 5%.
• The third step is to sum these resulting weighted positions, offsetting
longs and shorts, leading to the net short- or long-weighted position in the
given currency.
• The fourth step is to calculate the weighted position of the whole
company by summing the net short- and long-weighted positions
calculated for different currencies.
• The fifth step is to relate the weighted position to the limit exposure.

Table 1
Weighting factors per time band (second step in the calculation process)

Proxy of Assumed
Middle of time Weighting
Time band modified change in
band factor
duration yield
Up to 1
0.5 months 0.04 years 200 bp 0.08%
month
1 to 3 months 2 months 0.16 years 200 bp 0.32%
3 to 6 months 4.5 months 0.36 years 200 bp 0.72%
6 to 12
9 months 0.71 years 200 bp 1.43%
months
1 to 2 years 1.5 years 1.38 years 200 bp 2.77%
2 to 3 years 2.5 years 2.25 years 200 bp 4.49%
3 to 4 years 3.5 years 3.07 years 200 bp 6.14%
4 to 5 years 4.5 years 3.85 years 200 bp 7.71%
5 to 7 years 6 years 5.08 years 200 bp 10.15%
7 to 10 years 8.5 years 6.63 years 200 bp 13.26%
10 to 15
12.5 years 8.92 years 200 bp 17.84%
years
15 to 20
17.5 years 11.21 years 200 bp 22.43%
years
Over 20 years 22.5 years 13.01 years 200 bp 26.03%

14
Management of Exposure

Instruments for Hedging

To limit the exposure to changes in interest rates, corporates/institutions

employs techniques, commonly called hedging, which include (Explained in
Annexure):

• Forward Rate Agreement

• Interest rate futures,
• Interest rate options,
• Interest rate swaps
• Combinations of the above

Exposures Limits

This exercise aims to state where the company would like its exposures to
reach. Gap/Duration based approach is ideal while hedging decision has to be
taken, but based on market view, forecasts and the risk appetite of the
company the treasury manager can take a view on the gross exposure with
appropriate approval.

• The overall target for the Company / Group is to have the Gap limit of
USD X Million or 100% of Net Exposure (whichever is lower);

• Exposure Limits can be increased to the levels mentioned below after

taking approval from the respective authorities.

Exposure limits Approving Authority

100% of Gap (if it is greater than USD X mn) Head of Group
Y% of (Gross Exposure – Gap) + Gap Any Whole-time
Director
Z% of (Gross Exposure – Gap) + Gap BOD

• Under no circumstances the Gap can be more than USD million.

Therefore no authority can approve Gap limits where the absolute amount
exceeds USD million.

15
Limits

Notional Deal size limit for derivative instruments

The following levels of officials are authorised severally to transact by way of a

single deal (based on notional value of the transaction) in the following
derivative instruments:
(Rs. mn)
Whole
Head of Head of
Type Dealers time
desk group
Director
Forward Rate Agreements
Interest Rate Futures
Interest Rate Options
Interest Rate Swaps
Combinations

Deals to be done above the specified limits shall be approved by the next higher
authority having the requisite power to enter the deal of that size. In case the
deal size is beyond the limit permitted for the whole time director, the BOD shall
approve the same.

Portfolio Limit

The following levels of executive/ officers are authorized severally to take a

maximum gap position upto the following amounts at any point of time:

(Rs. mn)
Whole
Head of Head of
Type Dealers time
desk group
Director
Forward Rate Agreements
Interest Rate Futures
Interest Rate Options
Interest Rate Swaps
Combinations

16
 Bucket-wise Limit

The following percentage (of the portfolio limit) can be taken as net position (for
each executive/officers) in the time periods at any point of time:
(%)
Upto 1 >1 - 2 >2 - 3 >3 - 4 >4 - 5
Type > 5 yrs
yr yrs yrs yrs yrs
Forward Rate
Agreements
Interest Rate Futures
Interest Rate Options
Interest Rate Swaps
Combinations

Valuation

The marked to market value of the Company's portfolio can be arrived at, by
using market values of individual products on real time basis.

Forward Rate Agreements

• Forward Rate Agreements should be valued using the market rates as

quoted at the end of the day on the Reuters or any other information
service.

Interest Rate Futures

• Interest Rate Futures shall be valued using the market rates as quoted at
the end of the day on the Reuters or any other information service.

Interest Rate Options

• Interest Rate Options shall be valued using the market rates as quoted at
the end of the day on the Reuters or any other information service.

Interest rate swaps

• The marked to market is the net value of both the legs of the swap based
on the prices quoted on Reuters and other services or quotes obtained
from market participants and brokers.

17
 Commodities Price Risk

Identification of Exposure

• Any Cash Flow involving commodity price payable/receivable should be

reported to the Exposure Manager. Thus the Exposure Manager is
expected to maintain a running account of all commodity transactions on
a daily basis.

• It is the responsibility of the Exposure Manager to ensure that he receives

the requisite information on exposures from all sections of the company.

Measurement of Exposure

Exposure

An Exposure can be defined as the condition, in relation to procurement/sale of

the commodity in the open market where the ultimate financial outcome of the
transaction is dependent upon the price movement of the commodity, due to
changes in certain external circumstances. A Risk is the possibility that such a
difference in outcome could be negative. In the matter of commodity, the
exposure would involve purchase or sale of a commodity. A Commodity
exposure would arise when the amount payable or receivable on purchase and
sale respectively is likely to take place at a future time, and there is uncertainty
about the effective market rate.

Management of Exposure

Instruments for Hedging

18
To limit the exposure to changes in commodity prices, corporates/institutions
employs techniques, commonly called hedging, which include (Explained in
Annexure):

• Spot
• Forwards
• Futures,
• Options,
• Swaps and
• Combinations of the above

Limits

The limits for dealing in different commodities are set as under:

Asset type Limit

Commodity 1

Commodity 2

Commodity 3

Commodity 4

Commodity 5

Deal Size Limits

The following levels of executive/ officers are authorized severally to deal in the
following commodity contracts (applicable to each commodity asset separately)
by way of a single deal:
(Rs mn.)
Head of the Head of the Wholetime
Type Dealers
desk Group Director

Spot

Forwards

Futures

Options

19
Swaps

Combinations

Deal done above the specified limit shall be approved by the next higher
authority having the requisite power to enter the deal of that size. In case the
deal size is beyond the limit permitted for the whole time director, the BOD shall
approve the same.

Portfolio Limit

The following levels of executive/ officers are authorized severally to take a

maximum net position (applicable to each commodity asset separately) upto the
following amounts at any point of time:
(Rs mn.)
Head of the Head of the Whole time
Type Dealers
desk Group Director

Spot

Forwards

Futures

Options

Swaps

Combinations

Bucket-wise Limit

The following percentage (of the portfolio limit) can be taken as net position (for
each executive/officers) in the different time periods at any point of time:
(%)
Upto 1 >1 - 2 >2 - 3 >3 - 4 >4 - 5
Type > 5 yrs
yr yrs yrs yrs yrs

Forwards

20
 Futures

Options

Swaps

Combinations

Valuation

The marked to market value of the Company's portfolio shall be arrived at, by
using market values of individual commodities on real time basis.

LIQUIDITY RISK

Identification of Exposure

Liquidity, or the ability to fund increases in assets and meet obligations as they
come due, is crucial to the ongoing viability of any organization. Sound liquidity
management can reduce the probability of serious problems. For this reason,
the analysis of liquidity requires management not only to measure the liquidity
position of the company on an ongoing basis but also to examine how funding
requirements are likely to evolve under various scenarios, including adverse
conditions.

Measurement of Exposure

An effective liquidity measurement process involves assessing all of a

company’s cash inflows against its outflows to identify the potential for any net
shortfalls going forward. This includes funding requirements for off-balance
sheet commitments. A number of techniques can be used for measuring
liquidity risk, ranging from simple calculations and static simulations based on
current holdings to highly sophisticated modeling techniques. As all companies
are affected by changes in the economic climate and market conditions, the
monitoring of economic and market trends is key to liquidity risk management.

Whether a company is sufficiently liquid depends in large measure on the

behaviour of cash flows under different conditions. Analyzing liquidity thus
entails laying out a variety of "what if" scenarios. Under each scenario, a
company should try to account for any significant positive or negative liquidity
swings that could occur. These scenarios should take into account factors that
are both internal (company-specific) and external (market-related). While

21
 liquidity will typically be managed under “normal” circumstances, the company
must be prepared to manage liquidity under abnormal conditions.

Management of Exposure

Investment Limit

The investment limits (based on book value of investment) of the company in

different markets is as follows:
(Rs.
mn)
Instrument Limit
Equity Market
Money Market Instruments
Debt Market Instruments
Mutual Funds
Bank Deposit/Cash

Deal size limit

The following levels of officials are authorised, severally, to invest in the under
mentioned instruments by way of a single deal
(Rs.
Mn)
Head of Head of Whole time
Instrument Dealers
desk group Director
Equity Market
Money Market
Instruments
Debt Market Instruments
Mutual Funds
Bank Deposit/Cash

Portfolio Limit

22
The following levels of executive/ officers are authorized severally to take a
maximum net position upto the following amounts at any point of time:
(Rs.
Mn)
Head of Head of Whole time
Instrument Dealers
desk group Director
Equity Market
Money Market
Instruments
Debt Market Instruments
Mutual Funds
Bank Deposit/Cash

Deals to be done above the specified limit shall be approved by the next higher
authority having the requisite power to enter the deal of that size. In case the
deal size is beyond the limit permitted for the whole time director, BOD shall
approve the same.

Maturity wise limit

The cumulative investment in Debt Market Instruments across maturities shall

not exceed the following limits.
(Rs. mn)
Maturity
1 - 3 yrs
>3 - 5 yrs
>5 - 10 yrs
>10 yrs

Rating wise investment limit

Investment in Money/Debt Market Instruments other than central and state

government guaranteed bonds, of a single issue shall not exceed any of the
following limits:
(Rs.
mn)
Cumulative for rating
Rating* Issue wise Limit
category
AAA/ AA+
AA, AA-
A+, A
A-, BBB+, BBB, BBB-
* Rating limit includes structured obligation (SO) instruments also
The rating from CRISIL, ICRA, CARE and Fitch are to be considered for the
above.

23
 Industry wise limit

In order to maintain exposure to industries at prudent levels and to diversify

risks involved, Company’s total exposure to a particular industry / sector would
be limited to a maximum of 15% of total exposure per industry / sector.

Valuation

In an ideal situation, the marked to market value of the Company's portfolio can
be arrived at, by using market values of individual securities on real time basis.
The absence of market data on some of the instruments precludes the use of
this methodology. Considering the constraints in terms of data availability,
different methods are proposed for different set of securities.

Commercial Paper (CP)

• Commercial Paper shall be valued at carrying cost. The carrying cost shall
include the acquisition cost and the discount accrued on it from the date
of purchase.

GOI Securities, State Government Securities and Treasury Bills

• GOI Securities shall be valued on daily basis at FIMMDA prices.

• In case the rates are not available for State Government securities, these
shall be valued applying the YTM method by marking it up by 25 basis
points or as may be stipulated by RBI, above the yields of GOI Secs of
equivalent maturity published by FIMMDA periodically.
• Treasury Bills shall be valued at carrying cost. The carrying cost shall
include the acquisition cost and the discount accrued on it from the date
of purchase.

24
Debentures/ Bonds

• All quoted debentures/ bonds shall be valued at prices as available from

the trades/ quotes on the stock exchanges.
• Where traded prices/ quotes are not available, rated and unrated
debentures/ bonds shall be valued based on appropriate mark-up over the
YTM rates for GOI Securities as published by FIMMDA.
• Where a particular structured issue (with (SO) rating) has been rated by
any one credit rating agency, appropriate mark-up as per the said rating
shall be considered for valuation purpose. Where more than one credit
rating agencies have rated such an issue, appropriate mark-up as per the
lowest of the ratings shall be considered for valuation purpose. For all
other issues, lowest of the available ratings among all the credit rating
agencies for comparable issues shall be considered for valuation purpose.
• Where the bonds have simultaneous call and put options (on the same
day) and there are several such call and put options in the life of the
bond, the nearest date shall be taken as maturity date for price/ YTM
calculation.
• Where interest/ principal on the debenture/ bonds is in arrears, the
provision would be made for the debentures as in the case of debentures/
bonds treated as advances. The depreciation/ provision requirement
towards debentures where the interest is in arrears or principal is not paid
as per due date, shall not be allowed to be set-off against appreciation
against other debentures/ bonds.
• Where the debenture/ bonds is quoted and there have been transactions
within 15 days prior to the valuation date, the value adopted should not
be higher than the rate at which the transaction is recorded on the stock
exchange.

Certificate of Deposits (CDs)

• CDs shall be valued at carrying cost. The carrying cost shall include the
acquisition cost and the discount accrued on it from the date of purchase.

Securitised Paper

• All quoted instruments shall be valued at prices as available from the

trades/ quotes on stock exchanges.
• Where traded prices/ quotes are not available, valuation shall be done by
discounting the future cash flows at an yield based on appropriate mark-
up over the ZC rates for GOI Secs as published by FIMMDA.

Equity

• In case of equity shares ex-dividend, ex-bonus and ex-rights prices shall

be considered.
• Equity shares for which current quotations are not available or where the
shares are not quoted on the stock exchanges, should be valued at break-
up value (without considering ‘revaluation reserves’, if any) which is to be

25
 ascertained from the company’s latest balance sheet (which should not
be more than one year or eighteen months (in case of companies with
accounting year ending other than March 31) prior to the date of
valuation). In case the latest balance sheet is not available the shares are
to be valued at Re.1 per company. In case of shares with a lock in period,
valuation shall be based on current market price/break up value. Equity
shares, which are not traded in the last thirty days, shall be unquoted for
the above purposes.

Mutual Funds

• In case of listed units, quoted market price shall be used for valuation
purpose.
• In case of unlisted units, Net Asset Value (NAV)/ repurchase price shall be
used for valuation purpose.
• Units of mutual funds with a lock-in period for which repurchase price/
market quote is not available will be valued at carrying cost.

CREDIT RISK

Identification of Exposure

The basis for an effective credit risk management process is the identification
and analysis of existing and potential risks inherent in any product or activity.
Consequently, it is important that the company identify all credit risk inherent in
the products they enter and the activities in which they engage. Such
identification stems from a careful review of the existing and potential credit risk
characteristics of the product or activity.

Measurement of Exposure

An effective credit monitoring system will include measures to:

• Ensure that the company understands current financial condition of the
counterparty;
• Monitor compliance with existing covenants;
• Identify contractual payment delinquencies and classify potential problem
credits on a timely basis; and
• Direct promptly problems for remedial management.

26
 The Company should have methodologies that enable them to quantify the risk
involved in exposures to individual counterparties. Company should also be able
to analyse credit risk at the product and portfolio level in order to identify any
particular sensitivities or concentrations. The measurement of credit risk should
take account of

• The specific nature of the credit and its contractual and financial
conditions (maturity, reference rate, etc.);
• The exposure profile until maturity in relation to potential market
movements;
• The potential for default based on the credit rating.

Management of Exposure

Aggregate Counterparty Exposure Limits

Counter Party Tenor Limit Amount

Upto 3 yrs
Counter Party 1 >3 - 5 yrs
>5 - 10 yrs
>10 yrs
Upto 3 yrs
>3 - 5 yrs
Counter Party 2
>5 - 10 yrs
>10 yrs
Upto 3 yrs
>3 - 5 yrs
Counter Party 3
>5 - 10 yrs
>10 yrs

27
 Operational Risk

Identification of Exposure
Risk identification is paramount for the subsequent development of a viable
operational risk monitoring and control system. Effective risk identification
considers both internal factors (such as the company’s structure, the nature of
the company’s activities, the quality of the company’s human resources,
organizational changes and employee turnover) and external factors (such as
changes in the industry and technological advances) that could adversely affect
the achievement of the company’s objectives.

Measurement of Exposure

Amongst the possible tools which can used by the company for identifying and
assessing operational risk are:

Self- or Risk Assessment

A company assesses its operations and activities against a menu of potential

operational risk vulnerabilities. This process is internally driven and often
incorporates checklists and/or workshops to identify the strengths and
weaknesses of the operational risk environment. Scorecards, for example,
provide a means of translating qualitative assessments into quantitative metrics
that give a relative ranking of different types of operational risk exposures.
Scores may address inherent risks, as well as the controls to mitigate them. In
addition, scorecards may be used by the company to allocate economic capital
to treasury in relation to performance in managing and controlling various
aspects of operational risk.

Risk Mapping

In this process treasury functions or process flows are mapped by risk type. This
exercise can reveal areas of weakness and help prioritize subsequent
management action.

Risk Indicators

Risk indicators are statistics and/or metrics, often financial, which can provide
insight into a company’s risk position. These indicators tend to be reviewed on a
periodic basis (such as monthly or quarterly) to alert the company to changes
that may be indicative of risk concerns. Such indicators may include the number
of failed trades, staff turnover rates and the frequency and/or severity of errors
and omissions.

Measurement

Firms can also quantify their exposure to operational risk using a variety of
approaches. For example, data on the company’s historical loss experience

28
 could provide meaningful information for assessing the treasury’s exposure to
operational risk and developing a policy to mitigate/control the risk. An effective
way of making good use of this information is to establish a framework for
systematically tracking and recording the frequency, severity and other relevant
information on individual loss events. Firms can also combine internal loss data
with external loss data, scenario analyses, and risk assessment factors.

Management of Exposure

The company should ensure that internal practices are in place as appropriate
to control operational risk. Examples of these include:

• Close monitoring of adherence to assigned risk limits or thresholds;

• Maintaining safeguards for access to, and use of, company’s assets and
records;
• Ensuring that staffs have appropriate expertise and training;
• Identifying products where returns appear to be out of line with
reasonable expectations (e.g., where a supposedly low risk, low margin
trading activity generates high returns that could call into question
whether such returns have been achieved as a result of an internal
control breach);
• Regular verification and reconciliation of transactions and accounts; and
• Use of Voice Recording System while finalizing deals with counterparties.

29
 Stop Loss and Value at Risk

Stop Loss Limit

Stop Loss limits are risk control mechanisms. A Stop Loss is the maximum
permissible loss that can be incurred on a position or a portfolio of positions. It is
that point at which either approval of a superior authority is required to continue
with the position or the trader has to square off the position and book the loss.

Need for Stop Loss

The company is exposed to price risk arising out of interest rate movements,
foreign currency movements and credit risk on account of investments/
positions. Since the value of the positions undergoes a change on account of the
changes in the interest rates, exchange rates or the credit rating, the market
value of the position undergoes change, even though the position has not been
liquidated.

In order to limit the amount of loss, which can arise out of the adverse market
rate movements, stop loss limits are stipulated for treasury operations. It also
enables an efficient risk monitoring mechanism by which information can be
passed on to the management before a certain threshold level of stop loss limit
has been reached. The management shall then be able to take corrective action,
if necessary, before the actual stop loss limit is reached. The Head of Groups
and the Country Head, in case of overseas/ offshore offices, shall be informed by
email when the stop loss exceeds 75% of the limit prescribed in this policy.

The stop loss for foreign currency exposure of the company would be monitored
on a real time basis and the Head of Groups would be informed by email
immediately when the stop loss exceeds 75% of the limit prescribed in this
policy at any time during the day. However, in case the stop loss does not
exceed the aforesaid limit the Head of Groups would be informed the same by
end of day by the Daily Treasury Report. This process is applicable to breach of
daily as well as cumulative stop loss limits.

30
Limit Structure

Daily stop loss limits and Cumulative loss limits are stipulated for the portfolio as
a whole.

Daily Portfolio stop loss limit are set as under:

Rs. mn
Products Limits
Fixed Income (FI)
Foreign Exchange
Derivatives
Commodities
Total
• P&L due to foreign currency risk in derivatives shall form part of foreign
exchange limits. There is no limit for interest rate risk in derivatives.
• Derivatives limit is included in FI and Fx limits. The limits shall be fungible
across product categories.
• The total limit for currency option across all groups shall be Rs mn.
Notes: The upfront incentive income received on any security shall be
considered as part of profit for the purpose of the calculation of the stop loss
limit.

Cumulative Loss Limits shall be for a financial year.

Rs. mn
Products Limits
Fixed Income (FI)
Foreign Exchange
Derivatives
Commodities
Total
• P&L due to foreign currency risk in derivatives shall form part of foreign
exchange limits. There is no limit for interest rate risk in derivatives.
• Derivatives limit is included in FI and Fx limits. The limits shall be fungible
across product categories.
• The total limit for currency option across all groups shall be Rs mn.

Calculation of profit/ loss for monitoring of Stop Loss Limit

Profit/ loss on market exposures for the purpose of monitoring of daily stop loss
of the portfolio shall be computed as follows:

• Unrealised gain/ loss as on the date of the computation

• Less: Unrealised gain/ loss as at the end of the last trading day
• Add: Realised gain/ loss during the day

In case the underlying is hedged with a derivative the profit/ loss shall be
considered after taking into account the profit/ loss on the derivative.

31
Profit/ loss for the purpose of monitoring of cumulative loss limits shall be as
follows:

• Unrealised gain/ loss as on the date of computation

• Less: Unrealised gain/ loss as at the end of the last accounting year
• Add: Realised gain/ loss from beginning of the financial year till date of
computation.

Authorization Structure

In case a stop loss limit, as laid down by this policy, is breached, the position
shall be liquidated. However, if the position is intended to be continued further,
specific approval shall be obtained from the following authorities:

Stop loss limits Approving Authority

Portfolio-wise – daily Any Whole-time Director
Cumulative – yearly BOD

Chief Financial Officer & Treasurer and will jointly allocate the stop loss and
investment limits, product-wise, to various overseas/ offshore branches.

Stop loss limits breaches, if any, should be reported to BOD.

32
Value at Risk limits

Value-at-Risk (VaR) is a risk control mechanism and is the potential loss that can
be incurred on a portfolio under normal market conditions at a pre-determined
confidence level (99%) over a one-day holding period.

VaR for each portfolio is calculated by taking into account the factor sensitivities
and the volatilities of risk factors. For this purpose, factor sensitivities are used
to monitor the price risks of portfolios. Factor sensitivity measures the changes
in portfolio value for a defined change in risk factors (e.g., interest rates,
exchange rates, exchange rate volatility, etc.). These factor sensitivities would
be back tested to take into account the changes in the same at least once in a
year and the required revisions, if any would be made in the factor sensitivities.

Daily Value at Risk (VaR) limit

The Product wise VaR limits shall be as under:

Rs. mn
Products Limits
Fixed Income (FI)
Foreign Exchange
Derivatives
Commodities

For breach of VaR Limits, approval shall be obtained from any whole time
director.

33
 Simulation approaches

Many companies (especially those using complex financial instruments or

otherwise having complex risk profiles) employ more sophisticated risk
measurement systems than those based on simple maturity/repricing schedules.
These simulation techniques typically involve detailed assessments of the
potential effects of changes in interest rates, foreign exchange rate and
commodity prices on earnings by simulating the future path of the rates and
their impact on cash flows.

Simulation approaches typically involve a more detailed breakdown of various

categories of on- and off balance-sheet positions, so that specific assumptions
about the interest and principal payments and currency transaction arising from
each type of position can be incorporated. In addition, simulation techniques can
incorporate more varied and refined changes in the rates environment, ranging
from changes in the slope and shape of the yield curve to interest rate scenarios
derived from Monte Carlo simulations and similar scenarios can be created for
currency rates.

Static simulation

In static simulations, the cash flows arising solely from the company’s current
on- and off-balance-sheet positions are assessed. For assessing the exposure of
earnings, simulations estimating the cash flows and resulting earnings streams
over a specific period are conducted based on one or more assumed rate
scenarios. Typically, although not always, these simulations entail relatively
straightforward shifts or tilts of the yield curve, or changes of spreads between
different interest rates or movement in currency rate. When the resulting cash
flows are simulated over a specified period and discounted back to their present
values, an estimate of the change in the company’s profit/loss can be
calculated.

Dynamic simulation

In a dynamic simulation approach, the simulation builds in more detailed

assumptions about the future course of currency rates, interest rates and the
expected changes in a company’s business activity over that time. For instance,
the simulation could involve assumptions about a company’s strategy for
changing administered interest rates and/or about the future stream of business
that the company will encounter. Such simulations use these assumptions about
future activities and reinvestment strategies to project expected cash flows and
estimate dynamic earnings. These more sophisticated techniques allow for
dynamic interaction of currency rates, commodity prices and interest rates.

As with other approaches, the usefulness of simulation-based risk measurement

techniques depends on the validity of the underlying assumptions and the
accuracy of the basic methodology. The output of sophisticated simulations
must be assessed largely in the light of the validity of the simulation's
assumptions about future rates and the behaviour of the company. One of the

34
 primary concerns that arise is that such simulations do not become “black
boxes” that lead to false confidence in the precision of the estimates.
Reporting and Review

Reporting

The Reporting would consist of the following two aspects:

• Historical Information - Information on ‘actual’ inflows and outflows for the
past period, i.e., historical information. This would involve maintaining of
a log of all foreign exchange transactions indicating for each transaction,
the date and time of the transaction, the counter party and all relevant
particulars of the transaction.
• Estimates for future - Information on ‘estimated’ future inflows and
outflows to be prepared based on transactions that are to be entered into
in the next 3 months;

Exposure Reports

The treasury of the company should prepare the following reports.

Management Information reports:

The following Management Information report should be sent to the under
mentioned as per the schedule given below.

Sr. Periodicit To be submitted

Name of the Report Submitted to
No. y within/by
Daily Treasury Report Senior
1 Daily By next working day
(DTR) Management
In the BOD meeting
Investment Review of
2 Quarterly post finalization of BOD
treasury transactions
accounts
Review of Foreign
Within fortnight of
3 Exchange Quarterly BOD
closure of accounts
Transactions
Downward credit
4 Monthly Within fortnight BOD
migration

Money Market reports:

The Money Market Reports should be submitted to the CFO of the company as
per the schedule given below

Sr. To be submitted
Name of the Report Periodicity
No. within/by
Daily Return on
Before 6 pm on the
1 Call/Notice/Term Money/Repo Daily
same day
Transactions
By the end of the next
2 IRS Return Fortnightly
fortnight

35
 Status of Interest Rate By 10th of the following
3 Monthly
Futures month

Foreign Exchange & Derivatives reports:

The Foreign Exchange & Derivatives Reports should be submitted to the CFO of
the company as per the schedule given below

Sr. To be submitted
Name of the Report Periodicity
No. within/by
Long Term Foreign Currency
1 Weekly By end of next week
Rupee Swap
2 Weekly Position Weekly By end of next week
Statement on balances held
3 Fortnightly Within next 7 days
abroad (BAL)
Last Friday of
4 Maturity and Position (MAP) Within next 21 days
Month
Last Friday of
5 Outstanding Export Credits Within next 10 days
Month
6 Cross Currency derivatives Half-yearly No statutory deadline
By the following
7 Rupee Dollar Option Monthly
Monday
Outstanding overseas
8 Monthly Within 10 days
foreign currency borrowings
Review of Foreign Exchange Within week of closure
9 Monthly
Transactions of accounts

Monitoring of Compliance

The Internal Assurance department should monitor compliance of the policy as

part of their audit plan. The company should have in place adequate internal
audit coverage to verify that policies and procedures have been implemented
effectively. The company should ensure that the scope and frequency of the
audit programme is appropriate to the risk exposures. Audit should periodically
validate that the firm’s treasury risk management framework is being
implemented effectively across the firm.

36
 Annexure

Hedging instruments

Forward Contracts

A forward contract is an agreement to buy or sell an asset at a certain time in

the future for a certain price (the delivery price). It can be contrasted with a spot
contract, which is an agreement to buy or sell immediately. The contract is an
agreement between two financial institutions or between a financial institution
and one of its clients. No money changes hands when contract is first negotiated
and it is settled at maturity. The forward price for a contract is the delivery price
that would be applicable to the contract if it were negotiated today (i.e., it is the
delivery price that would make the contract worth exactly zero). The forward
price may be different for contracts of different maturities.

Options

There are two basic types of options. A call option gives the holder the right to
buy the underlying asset by a certain date for a certain price (the strike price). A
put option gives the holder the right to sell a certain asset by a certain date for
a certain price (the strike price). American options can be exercised at any time
up to the expiration date. European options can be exercised only on the
expiration date itself. In India only European options are permitted.

Swaps

A swap is an agreement to exchange cash flows at specified future times

according to certain specified rules. Converting a liability or investment from –
fixed rate to floating rate or –floating rate to fixed rate. A swap can be regarded
as a convenient way of packaging forward contracts. The value of the swap is
the sum of the values of the forward contracts underlying the swap.

Forward Rate Agreement

A Forward Rate agreement is an agreement between the company and a

counter party which effectively fixes an interest rate for a deposit / loan which
will arise at a future date. The FRA is based on a notional principal amount.

Interest Rate Futures

An interest rate futures contract is based on an Interbank deposit rate or an

underlying debt security. The price of futures is inversely related to movements

37
in interest rates. Therefore, if it is believed that interest rates will decline,
hedging of underlying position can be achieved by buying futures contracts now
to benefit from the price rise.

Interest Rate Cap

An interest rate cap is an option that affords the company protection against an
upward movement of rates while still allowing the company to exploit the
benefit of falling interest rates. This is achieved by setting an upper limit (or
cap) on the floating interest rate. If that limit is exceeded, the company will be
fully compensated by the bank. The company pays a cash premium for the cap
up front. The closer the cap levels to the current interest rate, the more
expensive the option.

Interest Rate Collar

An interest rate collar is an option that affords the company protection against a
downward movement of rates while still allowing the company to exploit the
benefit of increasing interest rates.
The collar is used when a company does not want to pay the full premium for a
cap. The company can negate some of the cost by selling the bank an interest
rate floor, which can totally or partially offset the cost of the cap. The company
benefits from falling interest rates until the floor level is reached. The company
is still protected from an adverse rise in rates above the cap level. Therefore a
range or 'collar' is created and the company will never pay a lesser interest rate
than the floor rate nor a greater interest rate than the cap rate.

Interest Rate Swap

This product allows you to swap the interest rate basis of an asset or liability
from a floating rate to a fixed rate or vice versa. This is an off-balance sheet
instrument involving no exchange of principal amounts at any stage.

38