CERTIFICATE COURSE ON DERIVATIVES

This course covers financial derivatives such as forward contracts, futures contracts, options, swaps and other recently created derivatives. It follows pragmatic approach and discusses both the markets and the derivative products and their use.

The emphasis of the course is on the successful execution of financial strategies using derivatives as product. It focuses on practical understanding of how the derivative markets function, how the derivative products are used and why they are used and how they are usually priced.

Learning Objectives (LO)

o To enable candidates to have a detailed understanding of the main characteristics of financial derivatives and their relationships with the underlying assets; o To be able to use of these instruments in a wide range of hedging, trading and arbitrage purposes; o To understand how to control the risks of financial derivatives and derivatives portfolios; o To demonstrate a knowledge of the regulatory framework for financial derivatives; o To demonstrate a detailed understanding of the valuation principles and models for derivatives; o To be able to design alternative derivatives strategies that would be appropriate for different situations and describe the advantages and disadvantages of each;

The course for Derivatives shall be comprised of the following four Modules / Papers and Syllabus.

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MODULE – I

1. Financial derivatives an introduction 1.1 Derivative markets 1.1.1 Past and present 1.1.2 Difference between exchange traded and OTC derivatives 1.2 Derivative instruments 1.2.1 Concept and definition 1.2.2 Purpose and criticism 1.2.3 Basics about forwards, futures, options and swaps 1.3 Hedgers, arbitrageurs and speculators 2. and products 2.1 Structure of Forward Market 2.2 Concept, characteristics and definition 2.3 Types of forward contracts 2.3.1 Equity forward 2.3.2 Currency forward 2.3.3 Bond and forward 2.3.4 2.4 Valuation of forward 2.5 Generic valuation principles 2.6. Practical Concepts in Forward Market on Currencies 2.6.1 What is forward premium in USD/INR 2.6.2 History of forward premiums in India 2.6.3 What moves forward premium in India 2.6.4 Impact of forward premium on exchange rates 2.6.5 Interlinkage of forward premium with call money and liquidity situation in country 2.6.6 Do forward premium in USDINR indicate outlook on Interest Rate of country ? 2.6.7 Trading in forward premium 2.6.8 Optimising Hedging decision based outlook on forward premium 2.6.9 Future outlook of forward premium with impending US Rate hike and lower inflation and Interest Rate in India 2.6.10 Does forward premium always reflect interest rate differentials? If not why? 2.6.11 Difference between forward premium in OTC and Exchange Traded futures and Arbitrage in USDINR 2.7. Practical Concepts in Forward Rate Agreement (FRA) 2.7.1 Liquidity in FRA market globally 2.7.2 FRA contracts permitted by RBI

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2.7.3 Do Corporates in India and Globally use FRA’s to and why? 2.7.4 Quoting convention of FRA’s 2.7.5 Bloomberg / Reuters Screenshot of FRA Markets and their interpretation 3. Future Market and products 3.1 Structure and role of global future market including leading future Exchanges 3.2 Concept, characteristics and definition 3.3 Types of future contracts 3.3.1 future 3.3.2 Index future 3.3.3 3.3.4 3.3.5 Commodity future 3.4 Valuation of future 3.4.1 Generic valuation principles-cost of carry model 3.4.2 Valuation of individual future product 3.4.3 Trading mechanism and concept of margins (IM, MTM, MM) 3.5 Basis risk 3.5 Daily settlement price and Final settlement price 3.6 Practical Concepts in Futures Market 3.6.1 How to detect probable trends in Futures Market using basis differential 3.6.2 and volume data of futures market 3.6.3 How to detect probable trends using change in Open Interest and volume in Futures market 3.6.5 How Index futures have evolved in India : NIFTY and BANK NIFTY 3.6.6 Index Funds and management of Index by Global Hedge Funds 3.6.7 Variety of Index in Indian Equity market and how to judge direction of single stock based on movement in sectroal index. 3.6.8 Bloomberg / Thomson Reuters chart showing Index movements 3.6.9 Practical concept of and Backwardation in Commodities Market and why they arise. 3.6.10 Bloomberg / Thomson Reuters chart and explanation of Contango / Backwardation 3.7. Applications & Risk Management of Forwards & Features – Regulatory Aspects & Reporting.

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MODULE-2

4. market and products 4.1 Structure and Role of Global Option Market including OTC and leading Option Exchanges 4.2 Concept, characteristics and definition 4.3 Option terminologies 4.3.1 4.3.2 4.3.3 American and European option 4.3.4 Option writer and buyer 4.3.5 Option premium including intrinsic value and time value 4.3.6 4.3.7 ITM, ATM and OTM 4.3.8 Option payoff 4.4 Trading mechanism and concept of margins 4.5 Types of options 4.5.1 Stock option 4.5.2 Index option 4.5.3 Currency option 4.5.4 Commodity option 4.5.5 Options on futures 4.5.6 Interest rate options 4.6 Put -Call Parity 4.7 Valuations of options 4.7.1 Factors affecting option valuation 4.7.2 Binomial model (portfolio replicating and risk neutral approach) 4.7.3 BSOPM 4.8 Upper and lower limit of option prices 4.9 Exercising an option vs closing out 4.10 Option strategies (spreads, and strangles) 4.11 Practical Concepts and Example of Options Market 4.11.1 Strategies adopted by Indian / Global Corporates to hedge exposures through Options and best practices. 4.11.2 Practical Examples of 4.11.2.1 Range forward, 4.11.2.2 Seagulls, 4.11.2.3 Ratio forward, 4.11.2.4 Forward extra, 4.11.2.5 participating forward, 4.11.2.6 Caps & Floors

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4.11.2.7 Spread Trades – Calendar spreads and strike spreads 4.11.3 Understanding of important components of Option pricing 4.11.3.1 Delta : 4.11.3.1.1 What is delta ? 4.11.3.1.2 Why option traders prefer to be delta neutral at inception ? 4.11.3.1.3 Why delta changes over the life of Options ? 4.11.3.1.4 What does delta trading imply when you are an option and when are the option ? 4.11.3.2 Gamma: 4.11.3.2.1 What is gamma ? 4.11.3.2.2 How does Gamma impact delta of an option ? 4.11.3.2.3 Relationship of Gamma with strike, time to export 4.11.3.2.4 Which Gamma does option trader hate to have ? 4.11.3.2.5 Impact of event risk on gamma ? 4.11.3.3 Theta: 4.11.3.3.1 What is theta 4.11.3.3.2 What is Theta bleed? 4.11.3.3.3 How does option trader avoid Theta bleed even if he is long an option ? 4.11.3.3.4 Impact of Theta bleed on your profit / loss ? 4.11.3.4 Vega: 4.11.3.4.1 What is vega and Rho? 4.11.3.4.2 What is long Vega and short Vega position? 4.11.3.4.3 How do option trader decide to be long Vega or short Vega? 4.11.3.4.4 Relationship of Vega and time to maturity of option? 4.11.3.5 What quoted and Traded in option market. 4.11.3.6. What is and fly and how are they quoted in option market 4.11.3.7 How to derive for any strike using at the money vol, fly and risk reversal. 4.11.3.8 How to identify future direction of market using fly and risk reversal.

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4.11.3.9 How did fly and risk reversal behave during US sub prime crisis and how have they evolved. 4.11.3.10 Brief understanding of running of Option book by professional traders. 4.11.3.11 How options provide superior pay-off then options 4.11.3.12 Directional strategies using Options 4.11.3.13 Non directional strategies using Options Comment. 4.11.3.14 How one make money through option even if the underlying is not moving much. 4.11.3.15 Using Options to hedge ECB, Buyers , current exposure and probable exposure. 5. 5.1 Types of exotic option 5.1.1 Bermuda option 5.1.2 5.1.3 5.1.4 5.1.5 5.1.6 5.1.7 5.1.8 Look back option 5.1.9 5.2 Hedging and pricing of exotic option 5.3 Practical Concepts and examples of Exotic Options 5.3.1 Frequently executed Exotic Options by Hedge Funds 5.3.2 Frequently executed Exotic Option by Corporates 5.3.3. Use of compound Options and Forward start options in Mergers and Acquisitions 5.3.4 Use of Basked Options by Hedge Funds and how they are superior to vanilla Options 5.3.5 Why institutions do Binary / Digitial Options 5.3.6 Combinations of Vanilla and Binary Options which are frequently executed by global corporate and funds 5.3.7 Knockin Knockout Options 5.3.8 Knockin Options – European and American 5.3.9 Knockout Options – European and American 5.3.10 Double knockin Options 5.3.11 Double Knockout Options 5.4 Third Generation Options 5.4.1 Target Redemption Forward ( TARF) 5.4.1.1 Vanilla TARF

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5.4.1.2 Pivot TARF 5.4.1.3 European knockin TARF 5.4.1.4 Digital TARF 5.5 Exotic Structures 5.5.1 Snowball Structure 5.5.2 Wedding Cake structure 5.5.3 Reverse Knockout Forwards 5.5.4 Applications & Risk Management of Currency Options – Regulatory Aspects & Reporting 5.5.5 Option pricing –bionominal , trinominal trees etc 5.5.6 Option strategies – black-scholes and option based hedging strategies.

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MODULE 3

6. Swaps 6.1 Concept, Characteristics, Definition and Pricing 6.2 Types of swaps 6.2.1 Interest rate (IRS) 6.2.2 6.2.3 6.2.4 Other types of swaps 6.3 Valuation of swap-overnight swap & 6.4 6.5 Credit risk and swap 6.6 Stragegies and Applications of Currency Swaps 6.7 Practical Concepts and examples of Swaps 6.7.1 Interest Rate and Currency Swaps executed in India by Interbank and Corporates : 6.7.1.1 OIS Swap 6.7.1.2 MIFOR Swap 6.7.1.3 INBMK Swap 6.7.1.4 Full Currency Swaps 6.7.1.5 Coupon only swap 6.7.1.6 Hedging of Buyers Credit / ECB in India 6.7.2 RBI regulations governing FX and in India 6.7.3 Reciprocal Swaps between Banks 6.7.4 Carry Trade 6.7.4.1 Concept of Carry Trade 6.7.4.2 Practical example of carry trade executed pre 2008 crisis and post 2008 6.7.4.3 Advantage and Disadvantage of Carry Trades 6.7.4.4 Indian Coporates experience with carry trades 6.8.4.5 RBI regulations governing carry trades in India 6.7.5 Caps , Floor and Collars to hedge interest rates 6.7.6 Intutitive understanding of swap pricing 6.7.6.1 Understanding components of swap in Indian market 6.7.6.2 Deriving indicative swap pricing intuitively in one minute without any calculator : A must have skill for any treasury manager 6.7.7 Unique characterstics of Indian swap market due to convertibility of our currency 6.7.8 Concept of Natural Hedge and Dollarisation of balance sheet in India by corporate through swaps 6.8 Bloomberg / Thomson Reuters screenshort showing FX swap curve

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across the globe and India and correlation between swap curves 6.9 Concept of Particpatory Notes in Indian Equity / segment and regulations governing them 6.10 Why Participatory Notes are so popular among FII’s investing into India 7. Credit Derivatives 7.1 The basic concept 7.2 Role and structure of credit derivatives 7.3 Types of 7.3.1 CDS (credit swap) 7.3.2 TRS () 7.3.3 CSO ( option) 7.3.4 CLN (Credit link notes) 7.3.5 CDO (collateralized debt obligations) 7.4 Practical Concepts and examples 7.4.1 CDS Quoting conventions in real market 7.4.2 Viewing CDS curve in Reuters/Bloomberg 7.4.3 Understanding of change in CDS curve pre and post Global Financial crisis 7.4.4 Deriving India’s CDS curve 7.4.5 Use of CDS curve to determine Risk Weighted Assets under Basel III framework by Banks 7.4.6 Indian Regulations on CDS 7.4.7 India’s experience with CDS and why the market for CDS in India is yet to takeoff 7.4.8 Concept and example of CLN 7.4.9 Use of CLN to reduce balance sheet risk by Banks under Basel III 7.4.10 Practical examples of CLN and TRS 7.4.11 Why CDO market was liquid pre Global Financial Crisis and what changed after that ? 7.4.12 ITRAXX Indices for trading credit 8. Other Derivatives 8.1 Weather derivatives 8.2 Energy derivatives 8.3 Insurance derivatives 9. Forward vs swap hedging – fundamentals , netting vs hedging , hedging of net exposure

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MODULE 4

10. Taxation of derivative instruments 11. Learning from derivative mishaps 12. Derivatives Risk Management 12.1 Market Risk 12.2 Credit Risk 12.3 Liquidity Risk 12.4 Operational Risk 12.5 Enterprise Risk 12.6 VAR 13. Regulatory framework for derivatives 13.1 Indian Regulations governing derivatives 13.2 Sweeping reforms in Derivative market in US and it’s global impact 14. International Swaps and Derivatives Association Master Agreement: 14.1 Role played by ISDA agreement during Global Financial crisis 14.2 Importance of ISDA after global financial crisis 14.3 Concept of Credit Support Annex and Global Collateral 15. Formulating the Dynamic Risk Management Policy by Corporates: 15.1 Identification and quantification of Exposure 15.2 Measuring the FX and Interest Rate Risk 15.3 Innovative Strategies for Risk reduction: 15.4 Change in commercial contracts 15.5 Establishing Benchmark / Budgeted Rate and how to outperform them 15.6 Determining Hedge Ratio through Multi Factor Model and monthly evaluation. 15.7 Designing Hedge strategy 15.8 Establishing Controls in Company for managing risk

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