JB Certificates on the 3Y Interest Rate in EUR/USD - An efficient instrument to hedge bonds and lombard loans against rising interest rates
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JB Certificates on the 3Y Interest Rate in EUR/USD
An efficient instrument to hedge bonds and lombard loans
against rising interest rates
Zurich, February 2012
Only for distribution in Switzerland
Why to hedge a bondportfolio or lombard loan against rising
interest rates?
Interest rates are still at very low levels
Market expects that central banks will not increase short term rates in the next 2-3 years, but…..
… a sudden change in economic datas or a change in market behaviour could cause a market
shock in interest rates and lift up interest rates fast (= fear that central banks might increase short
term rates sooner than expected)
Bonds with a duration of 3-5 would sharply fall in price
3 Years EUR Rate is 0.6570% p.a. and 3 Months Euribor is 0.15% = Spread only 0.5070%
3 Years USD Rate is 0.6130% p.a. and 3 Months Libor is 0.30% = Spread only 0.3130%
The compensation to hold an interest rate risk for 3 years is not compensated enough
2 Only for distribution in Switzerland
A bond has 3 embedded risks
Treasury Yield Swap Yield Bond
4.5
4
3.5
3
2.5
Asset Swap Spread
2
Swap Spread
1.5
1
0.5
0
1. Interest Rate Risk 2. Credit Risk 3. Liquidity Risk
Hedged with Interest Rate Swap = Asset Swap Hedge with Credit Default Swap = CDS No Hedge possible!
3 Only for distribution in Switzerland
Basics: Hedging interest rate risks with an interest rate swap (IRS) 4
A Swap (Payers) reduces interest rate risk
Swap (engl.) = exchange
Derivative contract between 2 parties
Exchange of a fix payment versus a floating payment
Predefined maturity
A „pays“ fix interest No exchange of Nominal! Only interest payment
Example
Bank A Bank B Bank A pays „fix“ and receives floating payment
At trade the pv of the floating is equal to the pv of
fix payments
If the sum of all received floating payments is higher
B „pays“ floating interest
than the fix payments Bank A makes a profit
So Bank A expectes higher rates and Bank B lower
rates
5 Only for distribution in Switzerland
Summary: Interest Rate Swap
Advantages:
Client is not exposed to interest rate risks anymore
Very liquid hedging instrument
Very efficient to change interest rate duration
Disadvantages:
A plain vanilla swap requires a minimum volume of 2-3 mio.
Additional documentation is needed
Cash flows need to be monitored
6 Only for distribution in Switzerland
JB Certificates on the 3Y Interest Rate in EUR/USD 7
JB Certificates on the 3Y Interest Rate in EUR/USD
Solution Securitization:
Certificates are securitzed interest rates swap
Pricing of certificates at launch - very simple - just the value of the 3 Years
EUR or USD Interest Rate (EUR 1.97 = 3 x 0.657 p.a, USD 1.84 = 3 x 0.613
p.a.)
No stop loss in the product
Hedge already possible for EUR 100 or USD 100
No documentation needed - Listed on SIX - Exchange
No additional margins, no margin calls
All cashflows are priced into the certificate
Clients does not have to monitor cashflows
8 Only for distribution in SwitzerlandJB Certificates on the 3Y Interest Rate in EUR/USD
3 – Years EUR Rate 3 – Years USD Rate
Issuer Bank Julius Baer & Co. Ltd., Guernsey Bank Julius Baer & Co. Ltd., Guernsey
Maturity Date 11.03.2016 11.03.2016
Nominal / Ratio EUR 1.00 / 100 USD 1.00 / 100
Issue Price EUR 1.97 (=0.657% p.a.) USD 1.84 (=0.6130% p.a.)
Stop Loss Limite No No
Valor/ISIN/Symbol 20.230.236 / CH0202302367 / JFPLT 20.230.237 / CH0202302375 / JFQJZ
9 Only for distribution in SwitzerlandHedging a EUR Bondportfolio
Yield 1.20% p.a. Pays fix 0.657% p.a. Bondportfolio: 10 Mio. EUR
(or 1.97% for 3 years)
Mod. Duration: 3.00 years
Floating 3 Months
Average Yield 1.20% p.a.
Euribor 3 Years Swap EUR 0.657% p.a.
Bondportfolio Client JB Price Certificate in EUR: 1.97 (3 x 0.657%)
Certificate Asset swap: 0.543% p.a.
0.543% p.a. = Average Yield 1.20% p.a. – Swap 0.657% p.a.
Summary: After Hedge:
Client exchanged his 3 years fixed Bondportfolio into Interest Rate Duration: 0.25 years
a 3 years floating rate portfolio which pays now: Credit Duration: 3 years
3 Months Euribor + 0.543% p.a. (= Asset Swap)
10 Only for distribution in SwitzerlandHedging a lombard loan linked to 3M Euribor
Example:
3 Months Euribor floating payments + 0.75% margin Client has a EUR lombard loan
He pays 3M Euribor (floating) plus margin of 0.75% p.a.
Lombard Loan Client If interest rates are rising the clients interest
payments are rising as well
Summary after hedge:
Pays fix 0.657% p.a. Client cannot benefit anymore from lower rates BUT
(or 1.9700 for 3 years) now he knows his interest payments for the next 3 years
No interest rate risk anymore, no more leverage risk
Lombard Loan
Client JB
Floating: Floating :
Certificate Client has a fixed term loan with for 3 years and pays
3M Euribor + 0.75% p.a. margin 3M Euribor 0.6570% p.a. + 0.75% p.a. = 1.4075% p.a.
11 Only for distribution in SwitzerlandHow many certificates do I need to buy to hedge my
bondportfolio?
Formula: Example how to hedge: Cost and Leverage:
Bondportfolio: EUR 1’000’000
Duration: 3.10 / Yield 1.20% Price 1 Certificate : 1.9700
Remaing years certificate: 3 years Cost of Hedge:
(Market Value Bondportfolio or Loan * Nominal Zertifikat: EUR 1.00 10‘333 * 1.9700 = EUR 20‘356
Hedging period) Ratio: 100 Cost of Hedge in Percentage of Bondportfolio
Number of Certificates EUR 20‘356 / EUR 1‘000‘000 = 2.04%
(Nominal Certificate* Ratio * Years to (1’000’000 * 3.10) (=Equal to a leverage of 49X)
maturity of Certificate) = 10‘333 Certificates
(1 * 100 * 3)
12 Only for distribution in SwitzerlandHedge Bondportfolio - Scenario Analysis
Immediate Interest Rate Change Bondportfolio Value Certificate P&L Hedge Combined in EUR
- 1.00% +3.00%/ EUR +31‘000 0.00 EUR- 20‘356 +10‘643*
- 0.50% +1.50%/ EUR +15‘500 0.72 EUR- 15‘500 +8‘060*
+/- 0.00% 0.00% 1.97 EUR 0.00 0
+ 0.50% -1.50%/ EUR – 15‘500 2.47 EUR + 15‘500 0
+ 1.00% -3.00% / EUR -31‘000 4.97 EUR + 31‘000 0
At maturity after 3 Years:
3M Euribor average fixing rate Bondportfolio Value Certificate P&L Hedge Combined in EUR
- 1.00% EUR 37‘200 0.00 EUR- 20‘356 +16‘844**
- 0.50% EUR 37‘200 0.00 EUR- 20‘356 +16‘844**
0.00% EUR 37‘200 0.00 EUR -20‘356 +16‘844**
+ 0.657% EUR 37‘200 1.97 EUR+ /- 0.00 +37‘200**
+ 1.00% EUR 37‘200 3.00 EUR +10‘643 +47‘843**
+ 2.00% EUR 37‘200 4.00 EUR +20‘976 +58‘176**
* The product cannot fall below the value of 0 in case of negative rates (positive convexity)
** Equal to an average 3M Euribor Rate + Asset Swap of 0.5430% p.a.
13 Only for distribution in SwitzerlandListing on the SIX – Swiss Exchange
Investor (internal or external) is independent of his bank,
he can hedge his interest rate exposure via a listed product
Foating LIBOR or EURIBOR Fixed Rate Investor can do a hedge with a securitized swap
he normally could only do if nominal is higher than
LIBOR or
EURIBOR based Loan 2 Mio.
Investors‘s Bank Investor Long Full flexibility, always fair value and real time pricing on SIX
Leverage
Certificate At what interest rate do I enter into the hedge?
Loss if rates are rising Profi if rates are rising Example.
Price 1.97, Maturity 3.00 = 0.6570% (1.97/3.00)
Profit if rates are sinking Loss if are sinking
Price 1.40 Maturity 2.40 = 0.5830% (1.40/2.40)
Price 2.50 Maturity 2.40 = 1.0420% (2.50/2.40)
14 Only for distribution in SwitzerlandSummary - JB Certificates on the 3Y Interest Rate in EUR/USD
Advantages:
Very simple product to hedge interest rate exposure for 3 years
No documention needed
Listed on SIX Swiss Exchange, very liquid secondary market
Certificates pay the sum of all 3M Euribor in EUR certificate or 3M Libor in USD certificate fixing
If rates are rising full hedged, if rates are sinking close to 0 or below benefit of positive convexity
Disadvantages:
Client / Investor gives up potential that interest rates (resp. Euribor or Libor Rates) will stay low for
next 3 years
15 Only for distribution in SwitzerlandLegal Disclaimer (1/2) Important legal information This publication constitutes marketing material and is not the result of independent financial research. Therefore the legal requirements regarding the independence of financial research do not apply. The information and opinions expressed in this publication were produced by Bank Julius Baer & Co. Ltd., Zurich, as of the date of writing and are subject to change without notice. This publication is intended for information purposes only and does not constitute an offer or an invitation by, or on behalf of, Julius Baer to make any investments. Opinions and comments of the authors reflect their current views, but not necessarily of other Julius Baer entities or any other third party. Services and/or products mentioned in this publication may not be suitable for all recipients and may not be available in all countries. Clients of Julius Baer are kindly requested to get in touch with the local Julius Baer entity in order to be informed about the services and/or products available in such country. This publication has been prepared without taking account of the objectives, financial situation or needs of any particular investor. Before entering into any transaction, investors should consider the suitability of the transaction to individual circumstances and objectives. Nothing in this publication constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate for individual circumstances, or otherwise constitutes a personal recommendation for any specific investor. Julius Baer recommends that investors independently assess, with a professional advisor, the specific financial risks as well as legal, regulatory, credit, tax and accounting consequences. Past performance is not a reliable indicator of future results. Performance forecasts are not a reliable indicator of future performance. The investor may not get back the amount invested. Although the information and data herein are obtained from sources believed to be reliable, no representation is made that the information is accurate or complete. Bank Julius Baer & Co. Ltd., Zurich, its subsidiaries and affiliated companies do not accept liability for any loss arising from the use of this publication. Structured products (e.g. baskets, certificates) are complex financial products and therefore involve a higher degree of risk. They are intended for investors who understand and are capable of assuming all risks involved. Structured products may therefore only be sold to experienced investors and require additional advice regarding the products specific risks. Structured products do not constitute a participation in a collective investment scheme. Therefore, they are not supervised by the Swiss Financial Market Supervisory Authority FINMA and the investor does not benefit from the specific investor protection provided under the Swiss Federal Act on Collective Investment Schemes. The value of the products is not only dependent on the development of the underlying, but also on the creditworthiness of the issuer, which may vary over the term of the product. In case of the issuer’s insolvency or bankruptcy, the investor in the product may loose his entire investment. Before entering an investment all documents related to the issue of the described structured product has to be read. This publication is not a simplified prospectus as stated in Art. 5 of the Swiss Federal Act on Collective Investment Schemes. The full terms of the respective structured product may be obtained free of charge. The investor may be exposed to currency risk, because the product or underlyings of the product are denominated in other currencies than that of the country in which the investor is resident. The investment as well as its performance are therefore exposed to currency fluctuations and may increase or decrease in value. 16 Only for distribution in Switzerland
Legal Disclaimer (2/2) This publication may only be distributed in countries where its distribution is legally permitted. This information is not directed to any person in any jurisdiction where (by reason of that person’s nationality, residence or otherwise) such publications are prohibited. Switzerland: In Switzerland this publication is distributed by Bank Julius Baer & Co. Ltd., Zurich, authorised and regulated by the Swiss Financial Market Supervisory Authority FINMA. United States: NEITHER THIS REPORT NOR ANY COPY THEREOF MAY BE SENT, TAKEN INTO OR DISTRIBUTED IN THE UNITED STATES OR TO ANY US PERSON. This document may contain information obtained from third parties, including ratings from rating agencies such as Standard & Poor’s, Moody’s, Fitch and other similar rating agencies. Reproduction and distribution of third-party content in any form is prohibited except with the prior written permission of the related third-party. Third-party content providers do not guarantee the accuracy, completeness, timeliness or availability of any information, including ratings, and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such content. Third-party content providers give no express or implied warranties, including, but not limited to, any warranties of merchantability or fitness for a particular purpose or use. Third-party content providers shall not be liable for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including lost income or profits and opportunity costs) in connection with any use of their content, including ratings. Credit ratings are statements of opinions and are not statements of fact or recommendations to purchase, hold or sell securities. They do not address the market value of securities or the suitability of securities for investment purposes, and should not be relied on as investment advice. © Julius Baer Group, 2013 17 Only for distribution in Switzerland
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