Interest Rate Futures

1.  Interest Rate Futures 21 November 2006

2. Outline of Presentation • Managing Interest rate Risk • Identifying market Expectations • Using Charts • Market Price Dynamics • MosPrime

3. Concept of interest rate risk • Fixing of the interest rate on an Asset or Liability • What is my exposure? • How do I measure it? => BPV

4. Instruments hedging short term interest rate risk Available instruments: • Cash instruments: Money Market and FX swaps • Non-cash Derivatives: OTC and Interest Rate Futures

5. Cash instruments • Money Market Instruments: • Allow for the perfect interest rate hedge • Dates and notionals can be tailored • But, credit line intensive • FX Swaps: • Exchange of notional between two currencies for the duration of the transaction • Allows for the perfect interest rate hedge in two currencies • Dates and notionals can be tailored • And use less credit lines than Money Market instruments.

6. Cash instruments: FX swaps • Uneven swaps • T0 • T1 • Even swaps • T0 • T1 USD Notional Bank A Bank B EUR Notional USD Notional + interest Bank A Bank B EUR Notional + interest USD Notional Bank A Bank B EUR Notional USD Notional Bank B Bank A EUR Notional + (EUR interest – EUR equivalent of USD interest)

7. Cash not always optimum to hedge the interest rate risk Where derivative instruments are available, it is usually more efficient to separate cash and interest rate risk management: This allows to take the preferred hedging decision for each exposure. For example, it may be preferable to hedge a disbursement on a 3 month loan with overnight funding (Cash management) and a DERIVATIVE instrument (interest rate risk management). i.e. we can take a curve view

8. Derivatives Over The Counter: Forward Rate Agreements (FRA) A FRA is an agreement about the future level of interest rates. Compensation is paid by one party to the other to the extent that on the interest fixing date, market interest rates deviate from the agreed rate.

9. Derivatives • Benefits of FRAs: • No cash involved (except at settlement): allows to separate cash management from interest rate risk management • Dates and Notionals flexible (within limitations) => more flexible than Futures • No basis risk (as opposed to Futures) • Drawbacks of FRAs: • Not perfect hedge (but if FRA dates close to those of the risk to be hedged, residual curve risk can be minimised) • Credit risk • ISDA legal agreement needed with every counterparty • Pricing may not be transparent for non standard dates • Legal and tax considerations in Russia?

10. Derivatives Exchange traded derivatives: Interest rate futures prices are defined as 100 – Interbank offered rate.

11. Derivatives Exchange traded derivatives: • Benefits of Futures: • No cash involved (except for margin): allows to separate cash management from interest rate risk management • Counterparty is the Exchange + initial margin + daily margin calls => reduced credit risk • Fewer Legal Agreements needed (with the Broker and Clearer only) • Transparent pricing • Brokerage fees cheaper than on OTC derivatives • Fast and simple execution • Drawbacks of Futures: • Not perfect hedge • Basis risk with the cash risk (converging to 0 towards Future settlement date => no real risk if Futures held to settlement date)

12. Derivatives FRAs vs. Futures: In principle, a Forward and a Futures price have the same payoff

13. Derivatives FRAs vs. Futures: However, • The margining can create a price bias, if there is a non-zero correlation between moves in the asset (Futures) price and movements in the interest rates • Margin in-flows need to be reinvested • Margin calls out need to be funded • The cash-settlement value of a FRA is discounted at the settlement price over the fixing period

14. Derivatives FRAs vs. Futures: the basis

15. Summary table of the different Instruments • According to information provided to the EBRD by market participants

16. Example: BPV impact of the different instruments MM and FX swap imply a perfect hedge in BPV terms. However, BPV analysis ignores transaction costs, which can only be recovered by taking some risk. => no risk = no loss, but also no gain!

17. Example: BPV risk

18. Example: Scenario

19. Example: Scenario

22. What drives price action? • Heterogeneous expectations • Speculators: critical to provision of liquidity • A special kind of speculator: the Black Box

23. MosPrime: Origins In April 2005, a new Rouble money-market reference rate was launched in the Russian market - the Moscow Prime Offered Rate (MosPrime Rate) - under the auspices of the National Foreign Exchange Association (NFEA).

24. MosPrime is the yield for money-market time deposits offered by first tier banks in the Russian market to financial institutions of comparable credit standing. MosPrime is calculated daily for 1, 2, 3 and 6 month tenors provided by eight Contributor Banks. MosPrime calculation procedure is based on international standards: the arithmetic average of quoted rates after rejecting the highest and the lowest offers. MosPrime: Description

25. MosPrime: Contributing Banks • A minimum of six banks contribute reference rates, and are selected on the basis of reputation, credit standing, scale of activity and experience in the Russian money-market. • NFEA’s Board reviews the contributors’ list at least once a year. There is no restriction on the recurring inclusion of a bank in the list. • Currently the list of contributing banks consists of:ABN Amro Bank, ZAO Citibank, ZAOGazprombank, CJSC International Moscow Bank, ZAO Raiffeisenbank Austria, ZAO Sberbank, OJSCBank for Foreign Trade (VTB), OJSC WestLB Vostok, ZAO

26. MosPrime: Bilateral Loans • EBRD has arranged RUB 30 billion of MosPrime-linked corporate and municipal loans. • MosPrime is used for long term mortgage lending, with one bank reporting 746 such loans in September 2006. • MosPrime is used by a number of banks in their corporate loan programmes, as well as for internal benchmarking.

27. MosPrime: Bonds • EBRD’s inaugural RUB bond (RUB 5bn 5yr), May 2005, was the first MosPrime-linked issue. • To date, EBRD has issued three such RUB 5-year Floating Rate Notes totalling RUB 17.5 billion, for which a coupon will be set at 3 month MosPrime on every calendar month of the year.

28. MosPrime: Derivatives • In May 2006 MosPrime-linked futures were launched on MICEX. • Banks are quoting RUB interest rate swaps using MosPrime as the index for the floating leg. Expected legal changes, clarifying enforceability of swap transactions in Russian courts should expedite this activity, and allow the hedging of interest rate risk.

29. MosPrime: Additional Information • NFEA undertakes to disclose MosPrime on a daily basis via its website, special Reuters pages and mass media. http://www.nva.ru • Contributor Banks undertake to lend to the other panel banks at their MosPrime quotation rate, and to accept deposits from them at no more than 50 basis points below that rate. • Contributor Bank’s have agreed to lend to EBRD at their MosPrime quotation rate and accept deposits at no more than 50 basis points below it on the dates of bond coupon fixings. EBRD tests the validity of the rates quoted, and monitors the panel of Contributor Banks to ensure the credibility of the MosPrime rate.

30. MosPrime: Additional Information Mosprime quotations for 0/n, 1 week, 2 weeks will be officially launched in January 2007 Technical start date 15 December 2006