puneet assignmnt 3rd

8/7/2019 puneet assignmnt 3rd

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ASSIGNMENT

OF

DERIVATIVESTOPIC:-SWAP DEAL CONTRACTS

SUBMITTED TO:-

SUBMITTED BY:-

MISS SAVITA SINGH PUNEET

MOHAN

R17B2A37

3020070154

BBA-MBA(8TH

S)


2/13

INTRODUCTION TO CASE

Reliance Industries and GAIL (India) on Thursday signed a gas swapdeal to fuel power plants in the country's south, a move that could

curb power deficit in peak summer and overcome pipeline constraints.,

Reliance will supply nearly 2.6 million cubic metres a day (mmscmd) of

gas, currently used by customers in Gujarat, to power producers in

Andhra Pradesh from Friday, India, which has a total installed power

generation capacity of 164 gigawatts (GW), aims to raise it to 187 GW

by the end of March 2012, a modest target given a 12% peak-hour

power shortfall that crimps its near 9% economic growth. According to

the deal valid May 31Oil Minister Jaipal Reddy said. In return, state-run

GAIL will transmit an equal amount of liquefied natural gas (LNG) to

customers in Gujarat, Reddy said, adding that the move would lead to

additional generation of about 600 megawatt of power. The move to

swap gas was considered as Andhra Pradesh did not have pipeline

connectivity to LNG plants in Gujarat. Gujarat customers would

continue to pay the price of D6 gas, while Andhra Pradesh power utility

will pay for imported LNG price. GAIL Chairman B.C. Tripathi said his

firm would supply spot LNG to Gujarat based customers. GAIL has

signed a deal to import 0.5 million tonnes of LNG from Marubeni.

Andhra Pradesh has gas-based power generation capacity of 2,700 MW

but due to inadequate pipeline infrastructure produces only about

1900 MW. India, which imports over two-thirds of the oil it consumes,

is actively encouraging the use of natural gas to reduce reliance on

costly oil imports. Domestic supply of natural gas has risen

significantly after Reliance started pumping from its deep-sea D6 block

in Andhra Pradesh in 2009.

SWAPS

Swap is a derivative in which counterparties exchange certain benefits

of one party financial instrument for those of the other partys

financial instruments.the benefits depends upon the type of the

financial instruments involved. Most swaps are traded over the counter


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derivative market.Some of the Swaps are also exchanged on futures

markets such as the CMEs, Chicago Board Of

Exchange,Intercontinental Exchange and Frankfurt based Eurex

AG.The cash flow generated from swaps is a substantial fraction of but

much less than the gross world product-which is also a cash-flowmeaure.The majority of this is due to the interest rate swaps.

Types OF SWAPS are:-

Interest rate swaps

Currency swaps

Commodity swaps

Equity swaps

Credit default swaps

ABOUT THE CASE DEAL

In this case the swap deal of the Reliance and the Gail company is

comes under the commodity swap deal within the two companies as

they came with the contract of the gas swap deal and it include the

swap of the companies to each other in the over the counter market,

as the Reliance is going to supply the supply nearly 2.6 million cubic

metres a day (mmscmd) of gas, currently used by customers in

Gujarat, to power producers in Andhra Pradesh from Friday, India,

which has a total installed power generation capacity of 164 gigawatts

(GW), aims to raise it to 187 GW by the end of March 2012, a modest

target given a 12% peak-hour power shortfall that crimps its near 9%

economic growth.So this kind of deal of the swap in the commodity

market comes under the over the counter market now there are so

many credit risks in the organization which they have to face. Every


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company has their own strategies to face the credit risks, and they

have to manage them properly which they will not affect the company.

CREDIT DEFAULT SWAPS

A CDS is a contract between two counterparties under which the

seller ("writer") agrees to pay the buyer a pre-determined amount

if a certain event transpires, most often default on a corporate

bond or asset-backed security, in return for the premium on the

CDS. Simply put, a CDS acts as a form of insurance for the owner of

a bond-like instrument, providing protection in the event of default.

Typically, the writer of a CDS (the insurer) agrees to pay the buyer

(the insured) the difference between a bond's face value and its

market value should the bond issuer default. A key differencebetween CDS's and more traditional forms of insurance is that the

buyer of a CDS need not own the underlying asset in order to

purchase the CDS. An investor can purchase a CDS that will pay in

the event of default on a specific bond without actually owning the

bond.

Today's CDS market is largely unregulated. Terms and conditions of

individual CDS contracts are negotiated between the two

counterparties and need adhere to no standard template, as with

exchange-traded derivatives. No specific capital requirements exist

for writers of CDS's, although many writers assign capital to back

the CDS's they write as part of a prudent risk management

program. Although difficult to measure precisely, the International

Swaps and Derivatives Association pegs outstanding CDS volume at

$39 trillion in notional value, down from a peak of $62 trillion in

2007. By comparison, the U.S. bond market has total outstanding

debt of $34 trillion, of which $21 trillion is in instruments on which

CDS's are written (corporate, municipal, mortgage-related andasset-backed securities). For some bonds, the notional value of

outstanding CDS's is many times that of the total outstanding

debt. While much of this difference is due to offsetting positions at

institutions who make markets in CDS's, it is also indicative of the

widespread use of CDS's as a "speculative" instrument to take

positions on specific debt issues and the broader bond market.


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CREDIT RISKS AND BENEFITS

Credit default swaps can be a useful tool for bondholders who want

to protect against specific credit events. The ability to write a CDS

tailored to the exact needs of the buyer makes them a uniquelyuseful risk management tool for companies with complex hedging

requirements. Events such as bankruptcy, failure to pay, and debt

restructuring are commonly covered by CDS's. Some portfolio

managers will pair ownership of a treasury bond with sale of a CDS

against a corporate bond that is in short supply to create what is

effectively a synthetic version of that corporate bond. Among the

reasons that some view credit default swaps as financial weapons

of mass destruction are the following:

Absence of any authority imposing capital requirements on CDS

writers

CDS writers can take on unlimited risk without needing to

demonstrate the financial ability to absorb it. While states and

rating agencies such as AM Best insist that insurance companies

hold sufficient capital to absorb potential losses, and exchanges

impose similar requirements on derivative traders, a company's

ability to write credit default swaps is limited only by its own good

judgment and the trust of its counterparties.

Scarcity of useful data on which to base loss

projectionsThe risk profile of a writer of credit default swaps is not unlike that

of a writer of facultative reinsurance. The difference is that where

history can be a somewhat useful guide in predicting even

catastrophic events like hurricanes and earthquakes, the frequency

and severity of accounting scandals, supply and demand shocks,

military coups, and financial crises affecting companies and wholemarkets obey no rules that even individuals as astute as Warren

Buffet, Alan Greenspan, and Ben Bernanke have been able to

divine.


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Limited visibility into the trading positions of

counterpartiesAIG was rescued because the federal government believed its

collapse would place our entire system of finance at risk. This came

about not only because AIG's financial condition had become

uncertain, but also because no one knew exactly where losses

would fall among AIG's counterparties. This lack of visibility into the

CDS positions of different companies and how they might or might

not net out against one another inside a given company was at the

root of the financial crisis in the Fall of last year and more than

anything else earned CDS's their classification as financial weapons

of mass destruction.

Moral hazard CDS's can createCompanies and individuals are not prevented from buying CDS's

without owning the underlying asset being insured. A CDS buyer

who does not own the underlying asset benefits if there is a default

and therefore has an incentive to take actions that may encourage

default. One who does own the underlying asset may be indifferent

to whether there is a default. This can have highly undesirable

economic consequences. Recently, some GM bondholders were, at

least initially, unwilling to exchange debt for equity to keep the

company alive and enable it to emerge from bankruptcy because

they held credit default swaps and were financially better off in the

event of a default.

HOW THE ENERGY COMPANIES MANAGE

THEIR RISKS

The management of credit risk has for energy companies in recent

times become a greater focus of attention. Along with that focus hascome increased sophistication in the methods of measuring,

monitoring, and managing credit related risks. As this deal of the

swaps between the Reliance and the Gail is about the gas swap deal so

both the companies are related to the energy companies sothese are

the some basics that how the companies are managing their risks. As


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in my case both are manageing their credit risk byentering into the

contract of the gas swap deal contract.

Recognize risk management not as risk elimination, but a

tradeoff among price, cash liquidity, credit and operating risks

Identify the unique aspects of credit risk for energy companies

Differentiate between liquidated damages and consequential

damages

View credit risk not just as default risk, but more broadly as non-

performance risk

Equate credit exposure for price-driven risks as the maximum

potential exposure

Apply Value-at-Risk methodology to measure unknown future

exposure (CVaR)

Derive measures for default risk using CVaR, default probabilities,

and recovery rates

Relate credit ratings to default probabilities and show its changes

with exposure terms

Identify sources of information that can be used to monitor

counterparty risks in a credit scoring system

Interpret market borrowing spreads as forward-looking default

risk indicators

Show how VaR methods relate to measuring credit exposure from

energy trades

Measure volatility and understand its dynamics and its time

dimension

Use volatility along with holding period and confidence level to

calculate CVaR


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Profile credit exposure and default risk changes with increasing

terms

Determine capital requirements, the profile of default risk over

increasing terms

Recognize the importance of consistent use of time buckets in

aggregating credit risks

Explain how joint credit support can boost credit ratings

Interpret correlation as an influence on credit expsorue and

credit risk

Quantify the risk reduction resulting from diversification on

aggregate risk, both on a single counterparty expsorue basis and

on a portfolio-wide basis

Recognize the implications of sector concentration on aggregate

credit exposures

Employ master netting agreements to reduce aggregate risk

Discern between apparent net exposures and pragmatic

exposure risks

Enter new transactions with a counterparty that will reduce

aggregate risk

Characterize credit exposures and risk for many commonly

traded energy products including swaps, forwards, EFPs, Index

contracts, basis trades, and options

Identify loans that are embedded in deal structures like "blend-

and-extend" swaps

Recognize synthetic storage structures as forms of

lending/borrowing

Understand the need for and approaches to pricing credit risk in

transactions to reflect the capital required to support the risk


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Compare and analyze alternative risk mitigation methods

including bank letters of credit, sleeving, two-way market puts,

and the use of clearinghouses

Devise a margining mechanism to minimize credit risk

Explain how credit derivatives are structured and priced, and how

they might be used in controlling credit exposures

BASIC CONTENTS TO MANAGING THE RISKS

1 - Credit Risk Issues in Energy

Credit in Enterprise Risk Management

Identifying Directional Price Risk

Characteristics of Credit Risk in Energy

Non-Performance Risk

Metrics Used in Credit Risk Management

Group Review

2 - Credit & Capital at Risk


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Measuring Credit Risk

Capital at Risk

Probability of Default & Credit Quality

Credit Scoring

Group Review

3 - Concepts Underlying Credit Risk Analysis

Evolution of Modern Risk Measures

Confidence Level

Volatility

Calculating CVaR

CVaR & MPE for Term Contracts

Group Review #1

Aggregating Risk Positions in Time Buckets

Capital at Risk

Aggregating Risk for CaR

Joint Credit Support

Group Review #2

4 - Analyzing Energy Transaction Risk

Credit Exposure for Index Contracts

Basis Swaps

Futures & EFPs

Credit Exposures for Option Structures


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Embedding Lending

Embedded Financing in Energy Structures

Swaps & Physical Priced Off-Market

Blend & Extend Structures

Group Review

5 - Mitigating Credit Risk

Netting Exposures to Reduce Risk

Multilateral Netting

Reversing Risk Position

Managing Credit Exposure under Netting

Mitigating the Risk of Default Losses

Margining

Market Resets

Two-Way Market Puts

Bond Puts

Default Swaps & Options

Credit Insurance

Group Review


12/13

CHALLENGES FACED WHILE IMPLEMENTING

THE CREDIT MANAGEMENT SYSTEMS BY

THESE COMPANIES

As the companies enter into the swap contract they have definitely

faced some challenges and some of the challenges which are found by

me are going to discuss

The main challenges are for both the counter parties are:-

Do your competitors bid higher for assets that you thought you had fairly

valued?

Conversely, have you ever won a bid for an asset and thought in hindsight

that you won because you bid too much?

Why are the recent prices paid for generation assets typically higher than a

standard NPV analysis would suggest?

When considering asset sales, do you say its worth more than that when

you see the results of traditional evaluations?

Do you own assets which may not meet EVA-type goals but you are reluctant

to sell because you think they might be valuable in the future if you hold

onto them?

If any of these do sound familiar, you may be systematically ignoring part of the

value imbedded in your assets the option value.


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CONCLUSION

At last, after studying this case study of the swap deal between the Reliance and the

Gail. We come to know about the real swap deal between the two counter parties

how the parties come into the swap contracts how they deal n how they making the

contract which is beneficial for both the parties. In this contract as the reliance is

getting the power by giving the same amount of the gas as written into the contract.

The most important thing is that I come to know that how the counter parties make

their swap contracts in the real world how they are facing the challenges and the

benefits of the swap contract. The basic swap contracts and the credit risks of the

companies, how they are appropriately managing the risk of credits. So, it is a very

learning assignment for me and it will give so much knowledge about the swaps,

swaps market, swaps deal, benefits.

puneet assignmnt 3rd

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