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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)
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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
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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.
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