Property Derivatives: Pricing, Hedging and Applications

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Currency Derivatives: Pricing Theory, Exotic Options, and Hedging Applications

On the other hand, the rent that the borrower is entitled to receive from the property will typically be a fixed amount payable each rental quarter. The borrower will be concerned to ensure that the rent it receives from the property can cover the interest on the loan.

This may not be the case if interest rates rise. The borrower can enter into a derivative transaction to hedge its exposure to interest rate rises. The borrower will then be able to match its outgoings to the fixed amount of quarterly rent payments which it is entitled to receive from its tenants. Such derivatives are typically entered into by a borrower with a bank, known as the hedging bank or hedging counterparty. The hedging bank is in a better position than the borrower to take the risk of fluctuations in interest rates, exchange rates or commodity prices.

Often, the hedging bank will hedge its own exposure under the swap through a back-to-back swap with a market-counterparty. Perhaps the most important principle to bear in mind when preparing the derivatives documentation for a lending arrangement is to ensure that there is consistency with the commercial terms agreed upon and contained in the facility agreement and other finance documents.

There are several provisions of the Master Agreement which need to be carefully looked at to ensure they do not clash with the loan documentation. If these standard ISDA provisions in the Master Agreement are not amended using the Schedule, they may conflict with the agreed position under the facility agreement and other finance documents. The events in the ISDA documentation should be the same as those in the facility agreement. An Additional Termination Event is often added to the ISDA Schedule to give the parties a right to reduce the hedge in circumstances where the loan is repaid or reduced.

Property Derivatives: Pricing, Hedging and Applications

The borrower will have a different perspective to the swap counterparty but clearly will want to have the right to terminate the swap if the loan is repaid it is unlikely to obtain this if the repayment is caused by acceleration. These set out the commercial terms of the hedge and usually have minimal legal input. Where a floating interest rate is being hedged, consistency between the facility agreement and the confirmation is key to ensure a proper match ie day count conventions and interest payment dates. Cross default provisions should apply only to the borrower and material companies within the group as agreed in the finance documentation.


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The ISDA Schedule must not state that all 'Affiliates' a very broad definition will be Specified Entities for the purposes of the ISDA cross default provision section 5 a vi , as this will cut across the agreed commercial position. The swap arrangements that form part of a finance transaction will be dictated by the requirements set out in the facility agreement and the other finance documents. Some transactions will contain the details regarding hedging in the intercreditor agreement or a side letter called a hedging strategy letter.

How Companies Use Derivatives to Hedge Risk

Regardless of what document they are contained in, these details will include:. The maintenance of hedging as provided in the finance documents will be one of the borrower's undertakings in the facility documentation.

For further information, see Practice Notes: Guide to hedging within a financing context—for the financing lawyer , Guide to hedging within a financing context—the ISDA documents and Use of derivatives in a lending context—documentation issues. A checklist which sets out the issues of which to be aware can be found at ISDA documentation in a finance transaction—checklist. NO YES. Selected type: Hardcover. Added to Your Shopping Cart.

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This is a dummy description. A groundbreaking collection on currency derivatives, including pricing theory and hedging applications. It surely will become required reading for both students and option traders. Emeritus Professor, University of California, Berkeley. Every investment practitioner knows of the enormous impact that the Black-Scholes option pricing model has had on investment and derivatives markets.


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  8. The success of the theory in understanding options on equity, equity index, and fixed- income markets is common knowledge. Yet, comparatively few professionals are aware that the theory's greatest successes may have been in the derivatives market for foreign exchange.

    Property Derivatives: Pricing, Hedging and Applications

    Perhaps this is not surprising because the foreign exchange market is a professional trading arena that is closed virtually to all but institutional participants. Nevertheless, the world's currency markets have proven to be an almost ideal testing and development ground for new derivative instruments. This book contains many of the most important scientific papers that collectively constitute the core of modern currency derivatives theory. What is remarkable is that each and every one of these papers has found its place in the real world of currency derivatives trading.