The OTC Options module in Oracle FLEXCUBE supports the complete lifecycle processing of the following over-the-counter derivative instruments:
You can define products for buying or selling each of the above instruments, enter details of specific transactions, terminate or exercise option contracts and generate a comprehensive range of reports pertaining to your transactions in OTC options. You can enter into deals for hedging your existing exposures against interest rate or exchange rate fluctuations (hedge deals) or for speculation (trade deals).
Based on your specifications, Oracle FLEXCUBE will:
Subject to relevance to a specific instrument, Oracle FLEXCUBE supports all the standard option expiration styles:
This chapter contains the following sections:
OTC options are traded in the over-the-counter market, where the active participants are banks and corporates. Therefore, deals can be inter-bank or between a bank and a corporate. Deals can be struck with a view to cover an existing exposure (hedge deals) or to create a speculative exposure (trade deals).
The terms of an OTC contract are tailored according to the mutual convenience of the counterparties. The counterparties also carry the complete exposure on each other, with no clearinghouse standing as a guarantor for the deals.
This section contains the following topics:
An IRO is an interest rate risk management product – that is, it protects the buyer from an adverse movement in interest rates.
A borrower of floating rate funds will be inconvenienced by a rise in interest rates, while a lender will be adversely affected by a fall in floating rates.
An IRO gives the buyer the right, but not the obligation, to fix the rate of a notional underlying loan or deposit for a specified period, commencing on a specified date. Thus, the buyer of an IRO is protected against the interest rate rising above (if she is a borrower) or falling below (if she is a lender) a specified level. At the same time, the buyer of an IRO can enjoy the benefits of the interest rate staying below (if she is a borrower) or staying above (if she is a lender) the specified level.
IROs can be of any one of the following categories:
Note
An IRO does NOT have an implied commitment by either counterparty to exchange the notional principal at any stage – so no credit has to be given (no debt security purchased) or deposit accepted (debt security sold) by either party.
This also means that an IRO can be entered into with a pure speculation objective, rather than only with a view to hedge against adverse interest rate movements.
A swaption gives the buyer an option to enter into an interest rate swap deal at a future date at a pre-agreed price.
Payer’s Swaption
A payer’s swaption gives the buyer of the option the right, but not the obligation, to pay a fixed rate and receive the floating interest rate in a swap contract. A swaption gives the holder the benefit of the agreed strike rate (fixed rate) if the prevailing market swap rate (fixed rate to be paid for receiving same benchmark floating rate) is higher, while giving her the flexibility to enter into the prevailing market swap rate (fixed rate to be paid), if it is lower than the strike rate.
Receiver’s Swaption
A receiver’s swaption gives the buyer of the option the right, but not the obligation, to receive a fixed rate and pay the floating interest rate in a swap contract. This benefits the holder if the prevailing market swap rate (fixed rate to be received against the same benchmark floating rate to be paid) is lower than the strike rate – in this scenario, the holder will exercise the swaption and enter into a swap whereby she receives the strike rate as the fixed rate. If the reverse happens, she will not exercise the swaption and enter into a swap at the prevailing market swap rate.
A swaption can be settled in either of the following ways:
Physically Settled – where the counterparties are obliged to enter into an interest rate swap deal on exercise of the swaption.
Cash Settled – where the counterparties are only expected to exchange money on exercise of the swaption.
A currency option gives the holder the right, but not the obligation, to buy a specific currency against another specific currency at a pre-agreed rate on or before a pre-specified future date.
Apart from plain vanilla currency options, the OTC Options module of Oracle FLEXCUBE also supports exotics in the form of binary, digital and no touch options. Barrier options – options that get knocked in or knocked out under pre-specified conditions – are also supported.
Currency options can have either of the following expiration styles:
The OTC options module interacts with the Foreign Exchange and Derivatives modules in Oracle FLEXCUBE for the generation of FX contracts and interest rate swaps on the exercise of currency options and swaptions respectively.
It also interacts with the Settlements, Messaging, ICCF, Brokerage, Tax and MIS sub-systems.