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Here, if at any time during 01-Sep-2003 and 01-Nov-2003, the spot rate touches or goes below 46 INR/USD
or touches or goes above 49 INR/USD, the option will be knocked out and a rebate of 50 AUD will be paid
by the seller of the option to National Bank, either on the knock out date or on maturity (31-Dec-2003). If the
spot rate does not touch either barrier during the barrier window, a fixed amount of 500 EUR will be paid by
the seller of the option to National Bank on the maturity date.
Explanation of Terms Associated with IRO Markets /
Transactions
8.2
Option Buyer (holder)
This is the party that obtains, on payment of a fee, the right to lend or borrow (notionally) a predetermined quantity of money at a specified rate of interest for a specified period starting from a
specified date. In effect, she obtains the right to compensation in the event of a future adverse
movement in a floating benchmark interest rate, which can, for example, be the USD 6-month
LIBOR.
Option Seller (writer)
This is the party that enters into an obligation, in return for a fee, to provide compensation to the
option buyer in the event of a future adverse movement in a floating benchmark interest rate.
Example
On May 02, 2003, Sarah Williams buys a Put IRO from Options Bank, giving her the right to lend 1 million
USD at 5% for the period July 01, 2003 to December 31, 2003. The benchmark rate is 6-M LIBOR. On June
27, 2003, when rate fixation takes place for the period July 01 – December 31, 2003, 6-M USD LIBOR is
4%. Options Bank has to pay Sarah Williams a sum of:
1,000,000 X ((0.05-0.04) X (183/360)) = 5,083.33 USD
Had USD LIBOR for the period July 01 – December 31, 2003 been 5.5%, Sarah Williams would not have
exercised the Call IRO.
Notional principal / Contract amount
This is the underlying principal amount, based on which payments or receipts for an IRO are
calculated. It is ‘notional’, since the IRO contract contains no obligation for either counterparty to
lend or borrow funds at the contracted rate. In the previous example, the notional principal is
1,000,000 USD.
Premium
This is the upfront fee or price paid by the option buyer to the option writer. This is sometimes
expressed as a percentage of the notional principal / contract amount. The premium is usually
payable on the same day when the option deal is struck, or within two business days from the
deal date.
Transaction date / Deal date / Trade date
This is the business day on which the option deal is entered into.
Interest period
The interest period or the contract period is the duration for which the underlying interest rate is to
apply and is the tenor basis on which the settlement amount is computed. This is the period
between the value date and the maturity date. In the previous example, the interest period is
between July 01 and December 31, 2003.
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