The ultimate aim of any modern corporate is growth with profit maximization. Growth is the first and foremost characteristic of nature and its products which include modern societies with all their industrial, agricultural and service sectors and above all the research organizations to cater to the needs of primary, secondary and tertiary sectors. Governed by the laws of the universe and nature, societies, markets and above all human life are in the constant churn of development in the realm of creativity and innovativeness.

Traded volumes in the Indian OTC derivatives market have grown exponentially since their introduction in the late 1990s. The products traded have gradually evolved from being simple `plain vanilla' to some extremely complex exotic structures. In this article, the author presents the findings of the survey undertakenonsite and offsite of the products traded in the Indian swap market. The broad conclusion of the study appears to be that a sizeable number of public sector banks and corporates are exposed to significant off-balance sheet risk arising from OTC derivatives; the counterparties to such deals being primarily major private banks and foreign banks operational in India.

Indian Over-The-Counter (OTC) derivatives market has witnessed phenomenal growth over the last few years. Notwithstanding the limited growth of the INR/USD options since their launch in July 2003, the OTC derivatives market has evolved largely on the basis of the swap market volumes. Daily trades in the interest rate swap market occasionally match that in the G-sec market. Fitch Ratings, in its report on `Fixed-Income Derivatives (September 2004), estimated that daily trading volumes in interest-rate derivatives in India are around Rs. 30 bn, significantly ahead of the foreign exchange derivatives market. It appears that volumes have spurted to these levels from Rs. 10 bn in January 2004. This rapid growth has been attributed to increased uncertainty surrounding interest rates as it is the only market that permits participants to take a two-way view on the market. The report identified only about 20 active players in the swap market. The present study, however, restricts itself to the survey of various products traded in the Indian swap market. It attempts to discuss the product structures and particularly highlight the risk inherent therein. The market being over-the-counter, the banks and other market participants in the swap market seldom share the information with regards to the exotic deals being structured amongst them. This severely restricts the range of products being assessed in this paper. The study draws on the interaction undertaken with derivatives traders as well as the information obtained through FIMMDA¹ reports, RBI guidelines and newspaper articles.

Indian swap market broadly comprises of parties with varied exposures to interest rate and currency risk, viz., banks, primary dealers, mutual funds, insurance companies and corporates. It is predominantly an inter-bank market, with maximum trading in Overnight Index Swaps (OIS), followed by MIFOR swaps. Tenors ordinarily do not go beyond five years, which is probably due to the absence of counterparty lines for longer tenors. Therefore, the market still lacks the tools to manage interest-rate exposure beyond five years. The traders follow the day-count convention of Actual/365 for the purpose of swap valuation. Reset date is usually two Mumbai business days before the start date of an interest period for MIFOR linked swaps and one Mumbai Business day before the start date of an interest period for other swaps.