Feasibility study of introducting real estate derivatives

The existent estate derived functions allow investors to derive exposure to the existent estate plus category without holding to purchase or sell belongingss by replacing the existent belongings with the public presentation of a existent estate return index. Real estate derived functions have become progressively popular in other parts of the universe as a comparatively efficient agencies of puting, fudging, re-balancing or showing positions about existent estate. Property derived functions enable an investor to take places on a generic package of commercial existent estate. Trades can be based on entire return, income or capital grasp.

In India existent estate market had been really active before the recognition crisis. Post crisis, it is merely now that the market has started demoing marks of recovery. At this occasion it would be interesting to make a feasibleness analysis for debut of existent estate derived functions in India – both as a method of fudging against volatile monetary value motions every bit good as a tool to let investors to put in this plus category.

Real Estate as an plus category

Fiscal markets all over the universe have been much developed today. There different signifiers of plus categories that are traded in assorted signifiers get downing with the existent plus, to derived functions affecting physical minutess or merely paper merchandises. The assorted plus categories traded today include stocks of companies, bonds, short-run recognition instruments, trade goods of assorted sorts, recognition derivative merchandises, and other sophisticated merchandises based on macroeconomic basicss like involvement rate, rising prices, GDP, etc. Among the existent assets that are portion of the fiscal capital markets oil, gold, and certain valuable agricultural merchandises like chocolate, etc are amongst the most traded. Real estate is one such existent plus keeping that greatly determines are populating conditions and buying power. However, really small has been done to handle it as a fiscal plus. Here, it is of import to acknowledge that existent estate is an income earning plus through leases and besides loses value through depreciation.

Figure: A sum-up of UK house monetary values between 1975 and 2006 ( adjusted for rising prices )

Over the past five old ages, the existent estate market all over the universe has seen surging monetary values and has lent immense concern to the fiscal markets indirectly through mortgage merchandises. The lodging monetary value bubble and the planetary fiscal meltdown that ensued was all based out of existent estate monetary values and extended guess on their future way of motion. However, all this was in the absence of a direct fiscal plus linked to existent estate or to existent estate monetary values. Hence, it can be said that the existent estate market has long been neglected and can be converted into a fully fledged traded plus categories though appropriate indices and derivative merchandises.

Figure: House monetary value alteration ( rising prices adjusted )

What are Property derived functions?

A belongings derived function is a derivative instrument whose value is derived from an implicit in existent estate plus. In world, existent estate assets are hard to monetary value accurately and frequently are marred by market inefficiencies. Hence, belongings derived functions largely use a scientific index of existent estate monetary values as the underlying alternatively of the belongings monetary values straight. This besides resolves the issue of multiple ownership that exists in the instance of existent estate assets merely as any other trade good. The index aggregates all market information relevant to existent estate and offers the investors one common representation of public presentation of belongings value. Besides, since existent estate non a homogeneous merchandise like a trade good, an index of existent estate monetary values is used to find the value of the underlying belongings market. Trading belongings derived functions has come to be known as man-made existent estate as it gives the investors the chance to fudge against or theorize in existent estate monetary values without really traveling through the boring procedure of purchasing and merchandising of land and edifices.

As these are derivative instruments built upon indices, they normally involve complex and advanced instruments like barters, forwards, hereafters and notes. Therefore, presently this market is dominated by High Networth Individuals and big institutional investors. These markets are more prevailing in developed economic systems like UK and USA. Even though India has fast developing fiscal market and Indian existent estate monetary values are at gait with the universe monetary value index, existent estate as an plus is merely get downing to be developed in India and derived functions are yet to be introduced to accommodate the demands of the Indian investors, both institutional and retail. In instance of barters, the counterparties would typically be a belongings company with physical assets and a bank with indirect exposure to belongings loans.

Uses of Property Derived functions

Global existent estate monetary values have been surging and falling in tandem with the public presentation of the province economic systems all over the universe. As the developed economic systems are yet to retrieve from the effects of the planetary recession wholly, there existent estate monetary values and lodging monetary values indices are still wavering. On the other manus Asiatic existent estate monetary values are dining towards a existent estate bubble, in sync with the speedy recovery of the Asiatic states from the planetary meltdown.

Singapore belongings monetary values have increased by 37 per centum from last twelvemonth while monetary values in China rose 36.8 per centum. Overall Asiatic markets have seen an addition by 14 per centum. The other states that saw boosting belongings monetary values are Latvia with 18.5 per centum and Australia with 18.4 per centum. In malice of low investor sentiments, and a gradual recovery of the dollar from dip caused due to a lodging bubble, even the U.S has seen a addition by 4.2 per centum while Canada place monetary values rose by 13.5 per centum.

Figure: Inflation-adjusted US place monetary values, population, edifice costs and bond outputs ( 1890-2005 )

Amidst such extremely market and economic system goaded fluctuations in existent estate, it is indispensable to supply investors with some fiscal instruments in order to fudge their belongings hazard or addition against their guesss about the future monetary value tendencies of the overall monetary values. Hence, there exists a demand for belongings derived functions.

Figure: House monetary values in Japan, US, Britain and Australia

Property Derived functions enable the investor to:

Hedge a presently outstanding place in the existent estate market

Speculate on the belongings market

Quickly change the composing of a portfolio i.e. exchange out of retail belongings and into industrial

Change their exposure to the belongings market as per their portfolio public presentation and hazard attitudes

The chief high spot of belongings derived functions is to avail all of the above mentioned aims without holding to transact in the belongings itself physically. Hence, there is no loss of resources over cast and responsibility revenue enhancements, attorneies, agents, holds and care of belongings etc. Even Bankss that give out loans against belongingss as mortgages can fudge their hazard against non-performing loans in times of falling existent estate monetary values. The graph below shows an illustration of one such scenario in the US context. Hedge fund investors besides speculate on the hereafter degrees of the index through curve trades.

Figure: Delinquent and non-performing commercial existent estate loans for all domestic commercial Bankss

To clearly stipulate the party-wise benefits of belongings derived functions:

Yet another manner of variegation for portfolio directors

Hedge financess, pension financess and insurance groups can hold exposure to yet another volatile plus category

Property financess can diversify their existent estate exposure across sectors and geographic parts which would non be possible for them to make with physical assets

HNIs invested to a great extent in belongings can fudge their hazard against crashing monetary values, depreciation of the belongings owing to assorted grounds, and earn the complete return at times of a existent estate bubble without acquiring involved with transportation of legal ownership of the assets

Real estate companies and belongings developers can fudge their portfolios for both capital value every bit good as rental income

Advantages of Property derived functions

Several existent estate indices have been developed in assorted states in order to mensurate the rise and autumn of existent estate monetary values and estimate its consequence on the economic system. These have already been discussed earlier in the survey. Some of the chief advantages of belongings derived functions are for investors who have an affinity towards existent estate and associated hazards. Property derived functions eliminate high barriers to entry of having belongings straight. This saves greatly on high dealing costs, clip and resources involved in looking for a suited plus, holds in assorted phases of processing and the illiquid nature of those assets. Besides they are non capable to the supply demand restraints of physical plus purchase. Any kind of derivative minutess is quicker and cheaper with nest eggs upto 7 % , excluding the care and agent costs of the assets for the continuance of its ownership.

Figure: Advantages of belongings derived functions

Speculating investors can take a position on the market without holding to merchandise the implicit in plus. Thus they can short or hanker a belongings plus without any hard currency investing. Investors, both retail every bit good as institutional, and belongings companies with bing exposures can pull off the volatility and illiquidity of their assets. Property barters supply them with instant variegation and the portfolio weights can be altered without incurring any kind of revenue enhancements each clip. A speedy snapshot of the advantages is given above.

Disadvantages of Property derived functions

Property derived functions would convey along with themselves all the hazards associated with derivative merchandises most of import of which is counterparty hazard. As most of these are OTC merchandises, in the absence of an exchange to bear the counterparty hazard of these minutess, the counterparty hazard is really high as new investors are easy embarking into these instruments. As the barter merchandises are acquiring more widely accepted, they have begun to come under the horizon of the ISDA ordinances for barter derivative merchandises. Besides, the hazards and returns associated with investing in belongings derived functions may non be in line with that of the physical plus particularly as there are no standardized pricing indices yet to track their alterations expeditiously. As other derived functions, these excessively suffer from deficiency of control over the referenced plus. As trading in these merchandises is still really illiquid and the construct of Greeks in the regard has n’t emerged much, it is hard to fudge exposure to these derivative merchandises dynamically. Among other things, most belongings derivative investings are through indices due to the non-homogeneous nature of the existent plus hence index defects are bound to be a hurdle. A speedy snapshot of the major disadvantages is given below.

Figure: Disadvantages of belongings derived functions

Real Estate / Property Indexs

The most prevailing benchmark used to construction belongings derived functions are belongings indices or existent estate indices. The composing of the index plays a critical function in make up one’s minding the use of indices for derivative instruments. This subdivision gives a brief debut to the popular belongings indices used in Europe, US & A ; India and analyzes the advantages and disadvantages of the methodological analysis of composing of these indices. Finally, a composing of a new belongings index is described that overcomes the defects of the bing indices.

Dow Jones Select Real Estate Indexs

The Dow Jones Select Real Estate Indexs are made utilizing the information for publically traded existent estate securities. Following indices come under this class:

Dow Jones REIT Composite Index

Dow Jones U.S. Select Real Estate Securities Index

Dow Jones U.S. Select REIT Index

Dow Jones Global Select Real Estate Securities Index

Dow Jones Global Select REIT Index

Dow Jones Global ex-U.S. Choice Real Estate Securities Index

Dow Jones Global ex-U.S. Select REIT Index

Dow Jones Americas Select Real Estate Securities Index

Dow Jones Americas Select REIT Index

Dow Jones Asia/Pacific Select Real Estate Securities Index

Dow Jones Asia/Pacific Select REIT Index

Dow Jones Europe Select Real Estate Securities Index

Dow Jones Europe Select REIT Index

Dow Jones Middle East & A ; Africa Select Real Estate Securities Index

Dow Jones Middle East & A ; Africa Select REIT Index

The REIT indices are subsets and step the public presentation of REIT and REIT-like securities. For inclusion in the existent estate indices, an issue must fulfill the undermentioned standards:

The company must be both an equity proprietor and operator of commercial and/or residential existent estate.

minimal entire market capitalisation of $ 200 million at the clip of its inclusion.

At least 75 % of the company ‘s entire gross must be derived from the ownership and operation of existent estate assets.

The liquidness of the company ‘s stock must be commensurate with that of other institutionally held existent estate securities.

The indices are constructed by weighing the issues by float-adjusted market capitalisation. This forms one of the major drawbacks for the indices because this weighing procedure does non stand for the true fluctuations in market monetary value of the existent estate.

FTSE indices

FTSE offers three types of indices in the market:

FTSE EPRA/NAREIT Global Real Estate Index Series

The FTSE EPRA/NAREIT Global Real Estate Index Series represents general tendencies in eligible listed existent estate stocks worldwide. The indices are farther broken down geographics wise in order to supply specific country’s/region ‘s tendencies in existent estate market.

Figure: Categorization of FTSE EPRA/NAREIT Global Real Estate Index Series

Like the Dow Jones existent estate index, FTSE EPRA/NAREIT Global Real Estate Index Series besides uses the shutting monetary value of stocks of relevant companies to build the index. The weightage given to each stock is relative to the market capitalisation of that issue. For each index, the undermentioned values are calculated at the terminal of each period: ( 1 ) a capital return and ( 2 ) a entire return. The chief computation currency is the Euro although the indices are besides calculated in US Dollar, British Sterling and Nipponese Yen on an end-of-day footing. The methodological analysis used for ciphering the FTSE EPRA/NAREIT Global Real Estate Index Series is the chained Paasche methodological analysis.

FTSE NAREIT US Real Estate Index Series

The FTSE NAREIT US Real Estate Index Series comprises of a household of REIT public presentation indices that span the commercial existent estate infinite across the US economic system, offering exposure to all investing and belongings sectors. In add-on, the more narrowly focussed belongings sector and sub-sector indices provide the installation to concentrate the commercial existent estate exposure in choice markets. The FTSE NAREIT US Real Estate Index Series acts as a placeholder for the appraisal of overall industry public presentation, and includes all tax-qualified existent estate investing trusts ( REITs ) that are listed on the New York Stock Exchange, the American Stock Exchange or the NASDAQ National Market List.

The FTSE NAREIT US Real Estate Index Series is calculated utilizing the undermentioned expression:



1,2,3, … … … .. , N


The figure of securities in the Index.


Price The latest trade monetary value of the component security ( or the monetary value at the stopping point of the Index on the old twenty-four hours ) .


Shares in Issue The figure of portions in issue used by FTSE for the security, as defined in these Ground Rules.

degree Fahrenheit

Investability weight The factor to be applied to each security to let amendments to its weighting, expressed as a figure between 0 and 1, where 1 represents 100 % free float. The free float factor for each security is published by FTSE.

vitamin D

Divisor A figure that represents the entire issued portion capital of the Index at the base day of the month. The factor can be adjusted to let alterations in the issued portion capital of single securities to be made without falsifying the Index.

The choice for the FTSE NAREIT US Real Estate Index is based on a set of rigorous standards and they are reviewed sporadically.

FTSE UK Commercial Property Index Series

FTSE UK Commercial Property Index Series, a set of indices for the UK commercial belongings market provides a day-to-day step of the public presentation of investable, institutional class commercial belongings in the UK. The indices besides provide investors with a more diversified and liquid option to puting straight in belongings.

The headline FTSE UK All Property Index comprises of three extra sector indices – retail, office and industrial. This has been done for the first clip in UK where the investor can acquire the day-to-day public presentation step of the single sectors thereby leting them to put expeditiously.

The index series is driven by the public presentation of the FTSEpx Fund which is a specialised belongings unit trust. NAV ( Net Asset Values ) and Accrued Income values that constitute the index computation are provided from the fund. The fund has made investings in a diverse portfolio of belongings assets and has exposure to more than ? 16 billion. The portfolio consists of of premier, institutional retail, office and industrial assets. Each index provides capital value and entire returns public presentation informations driven by the public presentation of the underlying belongings fund.

Unlike the antecedently discussed indices, this set of indices do non mensurate the public presentation based on the stock value of existent estate houses. Thus it gives a much better indicant of monetary value of existent existent estate belongingss to the client. However, the chief success factor of this set of indices is dependent on the incursion of the underlying fund with regard to its investings in all cardinal existent estate markets.

For each single index, three indices are calculated and published sporadically:

Gross Asset Value ( GAV ) Total Return Index

Net Asset Value ( NAV ) Total Return Index

Net Asset Value ( NAV ) Capital Return Index

The FTSE UK Property Index Assets comprise of direct belongings assets and indirect belongings assets. The former refers to the belongings involvements in land and edifices that can be held as investings in which the good involvement is in the bulk of the assets while the latter has minority retentions in belongings assets.

Moodys/REAL Commercial Property Price Index ( CPPI )

The Moodys/REAL commercial belongings index ( CPPI ) is a periodic same-property round-trip investing monetary value alteration index of the U.S. commercial investing belongings market that is based on informations from collected by MIT Center for Real Estate industry spouse Real Capital Analytics, Inc ( RCA ) .

The methodological analysis for the index building comprises of tracking the same-property realized unit of ammunition trip monetary value alterations that arise out of good documented completed existent estate minutess. Repeat-sales arrested development ( RSR ) is used for ciphering the value of the index. The index comprises of four types of existent estate sectors:





The set of indices include a monthly reported national all-property index, national quarterly indices for each of the above mentioned sector, indices for specific metropolitan countries and an aggregative index for the top 10 metropolitan countries for the major belongings types. The one-year indices are generated for four different clip frames – beginning in January, April, July, and October of each twelvemonth.

The RCA Database

The RCA database forms the footing of these set of indices. This databases collects sporadically the pricing inside informations of all commercial minutess that are valued above 2.5 million dollars. The RCA database represents one of the most extended and intensively documented national databases of commercial belongings monetary values in U.S.

Market deductions and Constraints

Existing Property derivative markets

Property derived functions have now been being for about five old ages in the developed fiscal markets. The UK belongings indices were introduced in 2005 and were followed by a assortment of existent estate derivative instruments introduced all over Europe. The US place monetary value indices were developed a spot subsequently in 2007 and therefore the derivative merchandises followed suit. Consequences indicated that the planetary belongings returns totaled to 11.5 % in 2007 as against 14.7 % in 2006. The Investment Property Databank ( IPD ) planetary belongings quarterly index has shown a 12.04 % addition so far and traded volumes of the last one-fourth have reached ? 756m. Discussed below are the belongings derivative markets in the UK, Europe and US.

UK and europe

The IPD developed the UK lodging monetary value index based on which assorted Real Estate Derivatives ( RED ) were developed and traded. This was subsequently adopted by the full European capital market. By August 2007 about investing Bankss in UK were licensed to merchandise in these instruments. It offered OTC trading in largely swap merchandises like the Total Return Swap based on IPD ‘s benchmark commercial belongings index for fixed periods in return for the London Interbank Offer Rate ( LIBOR ) plus a spread. The rapid growing of the UK market spawned the debut of these merchandises in newer markets in mainland Europe, parts of Asia and US. The Gallic and German market peculiarly proved to be fast turning although overall, the Red market still remains a really little section of the full derived functions market. Harmonizing to IPD informations, the Gallic belongings derived functions saw an addition to ? 721m while German market reached ? 181m trade value at the terminal of the 2nd one-fourth of 2007.

The belongings derivates played a major existent in the wake of the planetary liquidness crisis when purchasers and Sellerss failed to get at a monetary value through dialogue. The first one-fourth of 2008 saw ? 3.5 billion of trade which was about 20 % of all fanciful trade since start of this market in 2004. By terminal of 2008, IPD had recorded entire returns of -3.97 % . The twelvemonth 2009 started with a pricing of 2.5 % with 2010 outlooks upto 6 % as entire return for the twelvemonth farther increasing to 8 % for 2011 and 2012.

: Historical sector public presentation 3 month entire returns ( % ) for IPD UK monthly Property index

The western European markets were significantly outperformed in 2007 by the non-European markets with an overall return of merely 5.9 % . In malice of this, it was observed that planetary belongingss performed much better than equities. Even the South Africa belongings market posted returns of close to 27.7 % . The IPD indices include 22 mature belongings markets, which account for a‚¬3.25 trillion of belongings. Of these 15 are in Europe, and the balance are in North America and the Asia Pacific part.

Trade values in the Europe belongings market stood at ? 8.3bn and ? 7.7bn for 2007 and 2008 severally. In the 3rd one-fourth of 2010, Europe ‘s belongings derivative trade values are expected to traverse ? 1bn as progressively investors are turning to these instruments to fudge their belongings market hazard. Besides, in order to cut down counterparty hazard in these merchandises, a Eurex belongings derived functions exchange has been started since the past nine months. Hence, this market is fast germinating and progressively generating demand among the investors in UK and Europe fiscal markets.

United states

Figure: Historical sector public presentation one-year returns ( % ) for US Property index

The aggregative value of the US Residential Real Estate Market exceeds $ 22 trillion. As per the National Council of Real Estate Fiduciaries ( NCREIF ) in the US, four of the major investing Bankss were granted three-year trade licences in belongings derived functions in 2007 based on the benchmark belongings index of the NCREIF. The US RED market can be divided as OTC market dwelling of merchandises from investing Bankss and exchange-traded markets.

In May 2006, the Chicago Mercantile Exchange ( CME ) began naming U.S. house-price hereafters and options, which are designed to allow investors wager on monetary value motions in the S & A ; P/Case-Shiller place monetary value Index. A figure of investing Bankss have worked together to make an OTC property-derivative market on a different set of existent estate indices.A The US derived functions market was estimated to achieve a trade size of about $ 106bn in the following three-five old ages when it was foremost introduced. With regard to commercial existent estate which should anticipate more trade value, pension financess are the largest investors in the US and derived functions aid them in their turning existent estate plus allotment.

Figure: Historical sector public presentation for IPD US Property index

Types of Property Derived functions

All the bing belongings derived functions are based on some existent estate index as the implicit in plus. There are three chief types of belongings derived functions in the market presently: Property Index Notes ( PIN ) , Entire Return Swaps ( TRS ) or Index Return Swaps ( IRS ) and Forwards/ Futures based on some peculiar index. Each of these are described below in item.

Property index notes ( pin )

These are in the signifier of structured notes or investing bonds of a sort. The basic purpose of this merchandise is to retroflex the ownership and dealing on a physical belongings of similar value. The PINs pays a quarterly voucher to the investors along with the capital return earned out of the bond at salvation. The quarterly or monthly voucher is valued out of the income return or output of the relevant index and the capital return at salvation is derived from the capital growing of the index in the stipulated clip frame. Therefore, it resembles a physical belongings by supplying a regular watercourse of hard currency flows like rental income and an accrued return from capital grasp obtained while selling the belongings. Hence, the investor gets the entire return of that peculiar belongings as represented in the signifier of the index. The pricing of the note determines the sum the purchaser should pay the marketer to get this merchandise. An ordinary PIN involves a covering bank who issues certificates/notes of adulthoods three, five or seven old ages. The bank manages its exposure by fudging it against a existent estate exposure that receives LIBOR + spread for the continuance of index linked note. The covering bank earns its fees from the spread between the two minutess and at the same clip besides provides enhanced liquidness in the market. A typical PIN dealing is depicted as follows:

Figure: A typical PIN dealing

A Property Index Note leaves the investor exposed to the existent estate market hazard as posed by the index used to mensurate the returns and the voucher payments of the structured note. This may be used as hedge against falling monetary values and unequal lease from the existent estate belongings that the investor owns.


Barters in the instance of belongings derived functions can be of two types: Entire Return Swaps or Index Return Swaps. In both the instances the parties take places on opposite legs of the merchandise depending on their position of the future tendency of the underlying index based on fanciful principal value which is normally ne’er exchanged as portion of the hard currency flows.

The Total Return Swap ( TRS ) is a floating-floating barter with two legs- a return leg and a floating rate leg. The party that pays based on the returns of the implicit in index is the return remunerator. The return receiving system pays its counterparty a periodic drifting rate of return which is normally a benchmark rate like 3-month LIBOR plus a spread in exchange for the public presentation of the mention index. Hence, the return receiving system has indirectly taken a long place on the mention index. The payment on the index leg is typically made quarterly or yearly whereas the payment on the benchmark rate leg is typically made quarterly. The purchaser of the barter therefore undergoes a dealing that is economically tantamount to borrowing the fanciful sum from the bank at benchmark rate + spread and re-investing the principal in the relevant belongings index. The conventional word picture of the same is as follows along with the typical hard currency flows of the barter:

Figure: Conventional word picture of Entire return barter

Figure: Conventional diagram: Entire Return Swap

Figure: 2 twelvemonth ( 19 month ) All Property v. LIBOR swap spreads

The Index Return Swap ( IRS ) is much similar to the TRS except that the return receiving system pays a fixed rate on the fanciful which is the monetary value of the barter merchandise. The fixed payments could besides be quarterly or one-year to fit the hard currency flows of the other leg. As these convert the fluctuating index returns into an assured fixed series of regular hard currency flows, these are meant for more risk-averse investors or those who do non desire to stay open to the existent estate market hazard at all, whether in the signifier of an index investing or a physical plus of similar representative value.

Forwards, hereafters and options

These are typical contracts similar to any other index frontward and future contracts. In a forward contract, the two parties agree to a certain future value of the index on a pre-determined day of the month and at adulthood the purchaser of the contract is entitled to have the difference between the existent degree O f the index and the work stoppage rate agreed upon in the contract. If the difference is negative, the purchaser in bend has to pay the marketer. Therefore, both the marketer and the purchaser have fixed their hereafter exposure to the index at a specific negotiated degree. Forwards are OTC understandings and hence, necessitate counter-party. In the absence of an exchange playing as the counterparty, investors should be wary of counterparty default hazard. On the other manus, an option on the index gives the purchaser the right to undergo the dealing if the final payments are favorable. Options and hereafters on S & A ; P/Case-Shiller indices are similar, but they are traded on an organized market that reduces recognition hazard through the intermediation of a cardinal counterparty and through a margining mechanism. In most of the developed fiscal markets, barter and forward contracts are now regulated by the ISDA norms.

Suggested derivative products- Indian existent estate market

The Indian existent estate market is comparatively new and the derivative market is still at a nascent phase as compared to bing fiscal markets all over the universe. An debut of any kind of RED merchandise foremost requires a full cogent evidence index that would be about accurately represent the belongings monetary values of residential and commercial belongingss across different parts. This has already been discussed. However, for the interest of presentation of the derivative merchandises, the BSE Realty Index which is a market capitalisation based index, has been used here.

From the above discussed merchandises, surely structured notes can non happen many investors in India, given even the corporate bond market is non good developed. Once an appropriate index is developed, forwards, hereafters and options are the simplest and most vanilla derivative merchandises that are natural to follow. The pricing of these merchandises is besides rather straightforward. For illustration, a simple forward can be priced as per the expression below:

Where, my is the income output of the index, as existent estate is an income gaining estate in the signifier of rental

This leaves the option of barters which is one of the most popular derivative merchandises even in the more developed fiscal market where belongings derived functions have now existed for about three-five old ages. There are assorted sorts of barter merchandises that can be built to accommodate different sorts of investors both for hedge and guess.

Three chief sorts of barter merchandises have been suggested here. Two of these are the TRS and the IRS that have already been introduced and the 3rd is a spread based barter. Each of these merchandises has been demonstrated below with an illustration. Real estate barters are normally priced by utilizing an extended preparation based on martingales. The expression given below is one representation of the pricing theoretical account used. The spread on the LIBOR leg of the barter is calculated as:

However, the basic construct of barter pricing ballads in the Net Present Value of all the hard currency influxs and out flows for an investor at either leg of the merchandise should be zero at the start of the merchandise term of office. This has been used to show the approximative pricing of each of the barter merchandise theoretical accounts described below.

entire return barter

A TRS designed for the Indian existent estate-capital markets would utilize the Mumbai Interbank Offer Rate ( MIBOR ) on the drifting benchmark involvement rate leg of the merchandise. The day-to-day, monthly and quarterly returns for the BSE Realty Index have been calculated from the day of the month 09-07-2007, when the index was foremost introduced. These returns have been charted below and have been compared with the MIBOR rates tendency of this clip period.

The existent information has been attached in the appendix for easier mention. The above charts indicate the high volatility in the existent estate market. It is more relevant to utilize the monthly and quarterly returns against the MIBOR payments. The hazard free rate used for hard currency flow discounting is the 10 twelvemonth Government Bond Yield on the day of the months of the hard currency flows. Hence, the merchandise can be developed as follows:

Merchandise Name

3 yr Entire Return Swap-1



Index leg

Monthly return on BSE Realty Index, paid quarterly

Floating rate leg

3-month MIBOR rate + [ xx ] bits per second, paid quarterly


3 old ages aAug 2007 Aug 2010

Index public presentation floor

-15 %


-450 bits per second

The floor was introduced as due to high volatility, really high negative returns made the merchandise unfavorable for the investors. It can be reasoned that since the current market sentiment is rather cheerful and India is non yet near a existent estate bubble, monetary values can be expected to lift over the following 1-2 old ages without seting the counterparty at a hazard of loss from this floor. Hence, the merchandise is every bit attractive for both the parties. The elaborate hard currency flows have been attached in the appendix for mention. A minor fluctuation to the above merchandise is by doing the payments of the index leg monthly. As the monthly returns are used, this would enable better matching of this leg of the merchandise with the existent fluctuations of the index and hence a more representative payment form. The description of this merchandise is every bit mentioned below:

Merchandise Name

3 yr Entire Return Swap-2



Index leg

Monthly return on BSE Realty Index, paid monthly

Floating rate leg

3-month MIBOR rate + [ xx ] bits per second, paid quarterly


3 old ages aAug 2007 Aug 2010

Index public presentation floor

-15 %


30 bits per second

index return barter

The IRS differs from the TRS in merely the 2nd leg of the merchandise which is fixed rate alternatively of a benchmark drifting rate. This fixed rate is the monetary values of the barter. The consequence of the really high negative returns can be observed here as the monetary value of the barter becomes negatives. However, it has been stated in academic literature that pricing of existent estate barters can be expected to be negative as the market down motions can be really steep and for sustained clip periods. The first two IRS merchandises depict this consequence.

Merchandise Name

3 yr Index Return Swap-1



Index leg

Quarterly return on BSE Realty Index, paid quarterly

Fixed rate leg

-6.35 % , paid quarterly


3 old ages aNov 2007 Nov 2010

Merchandise Name

3 yr Index Return Swap-2



Index leg

Monthly return on BSE Realty Index, paid monthly

Fixed rate leg

-1.96 % , paid monthly


3 old ages aAug 2007 Aug 2010

The following two IRS merchandises indicate the barter monetary values with the debut of a floor of -20 % for the quarterly returns and -15 % for monthly returns. This makes the merchandise more attractive. The elaborate hard currency flows have been attached in the appendix for mention.

Merchandise Name

3 yr Index Return Swap-3



Index leg

Quarterly return on BSE Realty Index, paid quarterly

Fixed rate leg

1.55 % , paid quarterly


3 old ages aNov 2007 Nov 2010

Index public presentation floor

-20 %

Merchandise Name

3 yr Index Return Swap-4



Index leg

Monthly return on BSE Realty Index, paid monthly

Fixed rate leg

2.68 % , paid monthly


3 old ages aAug 2007 Aug 2010

Index public presentation floor

-15 %

Both these merchandises are typical hedge merchandises that provide the investors with equal protection from the existent estate market hazard. The 3rd merchandise suggested is typically for speculators.

sensex spread barter

The Sensex tendencies were analysed for the peculiar 3 twelvemonth period for which the BSE Realty information is available. As shown in the charts below it was observed that the hebdomadal, monthly and quarterly returns of the Sensex and the BSE Realty index follow each other closely, with merely higher volatilities for the existent estate index. This may be as the BSE Realty index is based on market-cap of existent estate companies and hence may non be so closely retroflexing for a well-developed existent estate index. Nevertheless, the differences can be exploited by the Bankss to suggest a merchandise for the speculators who wish to take a regular position in favor of the existent estate market or the diversified Sensex returns.

The floor conditions apply to this instance every bit good. The merchandise description is as follows:

Merchandise Name

3 yr Sensex Spread Swap



Index leg

Quarterly return on BSE Realty Index, paid quarterly

Sensex/Benchmark index leg

Quarterly return on BSE Sensex + [ xx ] bits per second, paid quarterly


3 old ages aNov 2007 Nov 2010

Index public presentation floor

-20 %


-10 bits per second

A similar bad merchandise can be constructed based on an accurate existent estate index to take advantage of the difference in existent estate monetary values across parts. It is observed that existent estate monetary values move faster in the major metropoliss like Delhi, Mumbai, Bangalore and Hyderabad and it take some clip slowdown for the consequence to dribble down to the mid-size urban metropoliss like Bhubaneshwar, Ahmedabad, Nagpur, etc. This can be done by establishing merchandise payments on regional existent estate indices and happening arbitrage across the public presentation of these indices.


hypertext transfer protocol: //www.bloomberg.com/news/2010-10-25/singapore-china-lead-increase-in-global-home-prices-knight-frank-says.html

Global Strategy and Investment Consulting- Property derived functions, a brief overview – by Ashwani Batra

Macro Markets, Real Estate Derivatives ( “ Derived functions 2007 ” , NYU Stern School ) – Robert J. ShillerChief Economist, MacroMarkets LLCProfessor of Economics, Cowles Foundation Yale University | Professor of Finance, School of Management, Yale University

Property Derived functions: A Primer, Excerpts of the EDHEC European Real Estate Investment and Risk Management Survey, November 2007

Property Derived functions, Commercial Real Estate – Fixed Income Strategy, United States, Merrill Lynch

Pricing Models for Real Estate Derivatives – Frank Fabozzi, Professor in the Practice of Finance & A ; Becton Fellow, Yale School of Management ; Robert J. Shiller, Arthur M. Okun Professor of economic sciences at Yale School of Management ; Radu Tunaru, Senior Lecturer in Financial Mathematics, City University, Cass Business School

hypertext transfer protocol: //www.sprefs.com/UserFiles/Property % 20Derivatives ( 1 ) .pdf

hypertext transfer protocol: //www.euromoney.com/Article/1969157/BackIssue/67518/UK-Property-Derivatives-Report.html

hypertext transfer protocol: //www.propertyweek.com/ipd-index-highlights-full-extent-of-global-property-slowdown/3117199.article

hypertext transfer protocol: //uk.reuters.com/article/idUKLNE5AO00F20091125

hypertext transfer protocol: //www.360enhancers.com/propderivstrat.html

hypertext transfer protocol: //www.ipd.com