Currency Futures and Options

A Changing Landscape
In the 2007 budget, Finance Minister, Trevor Manual promulgated the establishment of a Currency Exchange for trading of futures contracts on the Rand. In 2008, access to this market was opened up to include corporate and institutional traders. For the first time, South Africans have an efficient, regulated and accessible exchange through which to manage currency risk and speculate in currency movements. Imara SP Reid can now offer direct access to this exciting new exchange and provide our clients with solutions to manage currency risk without using a foreign exchange allowance or being restricted by reserve bank exchange control rules.

position will be closed at expiry. Contracts that expire will be settled in cash Imara SP Reid can provide a real-time online trading system which allows our clients to trade directly in the market

Margining
To protect itself from non-performance, the exchange employs a process known as margining. This mechanism is two-fold: Initial Margin When a position is opened (either long or short), the investor is required to pay an initial margin in cash (known as a good faith deposit) with the broker who subsequently deposits it with the clearinghouse This amount remains on deposit as long as the investor has an open position The initial margin attracts a market related interest rate which is capitalised monthly. The initial margin requirement varies between the different currency futures offered and changes periodically based on the JSE Portfolio Scanning Methodology Variation Margin The Exchange re-values each position at the close of each business day, and this process is known as Mark-to-Market (MTM) Any difference from the previous days MTM price is either paid to the investors, or paid by the investors to the clearinghouse, in Rand This payment is called variation margin and is simply the profit or loss on each position, it is also known as the daily settlement

Introduction
What are Currency Futures?

A futures contract is a legally binding agreement that gives you the right to buy or sell an underlying asset at a fixed price on a future date Currency Futures are agreements between two parties, where one commits to buy (long) a currency and another to sell (short) a currency on a specified future date Currency Futures are traded on Yield-X a regulated South African Exchange. You need to have a Yield-X account with a registered member; Imara SP Reid is a registered Member Pricing is transparent and our broker will be able to give you firm prices on request at which time you may place an order to transact. To close out the contract, the investor needs to enter into an equal but opposite transaction through the same process, alternatively the Page 1

How are they traded?

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How are Currency Futures quoted on Yield-X?

Yield-X quotes all currency future prices in the same way as the underlying spot exchange rate This is represented as the number of Rand per foreign currency quoted to four decimal places, e.g. R9.7050 to 1$

Why trade Currency Futures?

Currency Futures are used primarily to: Speculate have no interest in purchasing/selling the underlying currency but hope to make profit on short-term price movements in belief that the currency rates will change Hedge Seek to reduce risk by protecting oneself against currency fluctuations Allow individuals and smaller corporate clients to access favourable rates usually reserved for larger corporates Reduce administration for corporates no reporting to SARB required and no firm and ascertainable commitment required (i.e. no documentation required to hedge)

Currently, the following currency futures are listed on Yield-X: o Dollar / Rand o Euro / Rand o Pound / Rand o Australian Dollar / Rand

What happens at expiry?

At expiry the exchange will calculate a final closing price of the contact based on the spot rate of the underlying currency. This price will be used to calculate the final profit and loss for the contract, the position will then expire and the margin will be returned. If an investor wishes to hold their positions beyond the expiry date they will need to be rolled into the next contact. This is a fairly simple process which involves closing out the positions and subsequently entering the same position in the next expiry. The benefit to the investor is that the same exposure is maintained. Imara SP Reid offers discounted trade fees for all positions that are rolled over and the calculation is done off the same spot price.

Currency Futures vs. Forward Contracts (FECs)

Traditionally corporate clients have used Forward Contracts to manage currency risk. Forwards and futures share similar characteristics. Both allow investors to hedge against currency risk, the primary differences are highlighted below: Currency Futures are traded on a regulated exchange, FECs are traded OTC with a specific Bank and settlement is with the same bank There is no need to get credit approval to trade Currency Futures (as is the case when a company wants to initially apply to trade FECs). Paperwork such as financial statements, proof of invoices and exchange control approval do not need to be submitted every time a Currency Future is traded 14 day proof of invoicing does not apply Margin needs to be put down and maintained for trades in Currency Futures, these are typically lower than deposits for FECs. Mark-to-Market requirements of Currency Futures can be more onerous than FECs

Advantages
Currency Futures are used by different market participants for different purposes; some of the advantages of currency futures include: Provide an effective and transparent hedge against currency risk Allow participants to diversify internationally from South Africa Profit by taking a view on the underlying currency movement Instant execution and price transparency

Risks
Derivatives offer gearing because a post small amount of margin is placed against a much larger exposure As a result the profits and losses can be more than the initial margin posted

If you are not able to meet a margin call the position may be closed by the broker

different time zones. These deals will be booked to the clients local account once the market opens. Costs Imara SP Reid charge R15 per Currency Future contract (negotiable based on volume traded).

Options on Currency Futures

Perhaps the most exciting area of Yield-X is that it paves the way for a regulated options market on the Rand. An Option is a powerful financial tool because it is optional for the purchaser, but binding for the seller. Options are a useful tool for the transferral of risk. The key benefit of options is that they allow clients to protect themselves against adverse currency movements, but keep the upside should the currency move in ones favour. Trading Hours Global currency markets operate on a 24 hours basis. Yield-X will only be open Mon-Fri 9am5pm. Imara SP Reid can arrange for orders to be managed on a 24 hour basis, by currency desks in

Summary and Contact Details

This brochure is a summary of several pertinent points relating to Yield-X Currency Futures. It is intended to give you a useful overview, but is not a comprehensive explanation. For more information please refer to the more detailed: - JSE Currency Brochure or - JSE Currency Options Brochure Alternatively, speak to your Imara Investment Manager or contact the Yield-X trading desk: Tel: +27 11 550 6233.
Email: YieldX@imaraspreid.co.za

Currency Derivatives Specifications

Name Underlying Instrument Codes Contract Months Listing Programme Expiry Dates & Times j-Rand: Derivatives on foreign currencies Rate of exchange between one unit of foreign currency and SA Rand. e.g. Dec 09 ZAUS. March, June, September and December. Near, middle and far contracts. Specials on demand. At 10h00 New York time (i.e. 16h00 in SA winter and 17h00 in SA summer) two business days prior to the 3rd Wednesday of the expiry month (or the previous business day if that day is a public holiday). 30 Iterations, Arithmetic average of the underlying spot taken every 1 minute for a period of 30 minutes, ending at 10h00 New York time. (SA Summer: 16h31 17h00 and SA Winter: 15h31 16h00. 1,000 foreign currency nominal (e.g. $1 000) In Rand per one unit of foreign currency to four decimals. 0.0001 Cash settled in ZAR. As determined by JSE Portfolio Scanning Methodology. Explicit Daily. The forward value of the arithmetic average of the traded underlying taken for a 5 minute period between 16h55 and 17h00. As determined by Yield-X (9 am 5 pm) The JSE will extend the closing market times by 30 minutes on the expiry days that fall in the SA winter time.

Expiration Valuation Method Contract Size Quotations Minimum Price Movement Settlement Initial Margin Requirements Mark-to-market Market times
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This publication is issued by Imara S.P. Reid (Pty) Ltd. It is for the information of clients only. It shall not be reproduced in whole or in part without our permission. The information contained herein has been obtained from sources which and persons whom we believe to be reliable but is not guaranteed for accuracy, completeness or otherwise. All opinions expressed and recommendations made are subject to change without notice. No information contained herein, no opinion expressed and no recommendation made constitutes a representation by us or a solicitation for transactions in any of the securities mentioned herein and we have no responsibility whatsoever arising here from or in consequence hereof. Securities or financial instruments mentioned herein may not be suitable for all investors. Securities of emerging and mid-size growth companies typically involve a higher degree of risk and more volatility than the securities of more established companies. The recipient of this report must make its own independent decisions regarding any securities or financial instruments. Past performance is not indicative of future results, and investors may get back less than they invested. The inventories of Imara S.P. Reid (Pty) Ltd may from time to time include securities mentioned herein.

Practical Examples
Currency Futures are used primarily to: Speculate - No interest in purchasing/selling the underlying currency and hope to make profit on short-term price movements in belief that the currency rates will change Hedge Seek to reduce risk by protecting underlying shares. It removes the risk of existing or expected currency exposure Speculating Speculator expects Rand to weaken (Dollar strengthen) Buy 10 Contracts at R8.2000 an exposure of R82,000 Deposit R 4,600 for the initial margin (10 x R 460) Sell contracts at R8.5500 in the future Profit = R3,500 [10 x $1,000 x (R8.55 R8.20) = R3,500 Initial margin of R 4,600 is returned The R 4,600 initial capital outlay has returned a profit of R3,500 A return of 76 % during a period in which the Rand only weakened by 4% Daily Cash Flows Speculative Example Day 1 (trade day) Initial margin per contract: CF price: MTM price: (R4,600) R8.20 R8.25 Day 2 R0 R0 R8.42 R1700 (8.428.25x10x1000) R1700 Day 3 R0 R0 R8.40 (R200) (8.408.42x10x1000) (R200) Day 4 (trade) R4,600 R8.55 Irrelevant R1,500 (8.558.40x10x1000) R6,100 (4600+1500)

Profit / (Loss) for the day: R500 (8.258.20x10x1000) Net cash flow for the day: (R4,100) (-4600+500)

Summary of cash flows Initial Margin R0 (-4600 + 4600) Variation margin R3, 500 (+500 + 1700 200 + 1500) -------------------------------------------------------------------------------------------------------------------------------Hedging Example: Company ABC importing goods worth $1 Million i.e. client will need to pay $1million on delivery of goods. Protection against a weakening Rand is needed: Client would Buy (Long) 1,000 contracts at R7.7375 ($1 Million) An exposure of R7,737,500 Deposit R 460,000 as the initial margin (R460 x 1,000 contracts). When goods arrive, need to pay physical dollars on delivery. Company ABC now sells the dollar future contracts which are now trading at R7.9000 Initial margin of R 460,000 is returned Profit on currency future = R162,500 [1,000 contracts x $1,000 x (R7.90 R7.7375)] Pay for goods at R7.90 cost R7,900,000 The Net Cost of $1m was R7, 737,500 unchanged despite Rand weakness as the Currency obligation was hedged. Note that: if the Rand had strengthened the price would have gone down Company ABC would lose on the futures, but pay less for the physical when delivered.