Beruflich Dokumente
Kultur Dokumente
for
Risk Management
November 4, 2021
On Managing Currency Risk thus spake...
There is no sphere of human thought in which it is
easier for a man to show superficial cleverness and the
appearance of superior wisdom than in discussing
questions of currency and exchange.
Trade a/c
Export receipts
Current A/c Imports
Invisibles Remittances
Remittances
14000
12000
10000
8000
USD/IDR DAILY CHART
6000
4000
Jan97 Mar May Jul Sep Nov Jan98 Mar May Jul Sep Nov Jan99
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Managing Currency Risk
Increased Uncertainty, Increased Risk
140
135
130
125
120
110
Oct97 Nov Dec Jan98 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan99 Feb Mar Apr May
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Economic
Economic // Financial
Financial Risks
Risks
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Forex Forex deals may be commercial or speculative.
markets - Dynamics of currency speculation
Speculation
Currency price is a function of demand and supply gap
Leads/lags between trade and required forex affect gap
Also shifts in sentiments due to disasters, coups, regulations
Speculating on Trends
Sail with the wind and reap a harvest
Go long in the currency in demand and sell it when the
prices appreciate due to enhanced demand.
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Dialectics
Dialectics of
of Forex
Forex Markets
Markets
Forex Products
Spot Future
Future
Cash - Same day Forward - Future
Swap - Exchange Futures - Future
Tom - Next day
Spot - 2nd bus. day Option - A right Option - A right
Derivatives
Sources
Sources of
of Risks
Risks
Trade Exports
related Imports
Price fluctuations
Currency Rate fluctuations
Interest rate fluctuations
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Derivatives
Derivatives Market
Market
Size : US dollar 41 trillion
Players
Investment banks
Banks
Corporates
Funds
Investors
Complex and challenging
One man’s risk is another man’s profit opportunity
Uses of derivatives
To hedge risks on Forex and capital markets
To profit from opportunities created by risks
11/04/21 16
Derivatives
Derivatives Markets-
Markets- Structure
Structure
Derivative Products
Future
Future
Futures - Future
Forward - Future
Swap - Exchange Option - A right
Option - A right Derivatives
Derivative
Derivative Instruments
Instruments
Forex Interest
OTC Products Forwards Fwd Rate Agreements
Swaps (FRA)
Options Swaps
Put Options
Call Caps, Floors &
Collars
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Forward
Forward Contracts
Contracts
11/04/21 19
Forward
Forward Rates
Rates
Concepts Covering any time gap between cash available and cash
payable has a price in terms of interest received or paid -
or in terms of interest foregone.
Difference between spot and forward prices is a function
of interest differential between the pair of currencies
involved
LIBOR interest rates on Euro-currencies serve as basis
for working out forward rates for them
Money market dealers also quote two-way rates:
Offered Rate: The rate for lending money (offer of funds).
Bid Rate :The rate for taking deposit ( bid for funds).
11/04/21 20
Forward
Forward FX
FX Contracts
Contracts
Example Indco imported goods from USA for sale in India. Invoice
Importer’s currency is USD. Payment is due after 90 days. Indco
Case intends to pay the supplier out of sale proceeds.
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Forward
Forward Exchange
Exchange Rates
Rates
11/04/21 25
Forex
Forex Forward
Forward Rate
Rate
Direct hedge Indco wants to buy cars from USA for $ 2 mio. payable
against after 90 days. $/INR spot today is 48.91 while interest
forward risk rates for $ and INR are ruling at 2.25% & 8.75 % resp.
Indco may hedge against $ by borrowing INR necessary
to buy enough dollars in the spot that would become $ 2
mio. after 90 days if held in bank deposit.
By discounting at 2.25%, we can obtain dollars needed
to day that will become $ 2 mio after 90 days
2,000,000
= $ 1,988,813
2.25 x90
1 +
100 x 360
INR needed to buy $1,969,231 @ 48.91 are Rs. 97,272,840
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Forex
Forex Forward
Forward Rate
Rate
After 90 days
$ in bank deposits will become
11/04/21 28
Forward
Forward premiums
premiums &
& discounts
discounts
11/04/21 29
Forward
Forward Rates
Rates
11/04/21 30
Interest
Interest Rate
Rate Forwards
Forwards
Forward Rate Agreements (FRAs)
A contract to cash flows on a fixed future date, using fixed interest rates
agreed today
Example
XYZ company bought 3/6 FRA @ 5.74 to lock-in LIBOR for a 3-m deposit
for $ mio. to be made after 3 months when LIBOR for 3-m and 6-m are
5.31% and 5.60%. However, the deposit time LIBOR is 5.94%.
Advantages
Provides a hedge for maturities up to 2 yrs.
Standardized in form, so easy to arrange.
Disadvantages
A definite commitment to exchange flows -
future cashflows must be reasonably certain
Credit risk increases with the period
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Futures
Futures Contracts
Contracts
11/04/21 33
Futures
Futures Contracts
Contracts
4. Commodity futures
5. Options on futures
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Futures
Futures contracts
contracts ....
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Futures
Futures contracts
contracts ...
...
Contract sizes :
3m Euro $- 1 mio Treasury bills $ 1mio
Long gilts GBP 50,000
Price quotations - 1/32 for $ or 1/100th for DEM
Margin requirements depend on underlyings
may range from 0.0625% (Euro $) to 2%
(Treasury)
a) initial margin b) variation margin(marked-to-market)
Users
Investment banks - for hedging and speculating
Banks- for hedging, bridging gaps & speculation
Institutions and Corp. - Hedging - limited role
11/04/21 36
Futures
Futures Contracts
Contracts
11/04/21 37
OPTIONS
OPTIONS
Forex Interest
Option
Option Contracts
Contracts
Option Contracts
A contract with the seller, which gives the buyer the right,
but not the obligation, to buy or sell a specific amount of
the commodity, at a predetermined price on or before a
specified date in the future
11/04/21 39
Currency
Currency Option
Option Contracts
Contracts
Concepts in Options
Spot rate 1.90 GBP CALL 1.90 GBP PUT
1.85 Out-of-the-money in-the-money
1.90 at-the-money at-the-money
1.95 in-the-money out-of-the-money
An option is described as
in-the-money if it is profitable to exercise now,
at-the-money if exercising option does not result in +/ (-)
out-of- the money if it is unprofitable to exercise option
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Interest
Interest Options
Options
11/04/21 41
Option
Option Contracts
Contracts
11/04/21 42
Option
Option Contracts
Contracts -- features
features
11/04/21 43
SWAPS
SWAPS
Forex Interest
SWAPS
SWAPS
Definition SWAP
Swap is a legal agreement between two parties to
exchange specified cash flows at future dates
Eg.:
Interest rate swap to exchange fixed to floating or
floating to floating in a single currency
Currency swap to transform an obligation in one
currency into that in another currency
Cross currency to exchange interest related payments
in different currencies
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Forex
Forex SWAPS
SWAPS
11/04/21 46
State Bank Staff College
Forex
Forex SWAPS
SWAPS Hyderabad
Eg.: • Indco has dollars but can use them after 90 days. Has a rupee loan
costing 14% p.a.
• Exco needs dollars to close FCNRB loan while it will get dollars
after 90 days. Has spare rupees.
USD Libor
USD 10MM
Front Exchange CUSTOMER
State Bank of India
(USD 10Mio Liability)
INR 435 MM
INR Interest
(Fixed or Floating)
Interest Rate Derivatives
Interest Rate Swaps
Floating
Fixed
Swap Party
11/04/21 51
Interest Rate Derivatives - Rate Swaps
Interest Rate Derivatives
Application of Interest Rate Swaps
To obtain fixed rate financing when it is impossible to access the
bond markets directly
To achieve funding at rates below those available in the bond
market or from banks
To restructure a debt profile
6 MO USD LIBOR
State Bank of India Corporate
USD 6.75
NPA : USD 50 MM
Tenor : 5 Years
Interest
Interest Rate
Rate SWAP
SWAP Contracts
Contracts
Principle Ccy Balsara raises a 5 year dollar loan but likes to a rupee
Swap liability for principle and interest. Construct a SWAP
11/04/21 53
Interest
Interest Rate
Rate SWAP
SWAP Contracts
Contracts
11/04/21 54
SWAP
SWAP contracts
contracts
Advantages
Can be tailor made
Available for periods up to 10 yrs also.
Banks use for funding exposures
Disadvantages
Involves considerable credit risk on
counterparty
A definite commitment, so requires certain
cashflows
11/04/21 55
State Bank Staff College
Key
Key elements
elements of
of Hyderabad
RISK
RISK MANAGEMENT
MANAGEMENT
Objectives Philosophy
Low risk - Low reward
For best rate ?
Cover all exposures
Not feasible
Risk averse & conservative
For reasonable profit? High risk – Low reward
Over budgeted rate Open exposures
Cost centre? High risk gamble
Insure cash flows Low risk–Reasonable reward
Gross vs Net Selective hedging
What to cover Prediction driven
Choice of Currency High risk – High reward
Dollar vs non-dollar Active trading – Cancel/rebook
Profit centre approach
Risk Management
Process