• Save
Risk Management & Forex Derivatives
Upcoming SlideShare
Loading in...5
×
 

Risk Management & Forex Derivatives

on

  • 3,782 views

Presentation on various risk management strategies using forex derivatives.

Presentation on various risk management strategies using forex derivatives.

Statistics

Views

Total Views
3,782
Views on SlideShare
3,763
Embed Views
19

Actions

Likes
4
Downloads
0
Comments
0

4 Embeds 19

http://www.slideshare.net 9
http://apeldoornmetaalbuurt.com 7
http://www.brijj.com 2
http://www.lmodules.com 1

Accessibility

Categories

Upload Details

Uploaded via as Microsoft PowerPoint

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Processing…
Post Comment
Edit your comment

Risk Management & Forex Derivatives Risk Management & Forex Derivatives Presentation Transcript

  • Foreign Exchange Market & Derivatives Risk = Grammar of Business Finance = Language of Business
  • Introduction
    • Give & take principal gave rise to four business transactions i.e.,
      • Sale
      • Purchase
      • Lend
      • Borrow
    • Interest rates differ while borrowing in foreign currency due to time value of money.
    • For sustainable development & long term growth the mantra is to “control the cost or reducing it”
    • Carry trade transaction: Buying or borrowing foreign currency at lower interest rate & then lending in the home country at high interest rate.
    • Cost of hedging is more than the rate of interest on foreign currency.
    • Every currency has three values:
      • Internal value: Purchasing power of currency which depends on “inflation”
      • External value: Value against some foreign currency. Depends purely on “demand-supply”.
      • Time value: Given by LIBOR & LIBID.
    • Currency with lower interest rate will always be at premium whereas it will be at discount if interest rate is higher for a currency.
    • Premium Position is always better for exporter & vice versa.
    • Premium is always added and discount is always deducted.
    • Forward = Spot + Premium/Discount
    • Spot rate is the function of demand & supply.
    • Premium/discount is the function of interest rates.
  • Risk
    • Exposure & risks are inter-related but simultaneously differs from each other.
    • Risk is created by exchange rates.
    • Hedging is used for controlling & minimizing the risk
    • Hedging is part of failure management & not that of success management.
    • Hedging is not used to make profit; but for keeping the current position safe.
    • Longer the period, more the risk & vice versa.
    • Risk can be covered by:
      • Derivatives
      • Operational Hedging
  • Derivatives
    • Derivatives are agreements which derive their values from underlying variable.
    • Spread on loan for borrowing company depends upon:
      • Size of the Company
      • Business Profile of the company
      • Risk profile
      • Tenure of the loan etc.
  • Some information…
    • Subprime financial crisis leads to loss of 50 trillion Dollars.
    • CHIPS : Clearing House Interbank Payment system used for Dollar clearing.
    • SWIFT: Social Wide International Financial Telecommunication.
    • Dollar has the least LIBOR
    • Structured financing is most important these dyas.
    • When one currency appreciates, competitiveness of that country declines.
    • e.g., 1 $ = 100 Yen
    • If Yen appreciates,
    • 1 $ = 80 Yen
    • so to earn 100 Yen Exporter has to increase the price in dollar which make him less competitive.
  • Forex Derivatives
    • Hedging is not done while using forward contract.
    • Hedging means no loss & no gain & make uncertain things, certain.
    • Currency carrying lower rate of interest will always be at premium.
  • Stop loss order to maximize profit & minimization of loss Book the Contract Cancel the contract Demand – Supply Curve
  • Swaps
    • Four types of swaps:
      • Forex Swaps
      • Interest Rate Swaps
      • Currency Swaps
      • CIRCUS Swaps (Combined Interest Rate & Currency Swap)
    • Swaps are governed by comparative advantage.
    • Swap transactions come only in footnotes to the balance sheet. They don’t deteriorate the balance sheet.
    • Swap turnover is the highest than spot turnover in the forex market.
  • 1. Forex Swap
    • Two opposite sale & purchase at the same time of foreign currency.
      • In Swap: (Specific date & different rates)
      • Buy $1000,000 Value Spot
      • Sell $1000,000 Value 1 month forward
        • Used to arrange foreign currency funds.
      • Out Swap:
        • To use foreign currency resources
        • Have surplus dollar
        • Used as investment.
  • 2. Interest Rate Swap
    • To reduce the cost of borrowing
    • For interest risk management
    • Illustration:
    Company Funds Duration Conditions X 100 Million 5 Years On fixed rate Y 100 Million 5 Years On floating rate Company Rating Interest rate in Fixed market Interest rate in Floating rate X BBB 8.5% 6 LIBOR + 0.50% Y AAA 7% 6 LIBOR
  • 2. Interest rate swap contd…
    • Investment Banker Quotes (for 6 LIBOR):
      • Citibank – 7.25%/7.30% (Borrowing/Lending)
      • HSBC – 7.50%/7.80% (Borrowing/Lending)
    • Since Citibank is offering least rates so both the parties choose Citibank as their merchant banker.
    • On the basis of above requirements, Citibank suggests Co. X to borrow money from Floating Market and to Co. Y to borrow from Fixed Market at the interest rate of 6 LIBOR + 0.50% & 7% respectively. Because Co. X has comparative advantage in floating market and that of Co. Y is in Fixed market.
    • But Co. X agenda says to borrow on fixed rate and that of Co. Y says to borrow on floating rate.
    • Now, let’s see the process of this swap arranged by Citibank to fulfill their customized wishes.
  • 2. Interest rate swap contd… Company Y Company X 7.30% Fixed Rate 6 LIBOR Floating Rate 6 LIBOR Floating Rate 7.25% Fixed Rate Use $ 100 Mio Use $ 100 Mio 6 LIBOR + 0.50% Floating Rate $100 MiO for 5 Years $100 MiO for 5 Years 7.0% 0.05% Profit Citibank Floating Market Fixed Market
  • 3. Currency Swap
    • Company wants a particular currency to meet its requirement for the subsidiary in foreign country.
    • Objectives:
      • Currency of desired choice
      • No exchange risk
      • Reduced interest cost
  • 3. Currency Swap contd…
    • Illustration:
    • Both the companies have comparative advantage in their respective home countries.
    • Citibank agrees at the brokerage of 0.01%
    Company Funds Duration Interest rate in USA Interest Rate in Japan X (USA Co.) 10000 MiO Yen 5 years $ = 6% Yen = 5% Y (Japenese Co.) $ 100 MiO 5 Years $ = 8% Yen = 4%
  • 3. Currency Swap contd… T 0 T 1 T 2 T 0 T 1 T 2 T 3 T 4 T 5 T 3 T 4 T 5 X Y Borrow $ 100 MiO @ 6% Borrow 10000 MiO Yen@ 6% Give It to X Give It to Y Y will give $100 MiO to its US subsidiary X will give 10000 MiO Yen to its Japenese Subsidiary $100 MiO 10000 MiO Yen Y will pay Interest in $ @ 6% X will pay interest in Yen @ 4% Y will pay Interest in $ @ 6% X will pay interest in Yen @ 4% Y will pay Interest in $ @ 6% X will pay interest in Yen @ 4% Y will pay Interest in $ @ 6% X will pay interest in Yen @ 4%
  • 4. CIRCUS Swap
    • Illustration:
    Company Funds Mode € $ X 100 MiO € Fixed Rate 5% 6 LIBOR + 0.10% Y $ 150 MiO Floating Rate 4% 6 LIBOR + 0.50%
  • 4. CIRCUS Swap contd… T 0 $150 MiO T 0 150 MiO € T 1 -T 5 Int. @ 4% T 1 -T 5 6 LIBOR + 0.10% T 0 $150 MiO 6 LIBOR + 0.10% T 0 100 MiO € T 1 -T 5 Int. @ 4% Co. X Co. Y Floating Market Fixed Market
  • T 5 100 MiO € T 5 $150 MiO T 5 100 MiO € T 5 $150 MiO Co. X Co. Y Floating Market Fixed Market
  • Futures Derivatives
    • In India $/INR exchange is allowed because of dollar’s huge liquidity & it is the direct function of demand & supply.
    • Other exchanges are not allowed because determination of cross rates is a complex procedure and it will increase the economy’s exposure.
    • Contract is for 12 month.
    • Charges is equal to $ 1000.
    • No individual can’t access more than $5 MiO exchange in a day.
    • Daily turnover more than 1200 Crores.
    • Major players in futures market are speculators.