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FX Risk Management

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  • Currency Valuations: What factors generally determine the exchange rate? Socio-political analysis of these factors provides insight into market conditions and informs any forecast. With adequate knowledge of market drivers, you can begin to forecast on your own. Current FX Market Themes: What are today’s critical top issues? Key elements of economic conditions and monetary policy impacting FX markets. Market forecast for 2009: What’s next?
  • Narrow margins means FX is more important to their bottom line – agriculture companies, mature industries, etc – get examples Sometimes an attractive industry is not an attractive client
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    1. 1. July 20, 2010 Mark Frey – Regional Director Custom House’s Value Proposition
    2. 2. Today’s Agenda <ul><li>Who we are? </li></ul><ul><li>What we do? </li></ul><ul><li>What makes us different? </li></ul><ul><li>Our risk management philosophy </li></ul><ul><li>Tools for managing currency risk </li></ul><ul><ul><li>Forward Contracts </li></ul></ul><ul><ul><li>Currency Options </li></ul></ul>
    3. 3. Current Market Themes <ul><li>The world’s largest non-bank FX brokerage company </li></ul><ul><li>Trade roughly $30B USD per year globally </li></ul><ul><li>Founded in Canada, HQ in Victoria, presence in seven </li></ul><ul><li>international markets </li></ul><ul><li>Acquired by Western Union in September 2008 </li></ul><ul><ul><li>Balance sheet strength </li></ul></ul><ul><ul><li>Resources for growth </li></ul></ul><ul><li>More than 40 global banking counterparties </li></ul><ul><ul><li>Deutsche, BOA, Citi, Barclays, UBS, Credit Suisse, BMO, ANZ </li></ul></ul><ul><li>Focus on international payments and risk </li></ul><ul><li>management </li></ul>
    4. 4. Global Payment Solutions <ul><li>Wires in 153 currencies </li></ul><ul><li>Remote draft printing in 63 currencies </li></ul><ul><li>Employ our own nostro accounts and/or local correspondents in most cases </li></ul><ul><li>In-house investigations and payment services </li></ul><ul><li>Global expertise, local delivery </li></ul><ul><li>A/P and A/R outsourcing </li></ul><ul><li>Online, multiple payments, multiple currencies at one time, 24 hours a day, 7 days a week </li></ul><ul><li>Online system (MPP) can be fully integrated with accounting software </li></ul><ul><li>MPP – multiple approval and/or booking limits </li></ul><ul><li>SPP – consumer driven, single payments </li></ul>
    5. 5. FX Risk Management <ul><li>Competitive rates </li></ul><ul><li>Proactive service </li></ul><ul><li>Hedging products and solutions </li></ul><ul><ul><li>Limit Orders, Forward Contracts, FX Swaps, Vanilla and Structured Options </li></ul></ul><ul><li>Flexible collateral terms and hedging facilities </li></ul><ul><li>Phone execution and/or online execution 24 hours a day </li></ul><ul><li>Market information and analysis </li></ul><ul><li>154 currencies, 63 forward currencies including BRIC nations </li></ul>
    6. 6. FX Hedging Process
    7. 7. <ul><li>It rarely makes sense to hedge 100% of your known requirements </li></ul><ul><li>Psychologically optimal ratio is 50% </li></ul><ul><li>Typical risk averse Corporates hedge 70 to 85% of known requirements </li></ul><ul><li>The narrower the margins the higher the ratio </li></ul><ul><li>The wider the margins the lower the ratio </li></ul><ul><li>Known and contracted requirements vs. forecasted requirements </li></ul>Optimal Hedge Ratios
    8. 8. <ul><ul><li>Hedging Rationale </li></ul></ul><ul><li>A hedge should be initiated at a level that is consistent with; and protects the operating margin within the business </li></ul><ul><li>A hedge should not simply be booked opportunistically or at a rate that one simply thinks will be favorable at expiry </li></ul><ul><li>If the latter is chosen, a poor MTM result will often negate the value delivered by hedging </li></ul><ul><li>If you choose the former, the your business will be protected and you will see value from having engaged in hedging </li></ul><ul><ul><li>Hedging Rationale </li></ul></ul>
    9. 9. Forward Contracts: Future-dated settlement <ul><li>Benefits </li></ul><ul><li>Deliverable and non-deliverable </li></ul><ul><li>Any date - Any amount </li></ul><ul><li>Extremely liquid </li></ul><ul><li>No upfront costs or fees </li></ul><ul><li>Drawbacks </li></ul><ul><li>Commitment to buy or sell a foreign currency vs. </li></ul><ul><li>an option </li></ul><ul><li>Cannot participate in favourable market moves </li></ul>
    10. 10. <ul><ul><li>Plain Vanilla Option </li></ul></ul><ul><li>An option gives the buyer the right, but not the obligation , to buy or sell a predetermined amount of one currency for another at a pre-specified rate at or before an agreed upon point in the future. </li></ul><ul><li>An option gives the seller the obligation to perform the terms of the option should the buyer decide to exercise the option. </li></ul><ul><li>This is fundamentally, and importantly different from a forward contract. </li></ul><ul><li>Allows for a known worst case rate and upside participation. </li></ul><ul><ul><li>Plain Vanilla Option </li></ul></ul>
    11. 11. The Value of Structured Options <ul><li>Protect against the downside while maintaining the ability to participate in a favorable market movement </li></ul><ul><li>Structured options vary in four main ways: </li></ul><ul><ul><li>Efficiency of Protection – How close is the hedge rate to the ATM Fwd </li></ul></ul><ul><ul><li>Upside Participation </li></ul></ul><ul><ul><li>Sensitivity to Volatility </li></ul></ul><ul><ul><li>Risk vs. Reward – Payoff Scenarios </li></ul></ul><ul><li>Combine the efficiency of a forward, avoid paying premiums and participate in favourable market movement </li></ul><ul><li>Can completely customize the payoff scenario to the customer’s </li></ul><ul><li> unique requirements </li></ul>
    12. 12. Hedging Recommendations <ul><li>What you want to achieve? – Alignment of objectives </li></ul><ul><li>Balanced portfolio – forwards and options (where appropriate) </li></ul><ul><li>Protect your budgeted rate </li></ul><ul><li>Maintain flexibility </li></ul><ul><li>Participate in potential market </li></ul><ul><li>gains </li></ul>