Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.
Foreign Exchange (FX) Derivatives Information Session on Usage of FX Derivatives in Credit Union Operations  –  Picuz Solu...
Today’s Agenda <ul><li>Define Foreign Exchange (FX) Derivatives </li></ul><ul><li>Usage of FX Swaps </li></ul><ul><li>Pric...
FX Derivative <ul><li>4 major types of FX derivatives for financial institutions </li></ul><ul><ul><li>FX Swaps </li></ul>...
FX Swaps <ul><li>Definition – an agreement to sell US$ today against an offsetting purchase of US$ at a future date </li><...
Why are FX Swaps Used? <ul><li>Used to transfer liquidity (cash) from one currency to another without engaging in currency...
How to do an FX swap? <ul><li>Cash in US$ investments into C/A </li></ul><ul><li>Sell US$ value cash (today, spot is actua...
Pricing an FX swap <ul><li>Selling and buying at two different rates creates a loss/gain – Why do FX swap? </li></ul><ul><...
Math of FX Swap <ul><li>Cash in US$1 mil deposits yielding 0.20% give up $167 on 30 days of interest </li></ul><ul><li>Sel...
Beating the FX Swap Market <ul><li>Beating the FX market </li></ul><ul><ul><li>Find higher C$ yield than money market  </l...
FX Swap Factors <ul><li>If US rates > Cdn Rates forward yields at a discount to spot (ex. 1.10 & 1.0998) </li></ul><ul><ul...
Risk Factors <ul><li>US$ deposit expenses will build up if not offset with US$ spot purchases </li></ul><ul><li>Default Ri...
Risk Factors  <ul><li>US$ depos redeem before FX swap purchase </li></ul><ul><ul><li>Members draw down US$ deposits and pu...
Internal Issues <ul><li>Set Up Off balance Sheet accounts for US$ and counter C$ balances </li></ul><ul><ul><li>US$ forwar...
Calculation of FX Position <ul><li>Old FX position calculation </li></ul><ul><ul><li>Sum (Investments, Current Account) le...
Example US$ Deposit Redemption <ul><li>CU manager has $1 mil US$ deposits and enters into Sell/Buy FX swap </li></ul><ul><...
Policy Amendments <ul><li>Allow FX swap transactions under Market Risk policy </li></ul><ul><li>Set maximum term from spot...
FX Outright Forwards <ul><li>Second type of FX derivative used by credit unions </li></ul><ul><li>Related to Corporate cli...
Risks to Income from Outright Forwards <ul><li>Counterparty risk </li></ul><ul><ul><li>Client defaults = big risk to incom...
Policy Amendments for Outright Forward Activity <ul><li>Great way of earning additional income on commercial credits </li>...
Policy Amendments <ul><li>Forward Outrights require market risk policy amendments </li></ul><ul><li>Maximum terms, limits ...
FX Derivatives Reporting <ul><li>Sum On-B/S Assets and Liabilities </li></ul><ul><li>Sum Off-B/S FX Swap US$ Forward Purch...
FX Derivatives and the Regulations <ul><li>Regulations prohibit the use of FX derivatives (very prescriptive…) </li></ul><...
Conclusions <ul><li>Improved profitability levels </li></ul><ul><li>Swaps are safe and efficiently priced </li></ul><ul><l...
Upcoming SlideShare
Loading in …5
×

Foreign Exchange (Fx) Derivatives

6,007 views

Published on

  • Secrets To Making Up, These secrets will help you get back together with your ex. ▲▲▲ http://t.cn/R50e2MX
       Reply 
    Are you sure you want to  Yes  No
    Your message goes here
  • very clear a helpful papers
       Reply 
    Are you sure you want to  Yes  No
    Your message goes here

Foreign Exchange (Fx) Derivatives

  1. 1. Foreign Exchange (FX) Derivatives Information Session on Usage of FX Derivatives in Credit Union Operations – Picuz Solutions Sept/09
  2. 2. Today’s Agenda <ul><li>Define Foreign Exchange (FX) Derivatives </li></ul><ul><li>Usage of FX Swaps </li></ul><ul><li>Pricing/Math on FX Swaps </li></ul><ul><li>Risk Factors </li></ul><ul><li>Accounting Considerations </li></ul><ul><li>Risk Management / Policy Adjustments </li></ul><ul><li>Clearance from Regulations </li></ul>
  3. 3. FX Derivative <ul><li>4 major types of FX derivatives for financial institutions </li></ul><ul><ul><li>FX Swaps </li></ul></ul><ul><ul><li>FX Futures Contracts </li></ul></ul><ul><ul><li>FX Currency Swap </li></ul></ul><ul><ul><li>Outright Forward Purchases or Sales </li></ul></ul><ul><li>Credit Unions’ exposure should be limited to FX swaps and Outright Forwards related to member business </li></ul>
  4. 4. FX Swaps <ul><li>Definition – an agreement to sell US$ today against an offsetting purchase of US$ at a future date </li></ul><ul><li>US$ principals are equal </li></ul><ul><li>The FX rate today versus a FX rate in the future is established today </li></ul><ul><li>Short terms to long terms (1 day to 5 yrs) </li></ul><ul><li>Most activity inside 3 months for credit unions </li></ul>
  5. 5. Why are FX Swaps Used? <ul><li>Used to transfer liquidity (cash) from one currency to another without engaging in currency risk </li></ul><ul><li>Example – credit union has US$ deposits and no US$ loans – forced to invest in US$ investments </li></ul><ul><li>With FX swaps CU converts US$ into C$ and lends funds out at higher rate than US$ investment level or pays down C1 borrowings </li></ul><ul><li>FX swaps can boost income or reduce borrowing costs! </li></ul>
  6. 6. How to do an FX swap? <ul><li>Cash in US$ investments into C/A </li></ul><ul><li>Sell US$ value cash (today, spot is actually next business day) at 1.1000 </li></ul><ul><li>Agree to Buy US$ value 1 month from today at a future rate 1.1015 </li></ul><ul><li>On the future date US$ back into C/A and need to pay back C$ </li></ul><ul><li>Do a new FX swap (rollover) on that date </li></ul>
  7. 7. Pricing an FX swap <ul><li>Selling and buying at two different rates creates a loss/gain – Why do FX swap? </li></ul><ul><li>The gain or loss on FX swap is related to the interest rate differential between Cdn and US 1 month yields </li></ul><ul><li>Think interest rate costs not FX gains or losses when doing FX swap </li></ul>
  8. 8. Math of FX Swap <ul><li>Cash in US$1 mil deposits yielding 0.20% give up $167 on 30 days of interest </li></ul><ul><li>Sell US$1 mil at 1.10 for $1.1 mil C$ </li></ul><ul><li>Invest $1.1 mil at 0.45% and earn $406 </li></ul><ul><li>Give up $US167 at 1.10 = $184 vs $406 </li></ul><ul><li>Cost of buying US$ back will be higher than spot rate to claw back the $222 gain </li></ul><ul><li>If FX swap rates are 1.10 and 1.1002 most gains will be lost </li></ul>
  9. 9. Beating the FX Swap Market <ul><li>Beating the FX market </li></ul><ul><ul><li>Find higher C$ yield than money market </li></ul></ul><ul><ul><ul><li>Reduce C1 loan = savings 0.30% (0.75% - 0.45%) </li></ul></ul></ul><ul><ul><ul><li>Lend funds to members at Prime = bigger savings </li></ul></ul></ul><ul><li>Calculate the potential gain to CU </li></ul><ul><ul><li>US$ 1 mil * 0.20% * 30 / 360 = -C$184 </li></ul></ul><ul><ul><li>C$ 1.1 mil * 3.00% * 30 / 365 = C$ 2,712 </li></ul></ul><ul><ul><li>Less forward pts .0002 * $ 1 mil = -C$200 </li></ul></ul><ul><ul><li>Pick up from FX swap strategy = $2,339 </li></ul></ul><ul><ul><li>Annual gains $27,939 per million!!! </li></ul></ul>
  10. 10. FX Swap Factors <ul><li>If US rates > Cdn Rates forward yields at a discount to spot (ex. 1.10 & 1.0998) </li></ul><ul><ul><li>Sell and Buy results in a FX gain </li></ul></ul><ul><li>If US rates < Cdn Rates forward yields at a premium to spot (ex 1.10 and 1.1002) </li></ul><ul><li>Gains or Losses on FX swap not FX losses but interest costs </li></ul>
  11. 11. Risk Factors <ul><li>US$ deposit expenses will build up if not offset with US$ spot purchases </li></ul><ul><li>Default Risk </li></ul><ul><ul><li>If counterpart fails = result = open currency position </li></ul></ul><ul><ul><li>Mitigate risk by dealing with highly-rated counterparts </li></ul></ul><ul><ul><li>Consider only doing short term swaps 1 to 3 months </li></ul></ul>
  12. 12. Risk Factors <ul><li>US$ depos redeem before FX swap purchase </li></ul><ul><ul><li>Members draw down US$ deposits and put C/A into overdraft </li></ul></ul><ul><ul><li>Enter into Buy and Sell US$ Contract </li></ul></ul><ul><ul><ul><li>Buy US$ for cash to cover overdraft </li></ul></ul></ul><ul><ul><ul><li>Sell US$ forward to match date of previous purchase </li></ul></ul></ul><ul><ul><ul><li>Sell C$ investments to buy US$ today </li></ul></ul></ul><ul><ul><li>Potential Risk to income from the change in forward points on the outstanding buy and sell </li></ul></ul><ul><ul><li>Mitigate risk by keeping terms to less than 3 months </li></ul></ul>
  13. 13. Internal Issues <ul><li>Set Up Off balance Sheet accounts for US$ and counter C$ balances </li></ul><ul><ul><li>US$ forward purchases and forward sales </li></ul></ul><ul><li>FX Translation effects to understand </li></ul><ul><ul><li>Month end spot rate 1.10 </li></ul></ul><ul><ul><li>Sell FX at 1.08 on first of next month 1.0802 </li></ul></ul><ul><ul><li>Close current month end at 1.07 </li></ul></ul><ul><ul><li>Gain .03 on deposits, Loss of .02 FX Sale (1.10 vs 1.08) </li></ul></ul><ul><ul><li>Outstanding FX Buy at 1.0802 vs 1.07 (loss of .0102) </li></ul></ul>
  14. 14. Calculation of FX Position <ul><li>Old FX position calculation </li></ul><ul><ul><li>Sum (Investments, Current Account) less deposit terms and accounts = Net FX position </li></ul></ul><ul><li>New FX position calculation </li></ul><ul><ul><li>Old FX position add US$ forward Purchases and Sales </li></ul></ul><ul><li>Remember US$ deposit interest will exist without US$ investment income using FX swaps – requiring the occasional US$ purchase </li></ul>
  15. 15. Example US$ Deposit Redemption <ul><li>CU manager has $1 mil US$ deposits and enters into Sell/Buy FX swap </li></ul><ul><ul><li>On B/S = $1 mil US$ deposit (negative flow) </li></ul></ul><ul><ul><li>Off B/S = $1 mil Purchase (positive flow) </li></ul></ul><ul><li>CU manager pays out $600k in US$ deposits </li></ul><ul><ul><li>Manager Buys and Sells $US600k FX Swap </li></ul></ul><ul><ul><li>On B/S = $400k US$ deposit (negative flow) </li></ul></ul><ul><ul><li>Off B/S = $1 mil Buy and $600k sell = $400k (positive flow) </li></ul></ul>
  16. 16. Policy Amendments <ul><li>Allow FX swap transactions under Market Risk policy </li></ul><ul><li>Set maximum term from spot and maximum US$ dollar value </li></ul><ul><li>Review annually for appropriateness </li></ul><ul><li>Prepare Board reporting package </li></ul>
  17. 17. FX Outright Forwards <ul><li>Second type of FX derivative used by credit unions </li></ul><ul><li>Related to Corporate client business </li></ul><ul><ul><li>Importer or Exporter wish to hedge their exposure to US$ from their business </li></ul></ul><ul><ul><li>Buy or Sell US$ forward outright at a rate set today </li></ul></ul><ul><ul><li>Can provide Corporate Client with a option dated delivery (any time during a specific month at a specific rate) </li></ul></ul>
  18. 18. Risks to Income from Outright Forwards <ul><li>Counterparty risk </li></ul><ul><ul><li>Client defaults = big risk to income </li></ul></ul><ul><ul><li>Mitigate by shorter terms or collateral (deposits) </li></ul></ul><ul><li>Re-pricing risk </li></ul><ul><ul><li>Client doesn’t need FX when it matures </li></ul></ul><ul><ul><li>Client wants to roll over contract and use same rates </li></ul></ul><ul><ul><li>Client is borrowing money from credit union if same rate is used – must build interest costs into new forward rate </li></ul></ul>
  19. 19. Policy Amendments for Outright Forward Activity <ul><li>Great way of earning additional income on commercial credits </li></ul><ul><li>Require Assistance call us or Central One </li></ul><ul><li>Should match buys and sells with Central One or bank as close as possible </li></ul><ul><li>Should have maximum terms for transactions and fully matched for risk management reflected in market risk policy </li></ul>
  20. 20. Policy Amendments <ul><li>Forward Outrights require market risk policy amendments </li></ul><ul><li>Maximum terms, limits on levels of mismatch by time period, credit reviews and individual risk limits per client are important </li></ul><ul><li>Simple Excel solution should work for reporting and managing risk </li></ul>
  21. 21. FX Derivatives Reporting <ul><li>Sum On-B/S Assets and Liabilities </li></ul><ul><li>Sum Off-B/S FX Swap US$ Forward Purchases and Sales </li></ul><ul><li>Sum of FX Outright Forward Purchases and Sales </li></ul><ul><ul><li>Provide a gap report to board with US$ buys and sells outstanding by month with weighted average rate </li></ul></ul>
  22. 22. FX Derivatives and the Regulations <ul><li>Regulations prohibit the use of FX derivatives (very prescriptive…) </li></ul><ul><li>Request in writing an exception from Regulator on usage of FX derivatives </li></ul><ul><li>State the purpose of the usage of FX derivatives (FX swaps for liquidity management and FX outrights for customer business) </li></ul><ul><li>State the adjustments made to market policy to measure and report for this exposure </li></ul><ul><li>Receive response from Regulator </li></ul>
  23. 23. Conclusions <ul><li>Improved profitability levels </li></ul><ul><li>Swaps are safe and efficiently priced </li></ul><ul><li>Easy to account for and measure for risk management </li></ul><ul><li>Keep FX swap terms to 30 days and starting and maturing near start of the month will reduce any issues </li></ul><ul><li>Member business is profitable too, but be prepared for additional credit risk (collateral conditions, term and volume limits are required) </li></ul>

×