Managing Forex de Guzman

8/16/2019 Managing Forex de Guzman

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FX Sales & Hedging and Financial SolutionsSeptember 2010

FX Hedging Products! FX Forwards

" Regular Forward" Non-Deliverable Forwards (NDF)

! Swaps" FX Swaps

! Currency Options" Plain Vanilla

! Puts! Calls


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! Locking-in FX prices for settlement at a futuredate.

! FWD rate is the FV of the Spot rate givencurrent spot prices and interest rates.

! The FX FWD Rate IS NOT an FX Forecast orProjection

Two Types:! Regular Forward! Non-deliverable Forward

FX Forwards


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Regular Fwd vs. NDFRegular Fwd! Deal date

" Agree on a fwd rate! Maturity

" Actual exchange ofprincipal amounts.

! Suitable if cashflows arereadily and accuratelydeterminable.

NDF! Deal date

" Agree on a fwd rate! Maturity

" Net Settlement of cashflows

" Difference between pre-agreed FWD rate vs. FixingRate

! Suitable if cashflows are notreadily determinable

! Provides cashflow andpricing flexibility


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Pricing Mechanics for FWDs &

NDFs! General Formula:

" FWD Rate = Spot Rate + Swap Points

" Swap Points = Spot Rate x IRD x (tenor/360)

" IRD = Domestic Int. Rate – Foreign Int. Rate


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! Example:" Spot Rate: 45.00

" Php Int. Rate: 4.0%" USD Int. Rate: 0.25%" Tenor: 30 days


NDFs


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! IRD = 4.0% - 0.25%= 3.75%

! Swap Points = 45.00 x 3.75% x (30/360)= 0.141

! FWD Rate = 45.000 + 0.141

= 45.141


NDFs


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NDF Example (Scenario 1)! Assume the Php depreciates! On the 29 th day, assume USD/Php wtd. ave. exchange

rate is 48.141 (11:30am fixing rate)!

Net settlement amount:" 45.141 – 48.141 = -3.0 (i.e. client pays)! Client can sell USD holdings at current market of 48.141! Net effect to client:

" 48.141 – 3.0 = 45.141 hedge cost


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NDF Example (Scenario 2)! Assume the Php appreciates! On the 29 th day, assume USD/Php wtd. ave. exchange rate

is 42.141 (11:30am fixing rate)!

Net settlement amount:" 45.141 – 42.141 = +3.0 (i.e. client receives)! Client can sell USD holdings at current market of 42.141! Net effect to client:

" 42.141 + 3.0 = 45.141 hedge cost


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Added Risks

! NDF structures have “fixing risk”compared to a plain vanilla FWD.

! If markets are volatile and FX rates moveagainst the client after the fixing rate hasbeen determined, the client mayexperience a loss


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! What is a Swap transaction?" A swap is an agreement between two or

more parties to exchange a sequence ofcash flows over a period in the future." The cash flows that the counterparties

generally exchange are tied to the value of

foreign currencies or debt instruments .

Swaps


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! 2 General Kinds of Swaps:" FX Swaps - exchange of one currency vs. another

with a simultaneous opposite exchange in the

future.! Spot + reversing FWD

" Interest Rate Swaps – exchange of cash flowswherein one counterparty agrees to pay asequence of FIXED rate interest payments in

exchange for receiving a sequence of FLOATINGrate interest payments.

Swaps


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! On Spot Date

! On Spot Date, the

client sells USD vs.Php to SBC.

! On FWD MaturityDate

! On FWD Maturity

Date, the client buysUSD vs. Php fromSBC.

FX Swaps

Client SBC

$

Php

Client SBC

Php

$


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FX Swap Example# An SME has both USD Export proceeds frommerchandise sales and USD Import requirements for rawmaterial importations.# The SME needs to convert USD250K for Php at the startof every year and needs to buy USD250K at the end ofevery year.# The SME can execute a 1 year S/B FX Swap in order tobridge the cash flow gap.# The spot leg of the FX Swap generates Php liquidity for 1year which can be used for OPEX and CAPEX.# The FWD leg of the FX Swap ensures a fixed exchangerate in the future.


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FX OptionsWhat are FX Options?! An FX option gives the option buyer the right but not the

obligation to perform what is stipulated in the FX optioncontract.

! In contrast, option sellers have the obligation to perform what is stipulated in the FX option contract if the optionbuyer chooses to exercise his/her right.

! Option Buyers pay a premium for the right to exercise onan option contract.

! Option Sellers receive the premium for promising toperform what is stipulated in the option contract.


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FX Options! Two most basic kinds of options:

" Call option (right to buy the underlying asset)" Put option (right to sell the underlying asset)

! Two most basic types of options based on exercisemethod:

" American (option buyer can exercise the option anytime during the life

of the option)" European (option buyer can only exercise the option at maturity date

of the option)


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FX Options

! FX Options" Call Options:

" Hedge against Php Depreciation" Provides “upside protection”

" Put Options:" Hedge against Php Appreciation" Provides “downside protection”


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Advantages of FX Options vs. FX

FWDs & NDFs! Provides Option Buyers the flexibility in FX conversions . If

exercising the option is unfavorable to the client, then they willchose not to convert their currency. If exercising the optionproves to be beneficial for the client, then they will exercisetheir right to convert their currency.

! CALL OPTION BUYERS can buy FX at the pre-agreed strikeprice OR at the current market WHICHEVER IS LOWER

! PUT OPTION BUYERS can sell FX at the pre-agreed strikeprice OR at the current market WHICHEVER IS HIGHER

! Provides:!

Full Protection! Flexibility


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Trade Sectors / Potential Clients of

FX OptionsCALL OPTION BUYERS

! Importers! Clients with FCDU Loans! Local investors buying

foreign equities! Multinationals repatriating

funds abroad

PUT OPTION BUYERS! Exporters! Foreign investors buying

local equities! BPOs! OFWs! Shipping Companies

! Manning Agencies


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Client Pay-Off Profiles

Exporters / USDSellers

Importers / USDBuyers

P/L

FX Rate

P/L

FX Rate


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Option Pay-Offs: Hockey Sticks

Call Options Put Options

LONG LONG

SHORT SHORT


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FX Call Options! Pay-off profile of Importers hedging by buying

Call Options

Short USD Long CALL Hedged Position+ =


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Call Option Example

! Client decides to hedge FX risk by buyinga 1 month ATM European CALL Option

with Strike Price at 45.141! Option Premium: Php45,000 (i.e. Php0.45

per 1 USD).


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Call Option Example

! If Php weakens 1 month later to 46.141, then theclient chooses to exercise the Call Option to buyUSD at the pre-agreed strike price of Php45.141.

! Net effect:" 45.141 strike price + 0.45 premium = 45.591 effective

rate" vs. current market rate of 46.141" Savings: 0.55 vs. current market rate


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Call Option Example

! If Php strengthens 1 month later to 44.00, thenthe client will let the CALL Option expire andproceed to buy USD at the current market priceof 44.00

! Net Effect:" 44.00 spot + 0.45 premium = 44.45 effective rate" vs. FWD Rate of 45.141" Savings: 0.691 vs. FWD hedge


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FX Put Options

! Pay-off profile of Exporters hedging by buyingPut Options

Long USD Long PUT Hedged Position+ =


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Put Option Example:

! Exporter needs to sell USD100K onemonth from now.

! Market consensus is for the Php tostrengthen (Target 44.00)

! Current Spot Price: 45.00!

Computed FWD Rate: 45.141


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Put Option Example

! Client decides to hedge FX risk by buyinga 1 month ATM European PUT Option with

Strike Price at 45.141! Option Premium: Php45,000 (i.e. Php0.45

per 1 USD).


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Put Option Example

! If Php weakens 1 month later to 46.141, then theclient lets the PUT Option expire and proceedsto sell USD at the current market rate of 46.141

! Net effect:" 46.141 spot – 0.45 premium = 45.691 effective rate" vs. FWD Rate of 45.141" Savings: 0.55 vs. FWD Hedge


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Put Option Example

! If Php strengthens 1 month later to 44.00, thenthe client will exercise the PUT Option to sellUSD at the Strike Price of 45.141

! Net Effect:" 45.141 strike – 0.45 premium = 44.691 effective rate" vs. current market rate of 44.00" Savings: 0.691 vs. Market Rate


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How do you hedge?!

Calculate total costs and benefits" Direct Costs! Transactions costs, broker fees, etc.

" Indirect Costs! Opportunity Cost of holding margin capital! Forgone upside/benefits of favourable market moves

(probability; corporate view)

! Look beyond financial hedges! Contracting Decisions! Vertical integration! Operating off-peak hours


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ENDThank You!

For further questions, please call:SBC Hedging and Financial Solutions

888-7011 to 18

Rovic De Guzman – TMU HeadAileen Chua – Head of Hedging

Robin Galang – Hedging TeamSheilagh Rivera – Head of FX SalesFrancis Buenaventura – FX Sales Team

Managing Forex de Guzman

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