FX Hedging - Welcome to the Bangko Sentral ng Pilipinas ... Forex de Guzman.pdf · FX Hedging Products !! FX Forwards "!Regular Forward "! ... Pay-off profile of Exporters hedging

FX Sales & Hedging and Financial Solutions

September 2010

FX Hedging Products

!! FX Forwards

"!Regular Forward

"!Non-Deliverable Forwards (NDF)

!! Swaps

"!FX Swaps

!! Currency Options

"!Plain Vanilla

!! Puts

!! Calls


September 2010

!! Locking-in FX prices for settlement at a future date.

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

!! The FX FWD Rate IS NOT an FX Forecast or Projection

Two Types: !!Regular Forward

!!Non-deliverable Forward

FX Forwards


September 2010

Regular Fwd vs. NDF

Regular Fwd !! Deal date

"!Agree on a fwd rate

!! Maturity

"!Actual exchange of principal amounts.

!! Suitable if cashflows are readily and accurately determinable.

NDF !! Deal date

"!Agree on a fwd rate

!! Maturity

"! Net Settlement of cash flows

"! Difference between pre-agreed FWD rate vs. Fixing Rate

!! Suitable if cashflows are not readily determinable

!! Provides cashflow and pricing flexibility


September 2010

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


September 2010

!!Example:

"!Spot Rate: 45.00

"!Php Int. Rate: 4.0%

"!USD Int. Rate: 0.25%

"!Tenor: 30 days


NDFs


September 2010

!! 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


September 2010

NDF Example

!!The client wishes to hedge their USD

export proceeds by entering into a 1month

(30 day) NDF hedge to sell USD vs. Php

!!Current spot rate: 45.000

!! 1-month (30 day) NDF rate: 45.141


September 2010

NDF Example (Scenario 1)

!! Assume the Php depreciates

!! On the 29th 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


September 2010

NDF Example (Scenario 2)

!! Assume the Php appreciates

!! On the 29th 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


September 2010

Added Risks

!!NDF structures have “fixing risk”

compared to a plain vanilla FWD.

!! If markets are volatile and FX rates move

against the client after the fixing rate has

been determined, the client may

experience a loss


September 2010

!!What is a Swap transaction?

"!A swap is an agreement between two or

more parties to exchange a sequence of

cash 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


September 2010

!! 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 flows

wherein one counterparty agrees to pay a

sequence of FIXED rate interest payments in

exchange for receiving a sequence of FLOATING rate interest payments.

Swaps


September 2010

!! On Spot Date

!! On Spot Date, the

client sells USD vs.

Php to SBC.

!! On FWD Maturity

Date

!! On FWD Maturity

Date, the client buys

USD vs. Php from

SBC.

FX Swaps

Client SBC

$

Php

Client SBC

Php

$


September 2010

FX Swap Example

#!An SME has both USD Export proceeds from

merchandise sales and USD Import requirements for raw

material importations. #!The SME needs to convert USD250K for Php at the start

of every year and needs to buy USD250K at the end of

every year.

#!The SME can execute a 1 year S/B FX Swap in order to

bridge the cash flow gap. #!The spot leg of the FX Swap generates Php liquidity for 1

year which can be used for OPEX and CAPEX.

#!The FWD leg of the FX Swap ensures a fixed exchange

rate in the future.


September 2010

FX Options

What are FX Options?

!! An FX option gives the option buyer the right but not the obligation to perform what is stipulated in the FX option contract.

!! In contrast, option sellers have the obligation to perform

what is stipulated in the FX option contract if the option

buyer chooses to exercise his/her right.

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

!! Option Sellers receive the premium for promising to

perform what is stipulated in the option contract.


September 2010

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 exercise

method:

"! 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)


September 2010

FX Options

!!FX Options

"!Call Options:

"!Hedge against Php Depreciation

"!Provides “upside protection”

"!Put Options:

"!Hedge against Php Appreciation

"!Provides “downside protection”


September 2010

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 will chose not to convert their currency. If exercising the option proves to be beneficial for the client, then they will exercise their right to convert their currency.

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

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

!! Provides:

!! Full Protection

!! Flexibility


September 2010

Trade Sectors / Potential Clients of

FX Options

CALL 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


September 2010

Client Pay-Off Profiles

Exporters / USD Sellers

Importers / USD Buyers

P/L

FX Rate

P/L

FX Rate


September 2010

Option Pay-Offs: Hockey Sticks

Call Options Put Options

LONG LONG

SHORT SHORT


September 2010

FX Call Options

!! Pay-off profile of Importers hedging by buying

Call Options

Short USD Long CALL Hedged Position + =


September 2010

Call Option Example:

!! Importer needs to Buy USD100K one month

from now.

!!Market consensus is for the Php to

strengthen (Target 44.00)

!!Current Spot Price: 45.00

!!Computed FWD Rate: 45.141


September 2010

Call Option Example

!!Client decides to hedge FX risk by buying

a 1 month ATM European CALL Option

with Strike Price at 45.141

!!Option Premium: Php45,000 (i.e. Php0.45

per 1 USD).


September 2010

Call Option Example

!! If Php weakens 1 month later to 46.141, then the

client chooses to exercise the Call Option to buy

USD 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


September 2010

Call Option Example

!! If Php strengthens 1 month later to 44.00, then

the client will let the CALL Option expire and

proceed to buy USD at the current market price

of 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


September 2010

FX Put Options

!! Pay-off profile of Exporters hedging by buying

Put Options

Long USD Long PUT Hedged Position + =


September 2010

Put Option Example:

!!Exporter needs to sell USD100K one

month from now.

!!Market consensus is for the Php to

strengthen (Target 44.00)

!!Current Spot Price: 45.00

!!Computed FWD Rate: 45.141


September 2010

Put Option Example

!!Client decides to hedge FX risk by buying

a 1 month ATM European PUT Option with

Strike Price at 45.141

!!Option Premium: Php45,000 (i.e. Php0.45

per 1 USD).


September 2010

Put Option Example

!! If Php weakens 1 month later to 46.141, then the

client lets the PUT Option expire and proceeds

to 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


September 2010

Put Option Example

!! If Php strengthens 1 month later to 44.00, then

the client will exercise the PUT Option to sell

USD 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


September 2010

What do you hedge?

!!Hedge net economic exposure not nominal

exposure

"!Company-wide analysis across business units

"!Examine customer/supplier contracts

!!Hedge only what matters

"!Material impact on the bottom line

"!Ensuring cash flows match cash needs


September 2010

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


September 2010

END Thank You!

For further questions, please call:

SBC Hedging and Financial Solutions

888-7011 to 18

Rovic De Guzman – TMU Head

Aileen Chua – Head of Hedging

Robin Galang – Hedging Team

Sheilagh Rivera – Head of FX Sales

Francis Buenaventura – FX Sales Team

Documents

FX Hedging - Welcome to the Bangko Sentral ng Pilipinas ... Forex de Guzman.pdf · FX Hedging Products !! FX Forwards "!Regular Forward "! ... Pay-off profile of Exporters hedging