FX and FX Forward Bonggun Shin April 2012 General information - - PowerPoint PPT Presentation

FX and FX Forward Bonggun Shin

April 2012

2

• Global foreign exchange market turnover was 20% higher in April 2010 than in April 2007,

with average daily turnover of $4.0 trillion compared with $3.3 trillion. Spot turnover rose to $1.5 trillion in April 2010 from $1.0 trillion in April 2007.

• Foreign exchange market activity became more global, with cross-border transactions

representing 65% of trading activity in April 2010, while local transactions accounted for 35%

• In 2011, Mongolia exported USD4.7bn to the world and imported USD6.5bn from the
• world. A small fluctuation (up or down 10%) can have a significant impact
• These trading volumes are expected to grow rapidly as Mongolia reaches its next phase
• f development. According to Bank of International Settlement (BIS), the FX trading

volumes tend to double every 5-6 years in Emerging Markets but given the growth potential of Mongolia, it would be prudent to assume more rapid growth in FX value and volumes.

General information

3

Global Foreign Exchange Market Turnover and Growth

• 25

25 50 75 100 1 2 3 4 5

1998 2001 2004 2007 2010

Right, Total USD bn Left, % Growth

Source: Bank of International Settlement, 2010

4

Source: Bank of International Settlement, 2010

Global Foreign Exchange Market Turnover by Instrument

5

Source: Bank of International Settlement, 2010

Global Foreign Exchange Market Turnover by maturity

6

Source: SCB, Reuters

Mongolian MNT Foreign Exchange Market Historic Movement

50 100 150 200 250

• 85
• 19

1 22 105

Historic 5 Day Difference, MNT (2007-2012)

Lower tail Upper tail 2.5%

• 28
• 2.6%

2.5% 24 1.9% 5.0%

• 20
• 1.9%

5.0% 19 1.5% 10.0%

• 12
• 1.2%

10.0% 13 1.1%

Survey of Asian NDFs daily transaction volume (USD mio)

7

Source: SCB

4Q 2011 1Q 2012 KRW 3,330 3,000 CNY 3,830 4,000 INR 1,140 1,530 PHP 570 620 IDR 620 650 TWD 1,230 1,650 MYR 950 920

8

FX Spot and Forward – Basics

• An FX Spot transaction is an exchange of currencies at the prevailing market exchange rate. Physical

delivery typically occurs two business days later.

• An FX Forward is an agreement between two parties to exchange a fixed amount of two particular

currencies at a particular date/time in the future.

• Benefit: A tool to manage the risk inherent in currency markets by predetermining the rate and date on

which companies will purchase or sell a given amount of foreign exchange.

• Risk: A company that uses an FX Forward to hedge future cash flows may be worse off compared to not

hedging if the currency moves in the wrong direction.

8 JPY 83.23 mio @ 12 months

Client

Example – Forward (USD/JPY)

SCB

USD 1.00 mio

Supplier

Goods today JPY 83.22 mio @ 12 months Forward enables client to lock in USD/JPY rate of 83.23 12 months from now

9

FX Forward – Pricing

• The FX Forward Rate is calculated according to the following formula:
• Example:
• A company needs to buy USD 1,000,000 in 1 year
• Assuming there was no market for forwards, how do we calculate the forward rate?

On Day zero:

• The client would borrow JPY 83,700,000 in the market for 1 year (@ 0.47%)
• The client would sell JPY vs USD in the spot market and receive the equivalent USD amount (USD 1,000,000)
• The client would lend USD 1,000,000 in the market for 1 year (@ 1.03%)

In 1 Year:

• The client would pay the JPY amount on the JPY Loan and receive the USD Amount on the USD Deposit i.e. Buy USD and Sell JPY
• Implied Forward Rate = 83.70*(1+0.47%*365/360)/(1+1.03%*365/360) = 83.23
• Forward Rate is a function of the Interest rate differentials between the counter currency and the base

currency

• Counter currency interest rate > Base currency interest rate => Forward is at premium relative to spot
• Counter currency interest rate < Base currency interest rate => Forward is at discount relative to spot

rate interest r : where 1 1 * Rate Spot Forward FX          

Base Counter

r r

10

FX Forward – Flows

JPY Receivables

CLIENT SUPPLIER BUYER

USD Payable

No Hedge: The client faces FX risk With Hedge: The client is able to predetermine the future Exchange Rate

JPY Receivables

CLIENT SUPPLIER BUYER

USD Payable USD JPY USD 1,000,000 JPY 83,230,000 JPY 83,230,000 USD 1,000,000 @ 83.23