Tài chính doanh nghiệp - Chapter 10: Foreign exchange futures

© 2004 South-Western Publishing1Chapter 10Foreign Exchange Futures2OutlineIntroductionForeign exchange riskForward ratesForeign currency futuresDealing with the exposure3IntroductionThe capital markets across the globe have become one giant playing fieldThe U.S. share of market capitalization is steadily declining as foreign markets develop4Foreign Exchange RiskIntroductionFX risk and interest ratesThe concept of exposureFX risk from a business perspectiveFX risk from an investment perspective5IntroductionOverseas investments and international business involve foreign exchange riskA survey of corporate treasurers indicates that the primary corporate use of derivative assets is hedging foreign exchange exposure6Introduction (cont’d)Foreign exchange risk is the risk of loss due to changes in the relative value of world currenciesModest changes in exchange rates can result in significant dollar differences7FX Risk and Interest RatesIntroductionThe real rate of interestThe inflation premiumThe risk premium8IntroductionEvents in one industrial country affect the rest of the worldInterest rates are often a good barometer of events like high unemployment, changes in economic policy, etc.9The Real Rate of InterestThe nominal interest rate (the stated rate) can be expressed as the sum of:The real rateAn inflation premium andA risk premium10The Real Rate of Interest (cont’d)The real rate reflects the rate of return investors demand for giving up the current use of fundsIndicates people’s willingness to postpone spending their moneyIs not directly observableHovers in the 3% to 4% range11The Inflation PremiumThe inflation premium reflects how the general price level is changingMeasures how rapidly the money standard is losing its purchasing powerIn the past 75 years, U.S. inflation has averaged about 3.2% annually12The Risk PremiumThe risk premium is the component of interest rates that is most difficult to measureRisk-averse investors expect to be compensated for risks they takeThe price of a risky security must reflect a risk premium to entice someone to buy itThe magnitude of the risk premium depends on how much risk the security carriesThe higher the risk premium, the lower the price13The Concept of ExposureIntroductionAccounting exposureEconomic exposure14IntroductionExposure is the extent to which you face foreign exchange riskThere are two general types of exposure:Accounting exposureEconomic exposure15Accounting ExposureAccounting exposure is the exchange rate exposure that results when consolidated financial statements are prepared in a single currencyTwo types of accounting exposure:Transaction exposureTranslation exposure16Accounting Exposure (cont’d)Transaction exposure results from transactions involving the purchase or sale of goods or services with the price stated in foreign currencyExists until the payable or receivable is liquidatedE.g., a U.S. importer must pay a European supplier in Swiss francs17Accounting Exposure (cont’d)Translation exposure results from translating foreign assets and liabilities into U.S. dollars on the consolidated balance sheet18Economic ExposureEconomic exposure measures the risk that the value of a security or a firm will decline due to an unexpected change in relative foreign exchange ratesWould reduce the value of the security or firmThe most important type of exposure for security investors19FX Risk From A Business PerspectiveA Business Example of Economic Exposure An American importer agrees to purchase 400 Swiss overcoats at a price of CHF1,200 each, for a total of CHF480,000. The coats will take 3 months to produce, and the importer is to pay for them upon delivery. 20FX Risk From A Business Perspective (cont’d)A Business Example of Economic Exposure (cont’d) Assume the following exchange rates exist today:$ per CHF = $0.8073 (direct quotation)CHF per $ = CHF1.2387 (indirect quotation)21FX Risk From A Business Perspective (cont’d)A Business Example of Economic Exposure (cont’d) If the importer paid for the coats today, each coat would cost the importer:CHF1,200 x $0.8073/CHF = $968.76 The importer is concerned that the U.S. dollar might weaken between now and coat delivery time. 22FX Risk From A Business Perspective (cont’d)A Business Example of Economic Exposure (cont’d) If the dollar strengthens and the value of the Swiss franc falls to $0.7500, the cost of each coat will be:CHF1,200 x $0.7500/CHF = $900.00 If the dollar weakens to an exchange rate of $0.9000, the cost of each coat will be:CHF1,200 x $0.9000/CHF = $1,080.0023FX Risk From An Investment PerspectiveAn Investment Example of Economic Exposure You just placed an order with your broker to purchase 10,000 shares of Kangaroo Lager, trading on the Sydney Stock Exchange. You can currently purchase the shares for AUD1.45 apiece. The current exchange rate is $0.5755/AUD. Thus, the shares cost you:10,000 x AUD1.45 x $0.5755/AUD = $8,344.7524FX Risk From An Investment Perspective (cont’d)An Investment Example of Economic Exposure (cont’d) You hold the Kangaroo shares for six months, at which time the shares sell for AUD1.95. This is a return of (1.95 – 1.45)/1.45 = 34.5% 25FX Risk From An Investment Perspective (cont’d)An Investment Example of Economic Exposure (cont’d) In six months, the exchange rate is $0.5500. If you were to sell the shares, you would receive:10,000 x AUD1.95 x $0.5500/AUD = $10,725.00 This is a return on investment of($10,725.00 - $8,344.75)/$8,344.75 = 28.52% 26Forward RatesIntroductionPurchasing power parityInterest rate parity27IntroductionThe spot exchange rate is the current exchange rate for two currenciesThe forward exchange rate is a contractual rate between a commercial bank and a client for the future delivery of a specified quantity of foreign currency28Introduction (cont’d)Forward exchange rates are normally quoted on the basis of one, two, three, six, and twelve months29Introduction (cont’d)The forward rate is an unbiased estimate of the future spot rate for foreign exchangeE.g., if forward rates show that the dollar is expected to strengthen against the Swiss franc, it would make sense to delay paying Swiss francs as long as possible30Introduction (cont’d)The difference between the forward and spot rates can be quoted as an annual premium or discount:31Purchasing Power ParityPurchasing power parity is an arbitrage-based idea that in a world of perfect markets, the same good should sell for the same price in different countriesAssumes there are no trade barriers, no taxes, etc.32Purchasing Power Parity (cont’d)Unexpected inflation causes the value of the home currency to fallDifferentials in international inflation rates can be a source of foreign exchange risk33Interest Rate ParityInterest rate parity states that differences in national interest rates will be reflected in the currency forward marketTwo securities of similar risk and maturity will show a difference in their interest rates equal to the forward premium or discount, but with the opposite sign34Interest Rate Parity (cont’d)According to interest rate parity:35Interest Rate Parity (cont’d)Computing Implied Foreign Interest Rates It is now January 2, 2004. The six-months forward rate for the British pound is £0.5658/$; the spot rate is £0.5576/$. Also, the six-month T-bill rate is 1.01%. What is the implied British 6-month interest rate based on the interest rate parity relationship? 36Interest Rate Parity (cont’d)Computing Implied Foreign Interest Rates (cont’d) The implied British 6-month interest rate is 3.96%: The actual UK rate in early 2004 was 3.90%.37Foreign Currency FuturesIntroductionPricing of foreign exchange futures contracts38IntroductionForeign currency futures contracts were the first financial futures traded on exchanges in the U.S.Began trading at the Chicago Mercantile Exchange in 1972Foreign currency futures were quickly recognized as very effective ways to deal with foreign exchange risk39Pricing of Foreign Exchange Futures ContractsFutures prices are a function ofThe spot priceThe cost of carrying the particular asset or financial instrumentFor foreign currency futures, the cost of holding one currency rather than another is an opportunity cost measured by differences in interest rates40Pricing of Foreign Exchange Futures Contracts (cont’d)A basic pricing model:41Pricing of Foreign Exchange Futures Contracts (cont’d)Pricing A Foreign Currency Futures Contract Example In the Land of Leptonia interest rates are 10.00%, and the current dollar price of a Lepton is $0.4817. The current Eurodollar deposit rate is 7.50%. For how much should a 90-day futures contract on Lepton’s sell? 42Pricing of Foreign Exchange Futures Contracts (cont’d)Pricing A Foreign Currency Futures Contract Example (cont’d) Using the equation: The futures price for Leptons should be less than their cost in the spot market. This is because Leptonia’s interest rates are 2.5% higher than the U.S. rate. 43Dealing With the ExposureIntroductionIgnore the exposureReduce or eliminate the exposureHedge the exposure44IntroductionThe portfolio manager needs to decide whether to:Ignore the exposure,Eliminate the exposure, orHedge the exposure45Ignore the ExposureInvestors may be aware of economic exposure but accept it as a fact of lifeIgnoring the exposure may be appropriate if the dollar amount of the exposure is relatively smallIgnoring the exposure may be appropriate if the dollar is expected to depreciate46Reduce or Eliminate the ExposureAmounts to selling the foreign security or reducing the size of the positionMay be appropriate if the dollar is expected to appreciate dramatically47Hedge the ExposureInvolves taking a position in the market that offsets another positionHedging foreign exchange risk is also called covering the riskHedging can be done in the forward market or the futures market