Gm Presentation To Bab[1].fx.1

Bangladesh Association of Banks

FX Workshop Tarique Islam Khan Head of Global Markets

Nov 2009

Contents

Agenda

Basics

FX Rates

Forward

SWAPS

Spot FX

Determination of Retail Exchange Rate

Outright Forward

FX SWAPs

Pricing a FWD

Interest Rate SWP

Exchange Rate Conventions

Quiz

?

2

The FX Market and Spot A SPOT FX Transaction is • an agreement between two parties • to exchange a specified amount of one currency • for a specified amount of another currency • on the second business day (CAD is the exception) FX rate is the second currency exchanged per unit of the first currency If the FX transaction is to be settled beyond SPOT date then it is a FWD FX transaction

European Terms A few examples: • • • • •

$1 = CHF1.1655/60 $1 = JPY98.30/35 $1 = SGD1.5145/55 $1 = BDT69.00/05 $1 = AED3.6700/50

These are called “Direct Quotes”, because these currencies are quoted per dollar. In other words, dollar is the “unit currency” [also known as BASE ccy] while the other currency is the “variable currency” [also known as PRICING ccy]

American Terms A few examples: • • • •

GBP1 = USD1.4590/95 EUR1 = USD1.3445/50 AUD1 = USD0.7010/15 NZD1 = USD0.6555/65

These are called “Indirect Quotes”, because these currencies are not quoted per dollar. Here the dollar is the “variable currency” [BASE ccy] while the other currency is the “unit currency” [PRICING ccy]

Cross currency A few examples: • • • •

GBP1 = JPY136.90/95 EUR1 = GBP0.8845/48 AUD1 = BDT48.37/44 GBP1 = BDT100.67/78

• These are called “Cross currencies”. • The dollar has been calculated “out” of these rates. • The “variable currency” and the “unit currency” in cross-ccy quotations are determined by convention.

Two Way Quote

Big Figure: Shows the approximate amount of the pricing currency required to purchase one UNIT of the Base currency. In the above example, it is 1.59 Small figure or PIPS: The smaller numbers that contain the spread (difference between the bid and the offer). In the above e.g., the small figure is 60-65, which is 100th of one US cent. Dealers generally multiply this small figure with 10 thousand and call that PIPs and quote in pips. Different currencies use different number for pips (a.k.a. points), such as in Bangladesh we use the number just after the decimal and call that pips. For e.g. if USD/BDT is quoted 69.00-69.05, then we call the 69 taka as the BIG Figure and the 0.00-0.05 the SMALL figure and 00-05 becomes the pips.

Quoting/Dealing conventions • The entity quoting the rate or price is the “Market Maker” • The entity asking for the price is the “Market Taker” • Market Maker decides on the spread between the Bid and Ask/Offer • Market Taker is subjected to the spread, i.e. Mkt Taker has to buy at Mkt Maker’s Offer and sell at Mkt Maker’s Bid. • Mkt Maker takes the risk of quoting 2-way price not knowing which side the Mkt Taker will “hit” • Mkt Taker may or may not deal or hit on the rate quoted by the Mkt Maker

Retail Exchange Rate Set up Latest Interbank Bid – Offer for Taka against Dollar

Add Spread on Both sides

Latest interbank rates of the other currencies

Build in volatility and market competitiveness

Setting the Board Rate Interbank BID and Offer

69.00

69.05

-0.52

+0.43

68.48

69.48

Mkt Bid minus spread

Market Offer plus spread

Spread depends on following factors : 1. Market volatility. This is a subjective measure based on history. 2. Market competitiveness (are we too far off from competition?) 3. Any relevant regulatory guidelines (i.e. As for the dollar, regulation states that the spread cannot be more than BDT1.00)

Life of an FX Transaction

Customer calls dealer and wishes to buy $1m

What is the profit from this transaction

Dealer asks for quotes from several banks and takes the best quote

The best quote dealer gets is 69.00-69.05 from ABC bank to cover this $1 mln

Customer agrees. Deal Done with customer at 69.30

Dealer adds BDT0.25 to the offer price of 69.05 and quotes 69.30 to customer

Volatility! (EUR/$ 5-min chart) If Client calls a few hours later, client should not expect original price. Market has already moved Client calls to buy EUR0.5m agst BDT We quote 1.3270*69.35 = 92.03

Market Average USDBDT Chart [6 months] 6 9 .7 0 0 0 6 9 .2 0 0 0 6 8 .7 0 0 0

B u yin g R a te

S e llin g R a te

Mar-09

Mar-09

Feb-09

Feb-09

Jan-09

Jan-09

Dec-08

Dec-08

Nov-08

Nov-08

Oct-08

Oct-08

Sep-08

Sep-08

Sep-08

6 8 .2 0 0 0

Outright Forward A contract where : two parties agree to buy/sell a currency against another at an agreed exchange rate at an agreed future date. date Forwards are generally used by both Exporters and Importers to hedge against future exchange rate volatility.

Main Advantages are: •Hedge Exchange risk exposure and reduce exchange losses. •Advance knowledge of transaction price helps in forecasting balance sheet. Main Disadvantages are: •Contract must be closed out at or before maturity date. •Market rate may be against forward rate at maturity of the forward.

Example A 6-months USDBDT flexi forward contract Deal date

: 25 Mar 2009

Option Start dates Option End date Forward rate Customer to sell Settlement Date

: : : : :

Customer to buy

: BDT7,290,000

01 Sep 2009 30 Sep 2009 72.90 $100,000 Any date between 01-Sep-09 and 30-Sep-

09 Customer will be able to encash required amount any time during the option period

Deal Date 25Mar09

01Sep09 Month One

Month Two

Month Three

Month Four

30Sep09

Month Five

USD 100,000

Pricing a Forward Using the previous example of 6-mnth $/BDT outright FWD Spot rate on 25/mar

: 69.35

BDT int rate for 6 months : 11.75% USD int rate for 6 months : 1.45% Future value of BDT

: 69.35+69.35*11.75%*180/360 = 73.4243

Future value of USD

: 1+1*1.45%*180/360 = 1.00725

Future exchange rate

: 73.4243/1.00725 = 72.8958

Forward rate

: 72.8958

Shorthand estimation

: 69.35+69.35*(11.75-1.45)%*180/360 = 72.9215

FX Swaps • FX swaps are really money market instruments • It uses the FX to mitigate counterparty credit risk • Works because FX funds viewed as collateral against LCY • There are two legs of the transaction • First leg is the SPOT deal • Far leg (or the maturity leg) is the FWD deal • Pricing is exactly as calculating FWD • Key driver of SWAP points is the interest rate of the two currencies, whereas the key driver of FWD rate also includes the SPOT rate

FX Swaps & FWD

Forwards

SWAP Points

Base Ccy i/r is HIGHER than pricing ccy i/r

Base Ccy i/r is LOWER than pricing ccy i/r

SPOT rate increases

Both i/r of Base ccy and pricing ccy increases by same amount

FWD rate is lower than SPOT rate

FWD rate is higher than SPOT rate

FWD rate increases by same amount

Moves marginally closer to the SPOT rate

Positive

Minor change

SWAP points decreases marginally

Negative

Interest Rate Swap (IRS) Contract between two parties to exchange interest flows in order to hedge against interest rate movements Generally, a fixed interest rate is exchanged for a floating rate based on market benchmark such as LIBOR E.g. Client borrows USD10m from ADB at LIBOR6m+2.50% for 7yrs Libor changes every six months, so does client’s int payments US interest is low & bottoming out; exposure to rising Libor rates in future Client willing to pay a bit more than current Libor throughout the loan tenor

Client Libor

Libor+2.5%

ADB

5.85%

Bank

The client and the bank only swaps interest amounts on the NPA ($10m)

Interest Rate Swaps (IRS) Question: How does the BANK hedge itself? Answer: One way :–

Client Libor 6m

Libor 6m + 2.5%

ADB

5.85%

Bank

5.85%

Issues a $10m 7yr Bond with semi-annual coupon @5.85%

Libor 6m Buys a 7 yr FRN of $10m yielding Libor 6m with the money raised from issuing the Bond

Although the client and the bank only swaps interest amounts on the NPA ($10m), hedging this way the bank needs to buy and sell bonds/FRNs for the full amount ($10).

Quiz Time

Deal Date is 16Jun09 Spot Settlement date for a. EURUSD b. USDCAD c. USDBDT

Direct or Indirect Quote 1. USD 1 = BDT69.05 2. GBP 1 = USD1.6500 3. EUR 1 = GBP0.8449

American Term is Indirect Quote/Direct Quote?

Who is the market maker below? 1.65001.6505

Can you quote me 100 cable?

Market Rate is 69.00 To make a profit of 10 paisa what will be your rate for an exporter?

Difference between BID and OFFER is called A. PIPS B. Spread C. IRS

Calculate the Cross-rate USDBDT 69.05 EURUSD 1.4000 EURBDT=?

Calculate the Cross-rate USDBDT 69.05 USDJPY 98.50 JPYBDT=?

USDBDT FWD for Importer is At Discount or Premium ?

USDBDT forward for exporter is At Discount or Premium ?

THANK YOU !