International Finance Lecture 9 – Currency Derivatives – 3

The lecture is presented to Donghua University CIP students. Subject: International Finance

This is the structure but they don’t have the money for right now so what is the biggest risk biggest risk is that in future maybe the price will go up right so let’s talk about this i’m going to be erasing all those ink here here so they don’t have the money right now so it could wait 90 days and then exchange u.s dollars for singapore at a spot rate existing

At that time which means after 90 days what will be the spot rate they will be buying from the open market the singaporean dollars and paying singaporean dollars to a singaporean firm but ters does not know what the spot rate will be at that time so we have two scenarios here number one if the rate rises to point six zero which means rate here if the rate rises

0.502.60 it means one singaporean dollar is going to be now 0.60 so how many dollars needed to satisfy this 1 million singaporean dollar the singaporean firm will be receiving 1 million singaporean dollar because we already have contract but how much dollars indeed need to convert to pay them one million single billion dollar right now because it is increased

You multiply this singular dollar with the rate answer is 600 000 right previously when the rate was 0.5 it takes five hundred thousand dollar to convert into one million singaporean dollar but now in order to convert to one million singaporean dollar you need six hundred thousand it means an additional outlay or outflow of one hundred thousand dollar due to

Application of the singaporean dollar it means you will be having a loss of do you think it’s a small loss it’s a variable loss it’s a huge source use lost sorry okay now what happened if opposite happen here the rate decreases you will be very very angry when the rate goes up but what happened here if the rate decreases to 0.47 how many dollars you needed 0.47

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Multiplied by 1 million singaporean dollar answer would be 470 000 previously you would be needing so saving is that is your profit our saving would be 30 000 wow very smart right but compare one hundred thousand loss with that thirty thousand saving now you will understand what does it mean by hedging against currency movement you see when apple appreciation

Is huge you will be losing 100 000 when there is a depreciation you will be saving so you can compare this one right so to avoid exposure to exchange rate risk this is terminology that we also use in finance it means with no you know doing nothing making no strategies it means we are exposing our transaction with some kind of risk and we use this kind of work

We call that exposure right exposed to open air conditions exposed to open market condition right so we use this terminology so don’t worry about this okay so to avoid explore to exchange rate risk tours can lock in the rate it will pay for 90 if we pay for singaporean dollar 90 days from now without having to exchange u.s dollars immediately so rather waiting

For 90 days they can enter into a contract right so if they don’t enter into this contract then manager financial manager will be constantly in pain every day from 0 to 90 days he will be watching the upper market rate value up will you go down value of payload go down value up value go down like this right and this one is giving them constant pressure and

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Workload as well right financial manager job is to maintaining maintain the finances of the company not looking the the currency markets whether you know the dollar is going up dollar going is going down it he he is helping to arrange the money arrange the finances in a best way to minimize the risk so best way is to use some kind of derivative contracts so

By locking into into this rate or having this forward contract you hedge the risk of increase and decrease for example you lock the rate point five two and now you just focus on yeah you just wait for 90 days focus on your business activities rather having tension or taking tension of this currency market or forest market you know the dollar has increased or

Decreased what happened if g8 summit is going to be you know announcing the supply of the oil what happened if there is a war in in saudi and yemen it actually escalates what’s happening between you know russia iran america and azerbaijan you know this kind of so you don’t worry about the exchange market because you already lock in the rate and now you focus

On your job related to your company’s jd job description okay so there’s another example here and that is a very practical example so i just want you to do by yourself as well so i’m just going to read it sir and you have to make this strategy yes michael oh yes it’s david so i didn’t understand the whole point so what eventually what did the u.s do in the

Previous example to they should enter into forward contract or future contract yeah and that what happens because we don’t have enough information here we just have uh example to understand this because itself okay okay okay and now we are having this example here so you you need to tell me what kind of hedging strategy we should use so let me just read the

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Question and i’m gonna giving you uh instead i will be making a breakout room and you’re gonna be doing this by yourself and at the end and we will talk about you know what kind of strategy and what is the answer let me just read for for you meanwhile you also take the picture so gray lawn incorporation based in washington exports product to german a german

Firm and will receive payment of 200 000 euros in three months on june 1st the spot rate of the euro was 1.12 and the three one forward rate was 1.1 the expected spot rate of the euro on september 1st is 1.15 so what is the hedging strategy let me just tell you sell or buy forward since we are having only one forward rate it means we have only one choice to

Enter into forward contract and now which kind of our contract either we have to buy forward contract or we have to sell for our contract so this have the strategy you need to develop and also the answer of that strategy as well so i’m just going to be eliminating this inks take a picture and i will be making a breakout rooms for you guys i think three breakout

Rooms gonna be okay okay did you take the picture yes okay let’s do this i’ll send it to the group now good david

Transcribed from video
International Finance Lecture 9 – Currency Derivatives – 3 By Dr Jamal Naqvi