2010 AFI Convention Combating Currency Chaos Patricia Lifson First Vice President Israel Discount Bank New York US Dollar trading since September 11, 2001
Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.
Combating Currency Chaos
First Vice President
Israel Discount Bank New York
On September 11, 2001, in a series of coordinated suicide attacks by al-Qaeda upon the United States, the treacherous acts killed thousands, injured even more, and changed the course of the United States Dollar forever.
The US Dollar had been considered a safe haven. In a tumultuous world, investors felt comfortable and confident that their investments within the US markets and in the Dollar were safe.
After 9/11 that all changed. The United States had suffered a terrible attack within its sacred borders and confidence would be lost.
Are forward contracts for non liquid or restricted currencies
One Year Brazilian Real against US Dollars
(Spot) 1.7720 + .1600 (1600 Swap Points) = 1.9320 All In (Outright) Price
Brazil’s interest rates, in this example, are higher than US interest rates
At maturity, there is no delivery of currency. The contract is netted against the current spot and US Dollars are settled.
In this Example:
ABC Corp buys BRL 1,000,000 @ 1.9320 for USD 517,598.34
for May 2, 2011
On April 29, 2011 BRL is trading @ 1.6000 for May 2, 2011
On May 2, 2011
Sells USD 517,598.34
Buys USD 625,000 (BRL 1,000,000 @ 1.6000)
ABC Corp is paid USD 107,401.66
When ABC goes to pay the BRL obligation they will be charged at a rate of 1.6000 for USD 625,000. Because they had the NDF they have USD 107,401.66 to contribute toward the purchase effectively reducing the rate to 1.9320.
As with Forward contracts an NDF is a contractual obligation.
Should BRL in this example go to 2.10 ABC Corp would be obligated to pay the USD difference. However, they would benefit from the better rate of 2.10 when paying their obligation. By paying the USD difference the effective hedge rate of 1.9320 would remain intact.
The hedge has still accomplished what it set out to do. It locked in a guaranteed rate and eliminated currency exchange risk.
Options – An agreement between a buyer and seller of a contract in which the buyer pays a premium to the seller for the right but not the obligation to buy or sell a currency pair or commodity at a specified strike price (rate) on a specific value date. An expiration date is established, generally, in the case of currencies, two days prior to value date (one day for Canadian Dollars) where the buyer of the option must decide whether or not to exercise (buy or sell the currency pair or commodity) on the value date at the established strike price. If the option goes unexercised there is no exchange done on the value date and the option simply expires.
Call =The right to buy
Put =The right to sell
ABC Corp has sold his product to his customer in Germany. He wants to hedge the transaction to protect his budget pricing but he believes that the EUR might strengthen. He decides to purchase a EUR Put and pay a premium to the seller to give himself the right but not the obligation to sell his EUR at a specified strike price (rate). The purchase of the option is like buying an insurance policy and he is guaranteed that he will not have to sell the EUR at a rate worse than the strike price. He is hoping that the EUR appreciates and he can walk away from the EUR Put, letting it expire worthless and sell his EUR for a higher price.
IDB Bank distributes the information contained herein for general information and discussion purposes only, and such information does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with competent advisers. The Bank is not acting as your advisor, fiduciary, or agent, and is not managing your account and makes no recommendation as to the suitability of any of the products or transactions described herein. The information is provided “as is” with no assurance or guarantee of completeness, accuracy, or timeliness, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose. Additionally, the contents, graphics, design, articles, announcements, banners and any other matters related to this information are protected under applicable copyrights, trademarks and other proprietary rights. The information does not necessarily reflect the opinion or views of the Bank, may change without notice, and the information does not constitute an offer or solicitation of any particular product or financial, investment or tax service. Nothing herein shall constitute a solicitation or offer by Bank to sell products or services of any kind whatsoever including, without limitation, lending and deposit products.
IDB Bank New York
511 Fifth Ave
New York, NY 10017
877-229-6346 (Toll Free)