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Warren Geers General Manager: Bonds and Financial Derivatives Division January 2014

Currency Derivatives Presentation. Warren Geers General Manager: Bonds and Financial Derivatives Division January 2014. Structure:. Johannesburg Stock Exchange. IRC Market. Equity Market. Equity Derivatives. Commodity Derivatives. Currency Derivatives - Futures Options

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Warren Geers General Manager: Bonds and Financial Derivatives Division January 2014

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  1. Currency Derivatives Presentation Warren GeersGeneral Manager: Bonds and Financial Derivatives DivisionJanuary 2014

  2. Structure: Johannesburg Stock Exchange IRC Market Equity Market Equity Derivatives Commodity Derivatives • Currency Derivatives • - Futures • Options • Anyday Expiries • Cando’s • Index (RAIN) Interest Rate Products

  3. What is a Currency: • It is the Rate of Exchange between two currencies • I.e. $/R10.27 or €/R13.19 • You will pay R10.27 for every one $ and R13.19 for every one € purchased • Similar to paying R526.00 for 1 SAB Miller Share • The exchange rates quoted on the TV, radio and in newspapers say $/R10.27, this is a mid rate • A mid rate is the average between the rates quoted between a willing buyer and willing seller of that currency • Rennies Travel will quote a retail exchange rate to the public: • Example Rennies will buy Dollars at 10.03 and sell Dollars at 10.27 • The difference of 0.24 cents is known as the spread

  4. What are Currency Futures: • Contracts that allow investors to trade an exchange rate for sometime into the future • A futures contract gives the buyer exposure to the underlying asset immediately but only has to pay a deposit as opposed to the full value of the transaction.  If the buyer keeps the contract until its expiry date, only then will the full value of the transaction have to be funded by the purchaser • Buyers of Currency Futures (long), buy the Dollar’s and sell the Rand’s, i.e. You want the Dollar to appreciate in value or the Rand to depreciate in value, example: $/R to move from R10.00 to R10.50 (generally importers) • Sellers of Currency Futures (short), sells the Dollar’s and buy the Rand’s, i.e. You want the Dollar to depreciate in value or the Rand to appreciate in value, example: $/R to move from R10.20 to R10.00 (generally exporters)

  5. Why use Currency Futures and Options: • Effective and transparent hedge against currency risk (for all importers and exporters) • Hedge foreign portfolios • Diversify Internationally from South Africa • Take a view on the underlying currency movement • No credit lines required from Banks • Cost effective • Access to wholesale corporate rates • No counterparty risk • Deep liquidity in the foreign underlying instrument • Hedge to a specific date (as required)

  6. Differences between Currency Futures & Forward Contracts:

  7. Advantages over FEC : • Flexible dynamic hedge • Cost is known and deductable • Margin lower than collateral • Transparent and regulated trade • Can exit position with best priced counterparty at any time without penalties • No obligation to deliver Forex (unless explicitly required) • No SARB approval required • No firm and ascertainable commitment (paperwork) required to enter/exit a trade • Have a daily view on profit/loss of the hedge

  8. How are Currency Futures Priced: • What makes up the price of a Currency Future (Forward)? = Spot price + forward points • Spot price e.g. $/R10.3425 (bid) / $/R10.3435 (offer) • Forward points (interest rate differential between today and expiry date) • 300 points bid / 350 points offer • Future price is 10.3725 (bid) / 10.3785 (offer) • (10.3425 + 0.0300) (10.3435 + 0.0350) • On the exchange we quote and trade the expiry date so the price will always include the forward points

  9. Mark-to-Market and Expiry • Daily Mark-to-Market with daily physical cash flow • MTM Spot – Last 5 Minutes Arithmetic Average + Forward points • Standard Contracts Expiry: March, June, September and December • Any-Day Expiry: Select a date • ZAR Settlement at Expiry • Can roll to any future expiry (Only pay fees on the next leg and not the exit leg) • Brokers/Banks can arrange to swap the future for physical without unknown extra spread points

  10. What are Currency Futures and Options used for: • Currency Future’s are used Primarily to: • Hedge – Seek to reduce risk by protecting underlying portfolio/assets or hedging import/export foreign assets. It removes the risk of existing or expected currency exposure • Speculate – Speculators enter into currency futures contracts in order to take a view on the movement of the underlying exchange rate, without having the need to buy the underlying currency

  11. Margining: • Each trade is matched daily by Yield-X, i.e. the exchange ensures that there is a buyer and a seller to each contract traded • The JSE’s clearinghouse Safcom becomes the counterparty to each trade once each transaction has been matched and confirmed • The clearinghouse therefore ensures settlement takes place on each trade • To protect itself from non-performance, Safcom employs a process known as margining. This mechanism is two-fold:

  12. Initial Margin: • When a position is opened (either long or short), the investor is required to pay an initial margin in cash (known as a good faith deposit) with the broker who subsequently deposits it with the clearinghouse • This amount remains on deposit as long as the investor has an open position • The initial margin attracts a market related interest rate which is refunded to the investor once the position is closed out, or if the contract expires • Eliminates Counterparty Risk, thus no risk premium in hedge • Interest On Margin = 4.922% (19 November 2013) • Margin correlated to option moneyness • The initial margin requirement varies between the different currency futures offered due to different volatility on the different currencies

  13. November 2013 Initial Margin Requirements:

  14. Variation Margin: • Known as the daily settlement of profits and losses • The Currency Future price is determined from the underlying markets spot price to which forward points are added to deliver the final price used in the daily MTM process • The Exchange re-values each position daily at the close of each business day, and this process is known as Mark-to-Market (MTM) • Any difference from the previous day’s MTM price is either paid to the investors, or paid by the investors to the clearinghouse, in cash and Rand denominated • This payment is called variation margin and is simply the profit or loss on each position

  15. Hedging Example: Importing • Company ABC importing goods to the value of $100,000, has to buy $100,000 @ 10.37 • Therefore their exposure is R1,037,000 • Importer wants to know their landed cost, and eliminate any currency risk • Therefore need to buy 100 Currency Futures contracts • Deposit R43,500 only for the initial margin (100 x R435)

  16. Hedging Example: Cont.

  17. Hedging Example: • Summary of cash flow: Variation Margin: R21,000 Profit (+R3,000 + R5,000 – R3,000 + R8,000 + R8,000) • Use the profit from the currency future to off-set the increase in the Dollar exchange rate • Spot moved from 10.30 to 10.58 (expiry date) Loss of R28,000 • Future moved from 10.37 to 10.58 (expiry date) Profit of R21,000 • Net difference between spot and future is R7,000 (the 700 forward points) and this is the interest rate differential that was bought at day one • Importer will buy the physical $100 000 from the bank at an effective rate of 10.37 – R1,037,000 • 12.1% return on deposit (Investment) (21,000/43,500)*100 (Over a standard 3 month contract) • Currency (Spot) depreciated by 2.7%

  18. Hedging Example: • Summary of cash flow: Initial Margin: R0 (-R43,500 + R43,500) • Always returned to the investor • Money on deposit earns overnight deposit rate @ 4.922% (19 November 2013) • 23 times gearing (R435 deposit per R10,370) • If the dollar had weakened against the rand (i.e. moved from R10.37 downwards to R10.00) then the importer would merely pay R1,000,000 • But the loss on the futures would have been offset by the gain in the spot price

  19. Risks: • Gearing • Post small amount but valued on full nominal value • Businesses with severe cash flow constraints will need to understand the impact of the daily cash margining process of variation margining.

  20. Currency contracts listed : • Dollar/Rand • Euro/Rand • Pound/Rand • Australian Dollar/Rand • Japanese Yen/Rand • Canadian Dollar/Rand • Swiss Franc/Rand • Chinese Renminbi/Rand • Botswana Pula/Rand • New Zealand Dollar/Rand • Turkish Lira/Rand • Rand Index (RAIN)

  21. Live currency pricing as per 13th November 2013 • 4 Market Makers quoting live prices: • Best bid/offer market spread 0.0041 cents,

  22. Example of a Zero-sum game: For every winner there is an equal loser

  23. Currency Derivatives Statistics since inception (June 2007) to December 2013:

  24. Currency Futures Statistics: Jan – Dec 2012 compared to Jan – Dec 2013

  25. Currency Options Statistics: Jan – Dec 2012 compared to Jan – Dec 2013

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