```Currency Derivatives Presentation
Warren Geers
General Manager: Bonds and Financial Derivatives Division
January 2014
www.jse.co.za
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www.jse.co.za
Structure:
Johannesburg
Stock Exchange
Equity
Market
Equity
Derivatives
Commodity
Derivatives
Interest Rate
Products
IRC
Market
Currency Derivatives
- Futures
- Options
- Anyday Expiries
- Cando’s
- Index (RAIN)
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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
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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)
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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
No counterparty risk
Deep liquidity in the foreign underlying instrument
Hedge to a specific date (as required)
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Differences between Currency Futures & Forward Contracts:
Currency Futures
Currency Forwards
Hedging Instrument
Yes
Yes
Derivative Instrument
Yes
Yes
Credit Risk
No
Yes
Physical Delivery
No
Yes
Wholesale Exchange Rate
Yes
Yes
Active deep & liquid market
Yes
Yes
Standardised Product
Yes
No
Any day expiry (non-standardised)
Yes
Yes
Cost Effective
Yes
Depends on credit??
Gearing
Yes
No
Require credit lines from the bank
No
Yes
Speculation
Yes
No
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Flexible dynamic hedge
Cost is known and deductable
Margin lower than collateral
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
Have a daily view on profit/loss of the hedge
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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
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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
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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
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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
To protect itself from non-performance, Safcom employs a process
known as margining. This mechanism is two-fold:
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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
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November 2013 Initial Margin Requirements:
Contract Code
Expiry Date
Fixed Margin
VSR
Margin
ZAUS
2014/03/17
455
25
2.50
180
ZAUS
2014/06/13
460
25
2.50
180
ZAUS
2014/09/15
465
25
2.50
180
ZAUS
2014/12/12
475
25
2.50
180
ZAUS
2015/03/16
480
25
2.50
180
ZAUS
2015/06/15
490
25
2.50
180
ZAUS
2015/12/14
510
25
2.50
180
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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
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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)
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Hedging Example: Cont.
Day 1
Day 2
Month 3
Month 4
Day of expiry
Day
Currency
price
R10.37
R0
R0
R0
R10.58
Initial Margin
per contract
(R43 500)
(R435 x 100)
R0
R0
R0
R43 500
MTM price
(closing price)
R10.40
R10.45
R10.42
R10.50
n/a
Profit/Loss for
the day
R3 000
(10.40 –
10.37 x 100 x
1000)
R5 000
(10.45 – 10.40
x 100 x 1000)
(R3 000)
(10.42 – 10.45
x 100 x 1000)
R8 000
(10.50 – 10.42
x 100 x 1000)
R8 000
(10.58– 10.50
x 100 x 1000)
Net cash
in/(out) for the
day
(R40 500)
(-43 500 + 3
000)
R5 000
(R3 000)
R8 000
R51 500
(43 500 + 8
000)
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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%
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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
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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.
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Currency contracts listed :
Dollar/Rand
Euro/Rand
Pound/Rand
Australian Dollar/Rand
Japanese Yen/Rand
Swiss Franc/Rand
Chinese Renminbi/Rand
Botswana Pula/Rand
New Zealand Dollar/Rand
Turkish Lira/Rand
Rand Index (RAIN)
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Live currency pricing as per 13th November 2013
• 4 Market Makers
quoting live prices:
• Best bid/offer market
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Example of a Zero-sum game: For every winner there is
an equal loser
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Currency Derivatives Statistics since inception (June 2007) to
December 2013:
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Currency Futures Statistics: Jan – Dec 2012 compared to
Jan – Dec 2013
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Currency Options Statistics: Jan – Dec 2012 compared to
Jan – Dec 2013
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