Security Bank Treasury FX and Rates Hedging Division Gearing Up for External Competitiveness November 19, Treasury FXRH

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1 Security Bank Treasury FX and Rates Hedging Division Gearing Up for External Competitiveness November 19, 2014

2 HEDGING, DERIVATIVES AND SPECULATION HEDGING Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract. Investopedia explains An example of a hedge would be if you owned a stock, then sold a futures contract stating that you will sell your stock at a set price, therefore avoiding market fluctuations. Investors use this strategy when they are unsure of what the market will do. A perfect hedge reduces your risk to nothing (except for the cost of the hedge).

Investopedia explains An example of a hedge would be if you owned a stock, then sold a futures contract stating that you will sell your stock at a

3 HEDGING, DERIVATIVES AND SPECULATION DERIVATIVES A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage. Investopedia explains Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region. Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes.

The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.

4 HEDGING, DERIVATIVES AND SPECULATION SPECULATION The act of trading in an asset, or conducting a financial transaction, that has a significant risk of losing most or all of the initial outlay, in expectation of a substantial gain. With speculation, the risk of loss is more than offset by the possibility of a huge gain; otherwise, there would be very little motivation to speculate. While it is often confused with gambling, the key difference is that speculation is generally tantamount to taking a calculated risk and is not dependent on pure chance, whereas gambling depends on totally random outcomes or chance. Investopedia explains It may sometimes be difficult to distinguish between speculation and investment, and whether an activity qualifies as speculative or investing depends on a number of factors, including the nature of the asset, the expected duration of the holding period, and the amount of leverage. Speculation has its benefits in a free economy. By their willingness to assume the other side of the trade (for a price, of course), speculators provide market liquidity and narrow the bid-ask spread, enabling producers to hedge price risk. Speculative short-selling may also keep rampant bullishness in check and prevent the formation of asset price bubbles.

While it is often confused with gambling, the key difference is that speculation is generally tantamount to taking a calculated risk and is not dependent on pure chance, whereas gambling depends on

5 A MATTER OF PERSPECTIVE

6 A MATTER OF PERSPECTIVE

7 A MATTER OF PERSPECTIVE

9 BLACK SWAN EVENTS ARE HAPPENING MORE OFTEN THAN PREVIOUSLY THOUGHT

10 Why the need to hedge? USD SELLERS (such as EXPORTERS) A) A exporter company agrees on a contract to produce goods and sell to a foreign country USD BUYERS (such as IMPORTERS) A) An importer orders goods from a foreign company/supplier B) Goods are shipped B) Goods are shipped C) 92 days later, payment is received, and CONVERTED C) 92 days later, USD is BOUGHT for import payments Company will RECEIVE LESS PHP PER USD PHP APPRECIATES/ USDPHP Company will NEED LESS PHP PER USD Company will RECEIVE MORE PHP PER USD PHP DEPRECIATES/ USDPHP Company will NEED MORE PHP PER USD 9

IMPORTERS) A) An importer orders goods from a foreign company/supplier B) Goods are shipped B) Goods are shipped C) 92 days later, payment is

11 Why the need to hedge?

12 I. PRODUCTS A. SPOT B. FX FORWARDS i. Deliverable ii. Non-Deliverable / Cash Settled C. FX SWAPS II. DOCUMENTARY REQUIREMENTS

13 SPOT

14 SPOT Buying or Selling FX With settlement today, tomorrow, or day after tomorrow T+2 Today: Agree on a Price For Delivery? More than T+2 is a FORWARD Today Value Today T + 1 Value Tomorrow T + 2 Value Spot

15 DELIVERABLE FORWARDS

16 FORWARDS

17 FORWARDS Selling FX today for your export proceeds Locking-in FX Prices TODAY for settlement at a FUTURE DATE DELIVERABLE, ACTUAL EXCHANGE OF AMOUNT Today: Agree on a Price; No exchange of amounts Future Date: Exchange of amounts; On agreed FX Price Forward FX Rate (the FWD Rate) is not an FX Forecast or a Projection FWD rate is the Future Value of the Spot Rate given current spot prices and interest rates QUESTION: Is there a cost when you do a FORWARD? Is there a cost when you LOCK-IN a rate?

Price Forward FX Rate (the FWD Rate) is not an FX Forecast or a Projection FWD rate is the Future Value of the Spot Rate

18 FORWARDS (DELIVERABLE) Time Value of Money The idea that money available at the present time is worth more than the same amount in the future because money can earn interest Investopedia PHP100 today > PHP100 1 year from now 10% interest rate per year = PHP10.00 PHP (interest) = PHP110 PHP100 today = PHP110 1 year from now Present Value (PV) + Interest = Future Value (FV) Formula: SPOT RATE + SWAP POINTS = FORWARD RATE

year from now 10% interest rate per year = PHP10.

19 FORWARDS (DELIVERABLE) Formula: SPOT RATE + SWAP POINTS = FORWARD RATE PRINCIPAL + INTEREST = FUTURE VALUE Computing for Interest: INTEREST : Principal x Rate x Time : 100 x 10% x t/360 Computing for Swap Points: SWAP POINTS : Spot x IRD x Time : x IRD x t/360 IRD : Php% - USD%

Principal x Rate x Time : 100 x 10% x t/360 Computing for Swap Points:

20 FORWARDS (DELIVERABLE) Example: PHP Interest rate : % USD Interest rate : % Tenor : 92 days Spot : Computation: IRD SWAP POINTS FORWARD PRICE: : PHP Interest USD Interest : 1.71% % = % : Spot x IRD x Tenor/360 : x % x 92/360 = Spot + Swap Points : =

90 Computation: IRD SWAP POINTS FORWARD PRICE: : PHP Interest USD Interest : 1.

21 FORWARDS (DELIVERABLE) EXPORTERS (view that PHP would appreciate) Example: The client wishes to hedge their USD export proceeds Enters a 3 month (92 day) Forward to sell USD vs. PHP Current spot rate : month Forward rate :

22 FORWARDS (DELIVERABLE) Forward Example (Scenario 1) SPOT 44.90; FWD Rate Assume PHP depreciates (stronger USD) On settlement day, assume USD/PHP spot rate is Client sells USD at hedged rate of Forward Example (Scenario 2) SPOT 44.90; FWD Rate Assume PHP appreciates (weaker USD) On settlement day, assume USD/PHP spot rate is Client still sells USD at hedged rate of Linear Hedges For exporters who sell USD/PHP FWDs: You are protected from DOWNSIDE RISK BUT you also give up any UPSIDE BENEFIT

23 NON DELIVERABLE FORWARDS

24 NON DELIVERABLE FORWARDS

25 NON DELIVERABLE FORWARDS (NDF) EXPORTERS (view that PHP would appreciate) Example: The client wishes to hedge their USD export proceeds Enters a 3 month (92 day) Forward to sell USD vs. PHP Current spot rate : month Forward rate :

26 NON DELIVERABLE FORWARDS (NDF) EXECUTE a Non Deliverable FWD Hedge Notional : USD 1,000, Spot Rate : Forward Rate : Tenor : 3 months or 92 days In one month, if Spot Rate is: Get difference between FWD rate and Spot Rate to get net settlement amount = -1.0 CLIENT pays: 1.0 or PHP 1,000, In one month, if Spot Rate is: Get difference between FWD rate and Spot Rate to get the net settlement amount = +1.0 CLIENT receives: 1.0 or PHP 1,000, Sell USD 1,000, at Spot of Sell USD 1,000, at Spot of Net effect to client: = Net effect to client: =

27 FX SWAPS

28 INTEREST RATE HEDGES FX SWAPS Spot Forward FX SWAP

29 FX SWAPS

30 FX SWAPS

Maturity Date Start Date FX SWAPS Assume following Rates: Spot Rate : 44.900 Forward Rate : 45.070 Client 1 USD 44.

31 Maturity Date Start Date FX SWAPS Assume following Rates: Spot Rate : Forward Rate : Client 1 USD PHP SBC Day 1: Company sells USD at spot rate of 44.90, while entering into a forward buy at USD Client PHP SBC Day 92: Company buys USD at the forward rate of

32 Documentary Requirements FX HEDGES DOCUMENTARY REQUIREMENTS for DERIVATIVES

36 Thank you Raul Victor De Guzman First Vice President Treasury FX & Rates Hedging Desk Head to 18

Reference Manual Currency Options

Reference Manual Currency Options TMX Group Equities Toronto Stock Exchange TSX Venture Exchange TMX Select Equicom Derivatives Montréal Exchange CDCC Montréal Climate Exchange Fixed Income Shorcan Energy