FX Strategies. In the Low Yield Environment. Eddie Wang Head of FX Structuring, Asia. Hong Kong October 2010

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1 FX Strategies In the Low Yield Environment Eddie Wang Head of FX Structuring, Asia Hong Kong October 2010

2 Contents 01 Key Trends 02 FX Hedging Strategies 03 FX Investment Strategies

3 SECTION 01 Key Trends Low Yield Environment Investing in FX Market Internationalization of CNY

4 Low Yield Environment 4 Interest rates of major currencies have converged Low yield environment may continue for a period of time Market players are adjusting their strategies to the new environment Currency return is becoming dominant as rate differential is absent But rate differential is cyclical and the phenomenon may be short term 3 Month Depo Rates of USD, EUR, JPY USD/JPY Rate Differential 14% 12% 10% 8% USD EUR JPY USD/JPY Spot USD/JPY 3m Rate Differential 8% 6% 4% 6% 80 2% 4% 2% Source: Reuters Source: Reuters 0-2% -3%

5 Low Yield Environment 5 Impact on Market Players Corporates Low rate differential makes forward curve flat Swap points less concern for hedging cash flows No longer need to borrow in JPY to enjoy low rates But need to manage FX risk of legacy JPY loans Investors USD has become funding currency of choice Accelerated capital flows to high growth emerging markets Manage FX exposure as a result of investment Also seek returns from FX movements

6 Investing in FX Market 6 Daily FX market turnover grows 20% to $4 trillion from 2007 to 2010 Spot transactions have strong growth of 48% Non-bank financial institutions are main contributors Forwards, swaps and options see modest increase of 7% Trade based flows drop as global economy navigates out of financial crisis Foreign Exchange Turnover (Daily Averages in April) Turnover in OTC Derivatives Markets Current USD Ratio to trade flows Ratio to trade and capital flows Trillions Trillions Options Currency Swaps Outright Forwards and FX Swaps Source: IMF, BIS Source: BIS

7 Investing in FX Market 7 Methods for Generating Returns Carry Trade High yield commodity currencies are beneficiaries Increasing emphasis on emerging market currencies Captures yield differential in low volatility environment Market uncertainty poses risk for the strategy High Frequency Trading Electronic trading platforms offer tools to capture intraday opportunities Automated trading accounts for increasing share of trading volume Provides liquidity and creates more correlation between markets May contribute to volatility during extreme market moves

8 Internationalization of CNY 8 A circulation of CNY is being built between onshore and offshore Full convertibility will be a gradual and long term process Capital control is the major limiting factor CNY will become an international currency in coming decade But USD will maintain its dominance in the foreseeable future CNY Deposits in HK 2010 Global FX Market Turnover by Currency CNY 0.1% Others 35.9% AUD 8% GBP 13% USD 85% JPY 19% EUR 39% Source: HKMA Source: BIS

9 Internationalization of CNY 9 A Tale of Three Markets Onshore Deliverable Market in China Onshore deliverable spot and forward are accessible to onshore entities Market is open for documented trade flows but restricted for capital flows Offshore Non-Deliverable Market Outside China Non-deliverable forward and option are active among offshore participants NDF is lower than onshore deliverable forward in China Offshore Deliverable Market in Hong Kong Deliverable spot in HK is lower than onshore spot Current trading volume is small but growing Forward and option market are also developing

10 SECTION 02 FX Hedging Strategies FX Risk of Emerging Market Hedging Strategies

11 FX Risk of Emerging Market 11 Currency risk is an important factor for emerging market investment Emerging market currencies tend to rise steadily in normal times But they can drop sharply during times of crisis Usually companies hedge cash flows and leave balance sheet risk unhedged Need to develop risk management framework suited to risk tolerance Equity Indices of China, India, Korea, Malaysia Spot Prices of CNY, INR, KRW, MYR 450% SSEC BSESN KS11 KLSE 140% USD/CNY USD/INR USD/KRW USD/MYR 400% 350% 300% 130% 120% 250% 110% 200% 100% 150% 100% 50% 90% 80% 0% Source: Reuters 70% Source: Reuters

12 Hedging Strategies 12 Offshore Hedge USD based company needs to hedge projected cash flow in China Onshore market may be difficult to access due to strict requirements Offshore market is available using cash settlement USD/CNY Bonus Forward Company sells USD/CNY Expiry: 1 Year At Expiry: Upper Level = Initial Spot If USD/CNY > Upper Level, Strike = Upper Level; If USD/CNY Upper Level, Strike = USD/CNY Payoff (CNY) Initial Spot Upper Level USD/CNY -0.03

13 Hedging Strategies 13 Proxy Hedge USD based company needs to hedge assets in Malaysia But USD/MYR NDF market is small and illiquid Strong correlation between USD/MYR and USD/SGD in past 5 years Buy USD/SGD forward as proxy hedge for USD/MYR USD/SGD forward market is liquid and deliverable 1 year forward hedge can be rolled over if company continues to hold assets USD/MYR & USD/SGD Spot Prices Back Testing of Proxy Hedge 4 USD/MYR USD/SGD 1.8 6% Variation % 2% % -2% % Source: Reuters 1-6% -8% Source: Reuters

14 Hedging Strategies 14 Portfolio Hedge USD based company has exposure to multiple emerging markets Currency basket can be used to manage portfolio risk Purchase an option on the basket as insurance against extreme moves Premium of basket option is cheaper than individual options Basket Option Basket: CNY (25%), INR (25%), KRW (25%), MYR (25%) Company purchases USD Call / Basket Put for 1 Year Strike = 105% of Initial Spot Premium = 2% of USD Notional

15 SECTION 03 FX Investment Strategies Uridashi Market Investment Strategies

16 Uridashi Market 16 Japanese investors have been in low yield environment for a long time Uridashi bond is denominated in a foreign currency and sold to retail investors Issued in high yield currencies such as AUD, ZAR, NZD, BRL Investor takes credit risk of issuer and currency risk of conversion Popular form of investment in Japan in recent years Uridashi Issue in Billions of JPY 4,500 4,000 3,500 3,000 Uridashi Issue by Currency Others, 1% USD, 3% BRL, 5% NZD, 8% 2,500 2,000 1,500 1, ZAR, 14% JPY, 53% AUD, 16% Source: Bloomberg (Projected for 2010) Source: Bloomberg

17 Investment Strategies 17 Convertible Note Similar concept as Uridashi bond 1 year note denominated in USD Not principal protected possibility of conversion Coupon = 6% p.a. Strike = Initial Spot At Maturity: If AUD/USD 90% of Initial Spot, Investor receives principal and coupon in USD; If AUD/USD < 90% of Initial Spot, Investor receives principal and coupon in AUD, Converted at Strike

18 Investment Strategies 18 Passport Option Investor engages in discretionary trading to generate returns Investor purchases passport option on the balance of trading account Currency Pair: EUR/USD Expiry: 6 Months Investor pays Premium: 5% of Notional Limit Investor can buy or sell EUR/USD spot within the Notional Limit Profits and losses are aggregated in the trading account At Expiry: If trading account balance is positive, Investor receives the profits; If trading account balance is negative, the losses are covered by the Passport Option

19 Q & A 19

20 Disclaimer , CRÉDIT AGRICOLE CORPORATE AND INVESTMENT BANK All rights reserved. The information in this document (the Information ) has been prepared by Crédit Agricole Corporate and Investment Bank or one of its affiliates ( Crédit Agricole CIB ) for informational purposes only. Nothing in this document is to be construed as an offer for services or products or as an offer or solicitation for the purchase or sale of securities or any other financial product. The Information has no regard to the specific investment objectives, financial situations or particular needs of any recipient. While the Information is based on sources believed to be reliable, no guarantee, representation or warranty, express or implied, is made as to its accuracy, correctness or completeness. Crédit Agricole CIB is under no obligation to update the Information. Crédit Agricole CIB does not act as an advisor to any recipient of this document, nor owe any recipient any fiduciary duty and the Information should not be construed as financial, legal, regulatory, tax or accounting advice. Recipients should make their own independent appraisal of the Information and obtain independent professional advice from appropriate professional advisers before embarking on any course of action. In no event shall Crédit Agricole CIB or any of its directors, officers or employees have any liability or responsibility to any person or entity for any direct or consequential loss, damage, cost, charge, expense or other liability whatsoever, arising out of or in connection with the use of, or reliance upon, the Information. Furthermore, under no circumstance shall Crédit Agricole CIB have any liability to any person or entity for any loss or damage, in whole or in part, caused by, resulting from, or relating to, any error (negligent or otherwise), omission, condition or other circumstances within or outside the control of Crédit Agricole CIB or any of its directors, officers or employees in connection with the procurement, collection, compilation, analysis, interpretation, communication or delivery of the Information. This document and the Information are confidential and may not be copied, reproduced, redistributed, passed on, published, reproduced, transmitted, communicated or disclosed, directly or indirectly, in whole or part, to any other person without Crédit Agricole CIB s prior written consent. Recipients of this document in jurisdictions outside the United Kingdom should inform themselves about and observe any applicable legal or regulatory requirements in relation to the distribution or possession of this document to or in that jurisdiction. In this respect, Crédit Agricole CIB does not accept any liability to any person in relation to the distribution or possession of this document to or in any jurisdiction. This document is not directed at, or intended for distribution or use by, any person or entity who is a citizen or resident of any jurisdiction where such distribution, publication, availability or use would be contrary to applicable laws or regulations of such jurisdictions. United Kingdom: Crédit Agricole Corporate and Investment Bank is authorised by the Comité des Etablissements de Crédit et des Entreprises d Investissement (CECEI) and supervised by the Commission Bancaire in France and subject to limited regulation by the Financial Services Authority. Details about the extent of our regulation by the Financial Services Authority are available from us on request. Crédit Agricole Corporate and Investment Bank is incorporated in France and registered in England & Wales. Registered number: FC Registered office: Broadwalk House, 5 Appold Street, London, EC2A 2DA.

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