FX Strategies. in the Post-Crisis World. Eddie Wang Head of FX Structuring, Asia. Hong Kong October 2009

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1 FX Strategies in the Post-Crisis World Eddie Wang Head of FX Structuring, Asia Hong Kong October 2009

2 Contents ONE Key Trends in the Post-Crisis World TWO FX Hedging Strategies THREE FX Investment Strategies 1

3 Key Trends Improvement of Risk Appetite Return of Carry Trades Emergence of Asia

4 Improvement of Risk Appetite Risk appetite has improved significantly as measured by volatility FX volatility dropped from extreme highs reached during the financial crisis Implied volatility is close to long term average Trend is for volatility to consolidate in the near future But it is unlikely to return to extremely lows reached pre-crisis Calyon Risk Aversion Barometer Average G3 FX Volatility Jan 08 May 08 Sep 08 Jan 09 May 09 Sep Jan 08 May 08 Sep 08 Jan 09 May 09 Sep 09 Source: Bloomberg, Calyon Source: Reuters 3

5 Improvement of Risk Appetite Importers / Exporters Asian Imports/exports recover as global economies rebound Companies have more visibility in forecasting foreign cash flows Activities in FX hedging are picking up Asset Managers Asian asset managers are increasingly hedging currency risks of foreign equities As global equity markets rebound, more currency hedges are needed FX Investors Correlation between FX and other assets is going lower Investors look to FX for asset diversification 4

6 Return of Carry Trades Interest Rates are again key drivers of currency movements USD has replaced JPY as the favourite funding currency High yield commodity currencies are the main beneficiaries Factors for carry trades Rate differential Currency volatility Risk appetite 3 month AUD/USD Rate Differential 3 month AUD/USD Implied Volatility Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Source: Reuters Source: Reuters 5

7 Return of Carry Trades Main risk for carry trade is a dramatic unwind as seen during the crisis Negative forward point is implied by positive rate differential Risk reversal can be used as an early indicator of unwinding We may use risk reversal trade to manage the risks of carry trade 1 year AUD/USD Forward Points month AUD/USD Risk Reversal Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Source: Reuters Source: Superderivatives 6

8 Emergence of Asia The crisis accelerated Asia s emergence Asian economies keep growing faster than the US and Europe China s demand supporting Asia intra-regional trade Share of Asia trade with G3 economies is declining Asia trade with other emerging markets is growing Share of Asian currencies in FX trading is increasing GDP in current USD 40% 35% 30% 25% 20% 15% 10% 5% 0% Source: IMF, Calyon Notes: from 2010 onward: IMF forecasts; Rest of the world: 21% in 2009 (23% in 2014) US EU ASIA EX-JAPAN 2009 Japan Geographical Breakdown of Asian Exports 60% 50% 40% 30% 20% 49% 39% 12% Source: CEIC, Moody s, Calyon 42% 37% 20% 10% Asia intraregional trade Exports to G3 economies Other exports (incl. to emerging markets) 0%

9 Emergence of Asia CNY will become a world currency in the long term But China s currency reform will be a slow and gradual process In the near term, NDF and NDO remain the main hedging tools for offshore companies However, NDF has not been a good indicator for spot movement in the past year Which sometimes creates arbitrage opportunities between onshore and offshore markets CNY trading with other currencies such as EUR and JPY also increasing USD/CNY Historical Spot Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Source: Reuters 1 year USD/CNY NDF Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Source: Reuters 8

10 FX Hedging FX Exposures Hedging Strategies

11 FX Exposures Transaction Exposure Future foreign currency cash flows Mainly from import/export or short term currency loans Operating margins are impacted by currency fluctuations The type of exposure most commonly hedged Translation Exposure Foreign currency assets and liabilities translated into home currency to be included in balance sheet Medium to long term projects or loans No cash flow impact Economic Exposure Present value of future expected cash flows Longer-term version of transaction risk 10

12 FX Exposures Hedge Accounting FX hedge rate recorded on balance sheet at fair market value Allows gains/loss of FX hedge to offset those of hedge items Reduces earning volatility caused by currency fluctuations Fair Market Value of FX Hedge Basic Concept Fair Market Value of Hedged Item The FX hedge s change in value is opposite to the change in value of the foreign currency exposure (hedged item) 11

13 Hedging Strategies Do Nothing FX volatility can have significant impact on operating margin Hedging becomes more essential as FX markets move wildly Natural Hedge Net asset and liability in the same currency Maturity dates also need to match Active Hedging Account for the invoiced cash flow and sale and purchase with fixed price Forecast the cash flow by analyzing the business Formulating and execute hedging strategies 12

14 Hedging Strategies Hedge Ratio Hedge up to 100% of the fixed cash flow amount Should appropriately hedge a portion of the forecasted cash flow 1. Apply varying hedge ratios by Quarter Q1 = 100% Q2 = 70% - 80% Q3 and Q4 = 50% - 75% 2. Establish coverage levels for different timeframes Booked exposures = 100% Forecasted exposures over the next rolling 12 months = 50% Forecasted exposures between 12 and 24 months out = 25% 13

15 Hedging Strategies Hedging of Fixed Cash Flows Callable Par Forward Client buys USD / sells JPY every month for 1 year at Strike Favorable forward rate is guaranteed for first 3 months In 3 months, Calyon has the right to call If called, the remaining structure is early terminated If not called, the remaining structure continues as par forward Calyon can Call Strip of forwards Callable strip of forwards Market Parameters Spot = Y Par Forward =

16 Hedging Strategies Hedging of Uncertain Cash Flows Flexible Forward Client buys USD / sells JPY at Strike Client can exercise partially anytime between trade date and expiry date Any remaining amount must be exercised by expiry date Scenario Analysis - Flexible Forward Exercise Schedule Client: Forecast the needs to buy 20m USD/JPY over one year Hedge 50% of the exposure through Flexible Forward Exercise Date Spot Forward Exercise Amount Spot Amount Rate 1 month m USD months m USD months m USD months m USD year m USD Average Rate: Market Parameters Spot = Y Fwd Ref =

17 FX Investment Why Investing in FX Investment Market Analysis Investment Strategies

18 Why Investing in FX FX Markets Largest marketplace in the world Very liquid and transparent Wide range of market participants Flow driven by global trade Investing in FX Low correlation with other asset classes Diversification of portfolio No restriction on long or short Potential for return since many participants are not profit seeking 17

19 Investment Market Analysis Currency linked MTN market 700 FX linked issues in 2009 $3 Billions USD issues, $1 Billions EUR issues, $0.7 Billions YEN issues 41% of the issues are Baskets, 23% are Dual and Reverse Dual issues Calyon is number 3 Issuer and dealer in 2009 Breakdown per Type for FX 3% 12% 41% 21% 23% Baskets Dual Single Emerging Power Reverse Dual FX Others 18

20 Investment Strategies Improve return on an investment through client s view on FX market Short Term (1w to 3m) Non-capital guaranteed products work better Soft version of non-capital guaranteed product - possible conversion into a different currency Dual currency product most popular Medium Term (3m 3y) Normally capital guaranteed products Client gives up a risk free interest rate to finance the boosted return Longer tenor needed as interest rate is very low in shorter tenor 19

21 Investment Strategies MCN Multi-Currency Note A short tenor note linked to the client s chosen currencies Best performing investment for very short maturities Works especially well if cash is acceptable in all the underlying currencies Not capital guaranteed possibility of notional amount being converted Conversion rate can still be better than the initial forward rate Inception Expiration Notional Notional, possibly in different currency FX Option Sold to Calyon Enhanced Coupon More expensive FX option results in higher coupon 20

22 Investment Strategies MCN Multi-Currency Note 3 months USD MCN - linked with EUR/USD & AUD/USD Coupon = 6.00% p.a. EUR/USD Strike = (95% of EUR/USD initial spot) AUD/USD Strike = (95% of AUD/USD initial spot) Best Case Scenario At expiry, if EUR/USD and AUD/USD , Client receives principal and coupon in USD Worst Case Scenario At expiry, if EUR/USD < or AUD/USD < , Client receives equivalent EUR amount converted at or AUD amount converted at , whichever is less favorable Market Parameters EUR/USD Spot = AUD/USD Spot = month USD LIBOR = 0.28% Equivalent DCN Coupon EUR/USD linked: 2.00% p.a. AUD/USD linked: 5.00% p.a. 21

23 Investment Strategies 3Y CAII Basket Note Take advantage of the emergence of Asia Indexed to the performance of an equally weighted basket of CNY, AUD, IDR and INR against USD Low cost basket option with 100% principal protection Inception Expiration Option Payoff x Gearing Enhanced Coupon Upfront Option x Gearing Risk-free Interest Initial Investment Notional Present Value Note Notional Cheaper FX option results in higher Coupon or Gearing 22

24 Investment Strategies 3Y CAII Basket Note Coupon = Max (7.00%, 100% * Basket Performance), if Basket Performance > 0; No coupon otherwise 4 1 USD / CCY ( i) Basket Performance = 1 4 / ( ) i= USD CCYt i Principal protected in any case 0 1 CNY Coupon at Maturity Maturity Payoff Structure AUD IDR INR 7% 100% participation 0% 7% Basket Performance 23

25 Generic disclaimer 2009, CALYON All rights reserved. The information in this document (the Information ) has been prepared by Calyon or one of its affiliates ( CALYON ) 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. CALYON is under no obligation to update the Information. CALYON 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 CALYON 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 CALYON 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 CALYON 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 CALYON 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, CALYON 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: CALYON 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. CALYON is incorporated in France and registered in England & Wales. Registered number: FC Registered office: Broadwalk House, 5 Appold Street, London, EC2A 2DA. 24

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