Structure: Johannesburg Stock Exchange

Equity Market

ALtX

Equity Derivatives

Interest Rate Products

Commodity Derivatives

Yield-X/ Nutron

Currency Derivatives - Futures - Options - Index (RAIN)

What is a Currency: • It is the Rate of Exchange between two currencies • I.e. $/R6.86 or €/R9.80 – You will pay R6.86 for every one $ and R9.80 for every one € purchased – Similar to paying R256 for 1 SAB Share • The exchange rates quoted on the TV, radio and in newspapers say $/R6.86,

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 price to the public: – As at 20th May 2011: Rennies will buy Dollars at 6.6200 and sell Dollars at 7.0419 – The difference of 0.4219 is known as the spread

What are Currency Futures: • Contracts that allow investors to trade an exchange rate for some time into the future • Currency Future’s are agreements between two parties, but there is no counterparty risk as the clearing house of SA (i.e. Safcom) takes on the risk of each trade • 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 R7.00 to R7.50 (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 R8.00 to R7.00 (generally exporters)

Currency contracts listed: • • • • • • • • • •

Dollar/Rand Euro/Rand Pound/Rand Australian Dollar/Rand Japanese Yen/Rand Canadian Dollar/Rand Swiss Franc/Rand Chinese Yuan/Rand Botswana Pula/Rand New Zealand Dollar/Rand

What are Currency Futures 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

How are Currency Futures Priced: • What makes up the price of a Currency Future (Forward)? = Spot price + forward points

– Spot price e.g. $/R6.85 (bid) / $/R6.88 (offer) – Forward points (interest rate differential between today and expiry date) e.g. as at 08/11/2010

300 points bid / 350 points offer

• Future price is 6.8800 (bid) / 6.9150 (offer) [6.8500 + 0.0300] • On the exchange we quote/trade the expiry date so the price will always include the forward points

Profit or Loss per point move:

Initial Price

New Price

Price move in points

Nominal Value of underlying

8.0000

8.0001

0.0001

1000

0.10

10

1.00

8.0000

8.0010

0.0010

1000

1.00

10

10.00

8.0000

8.0100

0.0100

1000

10.00

10

100.00

8.0000

8.1000

0.1000

1000

100.00

10

1000.00

Rand price difference

Number of contracts

Profit in Rand’s

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:

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

• The initial margin requirement varies between the different currency futures offered

May 2012 Initial Margin Requirements:

Contract Code

Expiry Date

Fixed Initial Margin

Spread Margin

Series Spread Margin

Requirement

Requirement

Requirement

VSR

Dollar/Rand ($/R)

18 June 2012

R335.00

R20.00

R40.00

2.5

Dollar/Rand ($/R)

17 Sept 2012

R340.00

R20.00

R40.00

2.5

Dollar/Rand ($/R)

14 Dec 2012

R345.00

R20.00

R40.00

2.5

Dollar/Rand ($/R)

18 Mar 2013

R350.00

R20.00

R40.00

2.5

Dollar/Rand ($/R)

13 Dec 2013

R360.00

R20.00

R40.00

2.5

Dollar/Rand ($/R)

12 Dec 2014

R390.00

R20.00

R40.00

2.5

Dollar/Rand ($/R)

14 Dec 2015

R435.00

R20.00

R40.00

2.5

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

Speculating Example: • If you wish to take a view that the $/R exchange rate is going to move i.e. the Rand or Dollar to either strengthen or weaken, this is known as speculating • Remember you can make a lot of money, but you can also lose a lot of money by speculating with exchange rates! • Factors causing the exchange rates to move: – Purchasing Power Parity – Change in interest rates – Trade imbalances – Government Intervention – Political instability – Speculators – Terrorist attacks – Purchase of local company by foreign companies (e.g. Walmart buying Massmart)

Speculating Example: • Speculator expects Rand to weaken (Dollar strengthen) – – – –

Buy 10 Contracts at R8.35 – an exposure of R83,500 (10 x 8.35 x1000) Deposit R3,350 only for the initial margin (10 x R335) Sell contracts at R8.50 – an exposure of R85,000 (10 x 8.50 x 1000) Profit = R1,500 (R85,000 – R83,500) [10 x $1,000 x (R8.50 – R8.35) = R1,500 – Initial margin of R3,350 is returned – A return of R1,500 (44%) during a period in which the Rand only weakened by 1.8%

Hedging Example: • Company ABC importing goods to the value of $100 000, has to buy $100 000 @ 8.3550 = R835,500 • Importer wants to know their landed cost, and eliminate any currency risk • Therefore need to buy 100 Currency Futures contracts

Hedging Example: Day 1 (Trade Day close)

Day 2

Month 3

Month 4

Day of expiry Day (18/06/2012)

Currency future trade price

R8.3550

R0

R0

R0

R8.5500

Initial Margin per contract

(R33 500) (R335 x 100)

R0

R0

R0

R33 500

MTM price (closing price)

R8.4000

R8.4500

R8.4300

R8.4500

n/a

Profit/Loss for the day

R4 500 (8.4000 – 8.3550 x 100 x 1000)

R5 000 (8.4500 – 8.4000 x 100 x 1000)

(R2 000) (8.4300 – 8.4500 x 100 x 1000)

R2 000 (8.4500 – 8.4300 x 100 x 1000)

R10 000 (8.5500 – 8.4500 x 100 x 1000)

Net cash in/(out) for the day

(R 29 000) (-33 500 + 4 500)

R5 000

(R2 000)

R2 000

R43 500 (33 500 + 10 000)

Hedging Example: • Summary of cash flow: Variation Margin: R19 500 Profit (+R4 500 + R5 000 – R2 000 + R2 000 + R10 000) • Use the profit to off-set the increase in the Dollar exchange rate • Spot moved from 8.30 to 8.55 (expiry date) Loss of R25 000 • Future moved from 8.3550 to 8.55 (expiry date) Profit of R19 500 • Net difference between spot and future is R5 500 (the 550 forward points) and this is the interest rate differential that was bought at day 1 (i.e. 8.3550 compared to 8.30) • Importer will buy the physical $100 000 from the bank at an effective rate of 8.3550 – R835 500 compared to R850 000

Hedging Example: • Summary of cash flow: Initial Margin: R0 (-R33 500 + R33 500)

• • • •

Always returned to the investor Money on deposit earns overnight deposit rate @ 5.339% 24 times gearing (R335 deposit per R8 355) If the dollar had weakened against the rand (i.e. moved from R8.30 downwards to R8.00) then the importer would merely pay R800 000 • But the loss on the futures would have been offset by the profit in the better spot price

Benefits to trading Currency Futures: • • • • • • • • • • • •

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/speculation Deep liquidity in the foreign underlying instrument Gearing Protect the value of your Currency No credit lines required from Banks Cost effective Wholesale corporate rates Trade on a regulated and efficient platform/ No counterparty risk Equalize the playing fields for investors

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 No Obligation to Deliver Forex No SARB Approval Required Can be used for Quotes and Tenders – No underlying contact needed

Differences between Currency Futures & Forward Currency Futures Currency Forwards Contracts: Hedging Instrument

Yes

Yes

Derivative Instrument

Yes

Yes

Credit Risk

No

Yes

Physical Delivery

No

Yes

Wholesale Exchange Rate

Yes

No

Active deep & liquid market

Yes

No

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

Live currency pricing on Diro:

• 3 Market Makers quoting live prices: • Best bid/offer market spread 0.0033 cents,

Risks: •

Gearing – Post small amount but valued on full nominal value

Turnover: • Average monthly value traded − Futures − Options − Total

= = =

Example of a Zero0sum game: For every winner there is an equal loser