Protests Against Accumulation of Euro Currency
During 2011, Switzerland National Bank took a relative measure to reduce the valuation of Swiss Franc, due to the continuous increase in its currency valuation in comparison to other countries. In addition, the Swiss Franc was increasing in value in comparison to USD, GBP and Euro, which was drastically hampering the actual economy of the country. This is due to the exports that is conducted by Switzerland all over the world, which got hit due to the higher valuation of the currency. The exporters were not able to compete in the international market, which reduce their actual income. The export business of Switzerland mainly comprises 70% of its total GDP, which was one of the drastic condition presented to Switzerland National Bank (Reuters.com 2018). Therefore, in view of declining revenues and GDP the Switzerland National Bank started to the value of Peggy their Swiss Franc to reduce this valuation in the international market. this paging system relatively allowed Swiss National Bank to reduce the actual valuation of the currency, while boosting the economy.
Therefore, Switzerland National Bank started to accumulate Euro in their reserve, which tampered with the overall Swiss Franc and helped the bank to control its valuation. The more Euro was bought by Switzerland National Bank, the more Swiss Franc was printed and distributed in the market. This relatively decrease the overall valuation of Swiss Franc in the international market and help the bank to boost exports in Swiss Zealand. This relatively increased the accumulation of Swiss Franc within the Switzerland National Bank, which drastically helped in improving the economic conditions of the country (Admiralmarkets.com 2018). The measure used by Swiss National Bank to control its currency was discontinued during 2015, which led to a drastic change in its currency valuation and stock market. The de-pegging was relatively conductor due to certain factors which are depicted below,
In Switzerland they were relevant protest against the measure that was used by Swiss National bank for controlling their currency, which actually inflated the Swiss economy. the measure used by the bank was to print more Swiss Franc to purchase Euro, which increased circulation of the currency in the market, which relatively depicted an alarming rate for the citizens of Switzerland. The citizens mainly feared the rise of inflation within the economy, due to the printing of Swiss Franc for buying Euro currency. Swiss National Bank accumulated 480 billion of foreign reserves, which comprise only of Euro (Bbc.com 2018). This extreme accumulation of the currency is relatively depicting the problems, which might in Swiss Franc. Therefore, the continuous pressure from citizens Swiss National Bank be the decision of de-pegging the Swiss Franc and to start selling Euro in the currency market.
Reduction in the Value of Euro
The second main reason behind the debugging of Swiss Franc was the reduction in value of Euro, which was being conducted, due to the measures taken by European National Bank. The European National Bank mainly injected capital within the economy to increase inflation rate with the process of monetary easing. This process relatively increased the circulation of Euro within the Euro-Zone, which declined its overall valuation. This continuous devaluation of euro, due to measures taken by the European National Bank directly affected the actual valuation of Swiss Franc. The Swiss National Bank intended to keep a relevant value for the Swiss Franc, which was drastically reduced due to the depreciating Euro. The reason behind pegging was happening due to the excessive exposure of Swiss National Bank to the Euro currency. Therefore, the continuation of pegging measure would drastically affect the actual value of currency and negatively impact its economy. Consequently, the Swiss National Bank decided to discontinue the pegging measure used for devaluating their currency (Snbchf.com 2017).
Therefore, the exporters could use different hedging measure such as future contracts, option contracts, swap contract and forward contracts to hedge the exposure in the currency market. These derivative instruments could eventually help the exporters of Switzerland to reduce the negative impact of volatile currency market and maintain the level of profits. After the de-pegging the currency value of Switzerland was valued at 1.2 to 0.8 in a single day. This reflected the overall anxiety and confusion among the investors regarding the actual value of Swiss Franc. The most viable hedging choice which could be used by Switzerland exporters are option hedging and Swaps, which would allow the exporters to get high leverage on their trades by contributing low premium. This derivative instrument relatively allows the investor to increase is exposure in the current market for a nominal amount, which helps them to reduce blockage of essential capital (Wahab et al. 2017).
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The value of the deal according to the current exchange rate. Current exchange rate: $1.10 €50,000,000 × $1.10 = $55,000,000 Future spot rate: $0.80 €50,000,000 × $0.80 = $40,000,000 Profit: $40,000,000 – $55,000,000 = -$15,000,000 The unhedged strategy was unsuccessful. Future spot rate: $0.90 €50,000,000 × $0.90 = $45,000,000 Profit: $45,000,000 – $55,000,000 = -$10,000,000 The unhedged strategy was unsuccessful. Future spot rate: $1.05 €50,000,000 × $1.05 = $52,500,000 Profit: $52,500,000 – $55,000,000 = -$2,500,000 The unhedged strategy was unsuccessful. Future spot rate: $1.13 €50,000,000 × $1.13 = $56,500,000 Profit: $56,500,000 – $55,000,000 = $1,500,000 Unhedged strategy was successful. Future spot rate: $1.20 €50,000,000 × $1.20 = $60,000,000 Profit: $60,000,000 – $55,000,000 = $5,000,000 Unhedged strategy was successful. Future spot rate: $1.25 €50,000,000 × $1.25 = $62,500,000 Profit: $62,500,000 – $55,000,000 = $7,500,000 Unhedged strategy was successful. Future spot rate: $1.30 €50,000,000 × $1.30 = $65,000,000 Profit: $65,000,000 – $55,000,000 = $10,000,000 Unhedged strategy was successful. |
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1-year forward: $1.13 50,000,000 x 1.13 = 56,500,000 Future spot rate: $0.80 €50,000,000 × $0.80 = $40,000,000 The hedge worked. Future spot rate: $0.90 €50,000,000 × $0.90 = $45,000,000 The hedge worked. Future spot rate: $1.05 €50,000,000 × $1.05 = $52,500,000 The hedge worked. Future spot rate: $1.20 €50,000,000 × $1.20 = $60,000,000 The hedge was unsuccessful. Future spot rate: $1.25 €50,000,000 × $1.25 = $62,500,000 Future spot rate: $1.30 €50,000,000 × $1.30 = $65,000,000 The hedge was unsuccessful. |
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€50,000,000 Step 1: Borrow Euro PV= FV/ (1+r) = €50,000,000 / (1.02) = €49,019,607.84 à €49,019,608 Step 2: spot. Sell €49,019,608 Buy USD =€49,019,608 × $1.10 = $53,921,568.8 = $53,921,569 Step 3: Lend/ Invest $53,921,569 à @1.055 = $56,887,255.3 = $56,887,255 Future spot rate: $0.80 €50,000,000 × $0.80 = $40,000,000 The hedge worked. Future spot rate: $0.90 €50,000,000 × $0.90 = $45,000,000 The hedge worked. Future spot rate: $1.05 €50,000,000 × $1.05 = $52,500,000 The hedge worked. Future spot rate: $1.13 €50,000,000 × $1.13 = $56,500,000 The hedge worked. Future spot rate: $1.20 €50,000,000 × $1.20 = $60,000,000 The hedge was unsuccessful. Future spot rate: $1.25 €50,000,000 × $1.25 = $62,500,000 The hedge was unsuccessful. Future spot rate: $1.30 €50,000,000 × $1.30 = $65,000,000 The hedge was unsuccessful. |
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Put option Exercise price: $1.11, premium: $0.06 per unit If options are exercised Receipt – premium = (50 mil x 1.11) – 3,000,000 = 55,500,000 – 3,000,000 =52,500,000 Future spot rate: $0.80 = (50 mil x 0.80) – 3,000,000 =37,000,000 Do not exercise Future spot rate: $0.90 = (50 mil x 0.90) – 3,000,000 =42,000,000 Do not exercise Future spot rate: $1.05 = (50 mil x 1.05) – 3,000,000 =49,500,000 Do not exercise Future spot rate: $1.13 = (50 mil x 1.13) – 3,000,000 =53,500,000 Exercise options Future spot rate: $1.20 = (50 mil x 1.2) – 3,000,000 =57,000,000 Exercise options Future spot rate: $1.25 = (50 mil x 1.25) – 3,000,000 =59,500,000 Exercise options Future spot rate: $1.30 = (50 mil x 1.30) – 3,000,000 =62,000,000 Exercise options |
The calculation mainly helps in depicting the risk attributes involved in currency conversion of ABC company. In addition, the oval hedging strategies evaluated in the above calculations, which could help the company to identify the measure that provides the highest conversion rate. Strategies such as forward contract, option contract, money market hedge and unhedged is used to evaluate the relevant choices presented to the company. Currency conversion relatively has high risk, which increases losses of the company over the period of time due to problems faced by volatile currency market. and hedge strategy is a relatively and adverse measure way no hedging is conducted by the company who is intended to convert the currency in future. This relatively increases the risk of loss incurring from currency conversion due to the volatile currency market. Moreover, forward contract is also an adequate measure, which is only useful to fix the overall currency conversion rate. However, any increment in the currency conversion rate was drastically hampered the actual profit which could have been obtained by the company (Kim and Chance 2018).
Unhedged Payment for ABC
The evaluation of the four different hedging strategies, which could be used by ABC company the adequate and optimal strategy is chosen. From the overall assessment put option is one of the most viable investment option for the company, which could relatively help in increasing the conversion rate while reducing the risk. In addition, the use of optimal had such as option hedging would eventually allow ABC company to generate higher conversion rate in comparison to other options. Therefore, it could help in improving the actual revenues of ABC company that is being generated in the international market. Cadman et al. (2017) stated that with the help of adequate hedging measure, companies can reduce their exposure in currency and capital market. This reduction in risk eventually allows the investor to increase their exposure and return generation capacity by conducting adequate investment.
Reference:
Admiralmarkets.com. (2018). Price shock: when the Swiss National Bank unpegged the Swiss franc from the euro. [online] Available at: https://admiralmarkets.com/analytics/traders-blog/price-shock-when-the-swiss-national-bank-unpegged-the-swiss-franc-from-the-euro [Accessed 31 Mar. 2018].
Bbc.com. (2018). Swiss franc soars as euro cap ends. [online] Available at: https://www.bbc.com/news/business-30829917 [Accessed 31 Mar. 2018].
Bergbrant, M.C. and Hunter, D.M., 2018. (How) do credit market conditions affect firms’ post-hedging outcomes? Evidence from bank lending standards and firms’ currency exposure. Journal of Corporate Finance.
Cadman, J.M., Dissanayake, N.A., Mageed, S., Rogers, I.J. and Zavadlal, G., 2017. Results of survey on hedging practices. British Actuarial Journal, 22(2), pp.442-467.
Caldentey, R. and Haugh, M., 2017. A Cournot-Stackelberg Model of Supply Contracts with Financial Hedging and Identical Retailers. Foundations and Trends® in Technology, Information and Operations Management, 11(1-2), pp.124-143.
Kim, S.F. and Chance, D.M., 2018. An empirical analysis of corporate currency risk management policies and practices. Pacific-Basin Finance Journal, 47, pp.109-128.
Livingstone, K.T. and Ngugi, K.A.R.A.N.J.A., 2017. DETERMINANTS OF CORPORATE HEDGING PRACTICES USED BY COMPANIES LISTED IN NAIROBI SECURITY EXCHANGE. International Journal of Economics and Finance, 1(5), pp.73-92.
Mahadevan, S., 2017. An Empirical Analysis of Foreign Exchange Exposure of CNX 100 Companies. International Journal of Financial Management, 7.
Reuters.com. (2018). Swiss franc jumps 30 percent after Swiss National Bank dumps euro…. [online] Available at: https://www.reuters.com/article/us-markets-franc/swiss-franc-jumps-30-percent-after-swiss-national-bank-dumps-euro-ceiling-idUSKBN0KO16Y20150115 [Accessed 31 Mar. 2018].
Sehgal, S. and Agrawal, T.J., 2017. Bank Risk Factors and Changing Risk Exposures in the Pre-and Post-financial Crisis Periods: An Empirical Study for India. Management and Labour Studies, 42(4), pp.356-378.
Snbchf.com. (2017). How Derivatives Markets Responded to the De-Pegging of the Swiss Franc snbchf.com. [online] Available at: https://snbchf.com/2017/01/niepelt-derivatives-unpeg-swiss-franc/ [Accessed 31 Mar. 2018].
Wahab, H.A., Husin, M.A.A., Nordin, N.M., Yusoff, Y.S. and Zainudin, W.N.R.A., 2017. Foreign Currency Exposure and Hedging Practices: New Evidence from Emerging Market of ASEAN-4. Advanced Science Letters, 23(5), pp.4939-4943.
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