Reasons behind Swiss National Bank De-Pegging Swiss Franc
From the evaluation of de-pegging of Swiss Franc relatively indicates the decision that was made by the Switzerland Central Bank to reduce the negative impact on its currency valuation. the decision was mainly made due to the previous decision that was conducted by the Switzerland Central Bank to curb the currency valuation of their Swiss Franc. The economy of Switzerland is relatively based on Exports which allows the country to gain maximum of their GDP (Economist.com 2018). However, during the financial crisis Switzerland claimed to be the most secure location for financial sector, which increased depositors for Switzerland Bank that generated from all around the world. This rising demand for Swiss Franc a relatively increased evaluation of the currency in international market, which directly hampered their export capability and economic condition. Therefore, Switzerland Central Bank took initiatives for reducing the valuation of Swiss Franc by engaging themselves in accumulating euro currency in their reserves. The de-pegging resulted in devaluation of Swiss Franc in terms of other major currencies all around the world. The decision made by Swiss National Bank led to the rapid decline of the share market present in Switzerland, which posed as a short term financial crisis for the country (Economist.com 2018).
The decision made by Swiss National Bank was to buy large amount of Euro currency and accumulate it within the Reserve. This high purchasing of Euro would eventually increase the supply of Swiss Franc in the currency market, which could help in tampering the currency valuation of the Swiss currency. This would eventually evaluate the actual currency value of Swiss Franc and help the Swiss National Bank to maintain adequate level of currency conversion rate. This useful measure used by Swiss National Bank was a relatively halted during 2015, which post the greatest loss for the country after the financial crisis. Swiss National Bank halted the decision of pegging relatively posed the national stock market of Switzerland to crash due to high losses in currency valuation. Just highest negative impact on share market of Switzerland was due to the degradation of currency value, which is used for Exports. In addition, the export comprises 70% of total GDP that is currently valued for Switzerland (Economist.com 2018). This indicates that any kind of reduction in currency value would also alter capital market of the country.
The decision for repegging was relatively conducted during the start of 2015, where the actual Euro valuation was declining due to the easing movement used by European Central Bank. This easing movement allowed the European Central Bank to increase the flow of cash within the eurozone by buying more of Corporate and public bonds from the market, which increased the actual circulation of Euro all around the eurozone. This measure of intense injection of capital within the eurozone directly degraded the actual value of Euro in comparison to other countries such as USD and pound sterling. this relatively reduced the actual value of Euro which was be accumulated by Switzerland National Bank (Economist.com 2018). This in turn reduced or degraded the value of Swiss Franc in comparison to other currencies. This degradation of the currency was not intended by Switzerland National Bank, who then stopped the pegging in 2015. The second main reason behind the de-pegging of Swiss Franc was the continuous pressure from Swiss citizens who were concerned regarding the high accumulation of Euro within Switzerland National Bank. The pressure maintaining to sell Euro due to its degrading value relatively forced the Swiss National Bank to stop the pegging process in 2015 (Economist.com 2018).
Evaluation of Hedging Strategies Implemented by Swiss Exporters
The Switzerland exporters could eventually use different heading measures to reduce the risk from currency conversion. These measures could be identified as the derivative instruments, which are used in modern days to conduct transaction. the derivative instruments of such as forward rate hedge, future hedge, option hedge and swaps could be used by investors for reducing there is Kong currency conversion. The derivative instruments directly provide financial leverage to the Switzerland exporters for serving the devaluation of the currency and maintaining the level of prophets required to sustain their business. These derivative options are relatively helpful in controlling the risk involved in currency conversion. Moreover, the Switzerland exporters could also use money market hedge to control the rising devaluation of the currency. In this context, Bessis (2015) stated that currency conversion hedge allows investors to reduce the risk from volatile currency market by fixing the rate of conversion. On the other hand, Chance and Brooks (2015) argued that without adequate research the hedging measure could negatively affect the actual currency conversion rate of the company.
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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 above tables mainly help in depicting the overall hedging strategy, which could be used by ABC Company to reduce the negative impact of currency conversion. In addition, the relevant strategies such as un-hedge measure, forward contract, option contract and money market measure are relatively evaluated to detect the most viable option for the company. The overall calculation conducted in the above table evaluates different scenarios of future prices to evaluate the viability of the currency conversion hedge. The calculation also helps in identifying the problems that might be feasible for the organization to reduce negative impact from currency conversion. In this context, Kim and Chance (2018) stated that with the help of hedging strategy companies able to reduce the negative impact or volatility from currency market, which hampers their profit generation capacity. The evaluation depicts option hedging, money market hedging, and future contract hedging identified, as the most viable process, which could allow ABC Company to reduce the risk from currency conversion.
From the evaluation of the calculation, it could be identified that unhedged strategy is not an adequate measure, as the risk of from currency conversion ranges relatively higher than other options. Therefore, the unhedged strategy should be excluded from the option of currency conversion. the second option that is provided for hatching the risk of currency conversion is through forward contracts, which would allow ABC company to reduce its risk from currency market. However, the forward contract is restricted to limited exposure, which does not allow the ABC company to increase its currency valuation during high currency rate. The forward contract asphyxiated in $1.13, where any increment in the currency conversion value could hamper actual profit of the organization. (Bae, Kim and Kwon 2018)
The third option that is presented to ABC company is the use of options contract, which is relatively a measure that could allow the company to reduce its currency conversion rate if payments are adequate. The option hedging strategy does not provide adequate leverage of prophets to the ABC company due to the restraining of premiums which needs to be paid during the commencement of trade. Last option is money market Hedge, which portrays to be the optimal hedging strategy that could be used by ABC company. This hedging strategy relatively reflects the overall profit and losses, which write in curve by the company during the currency conversion (Bergbrant and Hunter 2018). This method has no negative profits while a minimum of 3 million profits is fixed with the help of hedging strategy.
Reference and Bibliography:
Bae, S.C., Kim, H.S. and Kwon, T.H., 2018. Currency derivatives for hedging: New evidence on determinants, firm risk, and performance. Journal of Futures Markets, 38(4), pp.446-467.
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.
Bessis, J., 2015. Risk management in banking. John Wiley & Sons.
Chance, D.M. and Brooks, R., 2015. Introduction to derivatives and risk management. Cengage Learning.
Economist.com. (2018). Why the Swiss unpegged the franc. [online] Available at: https://www.economist.com/blogs/economist-explains/2015/01/economist-explains-13 [Accessed 31 Mar. 2018].
Evans, C., Fisher, J., Gourio, F. and Krane, S., 2016. Risk management for monetary policy near the zero lower bound. Brookings Papers on Economic Activity, 2015(1), pp.141-219.
Gilbert, S. and Loi, H., 2018. Digital Currency Risk. International Journal of Economics and Finance, 10(2), p.108.
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.
Kryzanowski, L., Zhong, R. and Zhang, J., 2018. Currency Hedging of International Bond Portfolios: Effects of Unconventional Monetary Policy Regimes.
Sadgrove, K., 2016. The complete guide to business risk management. Routledge.
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