-: Hello, everyone!
Welcome to this webinar,
and we are now looking at module 6
so I hope you're very excited about it.
Now module 6 looks at foreign exchange
and commodity price risk management.
Now, we'll start off by looking at part A
which is foreign exchange risk.
So, let's first look at this article here,
and we're looking at this,
the relevance of managing foreign exchange exposure.
Now, this is about Australian pensions
and you'll see in this article,
what it's basically saying
is Australian pensions tend to try and hedge,
use their Australian dollar as a natural buffer,
especially when they are dealing with overseas
or foreign, offshore equity portfolios
and so they use the Australian dollar
to hedge against that.
Now, as much as that is the case,
what the regulators are saying
is that they still don't think it's enough.
And so you can see here,
it's saying that yet at 33% hedged,
which is the current situation at the moment,
this is well below the 75% level
that regulators deem neutral.
And so regulators feel
that our Australian pensions here
are exposed to that foreign currency risk
and they would obviously hope
that that hedging would be sort of increased.
All right, so what are the learning objectives
in this module?
So we'll be looking at those six learning objectives
and of course, these accounts for 14% of your exam.
So in this module,
we will look at foreign exchange risk,
and then we will look at commodity price risk.
What you would find interesting, however,
is that we'll use the same sort of framework,
so it's only that the risk is different,
exposure is different,
one is are about foreign exchange risk,
the other one is about commodity price risk.
But as you saw in module 5,
the framework itself is more or less,
the structure of it is more or less the same.
So we will first start
by calculating and explaining
what foreign exchange risk is,
we look at the drivers,
and then we will analyse it
and finally, we will look at hedging
so we will be looking at certain derivatives
that you can use to hedge these type of risks.
Now you can see
that we will follow the exact same process
when it comes to commodity price risk.
Let's now look at the background
to foreign exchange risk management,
and those are the learning objectives
that we will be looking at by looking at that.
Now, we have a short video on this
so very important to watch it
on foreign exchange rates.
I will try as much as possible
not to repeat what it says,
or I might just touch very, very,
at a very high level,
so it's very important that you watch the short video.
Now, this videos are obviously in guided learning
so you can easily be able to access them.
Now, look at this.
This is the Australian/USD exchange rate,
and you can see the volatility of it,
the variability that is there,
the exposure that is there.
Now, if you are running a business,
maybe it's an import business or an export business,
you can imagine the impact this can have
on your profitability,
on the value of your assets and the like
so, as an example,
let's just take a small example here.
Let's assume you are to export something
or import something at that level
at that time you made a decision to,
maybe you've signed a sales contract
or a purchases contract at that particular time
so that's, let's say around January the 20th,
that's when you did that
or January 20, the year 2020.
Now you can imagine,
by the time you get to somewhere there,
let's say that the spot rate to be used
will be at that time,
you can see that significant reduction.
Now, that will be horrendous for an importer.
Obviously for an exporter,
an exporter wants a weak Australian dollar,
an importer wants a strong Australian dollar.
If you're buying an electronic device,
maybe from the US,
you want the Australian dollar to buy a lot more
of the US dollar
and so this causes a very significant exposure
to organisations.
So whenever you hear an organisation
is dealing with importing
and exporting services and goods and the like,
just know that they have a very significant exposure
to foreign exchange.
So, what is foreign exchange risk?
It's the risk of variation in exchange rates
and the impact it has on an organisation.
Now, this could be cost,
it could be revenue,
it could be assets and liabilities.
Now, the reality is currency rates are highly volatile.
It's very different from say, interest rates.
Now, you and I know
that when it comes to interest rates,
the RBA controls it very closely.
When it comes to currency exchange rates,
it's used as a white noise
so the RBA does not directly control that
and so they can be very highly volatile
as I've shown you.
Now, I've already mentioned this,
Australian importers want a strong Australian dollar,
Australian exporters want a weak Australian dollar.
So, this table here shows the relationships.
So you can see a rising Australian dollar
for purchases,
it means you will spend lower AUD
and so that's a plus.
Now, obviously, if it is falling,
it means you need more Australian dollars
to purchase
and so that's the implication that it has.
Now this here,
we are referring to purchases in domestic currency.
Now, depending on what is happening outside,
you will find, sometimes you might actually want
to either purchase goods inside,
inside your own country,
or sell to your, within the country
as opposed to outside,
depending on the movements in exchange rates.
Now, for exporters, like I said,
a rising Australian dollar,
a strong Australian dollar is not good for them.
Why is that the case?
That's because the goods become very expensive
to people who are buying those goods and services
outside Australia.
Now, so they love it.
Even if they're Australians,
they love it when the Australian dollar gets weak.
So one man's gain is another man's loss.
So, then we have this thing,
and I'm hoping you have seen this in the news there,
the debacle or the rumours
that there is this currency war and a price war
between the US and China.
And that definitely happens between countries.
Now, what do countries actually do?
What countries do
is they tend to devalue their currency.
Why? Because they want other export,
they want to be able to export more goods
and so that's the reason
why sometimes there is that currency war,
especially if, say they are targeting
the same customers and the like.
Now, the challenge is or the problem is
sometimes it can be detrimental
to both countries or all countries involved
and so that has to be managed carefully.
But ideally,
all countries try as much as possible
to make whatever they produce,
cheaper for overseas customers.
So let's now look at demystifying foreign exchange.
Now, I know you've probably travelled around the world.
Maybe you've gone to France,
maybe you've gone to China,
maybe you've gone to the US and the like,
and so you know,
you've gone to probably an exchange place
and you've exchanged Australian dollars
for another currency.
Now, so what happens when,
say you want to enter a transaction in a year's time
or in three years time and the like,
what is that rate that you should be able to quote
at that particular time?
That's what we refer to as a forward rate.
Now, a few things I want to mention,
whenever you're using a derivative as an example,
the consideration that you pay at a particular time
is the fair value of that derivative.
Now you will find for most derivatives,
except maybe options,
you will find like swaps as an example forwards
and the like,
what will happen
is that the fair value at the commencement
is normally new,
you don't pay anything.
In fact, you pay very little or nothing at all,
because at that point,
it's not in the money and it's not out of the money.
Now later on, the forward rate starts moving
against the strike rate
and against the spot rate
and that's when now you start thinking,
"Hmm, am I in the money, am I out of the money?
Do I regret locking in that rate
or am I excited that I locked in that rate?"
Now, the thing to remember
is that price, that future price,
the one we're referring to as a forward rate
is not a forecasted rate.
Forecasted is where someone sits and say,
"Hmm, I think it should be 0.82."
No, it's not forecasted.
Banks don't scratch their heads
and think, "Ah, for that deal,
we will say AUD to USD would be 0.8."
That's not what happens.
It's actually a calculated rate.
That's what I'm saying here,
banks don't speculate for an exchange rates.
It simply calculated
and I'll show you how forward rates
actually calculated.
And so I want you to really understand
this concept of derivatives and foreign exchange,
but we'll be talking a lot more about it.
Let's now look at the elements
of foreign exchange.
These are the key terms
that you need to be very familiar with.
So, we have the spot price,
we will talk about the two-way prices,
we look at the forward rates, like I said,
and then we are going to be discussing swaps.
Now, I know we discussed swaps
when we are talking about interest rate risk,
but now we are going to be talking about
foreign currency swaps
so very interesting.
All right, let's talk about the spot price,
what do you think is a spot price?
The spot price is basically the exchange rate now, today.
Now, if you have travelled,
and I'm sure you likely have,
across the world or to a certain country,
and you've gone to exchange your money,
what you find is sometimes
they'll give you a quote like this, AUD/USD 0.75.
Now, whenever you see this,
AUD here is the best currency.
So just remember that one, the word base,
it's what is being bought
or sold by the dealer.
And then we have the terms currency,
it's the currency that you either want to buy or sell
or on the other side
and so there's a base currency
and the terms currency.
Now, in this case here,
we are saying 1 Australian dollar can buy 0.75 USD.
All right, so I have a quiz here for you,
an Australian exporter wishes to sell AUD a,
100,000 US dollars received from a sale
and buy AUD.
The exchange rate quoted by the bank is 0.7500 to 0.7525.
How much will the exporter receive in AUD,
in whole dollars?
I want you to think about this,
you've gone to a dealer,
or this exporter has gone to a dealer,
what is this exporter going to receive
in Australian dollars?
So I'll give you a few minutes
or rather a few seconds to think about this.
Now, what I want you to do
as you're working on it,
please pause the video until you finish
and then you can play the video or the webinar.
So it's very, very important to keep trying,
always try, attempt the quizzes
that I show on the screen.
So the correct answer there is 132,890.
How did I come up with that figure?
Now, remember, whenever you go to a dealer
and you see two rates,
the dealer always wants to make a profit,
and that's what we call a spread
and so the dealer will always buy low and sell high.
The dealer will always want to make money
and so in this case, you should be using 0.7525,
so you will divide 100,000 by that figure
and you end up with that.
So obviously, if you divide by 0.7500,
you will get more currency
so that means the dealer is giving the,
this person or the exporter more money,
which does not happen.
So the dealer will always make money from the deal.
All right, now, sometimes you may get
what we refer to as two-way prices
and so the dealer might quote,
AUD/USD 0.7500 and 0.7550.
This means that if the dealer is buying AUD,
they're going to buy at 0.75,
but if they are selling,
they're going to sell it to you at 0.755,
and that's the margin that they make.
Now, remember, if it is a private dealer,
they tend to make more money than banks,
especially with banks, if it's a commercial rate,
that rate will have a very small margin.
Dealers have quite,
can sometimes have quite a significant margin.
Let's now discuss this interesting topic
of forward rates,
and I really want you to grasp these concepts.
We'll start off with this quiz here.
The following information is currently available:
current AUD to NZD spot rate is 1.1200,
the New Zealand interest rate is 3%,
and the Australian interest rate is 4% per annum.
What is the Australian/New Zealand forward rate in 180 days?
Now, I'm hoping you have sort of looked at your study guide
so I want you to attempt this again,
pause the video or pause this webinar,
attempt the question,
and then you can play the webinar.
So the correct answer there is 1.146
so I'm hoping that 1.1146
so I'm hoping that you've got that answer.
If you didn't, don't worry about it,
I'm going to show you how I came up with it.
So, remember, a forward rate,
when you talk about that future rate,
maybe in six months time,
in one year's time,
in three months time,
that rate is not a forecasted rate,
it's actually a calculated rate,
and this is a formula for calculating that rate.
So the bank today,
if it wants to know what's going to be the forward rate
in the future,
they just use this formula.
And so what's this formula?
You can see here,
you apply the spot rate
and I'll show you.
So you apply the spot rate,
this is a terms currency, remember that,
and this is the base currency
so spot rate is 1.12, which we've been given,
now, we know that the New Zealand interest rate
is 3% per annum
so we have to use that which is a 0.03,
but we know also
that we're talking about 180 days only here
so we say 180 divided by the days,
account days convention
or day-count convention.
Now, just remember,
countries have different convention days,
so Australia is 365,
US is 360 and the like,
so you just need to be very careful about that.
Now, what's the Australian interest rate, 4%
and so we use the 4% there,
it's still 180 divided by 365
so you can see the convention days for Australia
and New Zealand are the same,
and that's how I arrived at 1.1146,
so that is the forward rate in 180 days.
So we have a short video on this on forward rates
so I'm not going to spend time on this
because we have a short video.
Watch it please.
So that's the formula for forward rate,
I've talked about it.
I've said that the forward rate
is not a forecast rate,
I've shown you how you use it.
That's the spot exchange rate,
that's the interest rate of the term currency
and we looked at the quiz.
That's the base currency interest rate,
and then that's the number of days,
which was 180 days in the quiz.
And then I talked about the number of days
in the conventional year.
So be careful about that
because it differs with countries
so in Australia, in New Zealand, in Canada is 365,
in US and in the Eurozone, it's 360.
So with that, we've looked at the background
of foreign exchange risk management,
we've also discussed
the attributes of financial instruments,
I've talked about the key elements of foreign exchange,
and then we finished with forward rates.
And that brings us to the end of this webinar. Thank you.