currency markets: best practices for determining fair value...best practices for determining fair...
TRANSCRIPT
![Page 1: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/1.jpg)
CURRENCY MARKETS: Best Practices for Determining Fair Value
OCTOBER-2013
![Page 2: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/2.jpg)
To Define Best Practice First Define the Exposure
• Long-Term: M&A; Plant
Expansion; Net-Equity
• Medium-Term: Multi-Year Supply
Contracts
• Short-Term: Three-Month
Receivable
![Page 3: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/3.jpg)
To Define Fair Value Define the Horizon
![Page 4: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/4.jpg)
Three Months
![Page 5: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/5.jpg)
5 YEARS
![Page 6: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/6.jpg)
30- YEARS
![Page 7: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/7.jpg)
Further Defining the Exposure
• Cash Flow VS Balance Sheet VS
Economic
• Recievables,Dividends,Inter-
Company
• Incidental VS Potential EPS Impact
![Page 8: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/8.jpg)
BUILDING A FRAMEWORK FOR ANALYSIS
• Long-Term: PPP; Real Effective Exchange Rates
• Medium-Term: Trade Flows; Rate Differentials
• Short-Term: Market Positioning;
Risk Appetite
![Page 9: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/9.jpg)
THE LONG-RUN
• PPP
• Productivity
![Page 10: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/10.jpg)
PPP: Real Long-Run Valuation
• Determined by Relative Inflation Rates
• Focus on Mean Reversion
• Defining Over/Under Valuation Based on PPP: Magnitude + Duration
![Page 11: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/11.jpg)
Defining Over/Under Valuation
• Magnitude: 15-20%
• Duration: Five to Seven Years
![Page 12: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/12.jpg)
PPP Case Study: The AUD
![Page 13: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/13.jpg)
Additional Long-Run FX Valuation Techniques
• REERS: Real Effective Exchange
Rates: BIS/IMF
• The BIG-MAC Index: Bugernomics
![Page 14: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/14.jpg)
REER: Real Effective Exchange Rate
• A Trade Weighted Average of
Individual Exchange Rates
• More Reliable than Relying on
Individual Bilateral Exchange
Rates
![Page 15: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/15.jpg)
AUD:
Other Long Term Valuation Techniques
![Page 16: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/16.jpg)
AUSSIE BIG-MAC INDEX:
A Leading Indicator?
![Page 17: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/17.jpg)
PPP and Other LT Approaches:
How Useful?
• Clearly a Long-Term Technique
• Caveats: Choice of Base Year
Choice of Price Deflator
• In the Long-Run Markets are a
Weighing Machine….in the Short
Run Markets are a Voting Machine
![Page 18: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/18.jpg)
The Medium-Run
• Cyclical Trade Patterns-Price
Trends
• Monetary Policy/Interest Rate
Differentials
![Page 19: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/19.jpg)
Trade Flows-Volumes and Prices:
Affected by The Business Cycle
![Page 20: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/20.jpg)
Looking Behind AUD Trade Flows:
Chinese Growth
![Page 21: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/21.jpg)
RATE DIFFERENTIALS
![Page 22: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/22.jpg)
MONETARY POLICY OUTLOOK:
FORECASTS
![Page 23: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/23.jpg)
MONETARY POLICY OUTLOOK:
MARKETS
![Page 24: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/24.jpg)
MONETARY POLICY OUTLOOK:
MODELS
• The Taylor Rule: Inflation VS
Unemployment
![Page 25: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/25.jpg)
THE SHORT-RUN:
RISK,SENTIMENT,POSITIONING
• Risk Appetite
• Investor Sentiment
• Market Positioning
![Page 26: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/26.jpg)
Assessing Risk Appetite
![Page 27: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/27.jpg)
INVESTOR POSITIONING
![Page 28: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/28.jpg)
MARKET POSITIONING: NDFs
![Page 29: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/29.jpg)
MARKET POSITIONING:OPTIONS
![Page 30: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/30.jpg)
SCENARIO ANALYSIS USING OPTIONS
![Page 31: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/31.jpg)
Looking Forward:
Devising an Early Warning System
• Real Exchange Rate
• Medium-Term: Sovereign and
Corporate Debt Profile
• Short-Term: Foreign Portfolio
Flows
![Page 32: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/32.jpg)
CREATING A COUNTRY-RISK MODEL
• Financial Market Risk: Cross Asset Volatility, Rollover Risk
• Economic Risk: Reserves VS Imports, Inflation,Unemployment
• Political Risk: Regulation and Corruption Indices
• For All of the Above: Current VS Trend
![Page 33: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/33.jpg)
Linking Valuation Techniques to FX Risk Management Policy
• Better Use of FX Valuation
Techniques= More Effective Hedge
Implementation
• Different Tenor Different Technique
![Page 34: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/34.jpg)
INVESTOR POSITIONING: FUTURES
![Page 35: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/35.jpg)
COMMON THEME:
MARKET BASED APPROACHES
• Fed Fund Futures:Policy
Outcomes
• NDFs, Options, Futures: FX Market
Valuation, Direction and Scenario
Analysis
![Page 36: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/36.jpg)
WHY?
• Corporate Business Strategies
Change Frequently
• Risk Appetite Cycles have
Shortened Dramatically
![Page 37: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/37.jpg)
KEY TAKEAWAY:
EXPOSURES EVOLVE OVER TIME
• M&A Transactions:
-Begin as Long-Term Valuation
Exercises
-But Often End as Spot
Transactions
• Short Term Cash Flow Hedges
Morph into LT Hedging Programs
![Page 38: CURRENCY MARKETS: Best Practices for Determining Fair Value...Best Practices for Determining Fair Value OCTOBER-2013 . To Define Best Practice First Define the Exposure](https://reader033.vdocuments.net/reader033/viewer/2022042006/5e701d37bceeda25ad013973/html5/thumbnails/38.jpg)
KEYS TO MORE EFFECTIVE FX
RISK MANAGEMENT
• Choose the Appropriate Market
Analysis Techniques
• Understand Internal Company
Dynamics and Requirements
• Educate Internally and Externally