Copyright© JSE Limited 2008

www.jse.co.za

Currency Derivatives Presentation

Warren GeersGeneral Manager: Bonds and Financial Derivatives Division

January 2014

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Copyright© JSE Limited 2008

www.jse.co.za

www.jse.co.za

Structure:

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Johannesburg Stock Exchange

Equity Market

Equity Derivatives

IRC Market

CommodityDerivatives

Currency Derivatives- Futures- Options- Anyday Expiries- Cando’s- Index (RAIN)

Interest Rate Products

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What is a Currency:

It is the Rate of Exchange between two currencies

I.e. $/R10.27 or €/R13.19• You will pay R10.27 for every one $ and R13.19 for every one € purchased

• Similar to paying R526.00 for 1 SAB Miller Share

The exchange rates quoted on the TV, radio and in newspapers say $/R10.27, 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 rate to the public:• Example Rennies will buy Dollars at 10.03 and sell Dollars at 10.27

• The difference of 0.24 cents is known as the spread

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What are Currency Futures:

Contracts that allow investors to trade an exchange rate for sometime into the future

A futures contract gives the buyer exposure to the underlying asset immediately but only has to pay a deposit as opposed to the full value of the transaction.  If the buyer keeps the contract until its expiry date, only then will the full value of the transaction have to be funded by the purchaser

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 R10.00 to R10.50 (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 R10.20 to R10.00 (generally exporters)

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Why use Currency Futures and Options:

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

No credit lines required from Banks

Cost effective

Access to wholesale corporate rates

No counterparty risk

Deep liquidity in the foreign underlying instrument

Hedge to a specific date (as required)

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Differences between Currency Futures & Forward Contracts:

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Currency Futures Currency ForwardsHedging Instrument Yes YesDerivative Instrument Yes YesCredit Risk No YesPhysical Delivery No YesWholesale Exchange Rate Yes YesActive deep & liquid market Yes YesStandardised Product Yes NoAny day expiry (non-standardised) Yes YesCost Effective Yes Depends on credit?? Gearing Yes NoRequire credit lines from the bank No YesSpeculation Yes No

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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 at any time without penalties

No obligation to deliver Forex (unless explicitly required)

No SARB approval required

No firm and ascertainable commitment (paperwork) required to enter/exit a trade

Have a daily view on profit/loss of the hedge

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How are Currency Futures Priced:

What makes up the price of a Currency Future (Forward)?

= Spot price + forward points

• Spot price e.g. $/R10.3425 (bid) / $/R10.3435 (offer)

• Forward points (interest rate differential between today and expiry date)

• 300 points bid / 350 points offer

Future price is 10.3725 (bid) / 10.3785 (offer)

• (10.3425 + 0.0300) (10.3435 + 0.0350)

On the exchange we quote and trade the expiry date so the price will always include the forward points

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Mark-to-Market and Expiry

Daily Mark-to-Market with daily physical cash flow

MTM Spot – Last 5 Minutes Arithmetic Average + Forward points

Standard Contracts Expiry: March, June, September and December

Any-Day Expiry: Select a date

ZAR Settlement at Expiry

Can roll to any future expiry (Only pay fees on the next leg and not the exit leg)

Brokers/Banks can arrange to swap the future for physical without unknown extra spread points

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What are Currency Futures and Options 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

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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:

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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

Eliminates Counterparty Risk, thus no risk premium in hedge

Interest On Margin = 4.922% (19 November 2013)

Margin correlated to option moneyness

The initial margin requirement varies between the different currency futures offered due to different volatility on the different currencies

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November 2013 Initial Margin Requirements:

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Contract Code Expiry Date Fixed Margin Spread Margin VSR Series Spread Margin

ZAUS 2014/03/17 455 25 2.50 180

ZAUS 2014/06/13 460 25 2.50 180

ZAUS 2014/09/15 465 25 2.50 180

ZAUS 2014/12/12 475 25 2.50 180

ZAUS 2015/03/16 480 25 2.50 180

ZAUS 2015/06/15 490 25 2.50 180

ZAUS 2015/12/14 510 25 2.50 180

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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

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Hedging Example: Importing

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Company ABC importing goods to the value of $100,000, has to buy $100,000 @ 10.37

Therefore their exposure is R1,037,000

Importer wants to know their landed cost, and eliminate any currency risk

Therefore need to buy 100 Currency Futures contracts

Deposit R43,500 only for the initial margin (100 x R435)

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Hedging Example: Cont.

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Day 1 (Trade Day - close)

Day 2 Month 3 Month 4 Day of expiry Day

Currency future trade price

R10.37 R0 R0 R0 R10.58

Initial Margin per contract

(R43 500) (R435 x 100)

R0 R0 R0 R43 500

MTM price (closing price)

R10.40 R10.45 R10.42 R10.50 n/a

Profit/Loss for the day

R3 000 (10.40 – 10.37 x 100 x 1000)

R5 000 (10.45 – 10.40 x 100 x 1000)

(R3 000) (10.42 – 10.45 x 100 x 1000)

R8 000 (10.50 – 10.42 x 100 x 1000)

R8 000 (10.58– 10.50 x 100 x 1000)

Net cash in/(out) for the day

(R40 500) (-43 500 + 3 000)

R5 000 (R3 000) R8 000 R51 500 (43 500 + 8 000)

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Hedging Example:Summary of cash flow:

Variation Margin: R21,000 Profit

(+R3,000 + R5,000 – R3,000 + R8,000 + R8,000)

• Use the profit from the currency future to off-set the increase in the Dollar exchange rate

• Spot moved from 10.30 to 10.58 (expiry date) Loss of R28,000• Future moved from 10.37 to 10.58 (expiry date) Profit of R21,000• Net difference between spot and future is R7,000 (the 700 forward points) and this is the

interest rate differential that was bought at day one

• Importer will buy the physical $100 000 from the bank at an effective rate of 10.37 – R1,037,000

• 12.1% return on deposit (Investment) (21,000/43,500)*100 (Over a standard 3 month contract)

• Currency (Spot) depreciated by 2.7%

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Hedging Example:

Summary of cash flow:

Initial Margin: R0 (-R43,500 + R43,500)

• Always returned to the investor

• Money on deposit earns overnight deposit rate @ 4.922% (19 November 2013)

• 23 times gearing (R435 deposit per R10,370)

• If the dollar had weakened against the rand (i.e. moved from R10.37 downwards to R10.00) then the importer would merely pay R1,000,000

• But the loss on the futures would have been offset by the gain in the spot price

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Risks:

Gearing• Post small amount but valued on full nominal value

• Businesses with severe cash flow constraints will need to understand the impact of the daily cash margining process of variation margining.

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Currency contracts listed :Dollar/Rand

Euro/Rand

Pound/Rand

Australian Dollar/Rand

Japanese Yen/Rand

Canadian Dollar/Rand

Swiss Franc/Rand

Chinese Renminbi/Rand

Botswana Pula/Rand

New Zealand Dollar/Rand

Turkish Lira/Rand

Rand Index (RAIN)

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• 4 Market Makers quoting live prices:

• Best bid/offer market spread 0.0041 cents,

Live currency pricing as per 13th November 2013

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Example of a Zero-sum game: For every winner there is an equal loser

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Currency Derivatives Statistics since inception (June 2007) to December 2013:

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Currency Futures Statistics: Jan – Dec 2012 compared to Jan – Dec 2013

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Currency Options Statistics: Jan – Dec 2012 compared to Jan – Dec 2013

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