Treasury and Risk Management of Swiss Franc †MyAssignmenthelp.com

Questions: 1. Identifying the reason for de-pegging of Franc and stating the hedging strategies implemented by Swiss exporters? 2. Calculating the dollar cash flow from each strategy and detecting their risk? 3. Depicting the most optimal hedge for ABC? Answers: The main reason behind the unpegging of Swiss franc is due to the decisions made by SNB is controlling the valuation of franc, which was rising due to continuous buying of the currency. The franc was mainly pegged with Euro, where SNB increased the supply of franc, which was used in buying the euro and reducing the actual valuation of franc. The pegging was conducted for reducing the franc value against other currencies, as exporters were having trouble selling their products internationally. The Swiss economy is mainly based on exporters, where rising valuation of Swiss franc was hammering progress of the economy. The SNB aimed in depreciating the Swiss franc by accumulating Euro and increasing the flow of franc in the currency market. Bessis (2015) stated that with relevant measure countries can control their currency valuation, which might help in improving the total GDP value. Moreover, the main problems started, when Euro value stated to depreciate against major currencies, which in turn declined value of franc, due to high accumulation of Euro currency by SNB. The value of Euro mainly depreciated by 10% to 12% against US dollar, which devalued franc in the currency market (The Economist 2018). In addition, motive of the SNB was fulfilled when euro stated to depreciate and they did not want any further devaluation of their currency, which led to the de-pegging of Swiss Franc. Approximately 480 billion of Euro currency was accumulated by SNB, which relevantly declined the valuation of Swiss Franc. This increment in foreign currency reserve is directly increasing the chance of hyperinflation due to the increase in supply of domestic currency. On the other hand, Chance and Brooks (2015) criticises that the control of currency was previously conducted by Asian countries, which resulted in the occurrence of Asian financial crisis. Moreover, the measure used by European central bank initiated a decline in euro, which resulted in the devaluation of Swiss Franc. In addition, the overall measure used the European bank resulted in printing more currency, which in turn increased the supply of Swiss franc to continue with pegging. However, the motive of SNB was to reduce the valuation Swiss Franc for supporting their exports, which was being fulfilled by the continuous devaluation of Euro (The Economist 2018). Therefore, the increment in printing of more France needs to be conducted by SNB for maintaining the pegging programs, which was resulting in hyperinflation in their country. Hence, it became the main reason behind the discontinuation of pegging, which was conducted by SNB for devaluating Swiss Franc. In this context, Hopkin (2017) mentioned that countries and government cannot control the impossible trinity, which lead to the augmentation of financial crisis. The above-mentioned reasons are the longing point, which forced SNB to unpegged the franc that was continuously being devaluated in comparison with other countries. The intervention of the government in controlling the rising currency valuation made a drastic decline in Swiss Capital market after the announcement of unpegging conducted by SNB. The swiss stock market collapsed, while the currency value of Franc went from 1.2 to 0.8 in in comparison with USD (The Economist 2018). The Swiss exporters seeing the devaluation of Franc could hedge their exposure in the international market for controlling their loss incurred from current exchange. In addition, the exporters of Switzerland could effectively use option hedging strategy for controlling their losses incurred from devaluation of their currency. In addition, the use of call option could allow exporters in Switzerland to curb the devaluation of franc in comparison to other currencies. In this context, DeAngelo and Stulz (2015) mentioned that the use of hedging process allows investor to reduce the risk from volatile currency and capital market. The sue of call option might help in curbing the exposure of rising currency value. Moreover, the money market hedge could reduce the negative impact of currency valuation, as it could allow the exporters to conduct the trade on similar date and nullify the impact of volatile currency market. This above measure could be used by exporters in Switzerland for curbing the losses, which might incur from currency exchange. In addition, the other form of over the counter hedging strategies could also be used by exporters such as forward rate contracts and fixed value contracts, which could help in reducing the losses from current exchange. Moreover, Alamgir (2015) stated that risk exposure of the exporters could be reduced by using alternative measures, which might support in maintaining the level of profits. On the contrary, Sadgrove (2016) argued that rising volatility in currency market might reduce profits of the exporter, while decline their actual revenue from trade. 2. Calculating the dollar cash flow from each strategy and detecting their risk: Particulars Amount Rate Payment in 1 year 50,000,000.0 Up-Probability $ 60,000,000.0 $ 1.200 Down-Probability $ 40,000,000.0 $ 0.800 Strategy (Un-Hedge) Value Value Payment in 1 year 50,000,000 Spot rate $ 1.100 $ 55,000,000.0 Up-Probability $ 1.200 $ 60,000,000.0 Un-Hedged (Loss) $ 0.100 $ 5,000,000.0 Down-Probability $ 0.800 $ 40,000,000.0 Un-Hedged (Profit) $ 0.300 $ 15,000,000.0 Strategy (Forward hedge) Value Value Payment in 1 year 50,000,000.0 Spot rate $ 1.100 $ 55,000,000.0 Forward rate $ 1.130 $ 56,500,000.0 Up-Probability $ 1.200 $ 60,000,000.0 Hedge (Loss) $ 0.070 $ 3,500,000.0 Down-Probability $ 0.800 $ 40,000,000.0 Hedge (Profit) $ 0.030 $ 16,500,000.0 Strategy (Money market hedge) Value Value Payment in 1 year 50,000,000.0 Interest in Euro 2.000% 1,000,000.0 Amount in euros borrowed 49,000,000.0 Spot rate $ 1.100 $ 53,900,000.0 interest in US 5.500% $ 2,964,500.0 Total payment received in 1 yr $ 56,864,500.0 Up-Probability $ 1.200 $ 60,000,000.0 Hedge (Loss) $ 3,135,500.0 Down-Probability $ 0.800 $ 40,000,000.0 Hedge (Profit) $ 16,864,500.0 Strategy (Option Hedge Put Option) Value Value Payment in 1 year 50,000,000.0 Put option 1.110 Exercise price 0.060 Total value of put option 1.050 $ 52,500,000.0 Up-Probability $ 1.200 $ 60,000,000.0 Hedge (Loss) $ 0.150 $ 7,500,000.0 Down-Probability $ 0.800 $ 40,000,000.0 Hedge (Profit) $ 0.250 $ 12,500,000.0 Strategy (Option Hedge Call Option) Value Value Payment in 1 year 50,000,000.0 Cal option 1.150 Exercise price 0.080 Total value of put option 1.070 $ 53,500,000.0 Up-Probability $ 1.200 $ 60,000,000.0 Hedge (Loss) $ 0.130 $ 6,500,000.0 Down-Probability $ 0.800 $ 40,000,000.0 Hedge (Profit) $ 0.270 $ 13,500,000.0 The table indicates overall risk and cash flow that is generated from the hedging strategy. Moreover, the evaluation of calculation indicates that unhedged strategy has the highest risk involved from investment, as the company does not know about the actual payment, which will be reduced over the period of one year. Furthermore, the risk reduction is conducted by reducing adequate hedging strategies, such as forward strategy, money market strategy and option strategy (Brooks 2015). 3. Depicting the most optimal hedge for ABC: Hedging Strategies Profit from strategy Loss from strategy Strategy (Un-Hedge) $ 15,000,000.0 $ 5,000,000.0 Strategy (Forward hedge) $ 16,500,000.0 $ 3,500,000.0 Strategy (Money market hedge) $ 16,864,500.0 $ 3,135,500.0 Strategy (Option Hedge Put Option) $ 12,500,000.0 $ 7,500,000.0 Strategy (Option Hedge Call Option) $ 13,500,000.0 $ 6,500,000.0 From the overall evaluation money market hedge is identified to be the most viable option for hedging the risk, as the loss is lowest, while the gain from hedging is highest. Therefore, ABC company should conduct money market hedge to reduce the risk from investment, which might incur in one-year period (Evans et al. 2016). References Alamgir, M., 2015. Treasury Operations of Banks in Bangladesh: Issues and Challenges.MERC Globals International Journal of Social Science Management,2(2), pp.96-118. Bakke, T.E., Mahmudi, H., Fernando, C.S. and Salas, J.M., 2016. The causal effect of option pay on corporate risk management.Journal of Financial Economics,120(3), pp.623-643. Bessis, J., 2015.Risk management in banking. John Wiley Sons. Brooks, R., 2015.Financial management: core concepts. Pearson. Chance, D.M. and Brooks, R., 2015.Introduction to derivatives and risk management. Cengage Learning. DeAngelo, H. and Stulz, R.M., 2015. Liquid-claim production, risk management, and bank capital structure: Why high leverage is optimal for banks.Journal of Financial Economics,116(2), pp.219-236. 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. Hopkin, P., 2017.Fundamentals of risk management: understanding, evaluating and implementing effective risk management. Kogan Page Publishers. Sadgrove, K., 2016.The complete guide to business risk management. Routledge. The Economist. (2018).Why the Swiss unpegged the franc. [online] Available at: https://www.economist.com/blogs/economist-explains/2015/01/economist-explains-13 [Accessed 23 Mar. 2018].