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Chapter 44 Entering the Family of Derivative Financial Instruments (3)
Exchange rate risk is a problem that any economic entity or individual has to face in foreign-related economic activities.Due to changes in foreign exchange rates, the value of assets or liabilities denominated in foreign currencies will undergo uncertain changes, thereby causing the owner to suffer economic losses.It includes trade exchange rate risk and financial exchange rate risk.

Generally, in international financial activities, special attention should be paid to avoiding trade risks.

Forward contract hedging is a powerful way to avoid trade-related foreign exchange risks.

When a multinational company uses the currency of its main trading country as a means of payment, the multinational company signs a contract with the other party, agreeing that on a certain future date, the company will pay it an agreed amount of currency to obtain another forward payment of the agreed amount Currency (means of payment), this is forward hedging.

The vast majority of forward hedging contracts are signed between the company and the company's account bank or other banks.Moreover, the term of the contract between the company and the bank is not limited to 1 month, 3 months and 6 months in the quotation.Although forward hedging with a maturity of more than 1 year is rare, the two parties can agree on any time period.

Suppose a Chinese multinational company opens a subsidiary in the United States, and the Chinese company's US subsidiary sells $100 million worth of goods to a Norwegian importer.The exchange rate on the day when the goods are sold is NOK 9 to US$1 (NK9=US$1), so the total payment for the goods is NOK 900 million.The two parties agreed that within 180 days, the importer should pay NOK 900 million to the exporter.The Chinese exporter in the US now bears any risk of any change in the exchange rate of the dollar against the krona.If NOK depreciates, say 11 NOK to 1 US dollar, then during this 180-day period, when the exporter receives the 900 million NOK, it is only equivalent to 818181 US dollars.However, the expectation of the Chinese exporter was to receive US$100 million, and the exchange rate change caused a loss of US$181819.

The Chinese exporter in the United States can use the forward contract to protect itself from such losses, that is, within 180 days, pay NOK 900 million to the other party of the hedging contract, and at the same time, the other party agrees to export to China The vendor paid $100 million in exchange.The actual amount paid by the counterparty to the Chinese exporter is generally less than US$100 million, because the krona may depreciate within 180 days, and the contract counterparty will therefore demand risk compensation.Assuming that the other party asks for 1% compensation and the Chinese exporter agrees, this 1% means 1 US dollars, so the other party only pays 990000 US dollars in exchange for 900 million kroner from the Chinese exporter.Compared with the above-mentioned depreciation of the krona, the Chinese exporter only received US$818181, and the loss of the company was reduced by US$171819.

Therefore, the US$1 can be considered as an insurance premium paid by the Chinese exporter to ensure that the US dollar amount is actually received within the 180 days.Of course, in making this decision, the Chinese exporter has to weigh whether the $990000 is an acceptable price for the goods being sold.As with other prices in the free market, there are no laws or regulations stating that 1% or $1 is the cost of hedging this $100 million.

In our example, a competent financial manager of the exporter will compare the various banks and find a cheaper price to trade with.The NOK is not traded on the CME International Currency Market.

If the currency used for payment is one of the 8 transaction currencies out there i.e. UK Pound, Canadian Dollar, Deutsche Mark, Guilder, French Franc, Japanese Yen, Mexican Peso, Swiss Franc, then the financial manager should also get an international currency Quotations for market (IMM) contracts.

Option, let him become a rich man from a "ironer"

More than ten years ago, Randall was a clothes ironer at Microsoft. "At that time, I hated my boss Bill Gates to death. He always gave me some options instead of real money. ". In 1987, when Gates distributed stock options to all regular employees of Microsoft, the American people hardly knew what stock options were.Randall stuffed the options he had received into a drawer in the office casually, and worked diligently at Microsoft for another ten years. "One day, I suddenly discovered that the thousands of stock options I owned brought me countless money."

In 1986, when Microsoft was listed on Nasdaq, the stock price was only 10 cents per share.By 1999, with the Internet frenzy, Microsoft's stock price soared to $59.56 per share, and this price was the result of multiple stock splits.Randall recalled that when the stock index was soaring, everyone at Microsoft installed the blank spreadsheet program on their computers. There was a burst of ecstasy when I was counting the numbers, and these rising numbers mean that I will always be a rich man in my life."

With so much wealth, the 38-year-old Randall retired from Microsoft early. He bought a luxury apartment in downtown Seattle and arranged his life as he wanted every day.As long as he invests rationally, his money will never be spent in his life.

According to Dick Conway, an economist who specializes in consulting for Microsoft, by the end of 1999, 8000 Microsoft employees had earned a total of $80 billion from options, which was 9.9 times the total annual income of Boeing's 1.5 employees at the time!
What exactly are options?Why can a small ironer become a rich man overnight!
Option refers to the power that can be bought and sold in a certain period of time in the future. It is the right that the buyer pays to the seller after a certain amount of money (referred to as the premium) within a certain period of time in the future (referring to American options) or on a specific date in the future (referring to European options). The right to buy or sell a certain amount of a specific subject matter to the seller at a predetermined price (referring to the performance price), but there is no obligation to buy or sell.An option is the right to buy stocks at a fixed price within a specified period. When the stock price soars, this right can become a real benefit.

Options trading is in fact the trading of such rights.The buyer has the right to execute or not to execute, and can choose flexibly.Options are divided into off-exchange options and on-exchange options.OTC option transactions are generally reached jointly by both parties to the transaction.

Option is a financial instrument based on futures.In essence, the option is to separate the pricing of power and obligation in the financial field, so that the transferee of the power can exercise his power within the specified time whether to carry out the transaction, and the party with the obligation must fulfill it.In the transaction of options, the party who buys the option is called the buyer, and the party who sells the contract is called the seller; the buyer is the transferee of the power, and the seller is the person who must perform the obligation of the buyer to exercise the power.

There are both differences and connections between options trading and futures trading.The connection is: first, both are transactions characterized by the sale and purchase of forward standardized contracts; second, in terms of price relationship, the futures market price has an impact on the strike price of the option contract and the determination of the premium.Generally speaking, the finalized price of option trading is based on the delivery price of similar forward-selling commodities determined by the futures contract, and the difference between the two prices is an important basis for determining the premium; third, futures trading is an option trading The content of the basic transaction is generally the right to buy or sell a certain number of futures contracts.The more developed futures trading is, the more foundation there is for the development of option trading. Therefore, the mature futures market and complete rules have created conditions for the emergence and development of option trading.The emergence and development of option trading provides hedgers and speculators with more optional tools for futures trading, thereby expanding and enriching the trading content of the futures market; fourth, futures trading can be long and short, and traders Not necessarily physical delivery.Options trading can also be long or short, and the buyer does not have to actually exercise this right, as long as it is beneficial, he can also transfer this right.The seller does not necessarily have to perform, but can release him from the responsibility by buying the same option before the option buyer exercises his rights; Both parties will get corresponding futures positions.

Swap: an important tool to avoid interest rate risk
In order to avoid the capital loss caused by the fluctuation of interest rate, among various derivative financial instruments, interest rate swap is produced, which is an important tool to effectively avoid interest rate risk.

2008年，银行间市场人民币利率互换成交额创出历年新高。2006年2月10日至当年末，人民币利率互换共成交339.7亿元，2007年则迅速增加至2168.4亿元，是2006年的6.38倍，2008年成交量继续迅猛增加到4000亿元以上。

From January to April 2008, interest rate swaps showed a continuous downward trend, which reflected that the market liquidity was relatively abundant.However, since the middle and late July, due to the economic downturn, market expectations have reversed, and interest rate swaps have continued to fall sharply, and fell at the end of the year. to less than 1%.

It can be seen from this that the trading volume of interest rate swaps is high under the situation of hot investment and tight liquidity.This just reflects its role in avoiding risks.Economists said that interest rate swaps have grown into an important financial derivative product in my country, making important contributions to institutions hedging interest rate risks, enriching investment portfolios, grasping market expectations, and improving profitability.Some cross-border institutions have also realized risk transfer, position balancing and arbitrage operations through the overseas non-deliverable interest rate swap market.

Under normal circumstances, the interest rate swap transaction shows that the circulating funds are relatively abundant and thick, which is because the investment risk is relatively small.Interest rate swap refers to a financial contract in which the parties to the transaction agree to exchange interest amounts based on the agreed amount of nominal principal in the same currency within a certain period of time in the future.What is exchanged is only the interest of different characteristics, and there is no exchange of actual principal.Interest rate swaps can take many forms. The most common interest rate swap is to switch between fixed and floating rates.

At present, my country's application is the simplest swap between fixed interest rate and floating interest rate.Its function is:

1. Reduce financing costs.Financial swaps aim to use the principle of comparative advantage to reduce financing costs.For example, in currency swaps, borrowers can take advantage of their own advantages to borrow currencies with lower interest rates and then exchange them for the desired currency; in interest rate swaps, customers can obtain fixed or floating interest rates lower than the market loan.

2. Avoid risks.At present, the capital market is mainly faced with exchange rate risk and interest rate risk, and financial swap is an important tool to avoid exchange rate risk and interest rate risk.If interest rates are expected to rise, in order to avoid the loss of increased financing costs caused by the rise in interest rates, the transaction party of floating rate liabilities can swap with a fixed rate trader with the same amount of liabilities, and the received floating rate is offset against the original liability , and only pay fixed interest rates, so as to avoid the risk of increasing financing costs caused by rising interest rates.Similarly, for borrowers with fixed interest rates, if interest rates are expected to fall, in order to enjoy the benefits of lower financing costs brought about by lower interest rates, they can also convert fixed interest rates to floating interest rates.

3. Promote the optimal combination of different financial instruments.In the entire financial market, there are various differences, such as differences in issuance forms, differences in credit ratings of market participants, and differences in market access qualifications. There is room for development.Financial institutions rely on increasingly rich financial products to provide intermediary services. The purpose is to create a financing space without differences and eliminate small continuity in financial transactions.

In essence, swap is to use various characteristics of different financing instruments to exchange.Currency swap bypasses the difference between the denominations of the two currencies by exchanging one currency liability for another; similarly exchanging floating-rate liabilities for fixed-rate liabilities is equivalent to raising funds in the floating-rate bond market. The benefit of the fixed-rate bond market eliminates the difference between fixed-rate bonds and floating-rate bonds; for institutions, since credit rating differences are restricted by entering a specific market, they can obtain higher credit rating requirements through swaps The same opportunity in the market, thus eliminating the market differences caused by different credit levels.It can be seen that swap transactions have the obvious ability to recombine different differences in financing instruments.

(End of this chapter)