Currency

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Currency

The Swiss Franc (CHF) is the official currency for Liechtenstein and Switzerland. It is also widely used in Büsingen, the German exclave. The currency is distributed by the Swiss National Bank and the following table illustrates the basic exchange rates for Swiss Franc and other currencies.

  Euro US Dollar GB Pound Australian Dollar Canadian

Dollar

Indian Rupee Emirati Dirham Chinese Yuan Malaysian Ringgit

 

1 CHF 0.8112 1.0772 0.6885 1.127 1.095 62.27 3.957 6.609 3.3748

Exchange Rate: Swiss Franc per one US Dollar (12/6/2013)

 

 

 

Exchange Rate: Swiss Franc per one GB Pound (12/6/2013)

Causes of Daily Exchange Rate Fluctuations

While it is common for free-floating exchange rates to rise and fall with time, several factors are at hand that serves to influence the extent of these changes. Bilateral transactions and currency exchanges show the largest changes within the money market when compared to measures of effective exchange rates. This refers to the rate of exchange for one currency against a collection of currencies for other states often assessed according to the level of transactions done with each nation. It is imperative to acknowledge that these changes in the exchange rates are predominantly caused by fluctuations in the supply and demand of a particular currency in the FOREX. When more people demand a certain currency, its exchange rate will rise. Conversely, when supple surpasses demand, the reverse holds true and the exchange rate drops.

Inflation is a major determinant of the level of exchange rates for any currency. If inflation in Switzerland is comparatively lower than in other nations, then Switzerland exports become more valuable and the demand for Swiss Francs will increase to purchase Swiss products. In addition, foreign commodities become less valuable and so Swiss consumers purchase less imports. Consequently, states with lower inflation rates are inclined to experience higher value in their currency. Differentials in inflation complicate the situation. Differentials refer to the separate inflation status of different countries. For over the last five years, Switzerland, Germany and Japan have experienced low inflation levels while Canada and the United States have experienced high inflation rates.

Differentials in interest rates also affected the exchange rates within Switzerland. Exchange rates, inflation and interest rates are all closely interrelated. By maneuvering the interest rates, Switzerland Central Bank exerted influence over both exchange rates and inflation, and influencing these interest rates affected the Swiss Franc values. The higher interest rates provide lenders increased profits when compared to other states. Consequently, the Swiss higher interest rates catch the attention of foreign investment cause the exchange rate to get higher. The impact of higher interest rates was limited, however, when inflation in Switzerland was much higher than in her trade partners, or when other aspects constrained the Swiss Franc. The reverse behavior was also witnessed when the declining interest rates lowered the exchange rates.

Hedging Foreign Exchange Risk

There are several assumptions that will be made throughout the calculations:

  1. All transactions are done in US Dollars ($) and Swiss Francs (CHF)
  2. Al the dates used will represent the latest figures unless otherwise indicated.
  3. All percentages and rates used represent the current market rates being used from the different sources.
  1. Currency Futures

June CHF futures contract exchange rate on June 12, 2013= $ 1.08 /CHF

One CHF futures contract= CHF 125,000; expiration month of futures contract= June 2013

  1. Currency Option

Strike exchange rate for call or put on CHF  =$1.08 /CHF ; Expiration month= June 2012;

Call premium =$0.0063/CHF  (0.63 cents); put premium = $0.0090/CHF ;

One option contract = CHF 62,500;

  1. Money Market Interest Rates

Annualized 180-day U.S. deposit rate =5.50%; annualized 180-day U.S. borrowing rate=5.75%;

Annualized 180-day Swiss deposit rate= 5.65%; annualized 180-day Swiss borrowing rate=5.85%; current spot $/CHF  (Rate as at June 12, 2013)=$0.9259.

The amount of US$ required for the futures (forward) hedge and money market hedge to realize CHF  625,000 in 180 days will be assured. Nonetheless, the US$ required for the option hedge will be influenced by the provisions in the option that can allow it to be exercised in the span of 180 days. This in turn depends on the spot exchange rate on the termination date in June 2013.

It is assumed that the actual $/CHF spot exchange rate as at June 12, 2013 was $0.9259.

  1. Cost of Futures Hedge

Amount of US$ required in 180 days = amount of futures contracts ´ CHF  125,000 ´ futures rate

= 5 ´ CHF  125,000 ´ $1.08 = $675,000

  1. Option Hedge

Total option premium ($)= number of option contracts ´ CHF  62,500 ´ call premium/CHF

= 10 ´ CHF  62,500 ´$0.0063=$3937.5

Option will be exercised since the exercise rate ($0.74) is smaller than the spot rate ($0.9259).

Total exercise price paid ($) = CHF  625,000  ´ $0.74= $462,500

Total payment in dollars to get CHF  625,000 = $3937.5 + $462,500 = $466, 437.5

  1. Money Market Hedge

Borrow the PV of CHF 625,000 in dollars on December 12, 2013; convert $ to CHF at the spot exchange rate; invest CHF  in the Swiss market for 180 days; and repay the $ loan in 180 days.

PV of CHF 625,000 on Dec. 12, 2013= (CHF  625,000/1.02825)=CHF 607,828.83

Borrow CHF 607,828.83 in dollars for 180 days:  CHF 607,828.83 ´ $0.9259=$562,788.713697

Convert $562,788.713697 to CHF @ $0.9259/CHF: CHF 607,828.83

Invest CHF 607,828.83 @ 2.825% for 180 days: CHF 607,828.83 ´1.02825=CHF 625,000

Repay $ loan @ 2.8750% in 180 days: $436,238.75 ´ 1.028750=$448,779.84

Total cost of money market hedge=$448,779.84

  1. No Hedge Situation

CHF 625,000 ´ 0.9259= $578687.5

Summary of Three Hedging Options

Cost of futures hedge = $449,375

Cost of money market hedge = $448,779.84

Cost of option hedge = $3937.5 +$406,250= $410,187.50.

Cost with no hedge = $406,250

            From the above analysis, it is evident that the costs of the money market hedge and hat of the futures hedge are almost similar. However, the option hedge was slightly lower making it the ideal alternative. The other reason for this choice is that

In the comparison of a hedged position to that which is unhedged, the company should definitely hedge their investment. This is because the fluctuations that have been illustrated in the earlier analysis of the international exchange rates between the Swiss Franc and the American Dollar

 

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