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forex project

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Bridget S

on 22 August 2014

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Transcript of forex project

RBS Foreign Exchange
By: James Byer, Bridget Stock, Mike Weber and Alexandra Burnett

USD/BRL Trade Proposal
Economic and Political Outlook in Brazil
- As economic growth is trending downward, inflationary pressures continue to rise

- An uncertain political system currently looms over Brazil; as the presidential election is set to begin October 5th

-USD/BRL has been depreciating in recent weeks.

- The elections in October move closer, uncertainty around Brazil's political system is driving investors away from the Real - further depreciating the currency.

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Implications of the upcoming election
Dilma Rousseff
Mariana Silva

Silva’s economic adviser, Eduardo Giannetti, said in a May interview Brazil needs to rein in spending and increase interest rates at the outset of the next government to help ease inflationary pressure.

Investors see Silva as a candidate who committed in 2010 to orthodox fiscal and monetary policy that she would leave in the hands of ministers with top-level expertise, Citigroup Inc. analyst Stephen H. Graham wrote in an Aug. 13 report.

Silva is slotted to win the election, after which analysts predict an appreciation of the Real.


S&P cut Brazil’s credit rating in March, citing sluggish economic growth and President Dilma Rousseff’s expansionary fiscal policies as reason for an increase in debt levels.
Rousseff's credibility was hurt by Brazil's inability to meet its fiscal targets, worrying investors that Brazil may not be able to even repeat last year's primary surplus of 1.9% of GDP, which was considered disappointing.
Going forward, analysts expect a selloff should Dilma win the election.
Risk Management
Counterparty risk is relatively low.
Sterling will likely depreciate against the dollar

Why?

1. Uncertainty surrounding Scottish Referendum in September

2. Popular notion suggesting GBP is overvalued

3. Bank of England sending mixed signals
Mansion House speech in June'14 where Mark Carney suggested rate hikes were possible as early as late Q4'14/Q1'15
Minutes from August BoE meeting reveal:
Mark Carney's emphasis on wage growth
Inflation rate drop to 1.6%
7 - 2 vote where majority voting to wait on rate hike, Martin Weale & Ian McAfferty maintain hawkish perspective

Who is the investor?
Why our product?
USD/BRL Trade
Assumption that Sterling will decrease in the short term is relatively reasonable
However, the date of the UK rate hike is particularly uncertain
If the BoE hikes rates in November,
British investor currently holding USD

Looking to maximize profits on USD in short term (cashing out in Q1'15)

Product could also be utilized by British investor looking to enter Cable market, long the USD at this time, increase returns and cash out quickly
What is the product?
A fixed income investment vehicle (bond) with a quarterly 4.8% coupon
In conjunction with a: protective call

Several bonds for client to choose from:
Options Pricing For Clientele
Jan. 1, 2015 Expiry:
ATM
eg. NP=£100mm = $165.96mm
~1.20% of NP =$1.991mm
forward (ITM) rate: 1.6581
breakeven: 1.6780
What are the risks?
For the Firm:
Depreciation of the Real
Trade 1: Buy October NDF
Profitability
Risk Management
Options Pricing for Clientele
Jan 1, 2015 Expiry: OTM
e.g. NP=£100mm = $165.95mm
~.99% of NP = $1.643mm
Forward (ITM) rate: 1.6650
breakeven rate: 1.6815
Option Pricing Summary

The implications of the Real's depreciation have not been terrible for Brazil, as a weaker currency has boosted exports and allowed Brazil to reduce its budget deficit (Currently US$9.2 billion)
- Multiple reports have indicated that as we get closer to the election, and media campaigns continue to circulate, the BCB will be more tolerant of currency weakness in order to save ammunition for after the elections.
- Allowing the Real to continue to depreciate will allow Brazil to further decrease the fiscal deficit. By doing so, they will help address an area that is extremely important in order avoid another credit downgrade.
- Although further depreciation may have an negative effect on inflation, the decisions behind inflation policy will not come until after the presidential election in October. Thus leaving Brazil with a few months to address the deficit.

- If given a notional principal of $1,000,000
-We expect an estimated profit in October of
$184,000 (i.e. (2.5000-2.3160) * 1,000,000) EDIT THIS


Hedging NDF Risk
To diversify the counter party risk associated with this trade, we will be engaging in NDF contracts with Citigroup and Deutsche Bank.
-By splitting our principal 50-50 between the two banks, we feel that risk will be reduced significantly
-As Citi and Deutsche Bank are the two biggest dealers in the FX market, we feel very comfortable with their ability to execute our contracts

New York-based asset management firm targeting high net worth individuals. It offers a wide range of outsourced/alternative investments


-To diversify the counterparty risk associated with this trade, we will be engaging in NDF contracts with Citigroup and Deutsche Bank.
-By splitting our principal 50-50 between the two banks, we feel that risk will be reduced significantly
-As Citi and Deutsche Bank are the two biggest dealers in the FX market, we feel very comfortable with their ability to execute our contracts
-As we expect depreciation to continue leading up to the election, this NDF will allow us to profit on the spread between 2.3160 and the USD/BRL spot price at that time.
-After researching various price forecasts at the end of Q3 - start of Q4, we expect the USD/BRL price to strengthen to the 2.5 price level
-This forecast is supported by RBS research and our FX strategy team
-If USD/BRL does strengthen to the price we have forecasted, we will be able to take advantage of a profitable spread of .184

Hedging NDF Risk
-To diversify the counter party risk associated with this trade, we will be engaging in NDF contracts with Citigroup and Deutsche Bank.
-By splitting our principal 50-50 between the two banks, we feel that risk will be reduced significantly
-As Citi and Deutsche Bank are the two biggest dealers in the FX market, we feel very comfortable with their ability to execute our contracts

Post-Election Appreciation of the Real
Trade 2:

Trade 2: Sell USD/Buy BRL

Target Client: Silvercrest Asset Management
BCB Mindset
Analyst expectations
Full transcript