Treasury and Management Asia Marketing

Question: Discuss about the Treasury and Management for Asia Marketing. Answer: 1- Futures Hedging In this section/ assignment, the futures hedging concept is discussed and understood with the help of an example. Given, Liquid X is an alternative energy source used by a company. The prices of Liquid X fluctuates with the changes in the prices of oil and change in price of Liquid X will incur huge losses to the company @ $500,000 for each 1 cent increase in the price per gallon of Liquid X. As a hedging strategy, the company uses gasolines futures to hedge its exposure to Liquid X which maintains 0.7 correlations with gasoline futures. Given, Liquid X has a standard deviation of 50% higher than gasoline futures price changes, each future contract to have 40000 gallons, increase in Liquid X is at 2% from $2.5 per gallon, and the following questions answers are as below: What should be the hedge ratio in the use of gasoline futures to hedge its exposure? Hedge ratio is defined as the size of future contracts in relative to the spot price elements. It is formulated as: where, is the correlation coefficient between the spot price element and the future contract element ; s is the standard deviation of spot price element; and F is the standard deviation of future contract. (DAHL, NA) Given standard deviation of Liquid X is 50% greater than the gasoline futures, Thus, correlation noted to be at 0.7, the hedge ratio is computed as below: h = 0.7 x 1.5 = 1.05 Thus the hedge ratio is computed to be 1.05 with the given details to hedge the risk involved with Liquid X with the help of gasoline futures. This hedge ratio helps in determining the optimal number of future contracts to be purchased to hedge the companys exposure to Liquid X and further related questions are discussed below. What is the company's exposure measured in gallons of Liquid X? Given, companys exposure to risk is the loss of $ 500,000 per 1 cent increase in Liquid X per gallon of Liquid X. This implies, per 1 cent increase in the price of 1 gallon of Liquid X, the loss is $ 500,000. Thus no of gallons of Liquid X exposed for 1$ increase at the cost of 1$ per gallon is 500,000x100 = 50,000,000 gallons. What position measured in gallons, what is the type of position should the company take in gasoline futures to hedge its exposure? As the prices are subject to rise, the company should take long position to buy Liquid X at predetermined price. (NYU, NA) (Montana, NA) The position company should enter with gasoline futures to hedge its exposure is equivalent to product of Hedge Ratio and the no of gallons of Liquid X. That is, 1.05 x 50,000,000 = 52,500,000 gallons of Gasoline futures. How many gasoline futures contracts should be traded in this hedging strategy? As mentioned above, optimal number of futures contracts equal to optimal hedge ratio multiplied by the no of future contracts corresponding to the risk of no of gallons of Liquid X exposed. Also, given each future contract has 40000 gallons, the optimal future contracts are computed as: Optimal # of future contracts = Hedge Ratio x (no of gallons of Liquid X no of gallons per contract) = 1.05 x 50,000,000/40000 = 1.05x1250 = 1312.5 Thus rounding off, 1313 number of 40000 gallon each future contract to be traded for hedging. After two months, what are the gain/loss in the spot market and the trading gain/loss on the futures contracts in part d? The trading gain/ loss on futures contract is calculated by checking the difference between the costs incurred at spot price and the future contract price. If the spot price is higher than the future contracted price in long position, then the company gains from the trading contract else it loses. That is, when the spot price is higher than the future contract price in long position, the company is able to buy at a lesser price than market spot price leading to gains while if the spot price is lesser than the future contract price, the company does not execute the future price and hence buys at market at smaller price thus hedging the risk involved. (Giddy, NA) Given, after two month the spot price of Liquid X has gone up by 2% from $ 2.5 per gallon, The spot price of Liquid X after two months = 2.5 x (1+2%) = $ 2.55 If the company buys from spot market the cost of position of 52,500,000 gallons taken is = 52500000 x 2.55 = $ 133,875,000 As the spot price in market has increased, it is advised to execute the future contracts. Executing the futures, the company would be able to purchase @ $ 2.5 per gallon and hence incur only cost of = 52500000 x 2.5 = $ 131,250,000 Thus the loss saved by the company or the profit gained by the company is = 133,875,000 131,250,000 = $ 2,625,000 In long position that is to buy shares, a future contract is only executed if the spot price is higher than the contract price (Chris Hurt, 2002) and thus in this case executing the contract would save a profit of $ 2.625 million. 2. This section of the report discusses about the interest rates fluctuations in United States and their impact on capital movements, Asian currencies and global economic growth. Asian and emerging economies are generally affected adverse during a tightening cycle in the United States monetary policy as they reduce the aggregate demand in these nations in different means. This adverse impact on the emerging economies has been observed historically. Increase in interest rates in the United States would increase the yields on the assets of the United States and thus would have negative impact on the other international cash flows. Along with affecting the cash flows, they also increase the cost of capital on domestic products as well leading to reduction in consumption. With the increase in interest rate, the dollar will continue to pump up and thus decreasing the values of currencies of other emerging economies leading to fall of international liquidity position resulting in market volatility especially in emerging markets. Thus overall increase in interest rate in the United States would lead to higher risk premiums and thus higher cost of capitals causing re duction in the GDP growth and decrease in the economic growth. (Warnock, 2006) It is observed and understood that the Asian economies have been under high foreign direct investments as shown below. The data above corresponds to 2012 and 2013. The data represents Foreign Direct Investment (FDI) cash flows of Chinese, Japanese, Singaporean and Indian economies. They are the top Asian nations which are noted to have high foreign direct investment flows. The Asian major, China has got the highest Foreign Direct Investment (FDI) noted at 120 billion USD above as on 2012-13 followed by Hong Kong at 78 billion USD. The Singaporean economy has been recorded to have 50 billion USD. Rest of the economies like India, Indonesia, Thailand, Malaysia, Korea, Vietnam and Taiwan are on the smaller exposure with the range varying from 5 billion to 30 billion USD under Foreign Direct Investment. Having such high exposure to the foreign investments, a smaller fluctuation in interest rate via cost of capital will have adverse impact on the growing economies of Asia as their cash flows are affected indirectly leading to financial crunches and strains. If the United states increase the interest rates these investments would strongly affect the Asian economies as these international capital flows would seek higher yields as they would be making better returns on lesser risky assets in United states with increased interest rate and thus would increase the cost of capital adversely affecting the domestic business. Thus, emerging economies like Asia and Middle East which actually do not form any homogenous groups has random affects due to increase in interest rates of the United States. These economies which are dependent on the foreign capital / investment are more vulnerable as compared to other economies. (Hwang, 2015) Along with affecting the foreign capital flows, increase in interest rates in the United States has been observed to be transmitted over the domestic interest rates as well. The trend has been studied internationally and is observed that higher interest rates of United States lead to exert downward pressure on the investments and consumptions, thus leading increase in domestic interest rates especially in developing economies. Raised interest rates increase the borrowing cost which would lead to increased debt service burden on the public and government sectors thus affecting all related services.(Acumen, NA) Asian economy also gets affected with its currency depreciation followed by increase in United States interest rates. The increase in interest rate would increase the potential for the United States assets and thus appreciates the United States Dollar (USD) and thus outflow from any local currency to USD would get affected at a higher exchange rate leading to local currency depreciation. The resultant increase in interest rates would affect the global consumptions as well due to increased costs and thus would lead to fall in demand for Asian exports. As has been discussed above, the increase in interest rate gets transmitted to domestic rates thus increasing the cost of products in these economies leading to decrease in demand of Asian exports. (Alpha Commentary, 2015) All these factors discussed above which include increased cost of capital, higher risk premium and volatility in the finances affect the economies of Asian nations especially those relied on foreign investments. This leads to loss of real income in these economies which result in reduction in the real GDP growth of the economies. Thus, Asian economies with nations having substantial budget with deficit in current account and high foreign investment flows, gets hit adversely with the change in interest rates as has been observed historically and thus having a prudential fiscal management would become the utmost important aspect to safeguard financial stability during the tightening cycle. (Park, 2014) Bibliography Acumen, NA. Whats the likely impact of rising US Interest rates. [Online] Available at: https://acumen.sg/whats-the-likely-impact-of-rising-us-interest-rates/ Alpha Commentary, 2015. US Fed rate hike: Mixed impact on Asia. Alpha Commentary. Chris Hurt, R. W., 2002. Principles of Hedging. NCH47. DAHL, NA. Optimal Hedge Ratio, s.l.: s.n. Giddy, P. l., NA. Futures, Forwards and Money Market Hedging. s.l., s.n. Hwang, G., 2015. How a Fed Rate Hike Will Affect Asias Markets. [Online] Available at: https://www.barrons.com/articles/how-a-fed-rate-hike-will-impact-asias-markets-1429865353 Montana, NA. Hedging Strategies using Futures and Options. Classnotes. NYU, NA. Risk Management- Profiling and Hedging. Stern. Park, C.-Y., 2014. Emerging Asia should brace for higher global interest rates. [Online] Available at: Emerging Asia should brace for higher global interest rates Warnock, F. E., 2006. International Capital Flows and Interest Rates. NATIONAL BUREAU OF ECONOMIC RESEARCH.