MANAGING EXCHANGE AND GAP POSITIONS

MANAGING EXCHANGE AND GAP POSITIONS

MONITORING EXCHANGE POSITIONS

Net Open Position [NOP] states the net position of all FCY [in terms of USD] inflows and outflows. Both spot and
forward flows impact the NOP. Suppose you start the day with the following CCY in your NOP and the corresponding
SBP Revaluation Rates [end of day average rates] for the beginning of Day 1;

Figure 1:

Amount in
Amount In USD SBP Reval Effective
CCY CCY equivalent Rates Rates in PKR Cross Rates1
USD -300,000 -300,000 USD 60.20
Euro 50,000 60,216 Euro 72.50 1.2043
GBP 15,000 27,471 GBP 110.25 1.8314
CHF -25,000 -18,812 CHF 45.30 1.3289
-231,125

Hence you begin Day 1 with an NOP of USD 231,125. The figures corresponding to each CCY represents your
overbought [positive balance] or oversold [negative balance] in the same, and includes all previous forward and spot
transactions per CCY. You have the following transactions in Day 1;

1. Spot Import Payments of EUR 30,000 – Servier Pharmaceutical

2. Forward Import Booking of USD 150,000 – Atlas Honda
3. Export Payments of USD 250,000 – Khalid Nazir Spinning
4. Bought USD 500,000 – Soneri Bank

In order to see what impact will these transactions will have on your NOP, we will construct the FX Blotter;

Figure 2:

Opening -231,125
Today’s' Balance 332,875
SBP Reval Rates in Effective
Rates PKR Cross Rates
Purchases Sale USD 60.25
Euro 72.30 1.2000
Khalid Nazir 250,000 Servier Pharma 36,000 GBP 110.30 1.8307
Soneri Bank 500,000 Atlas Honda FW 150,000 CHF 45.15 1.3344

The rates appended with the blotter represent end of Day 1 revaluation rates provided by SBP. Please note that the
EUR amount is converted into equivalent USD amount and included in the blotter. The rate used is end of day
revaluations rate as that represents the average parity of EUR for the entire trading day.

1
Please note that the SBP only provides rates in terms of PKR, and we have calculated the Effective Cross Rates
based on the rates provided by the SBP.

Prepared by: Ayaz Sheikh 1

NIB Treasury
 MANAGING EXCHANGE AND GAP POSITIONS

Since we had EUR 50,000 in our beginning NOP, there may not be any need to buy EUR to cover our position. If we
did have to buy EUR against USD from the interbank, it would not affect our NOP because;

Figure 3:

NIB - FX Deal Ticket

Deal Date 8-Nov-04

Counterpart Mashreq Dubai

Purchase Rate Sale

EUR 30,000 1.2650 USD 37,950

Value 10-Nov-04 Value 10-Nov-04

As shown above, if we bought EUR 30,000 against USD, it would diminish out USD NOP by 37, 950 and in crease by
EUR NOP by 37,950 [EUR in USD equivalent terms]. Please note that in case buy cover our position we will not use
SBP end of the day revaluation rates. [Consider you sold a stock for PKR 50. It closes the day at PKR 40. If you do
not cover your short position by the end of the day, you stand to gain a unrealized profit of PKR 10 on the share. BUT
if you covered your position and bought the share at 45, your realized gain is PKR 5 and not 10. Same concept
applies here]. Hence CCY bought against USD will not affect NOP. Only those transactions which have a PKR leg
will affect your NOP. However, if we had made an export payment of 30,000 EUR that would have affected our NOP,
and taken into the blotter. Hence it is not necessary to buy CCY from the interbank to cover your position; banks can
match their imports with exports.

The following table is to reiterate that NOP is the sum of open positions of CCY expressed in USD,

Figure 4:

Equivalent
CCY - Amount in
CCY Beginning Activity -Day1 CCY - Ending USD
USD -300,000 600,000 300,000 300,000
Euro 50,000 -30,000 20,000 24,000
GBP 15,000 0 15,000 27,461
CHF -25,000 0 -25,000 -18,734
-260,000 332,726

The “Activity Day1” column represents the CCY bought/sold during the day. [The difference in NOPs of figure 2 and 4
are due to changes in CCY rates. Such minor variation is reconcilable through adjusting entries].

How much NOP can be left un-squared? As per SBP regulations NOP or Foreign Exchange Exposure Limit [FEEL] is
10% of equity expressed in USD. Hence if NIB has equity of 1.2B and the ongoing Spot rate is 59.75, NIB’s NOP
limit is +/- USD 2.1M

Prepared by: Ayaz Sheikh 2

NIB Treasury
 MANAGING EXCHANGE AND GAP POSITIONS

FORWARD FX RATES

Forward FX rates are determined by the interest rates differential between two CCY. Corporate take forward cover
for their documents to hedge against FX movements and tend to affix rates on forward process at an earlier date.
Suppose we want to quote a 1M forward import rate to a client. Existing Market rates are as follows;

Figure 5:

Bid Offer USD PKR

Spot 59.75 59.80 Today
LIBOR 1M 1.00 1.25 Buy USD at 59.80 1 -59.8
KIBOR 1M 1.50 2.00 Borrow PKR 59.80 at 2.00% 59.8
Invest USD at 1.00% -1
Net Today 0 0

After 1M
PKR equivalent to 59.90
USD equivalent to 1.0008
USD/PKR 1M 59.85

The major assumption here is that LIBOR and KIBOR rates hold [i.e. are tradable]. If a 1M forward rate is to be given
to a customer it will have to be recorded in NOP today. Hence bank will be short of USD, and will need to cover that
position by purchasing USD from market. To fund the purchase of USD, bank will borrow money from the market.
Consequently USD so purchased would be placed for a 1M period so as not to keep them idle and conversely square
its position [see “Net Today” position]. Conversely if an export forward rate is to be given;

Figure 6:

Bid Offer USD PKR

Spot 59.75 59.80 Today
LIBOR 1M 1.00 1.25 Sell USD at 59.75 -1 59.75
KIBOR 1M 1.50 2.00 Lend PKR 59.80 at 1.50% -59.75
Borrow USD at 1.25% 1
Net Today 0 0

After 1M
PKR equivalent to 59.83
USD equivalent to 1.0010
USD/PKR 1M 59.76

[1 + PKR Bid Interest x n/365]

Forward Rate Bid = Spot Bid x
[1 + USD Offer Interest x n/360]

[1 + PKR Offer Interest x n/365]

Forward Rate Offer = Spot Offer x [1 + USD Bid Interest x n/360]

Prepared by: Ayaz Sheikh 3

NIB Treasury
 MANAGING EXCHANGE AND GAP POSITIONS

CURRENCY SWAPS

A currency swap is a simultaneous purchase and sale of a foreign currency amount for two different settlement
dates, a spot delivery date and a forward delivery date. Continuing from our above example, assume we book USD
0.1M import forward for a client today.

Figure 7

TDY 1M
Book FWD Import
NOP -0.10 -
NOSTRO - -0.10
Buy RDY
NOP 0.10 -
NOSTRO 0.10 -
Net Position
NOP - -
NOSTRO 0.10 -0.10

The said amount will be incorporated in our NOP today, but the actual payment is to be made 1M from now. Hence
our NOSTRO account will be hit after a month. In order to square NOP, we will sell USD in spot/ready, where
creating a long position [excess USD] in NOSTRO today and short position in NOSTRO [due to eventual import
payment. One way to cover this position is to place the funds generated in NOSTRO today at rates given by
respective NOSTRO accounts. Since these rates are substantially less than LIBOR rates, another more popular way
is to enter into a CCY swap. The position exemplified by Figure 7, can hence be squared by entering into a Sell/Buy
USD swap. Conducting a swap will not make any impact on NOP as it entails both buying and selling legs [in spot
and forward]

Conversely, if client enter into a forward contract for its export proceeds, USD can be sold in spot to square the NOP,
creating a short position in NOSTRO today and a long position [export proceeds] in NOSTRO in the forward leg.
Hence such a mismatch can be squared by conducting a Buy/Sell swap.

A closer scrutiny of cash flows in Figures 5 and 6 reveals the underlying concept OF SWAPS [B/S and S/B swaps
respectively]. Swaps are usually entered with interbank counterparts and are quoted on the basis of swap point
[which could be positive or negative depending upon interest rate differentials]. Forward Rates and Swap points are
inexplicably related as;

Forward Rate = Spot Rate + Swap Points

Hence the swap points from Figure 5 and 6 are 5 and 1 respectively. A bid for a swap quote shows willingness of
doing a S/B and an offer shows a willingness to do a B/S.

Prepared by: Ayaz Sheikh 4

NIB Treasury
 MANAGING EXCHANGE AND GAP POSITIONS

RUNNING A MISMATCH

Suppose you give a client a 3M forward import rate and expect FX rates to decline, hence it would make sense to
enter into a short dated swap and run a mismatch for the next 2 months as illustrated in Fig 8.

Figure 8

TDY 1M 3M
Book FWD Import
NOP -0.10 - -
NOSTRO - - -0.10
Buy RDY
NOP 0.10 - -
NOSTRO 0.10 - -
Net Position
NOP - - -
NOSTRO 0.10 - -0.10
S/B 1M
NOP - - -
NOSTRO - 0.1 -0.1

After a month once FX rates dip, we can enter into a 2M swap and cover our position completely.

COVERED INTEREST ARBITRAGE

When we enter into a S/B USD swap against PKR, it culminates into borrowing of funds, and B/S swap of USD/PKR
is lending of funds. Since forward premiums in an inefficient market are more driven by demand and supply hence
providing an arbitrage opportunity to borrow/lend from swaps and place/borrow in money markets.

Figure 9
Bid Offer
1M Swap 1.00 3.00
KIBOR 1M 1.50% 2.00%
LIBOR 1M 1.00% 1.25%
Spot 59.75 59.80
B/E 1M Swap 1.14 4.84

Assuming a broker shows you a 1M-swap quote of 1/3, and prevalent market conditions are as shown in Fig 9.
Breakeven Swap points can be determined [by equations shown in Fig 6]. Breakeven Swap points are 1.14/4.84 [i.e.
S/B at 1.14 or less or B/S at 4.84 or more]. If you are to execute the broker’s price you would be required to do a S/B
at 3 and a B/S at 1, hence no arbitrage is available.

Prepared by: Ayaz Sheikh 5

NIB Treasury
 MANAGING EXCHANGE AND GAP POSITIONS

Another way of tackling such a problem is to find out the PKR implied rate.

Swap Points 365

PKR Implied Interest Rate = USD Interest Rate

)
X

(
+
Spot Rate n

S/B B/S
Applicable Rate 3.00 1.00
`Applicable Spot 59.75 59.80
Applicable Libor 1.25% 1.00%
PKR Implied 1.86% 1.20%

PKR implied rate after doing a S/B is 1.86% i.e. borrowing cost of 1.86%, whereas implied rate for doing a B/S is
1.20% i.e. lending at 1.20%. Comparing the two rates with existing MM rates, we borrow funds from swaps at 1.86%
but can place them at 1.50%, whereas lending through swaps can be done at 1.20% and funds can be borrowed at
2.00%. Hence no arbitrage opportunity is possible from either. However, if the bank has a borrowing
requirement, it would be cheaper to use swap option, as it will get funding from the MM at 2.00%.

Prepared by: Ayaz Sheikh 6

NIB Treasury