The company. Business Situation

Transcription

1

2 The company Apollo Manufacturing, a US-based corporation produces automotive parts. Its Mexican subsidiary, Plata S.A, supplies catalytic converters for Volkswagen s new Bug. Business Situation With VW s 1999-plans to increase production of the Bug, Plata is expanding its production facilities. Plata contracted the project with a Mexican construction firm. Under this contract, Plata must make a payment of 50,000,000 new Mexican pesos in March 1999.

3 The Problem: Plata s receivables are in US$. The expansion contract has been included in the budget for a total of US$ 4,655,500 (using the March 99 Mexican pesos futures rate on Dec 11, 98) Plata is concerned that an adverse movement of the MP will increase the US-amount required to meet the March obligation. Plata s Currency Exposure: Plata is short MP 50,000,000 - equivalent to 100 contracts- Plata MP initial position: F

4 Board s Risk Guidelines: Due to major cash outflows expected next year, the Board plans to adhere closely to the budget, establishing strict risk criteria: Each contract typically has a cushion of 10% factored in for cost escalation. The Board decided that at any time there can be no more than a 5% chance of losing more than 20% of the cushion. Total contract: US$ 4,655,500 Cushion: US$ 465,550 Value at Risk Limit: US$ 5 %

5 New Mexican Peso: Contract Information Dec 11, 1998 Exchange: Chicago Mercantile Exchange (CME) Currency Futures Symbol: ZGH9 Size: 500,000 MP per contract Spot Symbol: MXN Dec-98 Mar-99 Jun-99 Sep-99 Settle Price

6 Initial Short Position Short Forward Position Price at Contract Maturity

7 Initial Short Position L or S (Long/Short) F, C, or P (Forward, Call, Put) F Forward/Strike Price Price (C or P), 0.0 (F) - FV Number of Contracts 1 S Calculated Profit of a Short Forward Position Difference ,124, , Strike F ,208, , to update ,294, , ,381, , Price at Maturity ,471, , ,562, , Input futures price ,655, ,748, , ,843, , ,940, , ,039, , ,140, , ,242, ,349.14

8 Initial Position: VAR exceeds limit Price Value at Risk Today 12/11/98 Volatility Daily price s.d Monthly price s.d Exposure (maturity) Dat 3/17/99 # of underlying 500,000 $ underlying -$4,655,500 Fix Risk!!! Exposure (+/-Contracts) -100 Daily Estimates Monthly Estimates T>25 days= 96 # s.d. V@R (e.g. 1.00) 1.65 Risk- (optional) Risk- (optional) Risk- (optional) Futures price metrics Own metrics Own metrics Own Risk Limit -93,110 weight last 75 estimate weight last 150 estimate weight last 150 estimate Standard deviations (e.g. 1% as 1.0) Short price*exp(+#*sd) $ V@R -53,213-53, , , , ,383 Short price*exp(-#*sd) $ profit 52,611 52, , , , ,595

9 Mexico - Currency Outlook. The Mexican Peso is expected to continue to depreciate relative to the forward and present high volatility due to the following forces: The global financial crisis continues to hit hard on Mexico. As of September 1998 the annual depreciation already has reached 27%. The Central Bank has declared its commitment to continue the free float system, particularly in light of the decline in Mexican exports relative to its imports; (e.g oil). Financing from abroad has contracted, and interest rates have risen to maximum levels since the 1995-crisis. There is little room to further contain the peso via higher interest rates. However, speculative flows will trigger significant volatility.

10 Recommended Strategy: + 89 F Net position: -11 F 5%: $ 88,575 Given the high risk-aversion of the Board Guidelines, and the lack of liquidity in the peso options market, option-based strategies are not suitable. We recommend going long 89 futures for a net position of -11 F.

11 Recommended Strategy Price Value at Risk For VAR information, Today 12/11/98 Daily VAR +1 s.d. = COP.C00 Monthly VAR +1 s.d. = For Vol information, Daily price s.d Monthly price s.d Exposure (maturity) Dat 3/17/99 # of underlying 500,000 $ underlying $4,655,500 Exposure (+/-Contracts) -11 Daily Estimates Monthly Estimates T>25 days= 96 # s.d. V@R (e.g. 1.00) 1.65 Risk- (optional) Risk- (optional) Risk- (optional) Futures price metrics Own metrics Own metrics Own Risk Limit -93,110 weight last 75 estimate weight last 150 estimate weight last 150 estimate Standard deviations (e.g. 1% as 1.0) Short price*exp(+#*sd) $ V@R -5,853-5,853-43,435-43,435-88,575-88,575 Short price*exp(-#*sd) $ profit 5,787 5,787 40,039 40,039 75,514 75,514

12 F, C, or P (Forward, Call, Put) F F Forward/Strike Price Price (C or P), 0.0 (F) - FV Number of Contracts Calculated Profit of a Combined -100F+89F Position Strike F9-100F +89F -100F+89F to update Prices at Maturity Input Futures=> Price Combined -100F+89F Position Price at Contract Maturity Profit $58,461 Loss $64,608 Per values in chart. VAR ($88,575)

13 Different Views Presented: 1. Stable, neutral on direction 2. Down, Unsure 3. Down, Less Unsure 4. Limited Down, Concern about big up 5. Same as 4, but fear more volatility

14 Options on Mexican Pesos Quotes as per Dec. 11, 1998 Calls Strike Price Price Quotes Volatility B O B O otm $ $ otm $ $ atm $ $ itm $ $ itm $ $ Puts Strike Price Price Quotes Volatility B O B O itm $ $ itm $ $ atm $ $ otm $ $ otm $ $

15 View One: Stable - Neutral on direction. Plata feels the peso: -will not depreciate more than 4.0% -will not appreciate more than 2.0% Strategy: Short Strangle -F -Pitm -Potm Position equals a -Cotm -Potm. Therefore, Plata chose otm options with strike prices closest to this view. This short strangle allows for a 4.4% depreciation and a 2.3% appreciation.

16 L or S (Long/Short) S S S F, C, or P F P P Forward/Strike Price Price (C or P), 0.0 (F) - FV Number of Contracts Calculated Profit of a Combined -100F-100P-100P Position Strike F9-100F -100P -100P F-100P-100P to update Prices at Maturity Input Futures=> Price *, (peso per contract) Max Profit: $170,500 =.3410 * 500,000 (pesos per contract) Max Loss: $250,450 = * 500,000 (pesos per contract) (Within 1.65 Standard Deviations) Combined -100F-100P-100P Position Price at Contract Maturity -100F -100P -100P -100F-100P-100P

17 View Two: Down Unsure Strategy: Synthetic Long Put -F + Catm Position equals +Patm

18 L or S (Long/Short) S L F, C, or P (Forward, Call, Put) F C Forward/Strike Price Price (C or P), 0.0 (F) - FV Number of Contracts Calculated Profit of a Combined -100F+100C Position Strike F9-100F +100C 100F+100C to update Prices at Maturity Input Futures=> Price Combined -100F+100C Position Price at Contract Maturity Max Proft: $361,460 Max Loss: $170,000 (Within 1.65 Standard Deviations)

19 View Three: Down Less unsure than with an Catm (previous view) Strategy: Synthetic Long Put -F + Cotm Position resembles +Pitm

20 L or S (Long/Short) S L F, C, or P (Forward, Call, Put) F C Forward/Strike Price Price (C or P), 0.0 (F) - FV Number of Contracts Calculated Profit of a Combined -100F+100C Position Strike F9-100F +100C -100F+100C to update Prices at Maturity Input Futures=> Price Combined -100F+100C Position Price at Contract Maturity Max Profit: $456,460 Max Loss: $274,500 (Within 1.65 Standard Deviations)

21 View Four: Limited Down Concern about big up. Less fear about volatility. Willing to extend Potm strike price to Strategy: Synthetic Bear Spread -F + Cotm - Potm Position resembles +Pitm -Potm Plata believes the peso -will not depreciate more than 4.0% and -could appreciate more than than 6%. But this scenario is not very likely and therefore Plata is unwilling to pay more to receive additional protection, as seen with view five.

22 L or S (Long/Short) S L S F, C, or P F C P Forward/Strike Price Price (C or P), 0.0 (F) - FV Number of Contracts Calculated Profit of a Combined -100F+100C-100P Position Strike F9-100F +100C -100P 0F+100C-100P to update (0.1500) (0.2928) (0.1500) (0.1245) Prices at (0.1500) Maturity (0.1500) (0.1500) Input (0.1500) Futures=> (0.1500) Price (0.1852) (0.1500) (0.1752) (0.3751) (0.1500) (0.3651) (0.5688) (0.3890) (0.7664) (0.3890) (0.9680) (0.3890) (1.1736) (0.3890) (0.5000) (1.0000) (1.5000) Combined -100F+100C-100P Position Price at Contract Maturity -100F +100C -100P -100F+100C-100P Max Profit: $310,500 Max Loss: $194,500 (Within 1.65 Standard Deviations)

23 View Five: Limited Down Concern about big up. Fear that greater appreciation volatility is likely. Strategy: Synthetic Bear Spread -F + Cotm - Potm Positions resembles +Pitm -Potm Plata is willing to pay greater premium to have a.0909 strike price. Of the five option-based strategies, this Synthetic Bear Spread has the lowest possible loss within 1.65 standard deviations.

24 L or S (Long/Short) S L S F, C, or P F C P Forward/Strike Price Price (C or P), 0.0 (F) - FV Number of Contracts Calculated Profit of a Combined -100F+100C-100P Position Strike F9-100F +100C -100P 00F+100C-100P to update Prices at Maturity Input Futures=> Price Combined -100F+100C-100P Position Price at Contract Maturity -100F +100C -100P -100F+100C-100P Max Profit: $150,500 Max Loss: $159,500 (Within 1.65 Standard Deviations)

25 Comparison between fractional futures hedge (page 12) and synthetic bear spread (option five, page 24) Series1 Series2 Fractional Futures Hedge Syn. Bear Spread

26 Within 1.65 standard deviations: The fractional futures hedge has a maximum loss of ($64,608) and the synthetic bear spread has a maximum loss of ($159,500). These values are net of any premiums paid and/ or received. Given a VAR limit of ($88,575), Plata should implement the fractional futures hedge strategy.