Challenges in currency derivatives management in the OTC market in Poland during the Covid-19 pandemic

Purpose: The aim of the chapter is to analyze the impact of the Covid-19 pandemic and market volatility increase on risk management in the OTC derivatives market in Poland. Design/methodology/approach: The chapter describes the legal background of derivatives trading with non-financial enterprises, then identifies the main risks, and discusses possible actions of market participants. In this regard, the study conducts volatility analysis based on selected market data. Findings: Due to volatility increase and the resulting negative valuation of non-matured currency derivatives by Polish exporters, margin call clauses were triggered, entailing the need to post additional collateral or prematurely close contracts. The described situation is particularly difficult when the pre-settlement limit is fully utilized on deal date, usually in the case of long-lasting large open exposures in non-flexible transactions. Research implications: To determine market risk, studies often apply the VaR approach. Inthis way, the specific amount of risk is analyzed on adaily basis and used by banks both to determine the maximum amount of the contract and to control pre-settlement risk. Apart from many advantages of the VaR approach, there are some drawbacks, especially related to volatility estimation, which usually relies on historical market fluctuations. It may cause that the risk will not be properly valued under crisis conditions. In such situations, supplementary methods should be also implemented (stresstests). Practical implications: Under high market volatility, preventive actions should be prepared in advance, including treasury limit increase, additional funds for collaterals, or contracts modification (flexible products should be considered).Originality and value: The study covers a challenge that banks face, which is rarely described in professional literature but very serious for bank management. Under normal market conditions, if the margin call clause appears and no additional collateral is posted, the transaction should be closed to limit the counterparty’s loss. However, this type of action during the pandemic may impose the risk of force majeure. From the company perspective, using such instruments threatens their early settlement and the need to finance closeout amount.

Currency Derivatives

In this chapter we develop a theory for derivatives based on the exchange rate between two (or more) currencies. This is initially done using classical delta hedging methods, but the main part of the theory is developed using martingale methods. We discuss the foreign and the domestic martingale measures and the relations between these measures, and in particular we show that the likelihood ratio between the measures equals the ratio between the foreign and the domestic stochastic discount factors. Option pricing formulas are also derived, and we discuss the Siegel paradox.

Economic exposure to exchange rate risk and financial hedging

Purpose The purpose of this paper is to examine the potential non-linear relationship between family ownership as a governance mechanism and exchange rate exposure of firms that use financial hedging. Design/methodology/approach The exchange rate exposure is estimated using two-factor Jorion (1990) model for a sample of 312 Indian firms over the period from 2001 to 2016. The cross-sectional regression model is used at the second stage to investigate the effects of family ownership on exposure for the firms that use currency derivatives. Findings The results suggest a significant non-linear cubic relationship between family ownership and exchange rate exposure. Exchange rate exposure increases with family ownership at low and high levels (as a result of improper hedging) and decreases with family ownership at intermediate levels (as a consequence of value-enhancing hedging). Practical implications The study has practical significance for firms to understand the circumstances in which currency derivatives usage is ineffective in alleviating exposure. Firms that have high or low family ownership should integrate operational hedges with financial hedges and should incorporate other firm-level governance mechanisms to avoid the misuse of derivatives. Originality/value This study provides new evidence that the relationship between family ownership and exchange rate exposure is non-linear for firms that use financial hedging which has not been investigated before in the prior literature.

An Analysis of Foreign Exchange Risk Management: Techniques Employed in Indian Pharma Industry

Foreign exchange risk management (FERM) involves using both internal and external techniques such as forwards, futures, options, and swaps that are called as currency derivatives. The firms with greater growth opportunities and tighter financial constraints are more inclined to use currency derivatives. The Forex market provides various derivative instruments to hedge against currency exposures such as currency forwards, options, futures, and swaps. The current article aims at studying various FERM techniques used in the Indian pharmaceutical industry and its impact on exchange gain/losses. For this purpose, foreign exchange cash flows arising out of imports and exports and exchange gain/losses of the companies during 2010–2017 of 10 sample companies chosen from the pharma industry are used. It is observed from the study that only two currencies—USD and EUR—hold command in the forex market and other currencies are being used minimally. It is also noted that there are several currency derivatives available to the business firms such as forwards, futures, options, and swaps for hedging currency exposure. However, among all these techniques, forward contract is considered to be an effective hedging tool and easier to understand.

Exchange rate fluctuations and firm value: impact of global financial crisis

Purpose The purpose of this paper is to examine the presence of exchange rate exposure and its relationship with currency derivatives usage in the dynamic environment of the global financial crisis of 2008. Design/methodology/approach Using a sample of 624 Indian firms over the period of April 2001–March 2016, this paper investigates the linear and asymmetric exposure by dividing the full sample period into different sub-periods around the crisis. Findings The evidence presented in the paper suggests that the firms are more exposed to the exchange rate changes since the onset of the financial crisis. However, there is a lack of evidence that the usage of currency derivatives is more effective in reducing exposure during the crisis/post-crisis period as opposed to the pre-crisis period. Practical implications The findings are important to investors and managers for a better understanding of firm behaviours in relation to their risk management policies during the period of external shocks like crisis. Originality/value There is a paucity of research to explore whether the effect of currency derivatives usage on exchange rate exposure varies during external shocks such as crisis periods. The paper provides novel evidence that the effectiveness of derivatives usage in alleviating exposure becomes less during the dynamic environment of crisis.