Finance Portfolio Management

This article discusses the change in currency exchange rate regime by the Swiss National Bank and its impact on the financial market. It also provides insights into hedging strategies for currency trading, including unhedged, forward, money market, and option hedge. The best hedging option for the unhedged trading strategy is also discussed. The article is relevant for finance students and professionals.

Running head: FINANCE PORTFOLIO MANAGEMENT
Finance Portfolio Management
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Table of Contents
In Response to Question 1..........................................................................................................2
In Response to Question 2..........................................................................................................4
Reference....................................................................................................................................6

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In Response to Question 1
The predictable and the slow decisions are the main decisions of the central banking in
today’s world. The Swiss National Bank announcement of the change of the currency
exchange rate scheme from the fixed exchange rate regime to floating rate regime has put the
whole of the capital and financial market into a panic (Bhagat and Farrell 2018). The
introduction of the fixed exchange rate regime was announced by the Swiss National Bank in
the year 2011, when the entire economy was trying to fight through a global financial turmoil
in the financial markets (Oloyede and Otapo 2018). This hard times had made investors belief
on buying and investing in the Swiss Franc Currency or either the American Treasury Bonds,
they acted as a safe haven for investor in hard times. The Swiss Government was a
considered to be a safe pair of hands for investment because it use to run a balanced budget.
The reliance and the reliability for the Swiss franc value was extensively high because of
overvaluation done by the investors. The Swiss currency has almost become to expensive for
all over the country and world to trade with. Switzerland economy’s major production of
goods and services are almost exported to the rest of the world. Almost 70% of the
Switzerland production of goods and services was almost exported and this account for
almost 72% of their GDP (TSAI and TSAI). The falling export and the overvaluation of the
Swiss franc in the terms of rising reserves with the Swiss government and the falling export
could again bring another turmoil for the financial markets. Thus it was the Swiss National
Bank who step out and took several measures like the selling of the new francs and buying
the Euro dollars in order to bring down the overvaluation. The increased supplying if the
franc currency had made the value of the franc to fall and ensure that one euro is actually
equivalent to 1.2 francs. There were an total of 3 factors/shocks that were the main factors
behind the change of exchange rate regime they were independent component for the demand
of money, decrease in the interest rate of the ECB, increased expectation for too much

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increase of the value of currency (Kotarski and Tkalec 2018). The overvaluation was leading
huge piled of reserves in the balance sheet of the central bank. These were the steps which
lead the Swiss National Bank to change the exchange rate regime. Interestingly, the Swiss
National Bank has not decreased the interest rate factor into the negative range regime and at
the period where the peg was in the place. Hence, the Swiss National Bank did not do
“whatsoever it takes” to protect the peg.
The evaluation of correct strategies and proper hedging strategies is to be used for
prevention of unwanted losses and volatile returns from the currency. The Swiss Exporters
needs to enter into currency strategies like pay floating and receive fixed strategy. The
strategy will be made on the basis of paying floating currency returns of the Swiss Franc and
receiving fixed leg of return that is real or Risk free rate of return (Šuterová and Suterova).
The strategy would ensure that the negative returns of the Swiss currency or Swiss franc
would be paid to the counterpart and a fixed amount of the risk free return would be achieved
by the above swap option strategy. The exporters or the domestic firms of the economy is
afraid of the extreme volatility in the currency market (Nadžaković and Hromić). If the Swiss
franc becomes more strong then the exporter who have sold goods and are yet to receive
payments will go for an option trading strategy where the exporter will want the home or the
base currency receivable to fall i.e., rise in terms of price and degrade in terms of the other
currency. The same exporter will go for a trading strategy for hedging where extreme fall in
the price of the home or the base currency will be controlled by using the pay floating and
receive fixed strategy. In this case the domestic exporter will receive floating currency of the
amount receivable and pay the same (Deaton 2018). The trading strategy will ensure that the
floating currency is cancelled on both side of the deal and the dealer gets hedged with the
changes in the currency price movements and he is left with the fixed rate of return in this
case. There are certain other intraday short term strategies that too could be used by the

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traders like the cross rates, triangular arbitrage, and carry out arbitrage strategies for extreme
volatility in the currency markets (Koźmiński 2017).
In Response to Question 2
a)
i) Unhedged Strategy: The risk exposed with the unhedged trading strategy would
be that the ABC company will receive the total inflow of the amount at the that
time currency rate which if calculated by todays base currency price and the
annual interest rate gives us the forward rate of around $1.13775. So under this
trading strategy the company will receive around 56.8875 million amount of Euro
in this case. The calculation of the forward rate will be 1.10*(1.055/1.02) =
$1.13775. That is 50million dollars multiplied by 1.13775 Euro Dollars (Kaiser et
al. 2017).
ii) Forward Strategy: The forward hedge trading strategy could be applied by the
company under which the company can go for the trade and enter into a forward
contract to buy a euro for $1.13. Under the strategy the company may be exposed
or at loss if the US dollar become extremely strong. The dollar amount receivable
under the trade would around the forward rate of 50million Euro Dollars*1.13 US
dollars which is equal to 56.50 US dollars under the trading strategy.
iii) Money Market Hedge: The hedging strategy would be used by investing or
buying the current value of the euro currency or the foreign currency at the spot
rate that is 1.10 Euro dollars and placing the same amount of euro currency and
receiving the Euro interest rate on the same. The amount of Euro dollar purchase
ABC company has to make is around 50/1.10= 45.45 amount of dollars and

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receive the Euro interest rate on the same that is 2%. So at the end of the year the
amount would be around 45.45*1.02= 46.359 Euro dollars and then converting
the Euro dollars to the US dollars at the forward rate that is $1.13 which is equal
to $52.3857. The ABC company then needs to deduct the interest rate on the
borrowing of the US dollar that is the 45.45 amount of US dollar * US interest
rate that is 5.5% which is equal to 2.50 US dollars. So the company finally
receives $52.3857-$2.50 which is equal to $49.88570.
iv) Option Hedge: The option strategy could be used by purchasing or buying a put
option or selling a call option the Euro dollars if the euro falls that is if dollar
becomes strong it would hurt the ABC company in terms of foreign exchange
receivables the same loss will be covered by buying the put option in this strategy
whereas selling a call option can be of a risky strategy and not a proper hedging
strategy in this case. The company can buy the put option at a cost of $0.06per
unit.
b) The best hedging option for the unhedged trading strategy as the forward rate of $1.13
is an underestimate of what the price should be that of around $1.13775 which was
calculated on the base of he calculation of the forward rate will be 1.10*(1.055/1.02)
= $1.13775. That is 50million dollars multiplied by 1.13775 Euro Dollars that is the
company can receive around $56.8875 (Gourinchas and Rabanal 2017).

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Reference
Bhagat, K. and Farrell, D., 2018. FX Markets Move on Surprise News Institutional Investor
Trading Behavior Around Brexit, the US Election, and the Swiss Franc Floor. JP Morgan
Chase Institute.
Deaton, B., 2018. Effects of the Swiss Franc/Euro Exchange Rate Floor on the Calibration of
Probability Forecasts. Forecasting, 1(1), pp.3-25.
Gourinchas, P.O. and Rabanal, P., 2017. Exchange Rates and External Adjustment.
Kaiser, B., Siegenthaler, M., Spescha, A. and Wörter, M., 2017. The Impact of Real
Exchange Rates on Swiss Firms: Innovation, Investment, Productivity and Business
Demography: Study on behalf of the State Secretariat for Economic Affairs SECO (Vol. 56,
No. 6). ETH Zurich.
Kotarski, K. and Tkalec, M., 2018. Monetary Policy in a Highly Euroized Economy.
In Policy-Making at the European Periphery (pp. 147-168). Palgrave Macmillan, Cham.
Koźmiński, K., 2017. Bank loans denominated and indexed to foreign currency‒a Polish,
Ukrainian or Europe-Wide problem?. Studia Iuridica, 71, pp.117-135.
Nadžaković, E. and Hromić, B., MONETARY POLICY OF THE SWISS NATIONAL
BANK, EXCHANGE RATE OF THE SWISS FRANC AND THEIR IMPACT ON
CITIZENS OF BOSNIA AND HERZEGOVINA.
Oloyede, J.A. and Otapo, T.W., 2018. Test Of Exchange Market Efficiency In
Nigeria. Advances in Social Sciences Research Journal, 5(7).
Šuterová-Reply_1, M. and Suterova-Reply_2, M., Did the exchange rate interventions
enhance inflation in Switzerland?. Assessment, 32(E31), p.E52.

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TSAI, P.C. and TSAI, C.M., Estimating the Proportion of Informed and Speculative Traders
in Financial Markets: Evidence from CHF/EUR Exchange Rate.