Treasury and Risk Management

This study material covers the topics of treasury and risk management. It discusses HSBC's Chinese depository receipts (CDRs) and its share listing on the exchange. It also explains the process of conducting a share trade between HSBC shares listed on the HKSE and those listed on the LSE. Additionally, it explores the concept of spot exchange rates and their impact on profitable trades. The material also includes a case study on a British export firm's futures hedge mechanism and its net receipt in the local currency. Overall, this material provides insights into the world of treasury and risk management.

Treasury and Risk
Management
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Question 1
Introduction
In the recent scenario, China has apprehended the world’s attention, depriving the forthcoming
stock connect arrangement in between Shanghai and London of the consideration it deserves.
This connection was established in October 2015 which would allow investors to trade shares on
each other’s share market. HSBC was the first foreign company to trade on a Chinese market
under plans by a new stock market link between Shanghai and London. This will be beneficial
for both the stock exchange and also for investors.
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a. Differentiate between HSBC’s CDRs and its intended share listing on the exchange.
HSBC’s Chinese depository Receipts is the receipts which are issued by the depository bank
which are entitled by the HSBC bank for the Chinese investors’. By the help of this, the cited
company could raise funding form the Chinese market by way of Depository Receipts (Huang,
2018). These depository Receipts are different from the other form of securities. As this
represents certificate which renders investors an opportunity to hold securities in equity form of
the foreign companies. HSBC becomes the first company which issued CDRs for the Chinese
investors (Meyer, 2018).
Generally this mechanism has created two securities: the receipt (shareholders which hold them)
and the actual foreign share (held by the depositary bank) (Alford and Lau, 2015). For example,
UK Company M&S wanted to list on the Shanghai Stock Exchange through Depositary
Receipts; this is how the whole process would work:
 M&S delivers its shares to custodian bank in the UK.
 Issuer then appoints depositary bank in target market which custodian will hand over the
shares to.
 The depository bank should be bank in Mainland China.
 The Depositary Bank then receives shares from foreign issuer and holds them.
 Then bank in china makes CDRs whose value is set by the shares of the foreign company
which it holds.
 Each CDR will be worth of “number of shares”
 CDRs Price would be issued in Chinese renminbi which converted from the equivalent
UK price of shares.
 CDRs now represent UK local shares which are held by the depositary.
 CDRs now offered to investors in the local market and these shares are traded freely and
issued on the Shanghai Stock Exchange (Lu and Ye, 2018).
b. Conduct a share trade between HSBC shares listed on the HKSE and those listed on the
LSE. Assume the transaction was for 100,000 shares purchased at the closing price on the
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HKSE on 16 November 2018 and all shares were sold at the opening price on the LSE on
17 December 2018. At what range of spot exchange rates would make the trade profitable?
You are provided with the following information:
16 November 2018 - HKD/GBP spot rate Bid 0.09950 and offer 0.09980
17 December 2018 - HKD/GBP spot rate Bid 0.10140 and offer 0.10170
HK dollar borrowing rate = HIBOR (1 month) 2.30 percent pa + 30 basis points
Spot exchange rate
The spot exchange rate is the amount one currency will trade for another today. In other words, it
is the rate at which the currencies can be exchanged immediately (Moosa, 2016).
100,000 shares purchased on 16th Nov. 2018 @ 66.200 HKD each
On the other hand, these shares were purchased by taking a loan from Hong Kong Bank @
HIBOR 2.30 + 0.30 basis point. Henceforth, the borrowing rate for 2.30/12 + 0.30 = 0.49%
So, the investor will pay loan on 17th December 2018 = 100,000*66.200 = 66, 20,000 + 049% =
66, 52,438 HKD
However, he will sell his shares on 17th December 2018 @ 64.900 HKD = 100,000*64.900
= 64, 90,000
So, the ultimately will have to occur loss = 64, 90,000 - 66, 52,438
= -162,438 HKD.
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Conclusion
This concluded that there should be a trade arrangement between the countries for their growth
and economic development. Depository receipts also affect positively on the national income of
the country because these receipts are part of it. The link in between Shanghai and London stock
exchange promotes a fair trade for investors.
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References
Alford, A.W. and Lau, A.W., 2015. A foreign investor's guide to accessing the Chinese equity
market. Journal of Portfolio Management, 41(5), p.31.
Huang, C., 2018, December. Research on Investor Protection System of Chinese Depositary
Receipts. In 2018 2nd International Conference on Economic Development and Education
Management (ICEDEM 2018). Atlantis Press.
Lu, L. and Ye, N., 2018. Chinese Depositary Receipts: What they are, How They Work and why
this represents a Golden Opportunity.
Meyer, D.R., 2018. Hong Kong, Shanghai, and Beijing. International Financial Centers after the
Global Financial Crisis and Brexit, p.126.
Moosa, I., 2016. Exchange rate forecasting: techniques and applications. Springer.
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Question 2
a. Calculate the bank dealer’s net profit/loss after executing all her trades. Ignore margin
considerations and other transaction costs (apart from the bid-offer spread).
The bank dealer’s net profit/loss after executing all her trades is listed below:
Trade cycle Trades Sell/Purchase
T = 0 1.2750*5*100,000 637,500 (sell)
T = 1 1.2500*8*100,000 1000,000 (purchase)
T = 2 1.2630*4*100,000 505,200 (sell)
T = 3 1.2480*6*100,000 748,800 (purchase)
T = 4 1.2620*5*100,000 631,000 (sell)
Sell = 637,500+ 505,200+ 631,000 = 17, 73,700
Purchase = 10, 00,000+ 748,800 = 17, 48,800
Profit = 17, 73,700 – 17, 48,800
= 24,900
b. In mid-June 2018, a British export firm contracted to receive USD 1 million at T=4 from
its United States customer. At that time, the company obtained this information from its
banker:
Spot rate : GBP1 = USD 1.3330
GBP/USD futures contract size : GBP 62,500
GBP/USD futures for delivery on 19 December 2018 : GBP1 = USD 1.3450
Explain the futures hedge mechanism for the firm and compute the company’s nett receipt
(in its local currency) on 19 December 2018. Explain if this hedge was effective.
Net receipt = 62,500* 1.3450
= 840,625
British export company receives 840,625 in terms of USD.
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Hedging minimizes or eliminates the risk by adopting certain protective strategies. There are
various techniques which help the investor in minimization or elimination of risk in the
derivatives market.
Following are different strategies using derivatives:
 Short Hedge
 Long Hedge
Hedge was effective to British exporter because it protects the exporter from any fluctuation in
the currency market. The exporter uses various strategies to protect them from risk. In hedging,
the hedger main aim is to hedge the risk of his earlier obligation or position in the foreign
currency.
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